Okay, we'll get going with the next section. I'm Nigel Dally, Morgan Stanley's life insurance analyst. I'm here with Jack McGarry, Executive Vice President and CFO. Long-term care, maybe good, Mary, to start. Just where do you stand with regards to the reserve analysis, and when do we, as investors, begin to hear something next?
We're definitely making good progress on the reserve analysis. We are well underway of the review of assumptions. It's a long process. There's a lot of assumptions with a lot of both kind of research work around how actual experience is emerging relative to those assumptions. As well as even once you get to the point where you kind of have an idea of the validation in audit work to make sure that it's right, make sure that everything ties together, getting it through independent audit, external audit. We will have a third party review it, independent third party review as well. Yeah, it's a long process. We're making good progress. It's moving along as expected thus far. It's a tricky process. You got second quarter coming up. I know people would like an update on second quarter.
We're working with our external auditors to figure out what we can and can't say because you're kind of in that, well, if you know it should be that, should you be saying and taking it now versus I can't promise what we'll be able to disclose. We will certainly give some form of an update of the progress in second quarter.
I guess there's a lot of different things which go into the reserve analysis, the interest rates, the lapse assumptions, the claims incidents. Which of those troubles you most and which of those are you most comfortable with?
Interestingly enough, it's not interest rates because that's pretty clear. We were very open with what our interest rate assumptions were last time, and everybody understands that. Among the other things, I would say, probably disabled life mortality and claim durations is the place. When we took the reserve charge in 2014, we were experiencing longer claim durations than the industry was. We made an assumption that we would revert toward the industry norm over time and look at a weighting between us and the industry table. Unfortunately, I think the industry has reverted toward us as those. That's a place that we know we have some work to do. Actually, we felt reasonably good about incidence rates. They've been pretty well-behaved over a volatile, but well-behaved over a long period of time.
We've actually seen morbidity improvement in our actual experience as a block, which has been helpful. I'd say mortality is, we're feeling reasonably good about the mix of mortality and as well as persistency. Particularly having good persistency experience on the group block, which is remarkably different. Persistency on the group block is largely driven by employment and how quickly people turn over in the block because most of it's employer-funded. I would say, the place we're really focused on the most is claim durations.
Right. Just on that point, I was going to ask, you've got two very different blocks, the group block and the individual-
Yep
block. When you kind of parse those apart and look at the reserve analysis, is it really the individual side that's been causing the most problem, or
Definitely the underlying dynamics of the group blocks are extremely different. They're even different than other people's group blocks. When other people sold group, they generally sold it on a voluntary basis. They got a couple of % participation in a large carrier, I mean, a large company. It was largely individual nature of business. Since people were voluntarily buying it, they were paying the premium, they were choosing the plan design and the coverage. It looked like just a little bit younger individual coverage. In our group block, most of our plans were sold to small to mid-size employers. Most of those plans had employer-funded coverage in them, so the employer would fund a $1,500 a month, two-year benefit period for all employees, and then allow voluntary buy-ups on top of that. We have 850,000 group lives.
It covered most of those are active employees with an employer-funded policy. The dynamics of that block are much different. The lapse dynamics are driven by employment and how long people stay with the company. A 35-year-old rarely takes that coverage with them and starts paying for it when they leave their employer. The plan designs are just so much more conservative on the group side. The underwriting dynamics of selection are dramatically different, and the experience is dramatically different as well.
Right. I think one of the things that people have been concerned about or what we've been looking more for has been disclosure.
Yep
On the long-term care side. We get very limited disclosure on the additional forms following the statutory statements. Has all of the recent experience with regards to maybe stock price movement and the questions that you're getting led you to take a different tack as to what potentially you'd be willing to disclose to investors on this?
We're certainly thinking about disclosure. It's a gnarly problem to think about, because the problem with it, anything you disclose, you can't explain it fully enough that you can absolutely corral how it should be interpreted.
Right.
Anything you put out there can be used for good or bad.
Potentially do different.
Equally. Not even additional. The additional questions we could handle. It's people making assumptions about what was disclosed and using those assumptions that they made about it to compare across industries and things that generally are unintended consequences of the disclosure. It's a trade-off between sharing enough that can give people comfort with where you are without getting yourself into jeopardy because people are misinterpreting or misusing the things that are being disclosed. We understand what the marketplace is crying for. We've heard the rumors of others that are going to come out with broader disclosure. We'll continue to look at that. We will disclose certainly what we think is helpful to us and to our shareholders. We understand we compete for capital in a marketplace that you need to kind of follow suit.
Right
with others, that'll be an active, ongoing discussion within Unum.
Okay. I know you've discussed this previously on conference calls, the GE charge really caught a lot of people by surprise, and I think it's made a lot of people nervous about any long-term care exposures. Probably worth reiterating just how your block of business is different from GE and the situation.
Yeah. It's different from a lot of perspectives. It's a direct block as opposed to a reinsurance block. A lot of the problems, and even GE's charges were not even across the board. A lot of it was concentrated on their ERC block. That was an older reinsurance block. The mix of our business, even our individual business is significantly younger and has a different composition than GE. Also half of our business, half of our premium associated with group policies that aren't even comparable to other long-term care carriers' group policies because they're dramatically different and are night and day relative to what GE is working with. Those underlying group blocks, I would say the fact that we've been in loss recognition since 2011.
We have been among the most transparent organizations in the industry in terms of how often we talk about long-term care, the disclosures we've made around the underlying block, the way we talk about some of our assumptions, particularly interest rates and things. It has just been an actively managed block, and in the management of that block, we have focused on being consistent. We have taken two GAAP charges. They've been in that mid-$500 million type of range. In the interim, we have rebuilt our STAT GAAP margins. We have done that while returning capital to shareholders, both in terms of pretty consistent around that $400 million level of share repurchase. We've been steadily increasing our dividend. The rebuilding of that STAT has cost us money from a capital perspective. We built that through the free cash flow generation.
That's kind of a consistent model that we want to continue to follow around, we will take our medicine with long-term care. We will rebuild our STAT GAAP differences so that as these charges come up, when they are needed, they will largely be STAT events that's already built into our capital models and already built into our view of the $400 million of share repurchase in our dividend structure. I think if you look at Unum, we have really valued being consistent and predictable. Our expectations as we go forward in managing the long-term care business is we'll continue to have that predictability and consistency.
I think one of the things that people came away with from last quarter's conference call, or at least on the fourth quarter conference call, you were very strong in your view that it was very likely that any charge would be GAAP, not STAT. People came away from the first quarter conference call perhaps a little less confident that that would be the case.
Yeah.
Was that on purpose, or were people just interpreting various comments in a different way?
I would say there were two things. I think there was, at the margin, maybe a little less confidence because of fourth and first quarter emerging results and not having actually begun the work to look at what that means. I'd say at least as much, if not more, was in the interpretation of what I was saying as opposed to the words. Like, the group I spoke to at the end of the first quarter was a completely different group than I spoke to at the end of the fourth quarter. The question at the end of the fourth quarter is, how does your block differ from GE? The question at the end of the first quarter wasn't even a question. It was a demand of prove to me that you're not GE.
I think it's a combination of some of the results that emerged. I don't think our view of the world of long-term care has changed significantly-
Right
between those two periods. I think the way the world views long-term care has changed dramatically, and so I think it's a mixture of interpretation as-
I guess you-
Well, as perhaps the words.
Right. Just given how volatile the long-term care can be and how long-term nature it is, how much the capital can change how much it can be variable or the amount of capital you need to hold against it, depending on experience. Would holding back on buybacks be something which you would consider, or is it just too long out that it really isn't something that consistency of capital return is more important?
That's something you think about. Look at GE. They said they're going to put $15 billion into long-term care reserves over the next seven years, right?
Did they say at the end, "I will guarantee you that we will never speak about this again." It would nowhere near be kind of those orders of magnitude. Because it's an emerging risk that's going to emerge over a very long period of time, we put $1 billion behind it. We put $2 billion behind it. Can you still give any guarantees that? What we're going to do is we're going to manage it, and we're going to take advantage of the time horizon that it has. We have the resources as a company to continue to return funds to shareholders. Actually, if you look over the history of the past seven, eight years, we've been funding long-term care to the tune of like $200 million a year. That's how that STAT GAAP difference builds over time, is through that funding.
If we said we're going to fund long-term care to the tune of $200 million a year over its entire life, we wouldn't change our capital plans at all. We would be the company we are today. It's like the equivalent of a multi-billion-dollar strengthening.
Right.
The question is with locked-in reserves, do you want to do that up front, or does it make more sense to just manage it over time, stay ahead of it, as we have, and take that? Because at some point, the need for that capital ends, and you don't want to be over-committed to it when that happens.
Right. One more question on capital before we get to some of the ongoing businesses. With capital, there's been a range of different changes on the horizon with regard to-
Yep
C1 factors, taxation changes.
Yep.
Does that alter the way you're kind of looking at capital management at all?
It certainly, it's had an enormous impact on the work the capital group has been doing over the past six months. I would tell you, I think those changes are a testament to the resiliency of our capital plan. We're in the market in the second quarter buying back shares. That's despite the fact that we had to write off deferred tax asset. We were well-capitalized when we did that. That brought us back into kind of our range of risk-based capital ratios. We've seen what the NAIC is proposing. We are in a position that we feel, it hurts capital. We have less excess capital than we had before, but we're in a position to manage that, and kind of maintain that buyback program. We're dealing with rating agencies. I think it's clear AM Best and S&P have been pretty comfortable with our capital levels.
They use pre-tax capital levels, which by the way, I think makes economic sense. Actually, I'd like to talk about that for a second, too. Moody's is the question mark, but we feel comfortable with where our capital levels are. Particularly if you look at the current proposed NAIC factor changes, they have an impact on us, but it's not as big as we originally expected. I think we're lower down on the scale than we were before, but we're still in a very comfortable position. In terms of the tax impact on capital, it's kind of a pet peeve of mine. People have said that tax reform was credit positive. I absolutely think it is. Even from a factor, it's hard to understand why taxes would be an economic factor in capital.
If you look at what happens with capital, if Unum has a $500 million loss in a line of business, that's less than our overall earnings. We are still a taxpayer, and we have more capital left at the end of the day in a lower tax environment than we do as a higher taxes environment, because we're still paying taxes. If you have a $2 billion loss, and you go a half a billion into the hole, you don't get any balance sheet relief from that because it's loss carry-forwards now, and those are not admitted.
You have that loss, you will have an impact on future taxes, but you need pre-tax income of $500 million to offset that pre-tax loss of $500 million. That doesn't change no matter what the tax rate is. Once you've offset the loss, going forward, you're earning money at a lower tax rate, and so you can not only overcome the loss, but replenish the capital you had before at a faster rate under a lower tax reform. Economically, I struggle to see how you can think that taxes impact the economics of capital. Yet, the RBC ratios are likely to go up as a result of tax effect. I subscribe to the S&P and AM Best models, where their formulas are not tax affected.
Just hitting on the topic of tax reform, I think one of the concerns that people had was tax reform could be a catalyst for an escalation in competition-
Okay.
-in the-
Yeah
U.S. brokerage business.
Yeah.
Any signs of that happening or?
We have not seen signs of that happening. The business we're in is always competitive. There's 15, 20 players who are there all the time. We have not seen a change in the pricing environment. I think what we have seen in the first quarter, we've seen, not only for us, but I think for other carriers, pretty good persistency. For some reason, cases are staying put where they are. We're happy with the renewal season we had on 1/1, had good persistency coming out of it. There's some disruption in the market with some of the transitions of blocks. Some of those are going to need some work as a result. We haven't seen that in the market. Tax reform is so small relative to the group kind of margins and premiums that it'd be hard to discern that level-
Right. Yeah
of changes in prices. It's not like you can cut rates 1%, all of a sudden you're writing a bunch of-
Right
more business. We've seen a lot of stability.
Okay. How about the impact of the labor markets, very tight labor markets. Is that beginning to result in additional wage pressure around-
I think we're beginning to see some signs. We didn't throughout most of the economic recovery, I think, because in part there was a lot of part-time work initially, a lot of low-paying service jobs. Kind of hourly jobs don't tend to be the population that we service. We've seen more of tight labor market in the salary type of core markets that we do cover. We've begun to see some signs of wage inflation. It's not remarkably robust.
Right.
I think we've seen some positive signs and would hope those would continue.
Okay. Just on the U.K. operations-
Yep
with Brexit and the like, it seems to have resulted in a bit of stagnation in that market.
Yep.
Do you see any change in that?
We really haven't seen a lot of movement in the growth of the market. I think we saw two things with Brexit. We did see stagnation in the market, and so a lot of business wasn't moving really. New cases weren't coming on board. Businesses weren't growing. I think we still see that businesses aren't necessarily growing. We've been putting rate into the market from both an interest rate perspective as well as some of the claims experience we saw during Brexit. Our view is, we talk to other people in the industry, they've seen that same type of claims experience. We've been having very good success with those renewal programs. We've been having good persistency on the heels of them, I think in part because it's an industry effort. Not a lot of growth, not a lot of switching either. Some good persistency trends.
We're seeing minor growth in the overall top line, but also see an environment that is stabilized, so we're not continuing to see pressure on risk results, and seems to be pretty favorable to taking some of the renewal actions you need to take to make some progress on the block.
Okay. One last one from me before I open up to everyone for other questions. For the sake of completion, Colonial
Yep
seems to have been posting up better growth and better sales in some
Yes
years. Why is that? What is the competitive advantage?
A piece of it, the environment's been favorable to voluntary sales, particularly the increasing trend toward high-deductible health plans. They open up things, room for Colonial with critical illness coverage, with accident coverage. We can't give you a comprehensive medical, but we can at least cover some of the big risks that you'd face if you think about how to fill those deductibles. We've been investing in geographical distribution expansion for Colonial. We've been building three or four new territories a year. That's been a successful effort. That's contributed to growth in Colonial. Last year we saw 7.5% sales growth in Colonial. We've seen 6-plus % premium growth. We're going to see double-digit sales growth, we believe, this year with the introduction of the dental product and the continued expansion of territories.
It's a great growth story in a market that doesn't see that level of growth in the same way, particularly if you're looking at the pure worksite market, which is where Colonial plays. A really good story. Our offerings are resonating. We have a very highly motivated and effective sales force, and our sales proposition of being simple and meaningful is resonating with our customers.
Okay, good. Why don't we open to the audience for any questions you may have?
Could you just talk about the pricing environment in long-term care, what you're asking, what you're being approved from regulators? Are you finding that the regulatory environment is getting tougher in terms of asking and then getting what you're requesting?
We are finding that it's getting tougher. In fact, if anything, particularly if you look at it over a longer time horizon of the last five years or so, it's definitely gotten easier to get rate increases. I think there's more recognition on the part of regulators that they have a dual responsibility for solvency in protecting consumers. I think some of the things that have happened with Penn Treaty and some of the problems have heightened their focus on that need to protect both the company as well as consumers. I think that's been favorable. We have not seen a pullback. We've been to the well before that we continue to see opportunities in our block for places that we haven't hit as hard recently that we can go back and ask for. We will closely tie our reserve assumption review to our rate increase plan.
To the extent that we adopt a more conservative set of assumptions going forward, we're going to be asking for the rate increases to support that assumption set. I think there's recognition on the part of regulators that there is a connection between reserve levels and rate increases. If they want, they can't require companies to hold reserves on one basis, but not approve rate increases on a consistent basis. I'd say it's been a positive trend.
This guy here.
Okay.
Not following the industry so closely, is it fully clear how GE could have got it so wrong that they needed a $15 billion reserve build? Are your auditors or your actuaries being given kind of a new set of standards from the regulators by which to sort of assess reserves?
It is completely unclear how GE could have gotten in the position they were. We don't understand it. We don't see how anything comparable to that, given how close we are to the assumptions, given how often we review assumptions, both internally, analyze quarterly results, deal with our auditors. We have a team of dedicated actuaries, probably a dozen or so full-time, working on long-term care. We don't understand it. We're very comfortable in how we manage our business and how we work with our auditors. That is not us.
The second part of the question is, are your auditors getting a new set of standards that is kind of raising the bar?
No, because GAAP hasn't changed as a result of GE. We're in loss recognition. We continue to hold our reserves, our GAAP reserves, under best estimate assumptions. We review those assumptions in gory detail with our auditors. They are fully disclosed. The model is accessible by our auditors. They've stood with us throughout. They have seen how experience is emerging. They will see completely how we react to that in our assumptions. It is a complete partnership with our auditors in terms of where we come up with and how we communicate that.
Over there.
Yes. I was wondering if you could walk us through how a GAAP charge becomes a STAT charge and what the implications are of that.
A GAAP charge becomes a STAT charge when it grows big enough that the net charge is over your GAAP STAT difference.
Could you highlight for us what that would be for you guys?
Right now there's about $1.1 billion difference as of the end of first quarter between STAT and GAAP. That will grow by $200 million by year-end.
Grow positively, wider?
Yeah, grow wider. It'll be $1.3 billion or something. When you're looking at a GAAP charge, the first thing you would do as you change assumptions is eat through any existing margin in the GAAP reserves themselves. Because we've had favorable investment experience under our old assumptions, there's some margin there. The second thing you'd do, you would look at revamping your rate increase plans and making estimates of, based on this new view of the world, what does that mean for rate increases and what I can expect to do. The third thing you do is you increase the GAAP assumptions, so you take a reserve charge. That third element, after you go through existing margin, any future rate increase assumptions, and increasing GAAP reserves needs to get through the statutory reserve threshold of over $1 billion before there's a statutory event.
I guess the last follow-up on that, should there always be a $1 billion spread between your GAAP and STAT reserves?
No, actually that $1 billion has been an accordion. When we've taken charges in the past, that spread has narrowed to several hundred million. We have continued to grow statutory reserves faster than our best estimate GAAP reserves. That's why our events have tended to be GAAP events as opposed to statutory events. That excess growth of statutory over GAAP is incorporated in our current and future capital models. We would continue to endeavor to manage that business in a manner that's consistent with that.
Just one last one over here.
Are there some states where you're not getting the price increases from regulators that you may not write new policies on long-term care insurance?
People have speculated about that. If that were the case today, nobody'd be getting rate increases because there are very few people who are really in the market writing long-term care standalone policies. I don't think that is at all the driver. I think it's the justification for the rate increases. It's the relationship that I think the entire long-term care industry has built with the regulatory industry in terms of understanding where the long-term care industry is, understanding the need for future rate increases. I don't believe that's a factor.
Thank you.
We are unfortunately out of time, but appreciate all the commentary.
Thank you very much.
Thank you.