Good day. Welcome to the Unum Group conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tom White, Senior Vice President, Investor Relations. Please go ahead, sir.
Great. Thank you, Marguerite. Good morning, everyone. Welcome to this conference call to discuss the results of Unum's long-term care reserve analysis. We appreciate you joining us on short notice this morning. 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 from our forward-looking statements appears in the presentation entitled Long-Term Care Reserve Analysis that we will refer to today and in our filings with the Securities and Exchange Commission and are also located in the section 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 Form 10-Qs.
Today's presentation and our SEC filings can be found in the Investors section of our website at unum.com. I remind you that the 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. During this presentation, we will make reference to certain non-GAAP financial measures. A presentation of the most directly comparable GAAP measures and reconciliations of the non-GAAP financial measures included in today's presentation can be found in the appendix to the presentation and is available on our website, also in the Investor section. Participating in this morning's conference call are Unum's President and CEO, Rick McKenney, CFO, Jack McGarry, and Steve Zabel, President of the Closed Block. Now I'll turn the call over to Rick for his opening comments.
Thanks, Tom. Good morning, everyone. Today's call is to update you on the work we're doing and have historically done to actively manage our long-term care business. As we go through today's presentation, I want you to keep these points in mind. First, that our strong core business allows us to effectively manage the LTC block. I'll speak more to that in a moment. Secondly, that we have substantially completed a comprehensive review process which takes into account all of our experience to date. That gives us confidence that we're taking the correct action to increase our long-term care GAAP reserves in the third quarter by $590 million after tax. We have used a number of third parties to assist our internal team of experts in this review. Jack and Steve will take you through the details of that.
Third, because of our strong cash flow generation capability and the finalization of these results, we are on a path to resume share buybacks in the fourth quarter as planned. Having substantially completed the analysis, and though we have not yet completed the quarter, we wanted to provide this information to our shareholders as soon as it was available, particularly in light of the questions about this line of business across the industry. Given this industry focus, our recent discussions with shareholders often center on long-term care, but I would like to point out that LTC represents less than a quarter of our company's total GAAP equity, excluding AOCI.
While LTC is the topic of today's call, it's important to also understand that over the past decade, our core businesses have seen healthy growth in every key metric, have generated significant cash flow, and as a result, provides us ongoing financial flexibility. To illustrate that point, over the last 10 years, sales have grown by over 50% while maintaining strong margins on those new premiums. Additionally, net income per share on a GAAP basis has risen significantly, with after-tax adjusted operating earnings per share up over 70% over the same time period. As a result, adjusted operating return on equity in these core segments has been strong in a range of 14%-16%. Over the same time frame, in some pretty difficult markets, we have grown book value per share at an annual rate of over 10%.
Because of these great businesses, our franchise has consistently generated excess capital. Much of it, $5.5 billion, has been returned to shareholders over the past 10 years. This has been through dividends, which have increased for each of these years, and a steady share repurchase program. All of this was accomplished while maintaining capital levels and leverage ratios well within our targeted ranges. Our core businesses have delivered these results because of our disciplined execution of a simple strategy, a singular focus on the employee benefits market, taking care of our customers in times of need, and consistently executing on our plans. The same skills that allow our core franchise to be so successful are also beneficial to actively managing our closed block of long-term care policies. We have been doing this for over the last decade, beginning with our closure of the individual long-term care business in 2009.
Since then, our teams have implemented rate increases, made prudent cash contributions, taken risk management actions, such as our landing spot option, and updated liability assumptions to reflect emerging experience. Between rate increases and reserve changes since 2006, we will have strengthened our reserves by $4.9 billion in the block. Today's update is another step in our management of the block in providing clear communications to our shareholders. Jack and Steve will take you through the attributes of our block and our actions to bring our assumptions current based on our own experience and industry data. The data analysis the team will share today is specific to our unique block, and I would caution against applying our assumptions on LTC to others. We have seen that in reverse, and it can lead to inaccurate views.
For our block, we believe this action reflects our current LTC assumptions that not only indicate where the block is today, but our best estimate of where we'll be in the future. Now I'll turn it over to Jack. Jack?
Thank you, Rick. Good morning, everyone. As Rick noted, we've accelerated the work on our long-term care annual reserve analysis. We've now substantially completed the work and are here to discuss the impact on both our GAAP and statutory reserves and the related implications to our capital deployment plans. Based on our analysis, we will increase our GAAP reserves by $590 million on an after-tax basis. This amount, and other financial impacts discussed on the call, are subject to the final close procedures for the third quarter and may change when we close the quarter in amounts we believe to be immaterial. This increase is well within the guidance that we discussed during our second quarter earnings call and reflects impacts on both our active life and disabled life reserves.
In addition, the impact on our statutory reserves across all of our legal entities will be approximately $200 million pre-tax. The majority of this amount reflects our new assumptions being incorporated into our best estimate claim reserve for those people already on claims. With the conclusion of this work, we intend to resume our share repurchase program of 100 million shares per quarter, beginning in the fourth quarter of 2018 and continuing into 2019. As we indicated in our second quarter earnings release, we have not executed on share repurchases in the third quarter due to our reserve analysis. We remain inclined to increase repurchases in late 2018 or early 2019 above the $100 million to compensate for not buying back shares in the third quarter of 2018.
Turning to the analysis, this review included a look at all of our reserve assumptions, including morbidity, mortality, lapsation, interest rates, and the impact of premium increase strategies. We've utilized a combination of our own experience, incorporating both long-term and more recent trends, as well as industry information to supplement our own data. In addition to the expertise of our internal actuarial teams, we have validated our assumptions by working with two third-party actuarial consulting firms. We have also validated the integrity of our projection reserve models and our experience data through the company's internal audit function. Finally, as Rick said, we have very strong core businesses that continue to profitably grow and generate significant statutory earnings annually.
Now Steve will set the foundation of the results of our reserve analysis by giving an overview of our block of long-term care business before I discuss the specifics of our assumptions.
Great. Thanks, Jack. I will begin with a quick review of the demographics of our LTC business, highlighting certain aspects that affect the risk profile of our block. Touching briefly on the reserve levels for our long-term care block, I would remind you that as of June 30, 2018, our total statutory reserves were $11.7 billion, and total GAAP reserves were $10.5 billion, resulting in a $1.2 billion differential. Following the reserve changes discussed today, we expect the difference between statutory and GAAP reserves to remain above $600 million as of September 30, 2018. As we have discussed in the past, the difference between our statutory and GAAP reserves will increase over time, given the different rates of growth for each of these reserves.
Specifically, our statutory reserves are growing at a faster rate than our GAAP reserves due to both differences in the underlying methodology for those bases as well as different assumption sets. Before discussing reserves, it is important to understand the composition of our block because it is unique in the industry. Our LTC business is composed of both policies sold to individuals by independent agents, as well as policies sold to employees in the workplace as a complement to our other group coverages. Of the 962,000 lives covered, 816,000, or 85%, relate to employer group plans. This is important given the relatively lower levels of coverages sold at the worksite versus those sold to individuals. As an example, only 5% of our group-covered lives have lifetime benefits, and 74% do not have any level of benefit inflation in their policies.
These lower levels of coverage lead to lower morbidity risk for this segment of the block. In addition, the younger attained ages for group policies give more time for premium rate increases to mitigate the impact of the ultimate claims experience of the block. Drilling down one more level, we thought it informative to present our group business broken down between those lives that have employer-paid coverages and lives that are employee-paid on a voluntary basis. Of the 962,000 total insureds covered, both individual and group, 502,000 are in the employer-funded category. This subsegment has an even lower risk profile than the aggregate group business discussed on the previous slide. For employer-paid coverages, 90% of insureds do not have any type of benefit inflation, only 1% have lifetime benefits, and the average daily benefit is only $77.
In addition, most of the employees lapse their coverage when they leave their employers. These higher lapse rates and modest plan designs create a very different risk profile than either traditional blocks of individual policies or group policies more prevalent in the market. Now that we've provided some detailed information regarding the demographics of the block, Jack will discuss the work performed related to our reserve analysis.
Thanks, Steve. The process we've undertaken to analyze and update our reserve assumptions is consistent with our past practices and reflects our active management of this block. We are updating our reserve assumptions to reflect the evolving claims experience and trends affecting the block. Our long-term care block is relatively young, and therefore, we want our assumptions to keep pace with emerging experience. We've described our process in the materials, but I would highlight several important points. First, we look at our own experience to determine whether we have enough data to form an opinion in certain of the granular data cells with a bias towards using our own experience. If not, we look for industry data as a supplement and incorporate it as appropriate. In our case, we've leveraged industry data to help us determine our assumptions for mortality in older-aged policyholders.
We have taken into account experience over the long term, as well as recent trends that may be emerging, including the first half of 2018 when determining our future assumptions. Second, we retained a global third-party actuarial firm to provide guidance on our assumption selections and benchmark those selections against other blocks of business. Our internal audit function also provides validation that the detailed assumptions are mechanically accurate in our reserve calculation software and that our actual-to-expected analysis tools are accurate. We've retained a second third-party actuarial firm to assist in that validation. Third, we used our new proposed reserve assumptions to restate or back cast our historical financial results using what the new reserve would have expected in past periods and comparing it to our actual experience in those same periods.
That process is used to confirm the fit of our proposed assumptions and allows us to iterate and refine along the way until we settle on a set of assumptions that adequately fit our past experience. We provided this analysis in the following slides for applicable assumptions. Moving on to the results of the review, we've provided a breakdown of the drivers for our GAAP after-tax charge of $590 million. This attribution reflects a pre-tax charge of $750 million, assuming an effective GAAP tax rate of 21%. To start, we began this year's analysis with a level of reserve margin that was impacted by our ability to invest new money at yields exceeding our 2014 assumption of 5%. That margin totaled approximately $400 million as of June 30th, 2018.
As we will discuss later, we've reset our new money yield assumption to be 5.5% for the next three years and grade to 6.25% over the following four years. Recall that our 2014 assumption included a grading to an ultimate rate of 6.75%. This change of interest rate path results in a $500 million reduction in our margin. The collective impact of our new morbidity, mortality, and lapse assumptions resulted in a reserve strengthening of just over $2 billion. The drivers of this change relate primarily to our view on claims incidence and claim termination rates in our block of business. We will address each assumption individually in the upcoming slides. In conjunction with updating our reserve assumptions, we anticipate filing new premium rate increase requests with state regulators while we continue to pursue approvals on our already filed requests.
Of the estimated $1.4 billion of rate increase margin in our new assumption set, $700 million relates to outstanding requests from previous filings. Of the $700 million related to new filings, the majority relates to our group policies where we have not historically increased prices to the degree we have on individual policies. Although we continue to feel positive about the regulatory environment, filings on our group business should help to avoid any potential regulatory fatigue over late filing requests. Transitioning to the actual assumptions, our first assumption relates to active policy terminations. After careful consideration, we have decided to base our active life mortality assumption on an industry table, the 2012 Individual Annuity Reserving Table. We made adjustments to the industry table to better align with our experience in earlier policy durations where we have credible data.
In later durations where our data is not as robust, we're relying on the industry table to complete our assumption set. We've lowered our lapse assumptions, including a 25 basis point ultimate individual lapse rate. When we compare our assumptions for total policy terminations to a 2015 Society of Actuaries study, our assumed termination rate is lower as shown in the graph. We feel this selection fits our experience well. To finish off the discussion on active policy terminations, we have provided a one standard deviation sensitivity, which results in a favorable and unfavorable impact to margins of a little more than $300 million. Note that we use annual standard deviations to measure these sensitivities. These sensitivities assume the favorable and unfavorable deviations are applied throughout the entire life of the block.
Moving on to incidence, we've evaluated our collective experience in multiple dimensions and developed assumptions that we believe take into account our most recent experience. As shown in the graph, our new reserve assumption would have funded our actual incurred claims in most months going back to the beginning of 2015. It's important to note the level of volatility we've experienced historically in the fact that this new assumption would still not have funded certain deviations to the norm on a monthly basis, like we experienced in February of 2018. We believe that over the long term, our reserves will adequately reflect expected new claim expenses, including 2018 experience. The one standard deviation sensitivity for claims incidents results in impacts to margins of just under $300 million.
Moving on to claim terminations, this assumption represents the rate at which claims terminate based on duration, type of claim, and other factors. As grounding, the majority of claim terminations are driven by mortality of claimants, with the remainder resulting from claimants recovering from their disability or claimants exhausting their policy benefits while on claims. As shown in the graph, our assumption accommodates the vast majority of our historical experience. As with many of the experience graphs shown, an increasing aggregate rate of incidents or terminations is not necessarily reflected of an improving or worsening trend. It's merely the aging of the block resulting in expected higher aggregate rates. This dynamic is considered and reflected in our new assumption set. It should be noted that for claim terminations, a lower termination rate is a more conservative assumption.
I would also highlight the level of volatility caused by seasonality in our actual experience. Specifically, mortality rates tend to be higher during the winter months, consistent with other product types like life insurance. For claim terminations, the one standard deviation sensitivity equates to around a $360 million impact to margins. We now move on to our assumption regarding morbidity and mortality improvement. We recognize that this topic has generated a lot of discussion recently. We want to be clear on our position. Most importantly, we've seen significant morbidity improvement in our claims experience over a 10-year period. We believe that a longer-term view is the best way to evaluate this type of improvement. As shown on slide 13, our actual incidence rates, normalized for variables like age and claim type, have improved by more than 3% per year over the last decade.
We measure this by looking at actual claims incidence rates versus our expectations by calendar year. The graph presented shows our actual rates compared to our expected rates over time based on our new assumption set. A third-party actuarial firm concurred that our historical experience indicated a level of incidence improvement. Our actuarial consulting firm also indicated that morbidity improvement has been observed in the experience of other long-term care carriers. Supported by these results, we are assuming annual morbidity improvement of 1%, which is significantly less improvement than what we have observed in our own experience. Finally, morbidity improvement can only be assessed in conjunction with the base morbidity assumptions a company uses in its reserve calculations. By definition, improvement for each company is merely a relative comparison of how the actual to expected incidence rates improve over time.
While we cannot speak for the broader industry or other carriers, our actual to expected incidence rates improved from 105% in 2008 to 80% in 2017 in a fairly orderly fashion. This actual experience is why we feel comfortable that we have observed improvement in our own experience and believe our improvement assumption is supported by our data for our block of business. To close out this topic, our favorable sensitivity reflects our observed improvement over the last 10 years of 3% and would result in $1.6 billion of improved margin. Eliminating our improvement assumption would result in a $1 billion decrease to margin. As I stated before, this assumption is based on a decade of experience. Any adjustment to this assumption, if warranted in the future, would play out over years and decades, allowing the company to manage accordingly.
An important point regarding morbidity improvement is that there have been published studies that indicate the presence of some form of morbidity improvement in both insured and non-insured populations. We've listed several of these on slide 14. These include a solid study of non-insured medical trends in 2016, a presentation to a Society of Actuaries session by an associate of the Milliman actuarial firm in 2014, and an SOA article published in 2017 by an actuary from another carrier. Although these studies are careful not to attribute the improvement to a single cause, they do indicate that the data analysis shows varying levels of improvement. We acknowledge that there have also been studies published that do not indicate morbidity improvement in the data analyzed, and this is obviously an area of debate and varying views.
These studies do support some level of morbidity improvement generally, we always come back to our own experience and believe it supports our assumption. As mentioned earlier, we plan to submit new premium rate increase requests based on our new assumptions. These new requests will focus on our group block of business, including our newer generation group business. This newer generation has not previously been included in rate increase requests, and we believe regulator receptivity will be favorable. The margin impact of our assumption is $1.4 billion in total. This amount includes $700 million of currently outstanding requests pending, many of which are in states that have already approved smaller amounts, but which require us to come back annually for additional incremental requests. We continue to feel very comfortable about obtaining approvals over time on these filings.
A significant portion of the margin for pending requests not approved will relate to our California policies. We'll continue to work diligently with the California Department of Insurance toward resolving these requests. New rate increase submissions will be completed and filed during the next several quarters, and we believe the current regulatory environment is understanding of the need to mitigate risk in long-term care blocks. It should be noted that our new assumptions contemplate the success rate that is less than that which we have experienced with our previous filings, and we believe to be reasonable given the current regulatory environment. In closing, we've provided sensitivities based on a 10% margin variation from that assumed. As discussed earlier, we're decreasing the ultimate new money yield assumption to 6.25% from our previous 6.75% level.
As shown in the chart, our achieved new money investment yield since 2014 has fluctuated over time but has averaged 6.03% over that period. We have set our new short-term rate below that level at 5.5%, even though the current 30-year Treasury rate is above the average 30-year Treasury rate over the last three years of 2.83%. We have shifted out the time frame in which we assume rates will remain flat to 2021, and then grade them to 6.25% over several years. Our investment strategy for this line is a combination of investment-grade long-term bonds, high-yield bonds, and alternative asset classes, which we believe best match the risk profile of our liabilities and deliver satisfactory risk-adjusted returns. The sensitivity shown represents a complete shift of the new money rate assumption path up and down by 25 basis points.
In other words, the unfavorable sensitivity would indicate short-term new money rates of 5.25% grading up to 6%, which is less than we have achieved over the last three and a half years. Those sensitivities impact margins by $250 million. Let me pause here to note that we provided this detail on our assumptions as we thought it important that you understand how our assumption picks relate to our actual experience in the magnitude of sensitivities to those assumptions. We want to set expectations that we don't intend to provide this level of detail on a quarterly or annual basis. This is a volatile business, especially when you pull apart the drivers of earnings like mortality and morbidity individually, and we do not react to this type of fluctuation on a monthly or quarterly basis. Instead, we track actual experience against expectations over years.
We have shown that when we see longer-term variations, we will promptly address them within our management framework and in a way that does not impact our capital deployment objectives. There are limited measurements around items such as achieved new money yields and premium rate increase progress that we have disclosed in the past, and we will continue to disclose going forward. Turning to slide 17, we will continue to use our overall loss ratio as a guiding principle of actual performance, and we'll provide this measurement quarterly and on a four-quarter rolling average, which is probably the more relevant measure. Make no mistake, we will continue to see volatility in this measurement, but expect to experience long-term care loss ratios in the 85%-90% range on average in the future.
By definition, a block of insurance business and loss recognition such as ours should report levels of benefits plus operating expenses that equal the gross premium reported. Given that our operating expense ratio is in the 10%-15% range for long-term care, the loss ratio would be expected to be in the high 80% range. As a note, when we reviewed our experience for the first half of 2018 and overlaid our new reserving assumptions, the back-cast loss ratios were in the 80s. Moving on to capital plans, we want to reiterate our statement made on the second quarter earnings call. We plan to resume share buybacks in the fourth quarter at our historic levels of $100 million each quarter. We remain inclined to increase repurchases in late 2018 or early 2019 above the $100 million to compensate for not buying back shares in the third quarter of 2018.
Our capital deployment plan is on track, and we look forward to discussing our 2019 planned sources and uses of capital in more detail at our December outlook meeting. In closing, this has been an in-depth, comprehensive review that we've completed utilizing internal and third-party industry experts on several fronts. We believe we've used a proven combination of our own data and broader industry data to form our conclusions. Based on this review, we will record a reserve charge in the third quarter that should restore our loss ratio to the expected range and can be managed within our capital plan. Unum's core businesses have been, and we believe will continue to be, strong generators of cash, growth, and value to our share owners. With that, I'll send it back to Rick for his closing comments.
Thanks, Jack. Before we answer your questions, I want to acknowledge the intense focus our closed block team dedicates to this work. Our people at every level, and in many areas of our business, are engaged every day in ensuring we manage the performance of this block. We've used every tool at our disposal to analyze the LTC landscape, while we can't predict the future, we're confident in our process, we believe strongly that our assumptions are reasonable and that our current reserve levels are appropriate. We have effective tools for managing this block, we will continue to use them to help ensure that long-term care does not overshadow the story of a consistently profitable, well-managed business that serves a real and growing need in our society. We're well-positioned to meet the pressing need for what we do.
Our core businesses continue to perform well, we have strong market positions, we aim to build on our momentum through continued top-line growth while maintaining solid operating margins and significant financial flexibility. We see opportunities to grow our business, we intend to capitalize on them while closely managing our closed block. With that, I'll turn it over to Marguerite to open it up for questions.
Thank you. If you would like to ask a question, please signal by pressing *1 on your telephone keypad. In the interest of time and fairness, please limit yourself to one question at a time. You may re-queue for questions. Again, that's *1 to ask a question. We can now take our first question from Ron Bobman from Capital Returns. Please go ahead.
Hi, good morning, thanks for all the good granular info on your LTC book. I had two questions. One was as it relates to rate increase requests, particularly in California and New York, how much of the projected revenue pickup is based on those two states, given that they've been so reticent to provide any rate increases? Then I had a second question about claims handling.
Yeah, this is Steve. I'll take the premium rate increase question. I would say we feel very good about where we are with both of those states. We've received increases, some pretty significant in New York, historically. We're now working through kind of smaller increases on an annual basis with them, but we feel pretty good that ultimately we will be able to achieve what we had filed there. In California, we have not historically received increases, but we do have two pretty substantial increases in queue with them. We've been working with them over the last several months. Feel optimistic about that. We do have an estimate of that in our current margin analysis that's quite a bit less than 100% of our request. We'll continue to work with them and just feel good about the relationship there.
Okay, thanks. On claims handling, do you handle claims in-house or do you use a third party?
We primarily handle it in-house. There's maybe smaller pieces of the claim handling process that we do use outside parties that have different capabilities. When it comes down to the claim decision-making, that's all handled in-house.
I'd remind you, Ron.
Do you expect changes there?
No.
I'm sorry I spoke with you, Steve. I couldn't hear what you said.
I'd remind you that claims management is one of the core competencies of our company. We've been managing complex disability claims for decades now and actually used a lot of the learnings from our disability block to impact the long-term care block.
Thank you.
Again, as a reminder, you may limit yourself to one question and re-queue for follow-up questions. We can now take our next question from Ryan Krueger from KBW. Please go ahead.
Hi.
Hi, Ryan.
Good morning. Thanks for the additional detail. About morbidity improvement, I guess, what are you assuming for annual mortality improvement? When you gave the $1 billion sensitivity for removing both morbidity and mortality, could you disclose what that would be if you just removed the morbidity piece of it?
Yeah. From a mortality perspective, we assume 0.6% mortality improvement, so it's a 1% morbidity, 0.6% mortality. That mortality piece is in the 4 to $500 million range. If you remove the mortality, the morbidity would be $1.5 billion.
Thanks. Then, on the $2.5 billion impact to liability assumptions, could you give some breakdown in very rough terms, some kind of I know you talked about both incidents and terminations. Can you give some sense of kind of the relative impacts?
Yeah, we're not going to parse it, the majority of it was claim terminations. There's an interplay between the two, because as you reduce your claim termination assumptions, kind of increases the average size of new claims that incidents get supplied to.
Okay.
The bigger portion was clearly claim terminations. When you say claim terminations, you're essentially saying extended durations of claims?
Yeah, longer durations on claims.
Got it. Thanks a lot.
Thanks, Ryan.
Next question comes from Randy Binner from B. Riley Securities. Please go ahead.
Hey, good morning. Thanks. I wanted to understand how the collective $1.4 billion of future rate increases squares with the kind of industry practices or studies that you laid out. You've explained the methodology, I think, somewhat in the opening comments, but the different issuers out there seem to have different assumptions, which are pretty widely different about how to assume future pricing. I understand you're using kind of your historical success rate, and you had some state-by-state comments earlier, but is there any guidance you get from these studies out there or best practices from the consultants about what the right assumption should be on future price increases?
Yeah, this is Steve. I'll take that. We really just have one set of best estimate assumptions that we utilize for really all of our adequacy testing as well as our rate increase work. I would say, generally speaking, the assumptions we use to file rate increases and support those are the same that we're using for reserve adequacy for both stat and GAAP.
Yeah. I would say, Randy, it's difficult to say there's industry practice.
Yeah.
We do it at the bottoms up. It's by policy type, by state. To have generalization across the industry, I think, would be quite difficult. We look at our process. We look at when we record or assume that we're going to get that type of rate increase. As we said, we think we have a good estimate of what we'll get on the next round, including the follow-up from previous rounds that we've done as well.
Yeah, Randy, the only other thing I'd add to that is, in general, our assumption set justify much larger rate increases than we're actually going for. One of the commitments we've talked to regulators about is we're trying to make the block self-sustaining, not returning historical profitability levels. That has resonated really well with regulators as well.
What's the biggest risk factor on that, on getting this 1.4?
From my perspective, it's probably timing. It's when it happens, because we're going to continue to pursue rate increases for as long as there's requests outstanding. Even if we get an answer that's not the full rate increase, we'll continue to pursue any remaining rate increases over time. I think that's probably the biggest risk. When we filed rate increases in 2014, we assumed we'd have a 65% success rate. We're at 70% already, and that's going to grade up into the 90% range by the time we finish out that total filing. I think we feel good about it, and we'll continue to work at it.
All right. Thank you.
Thanks, Randy.
Again, if you would like to ask a question, please signal by pressing star one. We can now take our next question from Alex Scott from Goldman Sachs. Please go ahead.
Hey, good morning. The first question I had was just on the statutory side of things. I was interested in if you could just do any kind of compare and contrast for us to help us think about what kind of mortality morbidity assumptions are being used in the AG 51 asset adequacy testing. Was it changing some of those assumptions that drove the stat charge? Are those assumptions consistent with what you're doing in the GAAP reserves? I guess X interest rates, obviously. I think you have to use a lower discount rate there.
Actually the statutory reserve assumptions were set at issue. We've not changed those assumptions. They have a very conservative interest rate. They have a very high lapse rate, which actually contributes to one of the reasons why statutory reserves increase faster than GAAP because when those people don't actually lapse, you have to set up a bigger reserve on them going forward. There's an outdated mortality assumption that's much higher than current mortality. You really can't do a comparison by assumption set with statutory versus GAAP. The only basis you can really do is look at the ending amounts and see if the statutory reserve amount is greater than your best estimate GAAP assumption.
In terms of AG 51, we used our old assumption set when we last filed last year, but we will update that and use our new assumption set when we do our next AG 51 filing. As Steve said, we only have one best estimate assumption set at a time. We use it for reserve adequacy studies, we use it for AG 51 filings, and we use it for rate increase requests.
I guess what I'd say is the $200 million for statutory impact that we quoted does reflect this new assumption set and our new view of AG 51 and all other asset adequacy tests. The majority of that actually relates to our disabled life reserve and just the flow-through of best estimate assumptions into the claim reserve.
Got it. Then the follow-up question I had was just when I think the group policy seemed to be a bigger part of the premium rate increases in the future. I know there's a lot going on with this long-term care pricing working group that I think is trying to standardize assumptions across the industry, but also potentially allow you to go out and ask for increases from multiple states at the same time. Can you talk about some of the puts and takes from that and whether you view that as a positive or if level setting some of the assumptions could be an offsetting item?
Yeah. Just to clarify what's being discussed right now, I would say it focuses on consistency of process. I think the states will continue to have control over both the assumptions used in the analysis, working with the different carriers, as well as the actual approval of them. We're very supportive of trying to have consistency with the type of information that is submitted to the states. I do think that the authority will remain with the states. I don't see there being a lot of change with the process historically with what's being discussed currently.
Thanks.
Thanks, Alex.
Next question comes from Thomas Gallagher from Evercore. Please go ahead.
Good morning. Just one on morbidity and another one on interest rates. Slide 13 shows the 3.2% improvement per year is on incidence for morbidity. What about severity? Jack, you even referenced it in terms of the reserve adjustment. It was bigger for claim terminations and extended claim durations. If you roll in severity and incidence, are you still seeing 3% improvement per year or does that differ? Would you still be above the 1% per year bogey that's embedded in your assumptions if you also include severity?
I'd break severity down into two. One, most of the severity is related to the strengthening of our disabled life reserve assumptions. The claim termination rates, that would be consistent on claims throughout the period. When we looked at severity on a consistent basis relative to the set of claim termination rates, we didn't really see a trend. It's bounced around time to time, but it's been pretty steady. We looked at severity. There was no discernible trend within it. There was a very discernible trend on incidence, that's what you're looking at. We did take a look.
Got you. That was kind of neutral-ish. The improvement is really on the front end, on the incident side.
Exactly.
Just on interest rates, $500 million of the charge was based on lowering future interest rate assumptions. Now you're using 6.25. You were previously using 675 further down the road. I know with the FASB changes, they're moving to a standardized discount rate, single A corporate bonds. I'm just looking at your sensitivity. I assume that based on the information you gave us, your discount rate for GAAP would be, I don't know, mid-fives to maybe high fives, something in that range. Just looking at when the new standard does go into effect, can you talk a bit about what the impact might be? I would think it would be north of $1 billion if it was implemented today based on the change in discount rate. Any clarity on that would be helpful.
Yeah. I think there's clearly going to be a lower discount rate. We don't have a single A portfolio. I'd caution you to read too much into that. First of all, it's going to show up in, we believe, in AOCI, so if you're looking at what our book value or return on equity is, excluding AOCI, that won't change dramatically. Probably more importantly, the FASB changes are GAAP changes. They talk about GAAP reporting. They don't talk about GAAP from a book value perspective. They don't talk about statutory earnings, which is the source of cash flow generation in the company, and they don't affect statutory capital. We'd see that as changing the geography of the accounting. There is a ton of work to go through to figure out how that works across our entire company, not just long-term care.
We'll be doing that over the next year. I think it's going to change the disclosures, and it's going to require more explanation about what's happening, but it doesn't change capital, and it shouldn't change the economics.
Okay, thanks.
Thanks, Tom.
Next question comes from Suneet Kamath from Citi. Please go ahead.
Thanks. Good morning. I know at a high level you had said that it's hard to compare blocks, and I get that. If I think back to Prudential's reserve review in the second quarter, the tone from them was very much along the lines of we wanted to put this
behind us and that any future reserve actions that we take will be fairly modest and not in the $billions, maybe $100 million-ish, kind of my putting words in their mouth. Is that the takeaway that we should have from the work that you've done here?
We feel great about the assumptions we've set. This has not been an installment payment. We feel that these assumptions are pretty conservative. You can look at the picks that we made around our morbidity assumptions. We lean toward the tips of incidence rates. We lean toward the troughs of claim termination rates. We feel better about this in that we've relied more on our own data than we have in the past. Over the last three and a half years, we've received a lot more claims, our data is much more robust, and we strengthened our underlying morbidity assumptions by over $2 billion. We feel very good about where we are. You've been around the long-term care business. I think anyone who says this is it is taking a chance. I think we would fall short of doing that.
We feel very good about where we are. We feel very good that if our current trends continue, that our reserves will hold up well. We're not going to go out in predicting what's going to happen in the next 10, 15, 20 years. The thing I would say is that as we've managed this in the past, we will continue to build up our statutory reserves faster than our GAAP reserves. We'll continue to put capital into the business, which is built into our capital plan, so that if we do have to react to things in the future, we'll be able to do that on a GAAP basis without impacting our capital deployment plans.
Got it. Just to follow up on that, as we think about potential third-party solutions for your block, when you've had discussions, have the underlying assumptions been the real sticking point, and do these actions get you closer to maybe moving on some of those potential transactions?
It's certainly a big step in our underlying assumptions, undoubtedly, if you look at our picks, people would feel more comfortable with our picks. That's a piece of the bid-ask spread, I think a lot more of it is just the risk that people are taking on to be in the long-term care business, the length of the guarantees that you need to make. The actual bid-ask spreads continue to be very wide. They continue to be what we would consider uneconomic in terms of how we feel about our block and how we're managing it and how we see it unfolding over the next decade. I think it's more the bid-ask spread. I think a good upward movement in interest rates would probably do a lot to cover that.
I think, Suneet, it is important that when we look at it overall, though, that there is movement in this industry, so you're starting to see transactions. I think as we've said often, you have to start to see some of those early-day transactions. People get more comfortable, and that's the beginning of the process. I think as Jack articulates, we're not there where we see a transaction imminently, but we're going to stay very close to the market.
Okay, thanks.
Next question comes from Ryan Krueger from KBW. Please go ahead.
Hi. Thanks for the follow-up. Could you give some additional info on the timeframe that you assume the premium rate increases occur over?
Yeah, this is Steve. For those increases that we already have approvals on but not implemented, obviously, we have an assumption in there around the timing, and that'll occur over the next several years as we can do the system implementation. When it comes to any of those increases that are not yet filed or not yet approved, we have a several year kind of moratorium on any reflection in the reserve as far as actually putting that in our assumption set. It was mentioned earlier about the new long-duration guidance that's coming out. That'll also give us a little bit of flexibility when that's implemented to adjust as we go on the timing of those rate increases. We feel like we have very little risk over the next 2-3 years as far as timing goes on approvals.
It's probably worth noting with that too, Ryan, that that 3% loss ratio pressure that we're feeling goes away with the reserve update because we've now aligned the timing with what actually happened.
Yeah. If we exclude the charge in the third quarter, would we already expect to get back to that 85%-90%, or would that not occur until the fourth quarter?
We don't have that third quarter results yet. We're not prepared to announce them. As we said, when we backcast it the first half of 2018, based on the new assumption set, we were in the 80s.
Okay. All right. Thank you.
Next question comes from Alex Scott from Goldman Sachs. Please go ahead.
Hey, thanks for taking the follow-up question. One more on AG 51, if you will.
I was just interested if you get any benefit at all from, I guess, aggregation with other businesses, and then also the captive reinsurance structure that you have in place.
In general, on AG 51, we don't get benefit from aggregation with other businesses. Most of our long-term care business is in Fairwind. That's a standalone entity. There aren't other businesses in there. You generally would do the aggregation within legal entities. For Fairwind, we test on a reserve adequacy basis using basically our best estimate assumptions against the statutory reserves. We don't get any meaningful other benefits from that captive structure. We're holding NAIC-based statutory reserves, the same statutory reserve basis that we would've been holding in Unum America. The only permitted practice in that Vermont captive is related to, we use a GAAP deferred tax asset as opposed to a statutory. With the lower tax rates now in effect, that's just not material anymore.
Got it. Thanks very much.
Thanks, Alex. I think that's actually all the questions that we have in the queue. I'd like to thank everybody for taking the time to join us this morning, and we look forward and we'll talk to all of you as we close up third quarter results, and then we'll have our normal investor outlook meeting in December as well. Thanks for taking the time this morning. We appreciate it.
That concludes today's conference call. You may now disconnect.