Good day, welcome to the Unum second quarter 2018 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tom White. Please go ahead, sir.
Great. Thank you, Bettina. Good morning, everyone, welcome to the second 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 Securities and Exchange Commission, are also located in the sections titled Cautionary Statement regarding Forward-Looking Statements, and Risk Factors in our annual report on Form 10-K for the fiscal year ended December 31, 2018, and our subsequently filed Form 10-Q. 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. A presentation of the most directly comparable GAAP measures and reconciliations of any non-GAAP financial measures included in today's presentation can be found in our statistical supplement in our website in the investor section. Participating in this morning's conference call are Unum's President and CEO, Rick McKenney, and 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 Steven Zabel for the Closed Block. Now I'll turn the call over to Rick for his comments.
Thank you, Tom, good morning, everyone. The second quarter was a very good quarter for the company. Our net income totaled $285 million, which is $1.29 per share. Our adjusted operating earnings per share of $1.30 is an increase of 24% compared to $1.05 in the second quarter of 2017. Through the first six months of the year, our earnings per share has grown over 20%. Our results this quarter benefited from the continuation of positive operating trends, including overall favorable benefits experience and solid premium growth in our core business lines. We're also benefiting from a lower tax rate. Our capital management has also kept pace with an additional $100 million of share repurchases this quarter, bringing us to $200 million for the year. Finally, we have increased our dividend 13% in this quarter, marking the 10th year of a dividend increase.
Looking closer at our core businesses, we are seeing good sales and premium growth while maintaining strong margins. Growth-focused initiatives are paying off as premium income grew almost 5% for our core businesses. Overall sales were up this quarter, led by a 14% increase at Colonial Life. Importantly, from a margin perspective, we generally saw overall favorable benefits experience across many of our lines. Our expense management efforts have also allowed us to keep expense ratios stable while we invest in the future. Margins are very strong, with an adjusted operating ROE of 18% for the first half of 2018 in our core business lines. Strategic investments are also producing, as our recently acquired dental insurance businesses grow their foothold in the U.S. and U.K.
The combined performance of our core franchise again produced solid, consistent results and very healthy cash flows that allow us to continue a steady capital deployment plan. Our nearly 10,000 employees are doing a great job of protecting more people in both the U.S. and U.K. For our shareholders, however, these great efforts in serving our customers have been overshadowed in 2018 by our Closed Block of long-term care insurance. Managing our Closed Block of long-term care insurance has been something we've been doing for many years. After stopping sales of individual long-term care business almost a decade ago, we have been managing and monitoring our LTC line over time. We've taken price increases where appropriate, and when trends have deviated from our assumptions, we've updated them accordingly, which brings us to the first quarter of this year.
We had record levels of earnings, but the one challenge in the quarter was that we also saw a higher loss ratio in the LTC line of business. This was at a time when there was significant market focus on the LTC business throughout our industry. While we too were disappointed with our incidence results, we thought the reaction was not in alignment with our underlying trends in our reserve drivers. We've therefore accelerated the work during the quarter on our annual reserve analysis. We now anticipate that our reserve analysis will be completed in the third quarter of 2018. It is a significant undertaking and one that is still in progress, but we feel it is very important to give as much clarity as possible.
To that end, Jack will give you more detail on the quarter's trends and our current view as we look to wrap up this work in the third quarter. Overall, we're committed to the strategy of being the leading provider of employee benefits at the workplace. To that end, our core business is executing well and is continuing to grow and build momentum. The strength of our franchise has allowed us to generate financial flexibility to manage our Closed Block and at the same time return significant capital to shareholders. It is a strategy we will continue to execute throughout 2018 and beyond. Now I'll turn the call over to Jack to cover the details of the second quarter. Jack?
Thank you, Rick, and good morning, everyone. I'll provide commentary on our operating results for the second quarter and update you on our progress on the reserve review for our long-term care and what our current expectations are for that important work and its impact on our capital deployment plans.
Beginning with Unum US, it was another good quarter with continued positive trends in premium income, very good persistency, and favorable benefit ratio trends across our major business lines. Within Unum US, adjusted operating income for group disability declined by 11.7% to $81.6 million in the second quarter, primarily due to lower net investment income resulting from a lower level of assets backing this line in a lower portfolio yield. The amount of capital backing this business has been reduced with the update of statutory reserves in third quarter 2017 and the IBNR reserve update in the first quarter of this year. The reduced capital, along with the steady pressure on portfolio yields, puts pressure on the net investment income. With the stable earnings we expect to continue to generate, these lower capital levels are accretive to the adjusted ROE for the group disability line.
We continue to see positive trends in risk experience for group disability, with the benefit ratio improving slightly to 76.2% in the second quarter compared to 76.5% in the year-ago quarter, primarily driven by lower claims incidence in the group long-term disability line, which was partially offset by higher claims incidence in some of the group short-term disability products. The group life and AD&D line had a very strong second quarter, with adjusted operating income of $67.2 million, an increase of 10.3% from the year-ago quarter. Premium income increased 7.3%, driven by improved overall persistency in our recent sales trends. The benefit ratio improved slightly to 70.3% in the second quarter from 70.6% in the year-ago quarter, due primarily to favorable experience in the accidental death and dismemberment product line and a lower average claim size in the group life product line.
The supplemental and voluntary lines continue to generate strong results, with adjusted operating income increasing by 8.3% to $102.3 million in the second quarter. Premium income increased 4.7% for the second quarter due to growth in our voluntary benefits business and the rapid growth being generated by the dental and vision product lines. Risk experience was favorable in the second quarter across the major product lines. Sales for Unum US in the second quarter declined by 5%, primarily driven by lower sales in the group disability and life lines. We did see some areas of strength in the individual disability line, the core market segment for voluntary benefits, and the ongoing rollout of the dental and vision product lines. We continue to be pleased with the persistency in our Unum US business lines.
For our group lines combined, persistency for the first half of 2018 improved to 90.2% from 88% in the first half of 2017. Unum UK continues to operate in a difficult and uncertain business environment. Given this backdrop, adjusted operating earnings declined in the second quarter to GBP 20.4 million compared to GBP 22.6 million in the year-ago quarter. Premium income increased 3% on a local currency basis this quarter, generated largely by improved persistency in the first half of 2018 and prior period sales growth. The Unum UK benefit ratio was 76.7% for the second quarter of 2018, up from 75.6% last year, driven primarily by higher group life claim volumes, which was partially offset by the favorable benefits experience we saw in the group disability line in the quarter.
Unum UK sales for the second quarter increased by 4% year-over-year, driven by higher sales in group long-term disability, which offset slower sales in group life in the supplemental lines. Persistency also improved, increasing to 86.8% for the first half of 2018 compared to 85.5% in the first half of 2017. The improvement is particularly encouraging given our active implementation of rate increases in the disability block. Colonial Life produced a strong result with adjusted operating income in the second quarter of $84.6 million, an increase of 3.4% from the year-ago quarter. Premium growth is trending well, increasing by 5.1% in the quarter. Overall benefits experience showed a slight improvement, with the benefit ratio at 51% for the second quarter compared to 51.3% in the year-ago quarter.
The operating expense ratio for Colonial Life was slightly higher on a year-over-year comparison, primarily due to costs related to our territory expansion initiatives, investments in our business, and the rollout of the dental product to the Colonial Life distribution system. These investments are paying off as new sales at Colonial Life increased 13.6% in the second quarter compared to the year-ago quarter. The introduction of the dental product certainly helped with that growth, with sales this quarter of $9.4 million. In addition to the strong dental rollout, sales from our other product categories all exhibited year-over-year growth. Sales also increased for both new accounts and existing accounts. Moving to the Closed Block, adjusted operating income declined to $29.6 million in the second quarter of 2018 from $32.6 million in the year-ago quarter.
In the individual disability product line, the interest-adjusted loss ratio was 82.9% in the second quarter compared to 82.3% in the year-ago quarter. Underlying risk performance for this block was favorable, while the higher interest-adjusted loss ratio reflects a reduction in the claim reserve discount rate to recognize the impact on future portfolio yields from higher miscellaneous investment income resulting from increased levels of bond calls and tenders. The results of the long-term care business line continued to be challenged, as the interest-adjusted benefit ratio increased to 96.9% in the second quarter of this year compared to the year-ago second quarter of 89.4% and 96.6% in the first quarter of 2018. Benefits experienced this quarter was again driven by new claim incidents that ran higher than expected.
Mortality impacts in the second quarter were not as favorable as in the first quarter, active life terminations improved to more normal levels. As we described in the first quarter, our long-term care results continued to be adversely impacted by the timing of rate increase approvals and the effect it has on premium income for this line. This has had the effect of increasing our reported loss ratio in the recent past by 3%-4%. If we unlock our GAAP reserve assumptions with the reserve analysis currently underway, this impact to the benefit ratio will be eliminated. As Rick said in his opening comments, as you read in our earnings release, in light of the recent market focus on long-term care business performance, we accelerated the work on our long-term care annual reserve analysis.
We now anticipate that our reserve analysis will be completed in the third quarter of 2018. Once completed, this work will include a review of all assumptions and incorporate our most recent experience. The review will also utilize internal and external data, as well as an outside actuarial consulting firm for quality assurance and industry benchmarking. Our current thinking, subject to the completion of our work, is that we may need to increase our reserves as part of our third quarter closing process. Although we still have work to complete, we are still assessing our assumptions, our current expectation is that any increase of our long-term care reserves will likely be predominantly a GAAP event and will likely not exceed $750 million after tax. We do not expect that any potential reserve increase will impact our ability to execute on our capital deployment plans, including our share repurchase strategy.
However, consistent with past practices regarding trading windows, we will not execute on share repurchases until we announce the results of our reserve analysis. We currently anticipate resuming our share repurchase program of approximately $100 million per quarter, beginning in the fourth quarter of 2018 and continuing into 2019. We are presently inclined to repurchase additional shares in late 2018 or early 2019 above that historical run rate to compensate for foregoing buybacks in the third quarter. However, we will evaluate this as we get closer to the fourth quarter. We'll share with you more details about our 2019 capital plan at our December investor meeting. The process we've undertaken to analyze and update our reserve assumptions is consistent with 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, therefore we want our assumptions to keep pace with emerging experience. We have also aggressively and successfully pursued rate increases on in-force business as appropriate, which is the most effective way to manage the block. We have routinely made cash contributions to support the long-term care block, we anticipate these contributions each year in our capital deployment plans. Importantly, we are managing this block within the broader scope of a very successful and well-positioned company. A market leader with strong, consistent cash flow generation capabilities that are enhanced by the benefits of tax reform. We believe this is an effective path to manage the long-term care block and will help to minimize the disruption to Unum that can result from its volatility.
It also leaves us with sufficient capital flexibility to fund our growth and return capital to shareholders through share repurchases and dividend increases. Moving back to this quarter's trends in long-term care, it was also a favorable quarter from a new money yield perspective we are realizing on our long-term care portfolio as they continue to exceed expectations we have embedded in our current assumptions. Interest rates and bond spreads were favorable for us in the second quarter, which was beneficial for all of our product portfolios. Moving on, the company continues to produce healthy levels of statutory earnings from our traditional U.S. insurance companies. For the second quarter, statutory after-tax adjusted operating earnings totaled $249 million compared to $225 million in the year-ago quarter. For the first half of 2018, our statutory after-tax adjusted operating earnings totaled $491 million.
The capital position of our company remains in very good shape. At the end of the second quarter, the risk-based capital ratio for our U.S. traditional life insurance companies was approximately 385%, while cash at our holding companies totaled $1.16 billion. The cash position includes $300 million from the issuance of junior subordinated notes during the second quarter. After the end of the second quarter, we paid off a $200 million maturing note, which subsequently reduced that cash position. Our return of capital to shareholders remains on a consistent path as we repurchase another $100 million of stock in the quarter. Back in May, our board approved a 13% increase in our common stock dividend, the 10th consecutive annual increase. I'll wrap up by reiterating our expectation of growth in adjusted operating earnings per share in the 17%-23% range for the year.
The base of adjusted operating earnings from 2017 is $4.24 per share, this projection excludes any potential reserve increase for our long-term care business. I turn the call back to Rick for his closing comments.
Great. Thank you, Jack. I just reiterate, all in all, it was a solid quarter for the company. We're encouraged by the operating trends produced in our core businesses. As Jack said, we're also aggressively working to complete our LTC reserve analysis so that any potential impact can be part of our third-quarter reporting, and we can provide more detail then. We'll be happy to take your questions, I'd ask Bettina to begin the question and answer session. Bettina?
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We will pause for just a moment to allow everyone an opportunity to signal for questions. Our first question today comes from Mark Hughes of SunTrust. Please go ahead.
Yeah, thank you. Good morning.
Good morning.
Good morning. Yeah. In evaluating the long-term care block, you've obviously had a jump in claims incidence rates the last couple of quarters. How much credibility do you give that when you forecast out over the life of the block? Can you give us some parameters about how this review or how your current thinking would incorporate this jump in frequency?
Yes. Certainly, we've incorporated recent claims experience into our reserve analysis. Long-term care is a very long-term product line. Two quarters isn't very credible relative to the long-term trend lines. We tend to look at those over multi-year periods. Certainly, it does have some impact and influences the outcome, but it's not a major driver of the outcome.
In the short-term disability saw claims incidence up a bit. Anything to read into that? Is that just variations near as you can tell, or is there something emerging there?
Thanks, Mark. Mike Simonds, do you want to answer that?
Sure, happy to. Good morning, Mark. Short answer is I wouldn't read anything too much into it. We saw a little bit of a pickup in new claim incidence for short-term disability, but in general, feel good about where we're positioned in the product line. That's also a product line, given the nature of how credible the experience is that we were able to move pretty quickly from a renewal point of view as well. It's been a very good contributor to a really healthy group disability segment. While we did see a little bit of an uptick this quarter, I wouldn't expect a long-term issue there.
Thank you.
Thanks, Mark.
We will now take a question from Randy Binner of B. Riley FBR.
Good morning. Thanks. I wanted to ask one on long-term care and the benefit ratio we saw in the second quarter, again in the high 90s. Just to kind of reflect on how that stayed at that level relative to the first quarter. Back in the first quarter, I think the thought was that some the flu activity effectively maybe pushed some of the population into a situation where they went on claim. This benefit ratio does not appear to support that, and you mentioned that mortality just continues to be less favorable. The net of my question is, should we plan on this level or potentially higher ongoing interest-adjusted benefit ratio in the high 90s for LTC in the Closed Block going forward?
I'd start looking at the quarter compared to first quarter. In the first quarter, we did have high claims incidence, but we also had very high mortality, and we had very unfavorable terminations in our active claim block, so deaths and lapses in the active claim block. I would say this quarter, the incidence levels continued. However, mortality reverted more toward kind of our long-term expectations. Still a little bit above the long-term expectations, but much closer to it. At the same time, the active life terminations reverted back to more toward the long-term norm as well. Those two things kind of offset each other in the quarter, and we were left with a very similar level of loss ratio in the first quarter related to claims incidence. In terms of looking at claims incidence, two quarters does not a trend make in long-term care.
We've actually seen periods where there have been four and six quarters of either very low incidence or very elevated incidence that has turned around in other periods. I wouldn't read too much into the second quarter and first quarter. We wouldn't have the expectation that this is it forever. With that said, though, as we look at our reserve work and we update our assumptions, our assumptions will incorporate the current experience we're seeing. Post-assumption review, I would not expect loss ratios in the high 90s to continue.
Yeah, understood. This is picking up on Mark's question a little bit. If we keep seeing it in the high 90s, I guess the question is that reflective of the review? I guess the answer is the review would probably expect a little bit lower benefit ratio to develop over time because that's more consistent with the historic trend. Is that fair?
Yes.
All right, great. Thanks a lot.
We will now take a question from Jimmy Bhullar of J.P. Morgan. Please go ahead.
Hi. First, just on your guidance on the results of the long-term care review, how much of the expected amount roughly is because of just changes in interest rate assumptions versus incorporating the uptick in incidence that you have seen? I think you mentioned that you'll assume higher incidence than before, but maybe not at the elevated level that you've seen in the first half of this year. Could you give us an idea on if you were to assume similar incidence as first quarter this year, how much higher would the $750 amount end up being?
Yeah. Jimmy, we haven't completed our work yet, and we still haven't finalized our assumption set. We're not in a position to really parse those assumptions and talk about what the individual changes are. We do anticipate that we will provide more specific guidance when we actually do finish the work, and we announce the results of the work. It's important to note that this review is a comprehensive review. It's looking at all of the different assumptions. I think it's hard to find an assumption that stays the same as opposed to thinking about what assumptions change. In aggregate, we feel very good about the progress the work has taken. We feel good about the limit we've put out in the marketplace, and we think it will have a meaningful impact on results of long-term care going forward.
Okay. Then if I could ask one more just on pricing and the competitive environment in the disability market, how that's trending, then also maybe discuss your weak sales this quarter, what really drove that?
Mike, do you want to talk about the environment? Maybe we'll turn over to Peter O'Donnell to talk a little bit about the U.K. as well after that.
Sure, happy to. Good morning, Jimmy. I would say, first question is about the competitive market and the pricing, and then second on sales. First on competition. I think first and foremost for us is the ability to keep and renew customers, and the story there continues to be a very good one. I think Jack mentioned it. Persistency in the quarter and on a year-to-date basis is up a bit from a strong result last year, just over 90%. We feel really good about the value prop and the experience that we're delivering to the client relative to alternatives in the market. I would say what we have seen in the first two quarters in particular has been a bit of a frothier, more aggressive new business pricing market. Sales have definitely been mixed.
We were up a bit in the Unum US segment in the first quarter, down 5% here in the second quarter. At the turn, mid-year, we're about flat year-over-year. As we look forward into the second half, I'd say in general, feel encouraged about the pipeline where we have a line of sight in the upper end of the mid and large case market. We do have about 60% of our sales year yet to book. We've also taken a few actions around additional marketing programs to sort of look to spur some growth. We talked heading into the year about 4%-6% sales year-over-year, full-year guidance, and I still think that that's probably the best estimate for us.
Longer term, I would say we feel very good about our growth prospects and being able to continue to grow the business and accelerate it in some spots, but in every case, maintaining the underwriting discipline that's allowed us to get the kind of margins and ROEs that we're targeting. That's sort of how I see the U.S. market. Maybe I'll turn it over to Peter to talk about.
Peter, you want to take on a little bit of the environment you're seeing in the U.K. with pretty good sales results, but also just what you're seeing overall?
No, happy to do that. I'm sure you see the sort of Brexit headlines heading over to the U.S. from the U.K., there's a lot of media hype around Brexit, I would say. From a business perspective, I think the way I describe it is it's dampening growth, businesses are a bit distracted at the moment from investing in their core franchises as they try and sort of work through what Brexit might mean. That is dampening our growth opportunities. However, I would say we've been performing very well in that marketplace. Like Mike, the first thing we look at is those persistency results. Are we keeping customers?
Particularly as we are still dealing with those low interest rates, the U.S. has recovered a bit, the U.K., well, we might see on Thursday a rate increase, we haven't seen a lot of rate increases over the past two years as the government has deliberately kept interest rates low to sort of manage some of the dislocations. We're getting a lot of rate through our book and maintaining persistency and growing it a bit. Really happy with that's a really good sort of indicator of future prospects for us. As Rick said, sales were good in the quarter. We were up 4% year-on-year, I was pretty happy with that. Particularly core sales were good, particularly for the small or medium-sized businesses. That was very good there, really happy with that.
We did see the benefit ratio for life slightly raised. Nothing to worry about there, just a little bit of volatility on the life line. Again, like Mike, as I look forward and we get through the Brexit dislocations in 2019, I think the marketplace and what we're doing with employers will be an area of significant growth for the U.K. economy in general, but also for Unum within that. I feel very positive about the future.
Yeah.
Thank you.
Appreciate that, Peter. I would, as we go through that, I think we'd be remiss not to talk about Colonial Life, which also had an excellent quarter. Still a competitive environment, Tim and the team are doing a great job. Tim, any comments in terms of the good quarter you had?
Yeah, thanks, Rick. I think at Investor Day last year, we shared a range of 8%-12%. We're pushing toward the upper end of that range. The market is certainly competitive, the employee-paid benefits market continues to grow. Colonial Life has, I wouldn't say an entirely unique, a competitively advantageous distribution system, especially in the lower end of the market. We feel great about growth in the rapidly growing small business segment, we also feel really good about our competitive capabilities in the mid-market, and even in the upmarket. About two-thirds of our business is produced through brokers, we have great relationships with our brokers. We continue to be very competitive in that segment. Public sector is a rapidly growing segment for us and a very large segment.
At the moment, we are feeling very good about our competitive position, our value prop, and our growth prospects.
Great. Thanks, Tim. Thanks for the question, Jimmy.
No-
We will now take a question from Alex Scott of Goldman Sachs. Please go ahead.
Hi, good morning. I guess the first question I had was just on the incidence rates that you've seen tick up. When I think about following the review, I get that you'll be at a lower benefit ratio. How should we think about a range? If the benefit ratio begins to increase again, will you do deeper reviews more frequently than you've done in the past? I guess on the individual block in particular, where are you in the duration of the book relative to peak claims? Are we getting to a point where you'll have to do deeper reviews like this more frequently?
Maybe I'll start off, Alex, and just talk about the reviews. We do deep reviews all the time. I think that every year we're going through that. I think what we're talking about here in the review is at a different depth and also incorporates a lot of external resources as part of that process. I think that's key, the data, the people, and everything else. This is going to be different. This is going to be deeper than we probably have done before, although we do consistent deep reviews analyzing this block really every quarter and then certainly every year. Jack, you want to talk a little bit more about where we are now in the different incident assumptions, et cetera?
You talked about the range of loss ratios that we would expect, and I'd remind you that we're in loss recognition. In loss recognition, by definition, your reserves plus your future premiums need to be set equal to your benefits and expenses. That, for us, that would continue to imply a long-term loss ratio in the 85%-90%, with expenses taking up the rest of the gross premium. In loss recognition, that's where we would expect to be. I'd still say that improves your long-term loss ratio outlook. You're still going to have volatility around that, because it's a very big block with a long way to go, that relative to reserve margins, you have very little premium in the block. The results can be volatile quarter to quarter. Again, that's where I'd gauge you.
I'd reiterate what Rick said, is we look at the assumptions all the time. The timing of the updates aren't driven by a clock. The timing of the updates are driven by emerging experience and when we feel we have enough credible experience, and that we need to take action on it.
Got it. My second question is just on cash flow. I know a statutory impact is sort of separate, and a GAAP impact is separate from the amount of cash that you guys actually put down into the long-term care captive as well as First Unum, the New York entity. Does anything around this review change the amount of cash that you'd put down? Can you kind of dimension the hold co cash balance for us a bit just in terms of what's contingent capital, what's your mark for maybe long-term care contributions, and what you'd view as excess that could be used for M&A or maybe a catch-up and buyback?
As we mentioned in my prepared comments, we are inclined to look at catching up on our buybacks. We're in a very strong cash position now. We ended the quarter at over $1 billion of cash. Even after having paid off that maturing note, we're still at the high end of our cash range. We said, if we do take a charge, and there's a lot of work that remains to resolve that, it would be predominantly a GAAP charge. We would see the potential for maybe some smaller
Statutory events, mostly related to disabled life reserve updates that we might do. As you know, the active life reserves are locked in, but the disabled life reserves are based on current assumptions. We wouldn't see a material change in our capital position as a result of this. We have built in our expectations for contributions to both First Unum, as well as Fairwind into our capital outlook. Those contributions have not changed dramatically, and we still feel very comfortable with our capital plan and our flexibility.
Okay, thanks.
Thank you, Alex.
We will now take a question from Humphrey Lee of Dowling & Partners. Please go ahead.
Good morning, thank you for taking my questions. Just to drill down a little more on the incidents. If I looked back in 2017, you had roughly 2,300 new claims in the year. Comparing that to kind of what you've seen in 2018, how much worse are you seeing relative to your expectation? If I were to assume kind of average of 200 claims per month using 2017 number, are we talking about 10 more claims or 50 more claims? Just how to size the kind of adverse impact that you've seen in the past two quarters.
Humphrey, I'm going to have Steven Zabel answer.
Great. Thanks for the question, Humphrey. Just one thing I'd start out with the annual claim volume is more probably in the range of 4,000 claims a year. Just kind of for level setting. You may be looking at information that only covers one of our legal entities or a subset of our block. I go back to kind of what Jack said around just the relationship between the reserves on this block and the reserve margins and our premium levels. We have about $160 million of quarterly premium on this block, if you equate that to a loss ratio, that's about $1.6 million for every point of loss ratio. Our average claim size is around $100 million, or I'm sorry, $100,000 per claim.
You can kind of do the math and see that it doesn't take a whole lot from a variance of count to drive a change in our loss ratio. Hopefully that gives you a little bit of perspective based on it's probably somewhere in the range of 4 to 500 claims a quarter.
Got it. Then, with the past two quarters, when you think about the drivers for the incidents, have you seen any correlation between kind of implementing the rate increase that's driving anti-selection? Is there some other factors that is driving the incident?
Yeah. This is Steve again. We obviously look at this on a week-by-week, month-by-month, quarter-by-quarter basis. We've done a lot of analytics on it. We've looked at it kind of state-by-state. We've looked at it from just a benefit coverage, if there's certain cells there, and we've looked at it by location of care, as well as other factors. Frankly, we just haven't seen anything that you'd say is statistically credible to show a differing trend in any of those cells than what we've seen historically. Again, we take that all into account as we're going through our reserve analysis. There's not kind of that one thing that you'd look at and say that's driving the volatility.
All right. If I can sneak in one more for logistic questions. For the review, you expect to complete it by the third quarter, do you anticipate it would be completed by the time of your release? If you were able to complete it earlier than your earnings release, would you choose to pre-announce the findings?
We would certainly keep that open as an option if we can complete it earlier. We are applying a ton of resources to this work. We understand how important it is to provide clarity to the markets about where we are, we're going to look to do that as soon as we possibly can.
All right. Thank you.
We will now move to a question from Erik Bass of Autonomous Research. Please go ahead.
Hi. Thank you. One more on the long-term care review, and I guess I appreciate that you can't provide a lot of color on what assumption changes you're making at this point, given that they haven't been finalized. But can you just talk about what gives you comfort in sizing the overall kind of maximum impact, given that you haven't finalized the assumptions? Has the third-party consultant been engaged with you throughout the process, and are they providing input on the assumptions?
Yeah. Even though we haven't finalized our assumption, there's still a lot of work to do. We haven't gone far enough that we've really done some of the experience analysis. We've kind of built kind of a framework around it. I think we are far enough along that we see that there are lots of assumption sets that we're looking at. There aren't assumption sets that at this point we think would cause to drive us outside of the range that we've given you. The ones we're actually considering and looking at fall within that range and actually even below that. We got to do the work. We need to finalize it. We're saying there may be a need to strengthen reserves, but we don't see the assumption sets we're looking at as going outside of that range.
With respect to the third party actuarial consulting firm. They've been with us at every step. We have been engaged in them in the review of assumptions. They've been very helpful for us. They provide an independent set of eyes and have made suggestions along the way of ways we can look at things. They've provided access to outside data that we wouldn't necessarily have otherwise. They've been important in terms of industry benchmarking and making sure that the assumptions we're picking are consistent with where other people are in the industry. They still have a lot of work ahead of them because they're going to be very deeply involved in validation and quality assurance work. We have been keeping them aboard with what we're doing. They've been very helpful in looking at the work, and a lot more work to be done.
Thank you for the color. When you complete the review, is your intention to provide incremental disclosures on how the individual assumptions are changing and maybe even any sensitivities to kind of future changes in those assumptions at that point?
Yeah. Eric, I'd say at this point, given that we haven't completed the work, we're really heads down on completing the work and driving to finalize this event. We do recognize there's a desire for additional disclosure in the marketplace. As we come to a conclusion of the work and we look at where our assumptions are, we will turn our attention to determining what level of disclosure we'll have. We will try to be consistent with kind of where the marketplace is, there'll be more detail. I just can't tell you exactly what level of detail there'll be until we get through the work.
Got it. Thank you. Appreciate that. Just last, just quickly, should we assume that if you make changes to your experience assumptions, that that could be accompanied by future rating or additional rate increase requests as well?
Yeah. I think that's an important point to make, Eric. If you look at the reserve charge as being the only piece of strengthening of assumptions, you'd be missing a big piece of what we're doing. When you look at reserves, there's really three components of strengthening the underlying assumption set. The first is that we had margin in our reserves under our current assumptions because of the investment beat we've had over the last four years. The first thing that any assumption strengthening would go through is to absorb that margin. The second piece is that as we strengthen the underlying assumption set, we will also refresh our rate increase strategy. We were in a good position in terms of having largely completed the rate increases that we had underlying our 2014 assumptions.
We have a lot of room on future rate increases to build into our assumption set. The third piece, once you've gone through those two, is the actual reserve charge. If you take those three components together, we're talking about a really robust strengthening of the underlying assumption set.
Great. Thank you.
Thanks, Eric.
We will now take a question from Thomas Gallagher of Evercore. Please go ahead.
Good morning. First to circle back, to understand the process a little bit on the long-term care review. Jack, I think after you guys took the charge in 2014, you had described it as unlikely to have to make any adjustments for probably at least another three years. Would you say the same will be true in this case? Realizing there's some caveats here, but at a high level, is that still from a process and procedure standpoint, still a reasonable expectation?
Yeah. I would say, when we took the charge in 2014, that statement was more related to the interest rate path that we had, you remember it was a pretty adverse interest rate environment. Our hope is that this is our best guess of how things are going to play out over time. We're hopeful that they would last longer than that. I mean, we're really feeling like we're putting together a robust best estimate about what the future's likely to hold. We'll continue to monitor experience as it emerges related to that. We'd certainly expect without something really dramatic happening for that assumption set to have a shelf life of at least that period, we're also hopeful that it will last a lot longer than that.
With that being the case then, is it fair to say most of the adjustment that you forecast based on the information now is longer term interest rate discount rate adjustment in the model?
No, again, we're deep in the work, but this is a comprehensive review of all assumptions. I think as I stated earlier, it's Assumption staying the same would be the exception. We're going to look at everything. We're going to update it for emerging experience. We're going to put together our best views. We would expect that those views would play out over time.
Got it. Then the first half adverse experience that you guys have been highlighting, is that just adverse versus GAAP by the six to seven points, or is that adverse versus your statutory assumptions, too?
Yeah, that's a good question. When you look at statutory versus GAAP, you really run your assumption set on a GAAP basis. That's where you develop your best estimate of how things are going to play out. When you look at statutory reserves, you generally don't view statutory reserves as an assumption by assumption. You figure out what your best estimate of the future is, that's your GAAP reserve estimate. Then you test whether your statutory reserves are higher than that estimate. You don't do the same review by assumption on a statutory basis that you do on a GAAP basis. Yeah, I'd remind you that as of year-end, our statutory reserves were $1.1 billion higher than our GAAP reserves.
When we update the assumptions based on anything we're seeing right now, we would still have a reasonable margin be between our stat reserves and GAAP reserves. You wouldn't be in a position of needing to strengthen your underlying statutory reserve assumptions. You wouldn't unlock them unless your GAAP reserve best estimate was above your statutory reserves.
Yeah. That's why I asked, because I get that it's showing deterioration versus GAAP, but ultimately, what really matters here, is it going to affect capital? I guess my question is, if we just isolate the recent trend, is that developing adversely or do you have enough margin embedded in statutory where that's not developing adversely? If I just isolate the more recent experience.
Yeah. Even the more recent experience, our statutory reserves are on a steeper trajectory than our GAAP reserves are. You'll remember, give you a for example, back in 2013, 2014, we strengthened GAAP reserves. We said we had a several hundred million dollar GAAP stat difference after that process. We're now at $1.1 billion. That excess strengthening, well, it's not really a strengthening, but the trajectory our statutory reserves are on is steeper than GAAP. We, as a result, put capital into our subsidiaries on an ongoing basis. Those capital contributions are built into our capital plans and have been a regular part of our capital plans over the long haul. We don't expect that to change. We expect statutory reserves to still grow faster than GAAP reserves.
We expect to continue to fund that out of our capital plans, and that's built into our expectations for capital deployment.
Okay, thanks. Just one final one, if I can. I appreciate you giving out the commentary on capital return. Just now that you've given us the output, can you give us some of the inputs? It's pretty clear you have a pretty good amount of holdco cash, and you have the.
Yeah
cash flow generated from your core business has been trending pretty good.
Yep.
Can you talk about the puts and the takes of how you get to the resuming the buyback between do you need to de-lever at all, assuming if you hit the high end of the range with the GAAP book value impairment, do you need to reduce leverage at all? Can you just give some ballpark of planned statutory contributions that you'd probably have to take this year in addition to potential de-leveraging? Thanks.
Yeah. From a leverage perspective, we ended the quarter at 27.4% leverage. When we paid off the $200 million maturity, that brought that down to 24.8%. If you looked at the impact of the reserve charge, even at the top end of our range, that's a percent and a half to 2% on the leverage. We'd be at the higher end of our leverage range, but still comfortably within it. We took that into consideration. For example, in the first quarter, when we issued debt, we issued hybrids that get more favorable leverage treatment than senior unsecured notes. We have a comfortable margin. The other thing is we're growing our book value at 8% a year pretty steadily. There'll be a little hiccup in that as a result of if we do take a charge.
That 8% growth is pretty good at de-levering the book in and of itself.
Okay, thanks.
We will now take a question from John Nadel of UBS. Please go ahead.
Hi. Thank you. Good morning, everybody. A couple more on long-term care. Jack, if we think about the upper end of this potential GAAP reserve charge on a pre-tax basis, I think that looks like $900 million or $950 million. What does your pro forma cushion between STAT and GAAP reserves look like at that point? Is it down to just a couple of hundred million dollars? If we look over the next couple of years, how fast does that cushion grow again?
I would say it's probably a little north of that at the higher end of the charge. A small piece of that charge, as we mentioned, related to disabled life reserves will be both a GAAP and a STAT event, so that reduces the impact a little bit on that GAAP-STAT difference. We would expect it to continue to grow. That GAAP-STAT difference has grown a couple of hundred million dollars a year over the past many years, we would expect that to continue in the future.
Okay. Pro forma for the charge and assuming some small portion of this charge impacts that, we're looking at the cushion, at least immediate cushion, post the charge at being what? three, four, $500 million, something in that range would be reasonable?
Yeah, we're still completing our work. We haven't finalized our assumptions. That'd be a reasonable guess.
Okay. Just thinking about incidence, Jack, I appreciate the fact that your block is somewhat younger relative to some other blocks out there. I guess, maybe my intuition here is wrong, wouldn't it be more likely then that as your block ages and matures, the incidence and other experiences that you see coming through today, for example, is far more credible than the experience, let's say, last year or the year before that? I guess I'm surprised to hear that you seem to be discounting your higher recent claims incidence here over the past two to three quarters as far as employing that incidence fully into your new assumption.
Yeah. Long-term care is a long, slow haul. Things are getting older, they're not getting older as fast as you would. It's not like the block ages a year every year because older people die out. As a result, the actual aging of the block is a long-term thing. There's nothing happening precipitously, either around the credibility of the block, the aging of the block or the underlying claims experience that would make one or two quarters significantly more credible than things that have happened in the past. Again, you're looking at two quarters of experience against a decade of trends. No, it wouldn't be a jumping-off point. If you look at our experience, again, I go back to it, if you plot our experience by quarter, it has been very volatile.
There have been periods of two, three, four quarters where we've had significantly elevated experience. There's been periods of two, three, four quarters where our incidence rates have been well below the trend line. That's the nature of this business. It's going to be a long haul. It's going to be volatile. Almost the good part of the business is that it allows you to manage it over the long haul because things that emerge are not cliff events in long-term care. They emerge over time. You get to see them coming, and I think we've done a pretty effective job at managing that over the past decade.
I appreciate all those comments. Then I've got maybe two real quick last ones. If you think about the excess of the investment income you've generated over the past several years since your fourth quarter 2014 update, how much is that worth in terms of the margin on your block today? I think you mentioned that the assumption changes in the reserve charge would incorporate some of the strength already in the block.
I wouldn't pinpoint exactly what's that worth. It's a meaningful amount. What I actually would point you toward is the fact that despite the fact that we've had an increasing loss ratio over that period, our earnings have been rock steady. That margin has really absorbed the pressure on the loss ratio. I think I'd think about it that way, we don't have a specific number for you.
Okay. Then just lastly, which outside actuarial firm are you actually using?
Yeah, we can't talk about that.
Okay. Thank you.
We will now move to a question from Suneet Kamath of Citi. Please go ahead.
Thanks. Good morning. I just want to try to reconcile some of the stuff that you've been saying, because if I look at that $750 million charge or $950 million pre-tax, it's bigger than, I think, the prior two charges, 2011 and 2014. Based on what you're saying, it doesn't seem like incidence is really scaring you too much here. I'm trying to understand where are the sources of pressure that's causing that charge to be so much bigger than what we've seen before, despite the fact that you've taken these charges in the past and have gotten rate increases.
Yeah. I don't think it's necessarily that much bigger than before. I think our 2011 charge was in the high $800s. Relative to the growth in reserve census, this is actually smaller than that charge. The charge in 2014 was around $700 million pre-tax. Again, the thing I'd point you to is we haven't completed the work yet. We haven't finalized where our reserve assumptions are. We've given you a number that we are not likely to exceed. We haven't given you a number yet. I'd ask for your patience to allow us to do our work, allow us to finalize where our assumptions are, make sure that we've validated those assumptions and done all the quality assurance. I mean, hold off. We're going as quickly as possible, but I'd wait to see where the charge is.
Understood. I was trying to get a sense of how concerned-
If there is a charge.
Okay. Relatedly, I just wanted to, for sort of score keeping here, I think in the past you had not built in future rate actions that have not been filed for in your GAAP reserves. Is that approach going to be, is that right, A? B, is that approach, are you going to take a similar approach this time?
Yeah, great. Thanks for the question. This is Steve, Suneet. Yeah, that would be our approach. There was recently a Actuarial Guideline 51 issued that actually makes that a requirement of how you think, at least for statutory reserve adequacy, makes that a requirement of how you go about that best estimate. That had always been our methodology, is to have at least a planned rate action strategy in place before we put any kind of estimate of future rate increases into our best estimate.
Okay, got it. Just lastly, on the three to four-point bump that you're getting from the delay in rate approvals, I guess. I had thought, or maybe I was wrong, but I had thought on the last call, the way it was described it was that this would reverse over a couple of years, my understanding was this is something that maybe the regulators had agreed to. They were just kind of making you hold off on implementing. I want to make sure. Is that right, or? Because it made it seem like if you take the charge, that assumption would essentially go away.
Yeah. It was expected to reverse over a couple of years just because we catch up to the premium level in the rate increases. They've been delayed, but we still expect to get them. Had nature taken its course, that would reverse over a couple of years as we actually get approved for those rate increases and implement them. The fact of the matter is, it's a timing difference, not an economic difference. As we update our assumptions, that'd be one of the things we'd be able to clean up.
Okay. Got it. Thanks.
Thanks, Suneet.
We now take a question from Joshua Shanker of Deutsche Bank. Please go ahead.
Yeah, thank you. I appreciate you extending the call late to take my question. I mean, what you're saying here is that the recent claims experience is probably not in the assumption set that's going to be used ultimately to determine the charge if there is one in 3Q. Isn't there a risk that the assumption sets you've chosen are inducing or are backing into the size of the charge rather than starting from the ground up of what you really have and saying, "This is the facts on the ground right now, and here's what they are." Why preannounce a charge, especially a charge whose incident rates are different from the ones you've most recently experienced? Am I wrong in thinking that there might be some risk of method as you size everything up?
Yeah. It feels a little bit like you're assuming there's one assumption that's driving everything we do. That's not the case. We're looking at all the assumptions. Let me bring you back to the process we're going through to do this. The first step in that process is to do a thorough and exhaustive experience analysis, looking at emerging experience relative to our underlying assumptions. We've made progress on the work. We've not completed that work as yet. We've made enough progress to kind of understand the box we're playing in, which is still a pretty wide box. That's the first step, is the underlying experience analysis. That experience analysis drives choices around what our best estimate of assumptions will be. As we make those choices, we run the results through our projection models.
You need to step back and analyze those results, understand what the drivers are, understand not only the underlying reserve that that generates, but also understand how that reserve will function as experience emerges and what the incidence of earnings that's likely to produce under different sets of scenarios. After you've analyzed those results, it's an iterative process. You'll go back, and some of that analysis will identify things that you may want to tweak in the process. We're working through that right now. There's not a single assumption set, but it's not an engineering piece around here's the results. We're engineering assumptions to get there. It's really an analysis of what we've experienced over the last
five and 10 years, what we think that portends for the future in making sure that we have a robust assumption set that covers that.
I think there's two things you said, Josh, which are important. One, it will include up-to-date assumptions through the point of when we make the determination. The second is, you talked about it being a top-down. It's absolutely a bottoms-up process, as Jack talked about, down to every assumption data flow. It rolls from the bottom up in the process, and we'll see where the numbers come in. I think that it's important, as Jack said, that we've seen enough now where Jack and the team think they can make a reasonable call, and that's what we've done. There's still work to do, and I certainly appreciate the work that the team is. They're going to close this process 50% faster with all the quality, with more people in the process. We look forward to bringing that to you in the third quarter.
Completely unrelated, can you weigh the pricing trends in disability right now to where you thought they'd be today given the tax reform impact that that should be having on pricing trends?
Go ahead, Mike Simonds.
Yeah, I can take it. When we talked about the tax, I still think the logic that we went through when we talked about the tax reform still holds. Which is, in general, for the industry, it's a relatively low margin business. A few of us tend to do a bit better. But when you look at what a tax reduction on the magnitude that we saw as a percentage of margin generated off of a business like group disability, and then translate it back to a percentage of premium, you're really only talking about one point to two points of pricing gravitation. We would sort of see that as just kind of normal give and take in the market. What we're seeing here in the first half, I wouldn't tie directly back to the tax cut.
I'd say, in general, it is a bit more competitive than we experienced in 2017. Having been through this cycle many times, I would certainly not call it abnormal. Again, when I look at it, most important to us is, are we able to place renewals? Are clients sticking with us? Persistency over 90%, it's a very good story. Renewals are actually tracking a bit ahead of plan in terms of placed rate increase where we need to do so. As I look at the pipeline for the second half, we are not going to abandon underwriting discipline, but I'm optimistic about growth in the segment.
Thank you for the answers.
Good.
Our next question comes from Robert Glasspiegel of Janney Montgomery Scott.
Good morning, Unum. Sorry to ask a group disability question, but it seems like through six months, your investment income's down $16 million on your adjusted income statement, and your adjusted operating income's down $17 million. This is a point in the economic cycle where, having followed Unum since you went public, when the unemployment rate's dropping and normally the benefit ratios sort of drive improving underlying earnings. It sounds like there's something more than just investment income holding back comparisons. What would that be?
Well, Bob, first of all, it's Rick. I'd like to say we very much appreciate your group disability question. Let me turn that over to Mike.
Yeah, thanks. Bob, appreciate the question. I think you do, and maybe just stepping back even from the pure second quarter, I think you've hit on one of the primary headwinds when we think about before tax operating earnings for group disability. Jack highlighted it a bit, but when you think about just based on new money, a slow decline in the portfolio yield, you look at the work we've done around looking at reserves behind the line and finding some spots where we updated assumptions and got a bit more capital efficient. Certainly, we have experienced favorable incidence and as importantly, very steady and strong recovery patterns, which is leading to a modestly shrinking claim block. When you kind of take the sum total of those changes, on the one hand, it means less income from invested assets.
That's a few million dollars of pressure if you look at it on a pure quarter over prior year pure quarter basis. I think that kind of order of magnitude of headwind's going to persist all else being equal over the next couple of years. That being said, a more capital efficient business is allowing us to generate a stronger return on equity. We're now in the mid to high teens in the group disability business. This is a really healthy business. The stickiness of client retention we've highlighted across the group business, certainly true in group disability. The stability of the loss ratio, just a tick over 76% here in the quarter and right in line with where we forecasted it would be at Investor Day.
When I look at them, I think where we're going to offset some of that headwind will be as we find ways to grow the business profitably. I look at some of the trends we're seeing with growth in employee and contrib pay and group disability. As we grow our capabilities, particularly around absence management, regulatory compliance around leave, the growth in corporate leave solutions, we've added some technology in helping individual employees plan around leaves. All those I think are contributing to a more bullish outcome for growth going forward. I'd say that's sort of the general picture on group disability. Yeah, Bob, this is Jack McGarry too. I would just add that the relationship between our discount rates and our new money rates have improved pretty significantly over the past six months.
Spreads are widened relative to year-end. Underlying Treasury rates have gone up as well. We have benefited from that.
Okay, if I could sneak one long-term care question. Can you remind me what your undiscounted reserve is for this block?
I'm not sure I understand the question.
When you put up reserves-
On discounted, you mean-
Go ahead.
You mean like the sum of future benefits, less premiums? We don't look at that.
I'm just trying to see if you're off by 5% on the ultimate claim before you discount it back all those years, what the sort of order of magnitude could be in sensitivity analysis.
Yeah. Given the length of long-term care, you can't look at it from a non-discounted basis, and we haven't tried.
Okay.
Interest rates will continue to be a really important element of that analysis.
I got you. Thank you.
Thanks, Bob.
We now take a question from Ryan Krueger of KeyBanc Capital Markets. Please go ahead.
Good morning, Ryan.
Hi, good morning. Just two quick ones. Do you have an estimate for your year-end RBC ratio contemplating tax reform and other factors?
Yeah. Actually, as the factors have changed, have played out, particularly some of the changes related to long-term care and disability insurance risk factors, the impact of tax reform has not been as dramatic as we once thought it was. We would expect to end the year kind of in that 360, 365 range.
Thanks. When you derive your capital plans, what do you typically assume for annual cash contributions to long-term care?
It has tended to be annual cash contributions in that $100 million to $200 million range.
Okay, great. Thank you.
Thanks, Ryan.
As a reminder, we will now move to our next question, which will come from Mark Till of RBC Capital Markets. Please go ahead.
Hey, good morning. Thanks for keeping the questions open. Just a point of clarification on something you had said in response to one of the prior questions. Normally, when we see reserve adjustments contemplated, they're expressed as an actuarial range. Are we meant to think of the $750 million guidances as kind of the 95% confidence level of the high end of the actuarial range? Or is there a different way we should really contemplate that number?
Again, we're in loss recognition, anything we do with reserve assumptions are going to reflect our best estimate. It's going to be kind of that 50/50 call, where we would expect actual emergence could go on either side of that. The 750 that we put out there isn't like the high end of an actuarial range. It's just saying that what we know now, which is we're still doing the work, and we haven't finalized the assumption set. We can't give you a number right now. We believe that number would fall somewhere in between 0 and 750 after tax when we actually finalize that. We are working as hard as we possibly can to get that information to you as soon as possible.
It's fair that a considerably lower number is at least theoretically still in play. We shouldn't just assume that
Yeah
The needle automatically goes to 750 and that's the starting point.
As I said earlier, I would ask you to indulge me with your patience. Again, I wouldn't just assume that it goes to the top.
Okay, thank you. That's helpful.
Thanks, Mark.
If there are currently no further questions, I would like to turn the call back over to your host today for any additional or closing remarks.
Yeah. Thanks, Bettina. I would just thank everybody for taking the time and actually extending out a little bit. Hopefully you got a good sense of the questions, and I think Jack did a nice job of talking about the dimensions of what we're still working on. So we'll do that as we get through the year. We will be out there in the market talking to all of you at a number of insurance conferences, investor meetings over the next several weeks, and we'll look forward to seeing you then and working through our third quarter process. That's all we have for today. That completes our second quarter earnings call. Thanks, everyone.
Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation. You may now disconnect.