Thanks for joining. I'm pleased to have Jack McGarry here, the CFO of Unum. Jack, you probably get a lot of similar questions. It's worthwhile to have you here. You ran the closed block business-
I did
for many years, and of course, it's dominating with the stock right now.
Sometimes I feel like I'm running it again, actually.
Yeah. I told Tom I'm not going to ask any questions about long-term care unless you volunteer information. Look, I'm known to ask the questions, I guess basically we want to talk about size. Obviously, the stock is reflecting what you guys think is a $3 billion or $4 billion hole.
Yes.
How should people think about a charge in any given year if things go adverse, if you had morbidity or mortality go the wrong way on you, and such, what would that mean for one year, and how can people get comfortable? It's not the market just thinking about what might happen this year.
Yeah
What might happen over the long term. Everyone has reasons why their long-term care book is not as risky as everybody else's.
Yeah
It's a free-form question. You take it where you want.
Okay
Go for it, and see where it leads.
The book is volatile. One of the things that drives that, we have $10 billion plus of reserves on the book that get adjusted by all kinds of assumptions. A little chunk of $1.5 million that either sticks to the reserves or falls off the reserves because of a change in assumption is worth 1% in the quarterly loss ratio. $1.5 million coming off of a $10 billion block just isn't much. That magnitude of difference between reserve levels and premium levels is going to contribute to the volatility of the block.
That talks about the nervousness around the one Q elevated attrition.
Yeah. It's a piece of that. I would say, again, that there's nothing that happens in a single quarter. There isn't even that much that happens in a year that necessarily precipitously changes your view. It happens over a number of years. You look at things that when you're looking at the assumption set, you look at things that have gone in the wrong direction relative to your initial assumption sets. There are things that have gone in the opposite direction that may or may not be coming through the loss ratio currently. It really is right now, it's an exercise of re-looking at everything we've done, taking a long-term view, looking at the direction that things are going, and accommodating both in a set that is a good reflection of our current experience. I'm not talking about last year's experience or 2000.
I'm talking current experience over many years. We feel good about going into the future, and that conforms with what we're seeing today from an experience perspective. Also, another measure is conforms to kind of industry standards as well.
I guess when we think about it, there are five variables that I think about. Maybe I should think of even a sixth one, which is the passage of time.
Yep.
The data gets better.
Yep.
Morbidity, mortality, lapsation, interest rates, price.
Yes.
I guess over the past three years, can we say, is mortality any different? That's a less volatile I guess, in many ways, I see the U.S. mortality is actually going down right now.
Yes.
People are dying younger.
Yes.
That's positive for long. I don't know. Can you walk through, I guess, the basic underpinnings the last three years, what's changed?
Yes.
We don't have the actuarial map here.
Yes.
Maybe we'll have the dummy map.
I'm not sure mortality is actually we're dying younger, but we're not-
We're not getting older.
We're not progressing the way we used to, the improvement in mortality has slowed down over the years. I'll take the assumptions. Interest, we have been very effective in putting new money to work over the past three years. We had assumed a 5% rate in our assumptions. We've exceeded that by a pretty reasonable margin. I think if you looked at our results, despite the fact that the loss ratio has floated up pretty steadily during that period, our earnings has remained pretty flat. A piece of that, because a lot of that has been offset by interest margin because we've exceeded the assumptions in the reserves. Interest feels good. We're at the point where we're going to begin to grade up. I felt pretty good about things until yesterday, which was a blow.
Me too.
Hopefully, things have rallied back today somewhat. Interest, there's enough volatility in the interest rate market, there's enough different asset classes to invest in, that we feel reasonably good. It's somewhat of a challenge. Interest rates have worked out pretty well for us over the past three years.
Lapsation?
Lapsation has been okay. Particularly group lapsation continues to be a help to us. You got to remember, the majority of our group block is employer-funded, so they're very small policies, maybe $2,000 a month, a two or three-year benefit that an employee gets. We're insuring 25-year-olds and 35-year-olds, so it's a workforce population. I will tell you, when a 25-year-old lapses, leaves the worksite. They don't pick up that premium from the employer, there's a steady churn of people as they leave the work. They don't bring the policy with them. That helps from a lapse perspective. As people get older and more of it's voluntary, they tend to approach a more individual lapse. I would say, at the older ages, I think we already had a pretty good lapse assumption. We were under 1% ultimate lapses.
There tends to be a gray area between lapses and mortality. Oftentimes, you can't really tell whether someone died or lapsed. All you can tell is that they stopped paying their premium. We used to have a better line of sight on that a few years ago because the Social Security Death Master File was a pretty good indication of overall mortality. I think it was like 2011, Social Security stopped reporting on state-reported deaths, so deaths that came to Social Security not through the decedent or their family, but through state reporting, like escheat things. About a third or 30% of the Social Security Death Master File has disappeared. It's harder for us to distinguish between mortality and lapses. I think when you look at the two of those combined, they've been pretty consistent with where our assumptions are.
The pricing rates or state-by-state rating.
State-by-state, we've pretty much fulfilled our 2014 assumption. We had built $1.4 billion into our assumptions, where we're kind of 90% of the way through with that, so I have kind of like $150 million left. We would get that $150 million from just those states that give us annual 10%, 15%, 20% rate increases year after year. I would say on the rate increase front, we've completed. The timing of that was a little later than we expected because we didn't necessarily build into our assumptions that we'd have states that would just give us ongoing 15% rate increases. Other states, where we're asking for 90, gave us 30, 30, rather than a straight up 90. There's a lag. That's actually putting 3%-4% of pressure on our current loss ratio.
That pressure would dissipate over the next three to four years as those tranches rate increases catch up. It's a current element to the extent we do take a reserve charge, and we update assumptions, that would take care of that 3% as well. Incidence has trended pretty reasonable relative to our assumptions. The pressure we have seen is with claim termination rates. When we took our reserve charge back in 2014, our claim termination rates were higher than industry average. We assumed that over time, they would grade more toward the industry average. Unfortunately, I think what we've seen is the industry average has graded toward us. That would be the place where there's some pressure on the reserves. It's a big puzzle to put together to figure out where are the pockets of incidence trends, how do they offset.
We're in that solution set now, where we're working hard at it. We'll see where it goes. We still feel good about kind of the history of our block of we've taken GAAP charges. We've, in interim, built up statutory reserves above our GAAP reserves. Most of our events have been largely GAAP events. We still feel comfortable over the long term that that's a good formula for managing this block. Can you guarantee that there won't be a statutory event at some time? No, we can't guarantee it. Within reason, we think that's the trajectory the block's on and how we'll manage it over time.
Along those lines, one of your, I don't want to call competitor, I would call it just another long-term care.
Yes
reservist.
Yep.
Manulife has said that they feel very confident in their position because they believe that Canadian IFRS accounting is more conservative than U.S. GAAP accounting.
Depending on what the interest rate environment is.
Right. I don't want you to opine what you think it would be, but to what extent is accounting a limitation or a scaffold on which you can actually feel good about what you've done?
Accounting is not a limitation. Within reason, you can set up as much reserves as you want to. Manulife is making that statement. I'm by no means an expert on Canadian GAAP. I'm mostly drawing on my experience with U.K. GAAP, which is kind of a similar IFRS notion. The GAAP reserves get marked to market. They use a current interest rate. They don't recognize in them that you've invested money at higher rates historically. That would tend to increase your GAAP reserve. I understand it that Canadian GAAP also has pretty significant provisions for adverse deviation in their GAAP assumptions that are required. That increases GAAP reserves. A piece of the mark to market, it increases your GAAP reserve. A piece of it gets offset by the fact that you're marking your assets to market too.
You get a similar increase in the assets backing reserves. It's still conservative because you have more future benefits than you do current reserves. That's a piece. I think their statement is probably accurate. I wouldn't aspire to be them because the funding of those reserves has come at a huge cost to Manulife. Manulife today is their stock has traded off 40% over the past decade. A big piece of where they trade is the fact that they're needing to plow what some would think is probably excess capital into their long-term care business because of the accounting regime they're in. We want to hold adequate capital.
It's not our goal to hold huge excesses either.
Well, I have lots of non long-term care questions, which I'm sure you'll-
Okay, great.
answer, but I don't want.
That would be a change.
End the long-term care questioning. Does anyone have any long-term care questions before?
Jack, there seems to be some question as to what the life, because everybody's comparing you to GE. What's the life of their average life what? Some people say, oh, you guys, I think would say it's in the low 80s, which would give you a lot of time. You've got 10 years to build your reserves. Other analysts have said it's more like 76, which is more concerning. Do you have a better feel for what it really was?
I don't know any more than anyone else does about what is underlying the GE reserve charge. I'd say too that from what I understand, the positions of the different companies that fall under GE are very different. The charges weren't the same % on all companies. It hit one company significantly harder than the other company. I would say, if you compare reserves, you can't compare Unum's reserves to GE, because half of our business is a group business, the bulk of which are working age people being covered. They have nothing to do with what GE looks like. If you compared GE to our old ILTC block, which was the block that was issued before 2004, yeah, our average reserve on that block is orders of magnitude today, $50,000 per policy. That reserve will double per policy in the next 10 years.
It's not on top of GE, but it's not inconsistent with GE either when you take a similarly situated block.
One other quick question on California sitting and rating?
Yep
sitting at the commissioner-
Yep
Any sense of timing on something like that?
We're through the process. They've done their actuarial review. They've signed off. It's through the actuarial process. It's now in a political process, it's hard to predict. We're not thinking it's years away either. We're hopeful that we will get an answer soon. I'd also note that the answer you get isn't necessarily the final answer.
So-
You'll get an answer. You'll keep on going back and providing new data and requesting additional rate increases.
Just to follow up on the previous question. Can you speak a little about the process about going through the state approvals, and then how the back and forth between the requests for rate increases and what actually ends up going through plays out? Because I think, particularly in the long-term care, I think that's a point of contention and kind of confusion for a lot of people in understanding how that process with the state approvals works. Thanks.
Yeah. I would say that there's, and just as I mentioned with California, there tends to be an actuarial process. Can you justify under the statutes additional rate increases? The answer to that tends to be unilaterally, yes, you can, based on the rules. In fact, you can justify significantly higher rate increases than most companies are actually asking for. That tends not to be a limiting factor. There's the difference between what you can justify and what you ask for and why you ask for it, which is an important element. That's on the actuarial side of the equation. There's a political process that varies dramatically across the country. There are states, particularly on the group side, there are states that have no approval rights to rate increases. You can just file and use the rate increases.
There aren't those on the individual side. There are states that have felt the need to balance what the deal was when companies signed up for this with consumer protection that had been largely approving rate increases. There are states like California, which it has been a long grind. I think they're finally getting there to looking at the reasonableness of rate increases. They have approved some significant rate increases. Recently, there's a state like Vermont that hasn't approved any rate increases. It's all over the map. I would say, in general, it has gotten more favorable with time. California wasn't contemplating major rate increases five years ago. Now they seem to be getting more into the work. We've gotten significant rate increases from New York, Florida, which have been traditionally difficult states.
I think things continue to move in the right direction from a rate increase perspective, but it's a state-by-state grind.
Just a quick follow-up. How much is their strategy of, I guess, you can call it political strategy of going to the states and requesting a very, very high number, but knowing that you're really only going to get a much lower number after the negotiation from ping pong goes back and forth a little bit?
That has not been our strategy. A long time ago with the states, because there's been all sorts of discussions. One of the things, the states believe, and I think rightfully so, that insurance companies issued these products. It was guaranteed renewable, but they should take some stake in the fact that they haven't emerged as planned. When we've gone to the state, we've generally asked for sustainability as our goal.
Yes.
We want the rate increases to fund the statutory reserves that we need to build up over time. We're not looking to enhance shareholder value or earnings. We just want the business to be self-funding. I think that has played well with the states. It's saying that, "Yeah, we do have a stake in this." It's not. Sometimes they still think they're exorbitant rate increases, but at least they're justified based on reasonableness. That's been our approach. Other companies, I'm sure, have taken different approaches with the states. We have tried to build personal relationships with the states. There's not a state in the union that we haven't visited throughout this process, most of them more than once. California, we've almost set up camp in working with them.
I had a couple, just to follow up. Can you just remind us when the annual review takes place for LTC? Do you think at year-end, auditors are going to look at the business any differently, just given the heightened sensitivity the issue has gotten this year?
Our annual review is ongoing now. We are looking at assumptions. It is a complex problem. I think people tend to think about incidence rates, for example, as a single number. Like the incidence rate you saw last quarter was X. Incidence rate in building reserves is actually hundreds of thousands of numbers. It varies by age, sex, plan design, inflation, non-inflation, benefit period. There is just all kinds of variations in there. It takes a lot to walk through and discern. The trends aren't consistent across all of those different cohorts, and it is important to understand how the cohorts perform. We are well into that. We have a very good relationship with our accounting, our auditors. We have stayed close to them throughout this process, throughout the long-term care process in total.
I wouldn't expect to see changes from them in terms of their view. You would hope that they wouldn't overreact to public sentiment. I think they would have a difficult time explaining why they did when they've been involved with us all the time. Are they people? Are they aware of that public sentiment and the heightened scrutiny? Yeah, I'm sure they are. I expect we will be able to work through.
Sorry, just on the annual review, is there a quarter, though, when it's every year where it's definitively completed and you set for that year and move to the next, or?
Yeah. It tends to be an annual review that concludes in the fourth quarter. I would expect that to be the same this year. We are doing a more in-depth view this year than our typical annual review, which has been pretty consistent every three to four years, we've done that. The work is geared up largely so that you can fully incorporate the prior year's full results. We have a mature 2017 book to look at. That is the trigger point for starting the review. With all the work that it takes, both to analyze the experience, to drive it through the models and understand the results, then to clear those results through first a pretty rigorous quality assurance process to make sure that you get it right, and then to clear it through the auditors, it tends to take a couple of quarters.
Just to follow up, the rest of the business is running great. Josh has questions on it, except the stock is, in my view, solely reacting to LTC, I have to go down to the last line of my model to look at the loss ratio at the end of the quarter.
Yeah
I get a sense of maybe which way the stock is going to react. Do you think there's more you can do on your end because the sensitivity has gotten feverish around.
Yeah
This issue where you could say more, you can disclose more. Maybe one extreme is putting more capital into the business if, like you said, you're not handcuffed by accounting, which is maybe arguably what GE did, and said, "Bury this for the next 10 years so I don't have to deal with it as the new CEO." Is there something more you can do to just get people away from this issue to focus back on everything else in the company that's seemingly doing pretty well?
That's a difficult question. Today, our stock is somewhat reacting to our long-term care business, but that's not all of the story. It's as much reacting to GE's long-term care business as it is to ours. It's reacting to the sentiment in the long-term care industry. It's not clear to me how much we want to react to that. Do our shareholders really want us to bury a bunch of their capital into long-term care because GE had this big problem? Or would they rather, as we have, kind of manage the long-term care business pretty smoothly over time, continue to share the rewards of that really valuable business we have as a core and as we have over the past eight years. Long-term care is a problem, but it's a problem we've been managing.
I would tend to say we will be more in the latter camp than the former. If there was one big solution and it came at a reasonable cost, yeah, it'd be great to have it done. I don't see that happening in the near term. If we put a bunch of capital behind long-term care, you might say, "Great, they put a bunch of capital behind long-term care." Half of the other people in this room would say, "Oh, my God, they put a bunch of capital behind. It must be way worse than I think it is." We can't control how people react to things. All we can control is what we do and how we manage it, and hopefully be consistent over time that will gain credibility. I think we did that from 2011 through 2017.
It wasn't what happened to us that rocked that. It was what happened to others.
I'm a fairly risk-averse individual.
Yep.
I have no portable disability insurance.
People say it's a huge hole in my coverage.
It is a huge hole in your coverage.
I noticed in your-
You can get mine done.
Yeah. In your investor presentation, say 70% of Americans have no disability protection.
Yes.
I watch how much insurance companies advertise on television.
Yes
mostly around auto insurance.
Yep.
Has there been a huge failure to educate the population about the need for disability insurance? Even someone who covers it myself, boy, it's expensive. I wonder, is there an opportunity here that Unum and others have failed to capitalize on? It seems like there's a fertile ground to sell more disability if only you could capture the imagination in a popular way, I guess. Maybe yes, maybe not.
Yeah. No. It's a good question. We hear it all the time. There are three categories in terms of marketing. There's marketing what people want, which is what Google and Amazon do. There's marketing what people need, which is auto insurance. Auto insurance is compulsory. It's not whether you get it or not, it's simply who you get it from. There's marketing things that people should have. Marketing the things that people should have is a lot tougher than marketing the things that people want or must have. That's squarely where the disability insurance falls. There really isn't a robust individual disability insurance market today, because it is really hard. There's a difference between educating people about the need and getting them to act on that education.
Why have employers successfully been educated to do it for their employees?
Employers do it for their employees.
Right, of course they do.
They do it 30%. That 30% is a misleading number because there's a lot of people working for very small employers that don't provide coverage. There's a lot of people who work part-time, that don't get coverage as well. There's a lot of people that work in industries that even if they wanted to give it, they wouldn't be able to because they're not covered industries that we view as being insurable. That 30%, it's not like it could be 100. There's a cap to that. I think there's good penetration in the employer market. I think there's very poor penetration in those people who are kind of cut out of the employer market because of either what they do, what the nature of their work is, or they're working part-time or something. That's not you, by the way.
You have a gap in coverage, not because your employer doesn't offer it, but because you haven't-
I haven't got the portable coverage
because you haven't bought up. You have income that's not covered by your employer.
Right. Maybe in the future.
In all likelihood that you should. Actually, the individual disability market, which we are a big player in, has become an employer-sponsored market. Most individual coverage today is sold through the employer. A lot of it is covering coverage gaps because of either the income that's covered is salary and not salary and bonus, or doesn't include commissions, or there's a $10,000 cap on the employer-sponsored coverage, so you need something above that if you're making higher incomes. That's a big market. It's a market we're a leader in. It's a extremely successful market for us. Again, it's a difficult market to distribute to. Getting out there in an efficient way is a real hurdle with disability insurance.
When you think about the disability market over the last, call it eight years, I'm waiting to be able to call it a decade, but we're not.
Yep
Quite there a decade yet. Where unemployment is right now and given where wage inflation has been, and how profit's been, are we at peak profitability? The other way, if wage inflation goes up a little, what are the impacts that are going to.
Yeah
drive future margin, I guess, on the business.
Two differences there. Wage inflation is good for us.
It keeps people wanting to stay at their jobs.
Well, it keeps people wanting to stay at their jobs. It's usually coupled with inflation. Most of our disability benefits are fixed benefits. They're not inflation-linked. It erodes the spending power of people out on disability. Plus the growth you get, our premium rates are a function of covered payroll. If wages go up, covered payroll goes up, we get more coverage, and you get it at basically zero marginal expenses other than the commission you pay on it. It's a very profitable business. We will benefit from wage inflation. If employment goes the other way, we may feel the impact of that. We didn't see a ton of impact during the 2008 Recession. We had seen it previously in the past.
We haven't seen a ton of benefit from employment, because a lot of the employment, particularly earlier on in the recovery, tended to be part-time employment and marginal workers that don't tend to be covered by us anyway. We would love to see the higher end of the employment marketplace continuing to expand. We'd love to see wage growth continue. We'd love to see inflation make a stand, and we'd love to see higher interest rates. All of those things are positive for us.
Well, believe it or not, long-term care took up most of the question and answer session. I can't believe it.
I can't believe that.
Thank you for coming and thank you all for tuning in.
Great.
Enjoy the rest of the conference.
Good. Thank you.