Good afternoon, everybody. I'm Jerome Pinar, Deutsche Bank's North America Life Insurance Analyst. With me today, this afternoon, I'm glad to have Jack McGarry and Tom White from Unum. Jack's the CFO-
Yep
of Unum Group, and Tom White is the IR. Hopefully we get to go through some exciting questions and learn more about the business. With that, I thought maybe we can start just by talking a little about Unum US, where we've seen a lot of growth and a lot of very strong performance the last, actually more than one year now. Just share your thoughts about the business, about the market, opportunities, and the like. Maybe one place we can start with is wage inflation.
Okay.
Is it a positive? Is it a negative? Is it neutral these days as far as the premium growth in the U.S. is concerned?
Yeah. We're kind of with the Fed, sitting around waiting for wage inflation to hit. It was pretty neutral in the first quarter. I'd say through 2016, it was a slight positive, maybe 1%-1.5%. Big improvement from prior to that, where it actually had been a drag on earnings since the beginning of the recession. Now it's neutral to slightly positive. We'd clearly be highly leveraged to an increase in wage inflation and jobs, and hopefully that will come.
Okay.
Things seem to be tightening.
Got it. Looking at Washington, clearly one area where we've seen some noise as of late is around healthcare reform, repeal and replace opportunities, or some attempts to change-
Yep
the environment there. Does that have any impact on Unum's business as far as sales momentum, persistency levels, what HR departments may be doing or not doing at the moment?
Yeah. I'd bring you back to 2013 at the implementation of the ACA. That had a pretty dramatic impact on our industry, as well as Unum. It was a down sales year. I think largely that was driven because brokers and employers were so preoccupied with the ACA. I do not believe the new Health Care Act or the repeal of the ACA will have the same impact. The original ACA put a lot of compliance demands that had to be completed within a certain timeframe. There's nobody who has a plan today that's going to have to change it as a result of the repeal and replacement. I think people may change over time. It's a difference between changing to comply or pay something versus changing to reap the benefit of perhaps different plan designs.
We don't expect it to have the same impact as before in terms of a dislocation in the marketplace. I would say, though, after 2014, the Affordable Care Act, as well as continuing with the current trends, have been really positive for our business, particularly from a voluntary benefits business. With higher deductibles, consumer-driven healthcare, higher out-of-pocket limits, they've really opened up a space for things like Critical Illness, hospital indemnity, accident coverage. People who can't afford to actually fund that whole difference recognize that some of the key things that could happen to you that would drive you up to your deductible levels or coverage limits, that they can afford to take care of. I think we've seen some pretty favorable marketplace reaction to that, and it's helped our company to grow our voluntary benefits business.
Should that ultimately reverse, ACA, should ACA reverse, do you think that some of that opportunity then reverses with it in the short term?
No, I think the opportunity continues to grow, actually. The reversal of the ACA isn't going to stop the trend of higher deductibles. It's not going to stop the trend of higher limits. In fact, the reversals talk about challenging the essential health benefits. They talk about challenging pre-existing limits on specific types of coverage and things. All of those things would continue to fuel that trend.
Okay. Maybe before we even dive into the segments within Unum US, another area that is of interest is the technology spend.
Yep.
Where I think it goes beyond Unum. We are seeing more and more of the players in the industry invest more in technology. Clearly, Unum has also done so.
Yep.
To what end? What are you trying to achieve with the technology spend? Is it something that will just be with us now year over year over year? Is it really a concerted effort to get to a certain point? Maybe you can talk a little bit about more.
I guess I don't see it as a one-time event. Clearly, the pace of change on the technology side is something that has never slowed down in my 30 years in the business, and I don't expect it to. We're focused right now. Our strategy is to buy versus build. We're not going to be spending on building our own legacy systems in the future. Our approach is cloud first. Our approach is to focus on digital. Much of our spend has been focused on the front end of our interaction, customer management. We implemented salesforce.com a couple of years ago. It's been focused on digital connectivity. We have a digital channel within our organization. It's a distribution channel that really focuses on building electronic interfaces with our major brokers that we deal with, BenAdmin systems, Zenefits of the world.
That's been a big focus in our spend as well. I think for the foreseeable future, there's going to be a lot invested in that front end in connectivity.
Got it. If we shift gears a little bit and dive deeper into the business. Your long-term disability business, I think the last year and a half or so, has really produced very strong.
Yeah
results and driven really results for the overall company. Looking at the benefit ratio there, which has really now sustained itself below 80%.
for the first time.
Yep
in memory. What has allowed the company to get to those levels, and how sustainable do you think a sub 80% benefit ratio is?
Let me start with the last and then go back to the first. We do believe it's sustainable. When we talked about loss ratio expectations at our investor meeting in December, we put it in a 76%-79% range. We didn't do that lightly. We had good insight into the underlying fundamentals and felt very comfortable with that. I'd say the drivers are threefold. One is we've seen a pretty slow but continuous improvement in recovery rates.
I'd like to think that's our great management as a company. The fact of the matter is the industry has seen it as well. If you look at the results of the recent Society of Actuaries disability tables, and kind of the longitudinal studies, I think it's across the industry, people have seen recovery rates improving. We've also seen favorable incidence trends. Again, I don't think we're necessarily alone in that in the industry. The big factor too for us has been rate increases. For the last three years, and even longer, in reaction to the falling interest rates, we've been putting rate increases through our book. We've been very successful at that. If you look at 2016 and 2015, really big years from a rate increase perspective and exceptional persistency performance as well. I think that's really the thing.
Rate increases have finally caught up with the interest rate pressures. We're seeing it come through in the loss ratio.
I want to get back to the rate increases. Maybe before we do that, can you talk a little more about the incidence rates, the lower incidence rates across the industry and the recovery rates? What is it that you think that's leading to that?
It's really hard to say. Certainly, employment would tend to help, although I'd note that we didn't see a big dip in recoveries or incidence rates when in 2008 through 2010, we were in the heart of the recession. It's hard to pinpoint exactly what it is. I think certainly as you see a continued shift from blue collar labor work to a more service and intellectual work, that helps both your recovery trends as well as your incidence trends. I don't know, too. I wonder personally whether the cost of healthcare relative to people's salaries.
particularly among the masses, may be a driver as well, that people just can't afford to. Where before they could afford to be out of work because they could still get by with healthcare, it has become such a big portion of people's outputs that they can't afford to be out of work. In effect, if you think about it, your replacement ratio when you take healthcare into effect, has decreased pretty dramatically over the last five years.
Beyond the company actions around claims management, seems like there is a portion that's maybe less tangible as to what it is that's causing lower incidence rates.
Yes
better Sorry.
Incidence.
Incidence rates. Yes. Thank you. It sounds like when you talk about the 76%-79% benefit ratio, a lot of that is hanging on the pricing improvements or the rate increases that you've achieved. Is that fair?
Yeah. We're not anticipating continued improvements in incidence or recovery rates.
Right.
We're anticipating a stabilization. In fact, probably our expectations would be maybe a little bit lower than the peak that they hit. It's not based on that. It's mostly based on where we believe the book is priced right now.
Okay
The stability in those levels that we've seen over the past 8-12 quarters.
Okay. Speaking of the repricing of the book. Clearly you were very proactive going into the lowering of the discount rate at the end of last year, in terms of getting pricing ahead of that. Is the repricing of the book essentially complete here, or do you think there's more to come?
It's never complete. We've been repricing our books since the, I'd say the early 1990s. There's always something in there, whether new business that you wrote that didn't perform the way you expected it to. There are always pockets within our small case block that there's a shift in the underlying experience of, it's an ongoing process. It is not as big a program this year as it was last year. We've pared back some, particularly in the large case. We'll continue to touch the block and fine-tune, and would expect to do that every year.
Okay. Maybe coming at it from a different direction. Clearly benefit ratio has improved quite a bit-
Yep
Gives you a strong margin. At the same time, we also saw a little bit of erosion in persistency in sales, at least last quarter.
Yep.
Has the pendulum maybe swung a little too far to one side to see that?
Yeah. I'd note that there was an erosion in persistency in the first quarter. First quarter tends to be our lowest quarter.
Okay.
You're comparing a year's worth of persistency against what tends to be your worst quarter because of 1/1 renewals.
Okay.
We would expect that, it's not going to get back up to the level it was in 2016, but it should rebound some in the coming quarters. I would say 2015 and 2016 were the aberration. If you go back and look historically, persistency in the high 80s has been where it's run. I think that's a reasonably healthy level to run at, particularly where you have an ongoing process of putting renewals into the marketplace. We expect it in the high 80s. We did not expect it to run in the 90s the way it did in 2016. I would say 2017 may be a little bit lower, but more of a reversion to the mean, as opposed to a drop from expectations.
From a sales perspective, would you say that's similar?
Yeah. Sales, it's a competitive marketplace. 2014, the beginning of 2015 was probably the best we had seen the new case market.
It is returned to a more normal level of competition. We compete effectively in it. It's work every day to go out there and make those sales. A little slower start on the group side in the first quarter of 2017. That's our smallest quarter.
Okay.
We had a good close to 2015, a really strong quarter. Off to a little bit slower start, we expect that to recover during the year.
Okay.
We had a great first quarter from a voluntary benefits perspective.
Right. Maybe you can talk a little bit more about competitive trends in the market and where you see Unum within those different markets within the U.S.
The group markets, as I said, continue to be very competitive.
Very competitive. I would say they're, at the moment, they're reasonably rational in that it's competitive, but you don't see like a single carrier coming in and just buying all of the business. Who wins on any given day is fleeting, but it's solid. On the voluntary benefits side, again, we've been able to compete very, very effectively in the market. I think a big piece of that is because ultimately on the voluntary benefits side, you're competing for, in Unum US, broker relationships. It's either enrollment firm relationships or broker relationships, and those are based on execution. It's less important where your product features are, or less important where your prices are. What's really important is that you can deliver on the enrollment, you can get people signed up, get the customer signed up, and administrated effectively, because it's a lot more complicated than the group side is.
It's individual record keeping. There are lots of ins and outs, We've been in this business for a very long time. We have a very solid track record of delivering on that, That really helps our competitiveness. Plus the marketplace, that trend of going from employer-funded to employee-funded continues. It's fueled by some of the changes in healthcare as well. It's been a very attractive marketplace that's grown as well.
Okay. If we look at the other part of the U.S. business, Colonial.
Yep.
Colonial Life, clearly seen very strong and continued momentum there.
Yep
From top-line perspective, stable margins, I would say.
Can you maybe talk about the dynamics there, where you see growth opportunities, maybe where the more competitive challenges may come from?
Yeah. Colonial, Unum US is largely broker and enrollment firm driven, tends toward the higher end of the market, larger case. Colonial starts at the low end of the market.
Right.
Its history is being a small case provider. The key to that is just being efficient in distribution. If you look at Colonial, the sales rep, the broker, and the enroller are all the same guy. That shortened distribution chain makes them more effective. There's only a couple of companies, Aflac would be another one, that really can compete effectively and make money at that small end of the market. Colonial has that formula down. I think as well as taking advantage of the trends in healthcare and some of those opportunities, expanding our geographic footprint. By way of comparison, Colonial has 10,000 independent agents. Aflac has 70. There are places where we're head-to-head with Aflac.
I think we compete effectively, there's a lot of places that they are that we're not currently, we're going to look strategically to just cover more ground as a company to build additional territories, hopefully, I'm very confident that once we do that, we can compete in those territories effectively.
Is that done organically, or do you look at inorganic growth?
Most of that's done organically. We've been pretty successful as we've built territories, being able to hire some experienced salespeople, either promoting people within Colonial or hiring from outside. The other thing we've done is we've really developed a recipe for how to put a new territory in place and make it successful. We have these SWAT teams from the home office that will go out into a new territory and actually experienced people who will help with agent recruiting, that will help with agent training. They'll actually go on new sales calls and knock on doors with agents to get them up to speed. It's been really effective to not just rely on the leader or the district manager of a new sales territory to get those new agents up to speed.
By bringing that home office expertise, we're more effective in making new territories successful than we've ever been in the past, and they get up to speed more quickly than they ever have in the past.
Got it. If we shift to the U.K. for a second.
Yes.
I sat in on lunch with our CEO, who took, I think, a more cautious view on the U.K. kind of post-Brexit.
Yep.
I haven't really seen that manifest itself so much in persistency rates or sales growth in Unum U.K. yet. Is that surprising to you? Do you think that it's something that's still to come?
It hasn't shown up in persistency and sales growth. The U.K. has been very active in developing new go-to-market strategies.
I would say before, and even today, most of the U.K. business comes through the big brokerage houses in the U.K. It's pretty concentrated. A couple of years ago, they kind of split their sales force into what they call hunters and gatherers, where some of their sales force is focused on those big brokerage houses and nurturing that relationship. More and more are hunters bringing new brokers and new IFAs in the U.K. market into the group risk market. That's been pretty successful as well. I think that's helped to forge growth. They've forged additional growth in sales through developing partnerships, particularly toward the smaller end of the market, just making it easy and effective to do business with us. That's been very helpful. The one place you have seen the impact of Brexit is on the in-force block.
There are definite tailwinds in natural growth in the U.K. as a result of Brexit. There's not the hiring, there's no wage increases. Despite the fact that you're seeing some decent level of inflation in the U.K., I think the U.K. consumer is losing ground, and that's being reflected in our total premium line.
Okay. Last year, I think it was, that you actually did an acquisition dental space in the U.K.
Yep.
Is inorganic growth still an area of interest in the U.K. post-Brexit?
The dental business was a great acquisition. It's a pretty rapidly growing market in the U.K. It's not nearly as saturated as it is in the U.S. It's also very close to our knitting, in terms of the people who are selling dental business, both in the U.K. and the U.S., are the same people that we're dealing with on a day in, day out basis selling group life and group disability. It fits very closely. It's been a very successful acquisition. It is beginning to be able to leverage the U.K. sales force, so dramatically expanded its distribution reach. It helped that the dental business had been owned by Capita before, which competed against a lot of the brokerage houses in the U.K.
Now that it's carrier-owned, it's kind of been able to reestablish relationships with the Aon and the Mercer of the world. That's helped as well. We're very pleased with that business in the U.K., pleased with where it's been going, and it's a really close fit. The other thing it does is a good piece of that business is voluntary-
Which is unique in the U.K. There's not a lot of employee-funded plans in the U.K. That leverages a strength. The other piece is it's transactional. Everyone who buys dental interacts with their carrier and interacts direct. That's not the same for a lot of our other businesses that are a couple in 1,000 types of incidents. It's allowed us to get a lot closer to our customers, which has been a positive effect.
Those attributes would be true as well in the U.S., I presume?
That's true in the U.S. as well.
Okay.
We tend to have closer relationships with the employers in the U.S. than in the U.K.
Okay. Shifting gears second to the regulatory front. One area that seems like Unum is really uniquely positioned within the life group is to benefit from some corporate tax-
Yep
reform. Do you foresee any offsets to either the balance sheet or income statement that would somewhat curtail the benefit from a lower corporate tax rate?
We would expect to benefit. As you say, we are a high U.S. taxpayer. We would expect there to be short term effects. For instance, if the corporate tax rate is lowered, we have a deferred tax asset on our statutory books-
that would have to be written off. That would be a temporary effect. The paybacks for that would be very quick. We would see maybe a short term capital hit as a result of that, not an unmanageable one. Within two years, that would be paid off and then some.
Would that have some statutory impact as well in terms of cash generation or?
It would have a statutory impact. Whether it would be cash generation or not would remain to be seen. I think the deferred tax asset's actually held in capital account as opposed to I don't think it would necessarily affect dividends coming up out of the legal entities.
Okay.
Affect risk-based capital ratios, certainly. We're pretty healthy there.
Okay. If we turn to free cash flows and capital deployment.
Yep.
Clearly statutory earnings have been picking up and been doing quite nicely, and yet I think you're still talking about a very stable $400 million or so in buybacks per year. I think management's gone on record saying you're not anticipating any acquisition this year. What use of capital do you foresee?
Yeah. I wouldn't say we've gone on record saying
Okay
we never anticipate-.
Okay
acquisitions. They either happen or they don't. As a major player in our markets, we'll be active looking at properties, whether one comes out at the price and that makes sense to us. We wouldn't try to predict that. I would say we had very effective free cash flow last year. We were able to build our holding company cash position. It's going to be greater this year because this year's dividends from the insurance companies are being driven by last year's statutory earnings, which were a record level for us. I would say at least this year we're exercising caution. I'd say there's two pieces to that. One is from a tax reform perspective, not knowing if we did have to take $150 million, $200 million hit
as a result of that. We'd want to be in a position to do it. The other piece is just as a company, we wouldn't want to get caught flat-footed if an opportunity to do something with the long-term care block came along. We think it's healthy for us to hold some level of capital in anticipation that something might come along at some point. I think a lot of those things, we'll certainly know more about taxes hopefully by year-end. There's some level of capital that we don't need to go beyond to feel comfortable with our position relative to long-term care. I do expect that this is a temporary holding period that we'll come out in December at our investment meeting with an updated outlook about what our capital plans are.
Okay. You mentioned long-term care, which is really the final issue I want to touch on before I open it up to the audience.
Yeah.
Beyond looking to transact with third parties, are there actions that Unum can take unilaterally in order to de-risk their portfolio or cordon it off?
Yeah. Every day we do everything we can to de-risk the portfolio. The major one there is rate increases. We've been very effective with rate increases. We built when we took our last reserve charge, a level of rate increases into that GAAP reserve assumption. We're 85%-90% of the way toward having accomplished what was built in there and feel very comfortable with achievability of the rest of it. We're not going to stop there just because we hit the GAAP assumptions. We'll continue to pursue justified rate increases beyond that. In terms of doing something with the business, We're always pursuing and taking management actions to do that. There's probably not much you can do unilaterally.
It would take a partner or maybe even several partners to do that, with the regulator being a major partner there. Anything that from a practical perspective that we would do, we would need to garner the support of our regulator. Now, we have a great relationship with our domestic regulators. We're in contact with them pretty consistently, but that's a major hurdle, you know to
Right
to move forward with something.
In terms of the rate increases that you've filed for, if we assume that the forward curve actually proves to be correct?
Yeah
Ultimately, do these rate increases get the block to be break even? Do they get the block above break even? Where do they get the block to?
The rate increases that are currently filed, because it was a gross premium valuation, so it was on a best estimate basis, they got the block to break even on that best estimate basis. The forward curve today would probably have another interest rate hit in the future. We're feeling much better about where we are today than we expected to be, so when we closed the block, we had a 5% level for five years and then grading to a long-term average after that. We've exceeded that 5% in the last nine quarters. We've actually built margin as a result of that in the reserves that we didn't anticipate. There's still hopes that at some point inflation's going to take hold, economic growth's going to take hold, and interest rates will go up. If they don't, we have more rate increases that we can draw on.
It's not like we've anticipated rate increases five years into the future.
We would be able to mitigate some of that. Long term, interest rates will have to go up or there'll be another hit. I did mention at our investor meeting in December that we have about a $900 million difference between statutory reserves and GAAP reserves. That's still there. That'd be about equal to a 525 new money rate forever.
Right.
If you were to believe long-term investments, high yield, and alternatives mixed in there, you could achieve 525. Basically, it'd be about $900 million to mark that to market.
Got it. Why don't I open it up to the audience if there are any questions? All right. More for me, then. In your underlying assumptions, whether it's with regards to the rate increases or the book in general, is there also some morbidity improvement that's factored in, or do you assume morbidity remains?
We have both morbidity and mortality improvement. Those are offsetting.
Okay
to a certain degree. We have some in there. It's not prolonged improvement. It's generally less than those scholarly papers would suggest it has been.
over the past couple of decades. There is some built in there.
If you remove both of those improvements, would the impact be material, or can you quantify it in any way?
Yeah, we haven't quantified it.
Okay. All right. With regards to the rate increases themselves, if there is some delay in approval, let's say a year delay, how much of an impact does that have on the overall?
For us, it's not very material because there's only a couple of hundred million left of rate increases in our assumptions. A year's worth of interest on that is 10%-15%.
Okay.
$10 million-$15 million.
Got it. I think we're just about out of time here.
Great.
thank you very much.
Good. Thank you.
Very much appreciate it.
I appreciate the time.