Good afternoon, everybody. Thanks for joining us. Today we have Rick McKinney, CEO of Unum Group, and Matt Royal, the head of IR for Unum. I'm Yaron Kinar, the North America life insurance analyst for Deutsche. Gentlemen, thank you very much for joining us today.
Thanks for having us.
Looking forward to a lively discussion here.
Great.
Matt, maybe we can start with a few questions on the market, what you're seeing today. Specifically, maybe we can start with the sales momentum and the competitive landscape here in the U.S.
Sure. Yeah. Starting out with, let me give you a perspective across our different businesses. Starting on our Unum US business, I think that coming off of the very good 2015, where we saw good sales growth, good premium growth. As we get into the beginning of the year, certainly saw in the first quarter, our sales growth was a little bit more muted, our absolute sales levels were quite good. Part of that is we were dealing with a large comparator, a hard comparator to 2015, where we actually saw a 14% growth. Even where we were in the first quarter, we're quite happy with where our sales were. That's across the board, both in our large case, our core business, as well as our voluntary benefits business, we're happy where they are.
I would say that we saw a little bit more pressure in our core business, that's kind of defined for us 500 to 2,500 employees. We saw a little bit more competition on that front. That can happen from time to time. We've seen some of our competitors getting a little bit more aggressive on the pricing front. That will generally work its way through the system, there's nothing that would cause us too much concern. We actually were looking at it very much. I would counteract that with, we saw very strong persistency levels. Our customers that have us today are staying with us. What we're most talking about are new cases for Unum. We're very happy with the persistency. People that have Unum today are keeping Unum, I think that's a very important point.
You wrap all that together, sales are good to talk about going forward, what's most important there is what it's looking like from an overall premium perspective, how big is our book of business, how much is it growing over time. We saw another 5% growth in our Unum US business, which we've seen now for several quarters, I think seeing that growing top line on the premium line is very important. We look at our other businesses. Colonial Life had a tremendous first quarter, up 16%, coming off of good results last year. Our Colonial Life business, which is an agency-driven force, people that are out there on the street enrolling customers across the United States, is doing very well.
They sell voluntary benefits to the smaller employers, all the way up through that core business I talked about in Unum US, having a very strong first quarter coming off of a very strong 2015. We're very happy with the sales results there as well. We saw premiums grow there close to 6% in our Colonial Life business. Lastly, in the U.K., 16% growth in sales there in the U.K. as well. Part of that coming from our new acquisition that we bought last summer. NDP is now being integrated into Unum, we're seeing sales coming from that. Overall, good sales levels in the U.K. Across the board, I think good. I think there are some around pressure in that core space, we're watching it. Once again, I'd focus more on the premium line, which continues to see good growth.
When we look at the sales growth and the momentum we've seen there, is that growth coming from selling to more people, or selling more product to the same people, or selling larger premium items to the existing customer base?
Yeah. Actually, where we're seeing the sales coming from is actually more customers, so we're actually adding people that are out there. The piece that you talked about, which is important to us as well, is more products per person, that we have in each of our customers we have today. Sometimes we talk about that as new cases. Sometimes we talk about that as sales to existing customers, because if somebody has 2 lines of coverage and they add a third, that's very good for us. It gives them a more holistic package, which to take forward in their company. We have seen that grow. It's a slower thing, but if you look over the last five or so years, we've seen that going from somewhere in the 2 lines per employer to 2.5, 2.3 to 2.5 lines per coverage.
That's been a help as well. There's opportunity there to continue to grow. There are more lines we have out there to be able to offer to those same customers. A good opportunity to grow both the products per person effectively in an employer, but at the same time, getting to more customers is also where we're focused.
Is there a natural entry point product that then moves to the second and third product and maybe beyond that as well?
I think overgeneralizing a little bit, Unum is certainly known as the lead disability writer across the U.S. as well as in the U.K. That's something that when we bring that to the table, people certainly take note. If that's a lead combined with a life, a typical or traditional group life policy, we can add on to that some of the voluntary benefits. We can add on to that some of the other services that we bring out there and expand that overall profile with each of our customers.
On the persistency side, you mentioned persistency has been quite good. How much room for improvement is there, or are we currently above average, or should we expect maybe a reversion at some point?
It's all about what you think the average is. We're above our historical norms, but it's been steady at that kind of 89%-90% now, going back probably four or five years. Is there a new norm? It's hard to look at it that way. It's something that we're very happy about. We spend a lot of time thinking about how we retain existing customers, both from an overall service perspective, making sure that we're very consistent, stable, and predictable in terms of what our pricing profile looks like with them. We want them to be our customer for a long period of time. Those relationships matter a lot to us.
Got it. Matt? One shift we've seen not recently, but for the last few years maybe, is the shift of premiums from employer-paid to employee-paid. Is there a difference from Unum's perspective, whether it is the employer or the employee that's actually paying the premiums? Is there a difference in the economics of the product?
You have to take that apart in a couple of different dimensions. Stepping back, start with the overall group market. Think of group disability, group life business as well. You have a shift from the employer to the employee. Now, that can be done by the employer just asking for the employee to pay more. We think about that as a split funded product, as opposed to the employer paying 100% of that type of product. Maybe they're paying 50% or anywhere along that gradient. The second piece of that is an employer offering to their employees voluntary benefits. When you shift to that, it's more traditionally on an individual construct. Can look a little bit different, and the employer pays for that. All have good margins for different reasons.
I would tell you that that shift in the overall absolute level of margin changes over time, we like very much the shift to the voluntary benefits, we're very well positioned on the voluntary benefits front. At the same time, our good core group business gives a good value to our customers. As they think about their funding mechanism, whether they pay the whole amount or ask their employees to help share in that cost, is also a very good margin business. One of the things that's consistent about Unum, the business lines that we're writing today are all very high return businesses. Overall, we want to make sure we maintain those margins as we look forward.
Maybe one last question on market before we move to another topic. The Affordable Care Act was clearly a headline, I'd say two years ago, a year ago. Haven't heard as much of it in our space this year. Do you still see this as a tailwind, a headwind? Has it really played out already from your perspective?
Actually have to go back a little bit further than two years. As it came into the market, a lot of distraction with employers and particularly with distribution, which had an impact on our sales because people were thinking much more about the Affordable Care Act and the impacts on their business as opposed to adding a line of coverage in an employee benefit space. We saw a distraction from the brokers, which actually caused our sales to go down through that period of time with that distraction. We've seen that recovery, I don't think that that's the conversation that's happening out there between broker and employer and ultimately with consumer, as much as it was a couple of years ago.
In the wake of all that, you have seen a change in construct about how people think about protecting themselves, protecting coverage, and it does allow us the opportunity to infill some of those products. If you think of a core voluntary product where somebody's either in the Affordable Care Act regime or maybe even in a high deductible health insurance plan, there's a gap there that they want to protect. That gap may be going to a hospital, it may be protecting against an accident. Voluntary benefits fill a very important need on that front. I would say overall, the distraction has pretty much gone away. At the same time, the need for some of our products probably has increased through that period of time.
Okay. If we shift to capital deployment, I think one thing you've emphasized is the very stable nature of your capital deployment program. With that in mind, I guess one question that I have is why not shift to more of a dividend-oriented capital deployment approach that is the essence of stability and move maybe some of that deployment away from buybacks?
Let me take a step back to think about capital generation first, because I think it's all predicated on that. One of the things that we've been able to do as a company, and it's because of our discipline, our underwriting, how we work with our customers, we've had very steady free cash flow generation, if you look back over the last eight or nine years. I think that you start there and say you've got choices then to make because of that steady stream of cash flows. First and foremost, we want to put that capital, that cash flow, right back into our business. We want to grow, we want to protect more people here in the U.S. and the U.K. We'd like to see a bigger footprint. We'd like more lines of coverage.
All those growth aspects we just talked about, we'd like to put capital behind our business. High returning businesses, good potential of doing good things for our customers. Second is on the M&A front. We want to take some of that free cash flow generation and actually enhance the size of our company through M&A. In the last 12 months, you would have seen us acquire two businesses, both dental businesses, one in the U.K., one here in the U.S. These are lines that actually we can leverage, very strategic in terms of how we leverage that product portfolio. Once again, adding a new line of coverage to an existing customer we think has great benefit. When you've done that, you start to think about capital deployment in excess of what you want to consume in the core business. We think about dividend rates.
We actually, if you look over the last many years, we've doubled the size of our dividend, if you look back over the last seven years. That's been important to us. Ever-increasing dividend stream is important to us. Last week, we actually raised our dividend another 8%, that does remain a core part of the story. The last piece is on the share repurchase side. We've repurchased a lot of our stock over the last several years, going back actually to 2010. We bought back about a third of our float. That's been very good for us, and good share price is good accretive value to our shareholders. Which brings me to your last question is, okay, if you are this stable and steady, why would you not pay out a higher dividend?
I think it goes back to those first two points. We would rather put that money into the core growth of our operations at high returns for our shareholders. We would rather actually acquire to grow at good returns for our shareholders. Then raise that dividend at a more immediate pace. We've been doing that. We've increased the payout ratio over time, and that's how we still think about it. It's a much longer-term trajectory. Dividends and dividend increases are important, but also maintaining flexibility to deploy capital how we want to is equally as important. That's how we've maintained a good process, and we're very fortunate to be in a spot where we have that free cash flow to make those type of decisions.
What % of your generated earnings is going back to the business these days?
Well, you have to just roughly do the math in terms of the free cash flow that we have coming out of $550 million. You're talking about the business is consuming probably somewhere from $0-$100 million in the core operations of the business, depending. At the growth rates we're seeing today, it's probably more in that $100 million side going back into the business. When you think about that, don't think about that as pure expense. That's actually allocated capital to a growing business. That's where we would like to put that.
Okay. You had mentioned the two dental deals. Can you maybe talk a little bit about the dental market, what you find attractive, or why all of a sudden do we see two deals coming from Unum in this market specifically? I have to say, my perception has always been that dental is somewhat commoditized. Where do you see the opportunity in a commoditized space?
Yeah. It's a fair question. I think it's one of the pieces that was probably missing in our portfolio. Regardless of the dynamics of the market, it's something we weren't participating in. It's core to our business, working with the employers in the benefits space to fill in the part of their employee benefits portfolio, and we really weren't participating in the dental piece of that. What we bring to that is that scale. I talked about having two products per person, two and a half products per person. Adding that dental piece, I think, is a logical fit for our sales force and our brokers as they take that out to customers. People like to have that fuller portfolio as we deal with them.
We're known for the quality of our service and the quality of our offerings, I think to bring that in more scale to employers is a good thing. The second piece of that is it will give us more chances to talk about our other product lines. If we can come in there with a full product suite, as opposed to start with a disability and move our way up. If we come in there with a full product suite, I think it will open a few doors as well. Both on the Unum US side, as well as in our U.K. business, as well as in our Colonial business over time, those are things that I think will be helpful to the overall product portfolio.
I would think also the dental business is probably shorter tail, more cash oriented than-
It is typical to a lot of our businesses, which we reprice on an annual basis, working with the employer, looking at stability and other things. It's akin to many of the things that we do, being able to reprice, manage risk well, and at the same time, bring a full product offering.
With regard to-
I should add to that also, good returns, too. You mentioned a commoditized product, relative to its return on capital, I think most people in the space would talk about it as a good returning business.
With regards to M&A, we've seen the two dental deals. Are there other markets or geographies that are of particular interest?
There are. First, let's start with a couple of different dimensions when we look at M&A. One is the core business that we have today. Where are there enhancements, either from a product or distribution, or reach that we can have? Dental was a good example of that. It's a product reach to fill in part of the portfolio. We'll still do that and look at that here in the U.S. We also will look at the U.K., similar to the dental deal that we did there. There are other product lines, other parts of the portfolio, which we continue to fill out. The second would be in consolidation. We manage our business very well, particularly the disability front, but that's true in the voluntary benefits and across the board.
If there are other blocks out there, other people that don't manage as well, we'd like to run that for them, and that's a second piece of consolidating M&A. You mentioned geographies. We'd like to take what we do here in the U.S. and the U.K. and think about other geographies that have similar dynamics that we can continue to grow the overall company by growing that footprint. We'll do so in areas that we know well. We have had operations in other countries before, and I think that that's something we always look at, is what's the right construct to bring our skill set to new geographies?
Finally, on capital. Your RBC ratio has been very stable at or near the top range of your 375%-400% target range. What would it take for the company to feel more comfortable to start lowering that number to maybe the lower end of the range? Conversely, are there any scenarios in which you think you would need to build an even greater buffer?
We don't see the second part of your question. We don't see the need for the greater buffer. As we think about it's where is the right level to run the company at. If you look back over time, we've actually maintained that 400% level because we've been taking all of our free cash flow and doing those things that I talked about, including buying back our stock and did not have those levels come down. Right now, they're running right around 390% type level, still towards the top end of our range. For the right opportunities, we would take that to a different level. I think that that's something we would have to look at in conjunction with what we're generating from a capital perspective, what we're doing with that capital, and what are the uses that we could do that.
There's certainly that opportunity out there ahead of us.
Okay. I don't think I can get through an entire fireside chat without talking about long-term care at some point.
Sure.
If I look at the long-term care block, it's comprised of two blocks for Unum, the group and the individual. I think in the past you've talked about the group having better characteristics.
Yes.
Maybe you can remind us what makes it a better block than the individual block?
Sure
What mitigating actions or characteristics you can put on top of that to lower risk even further.
Yeah. When you think about our business, it is two blocks. Actually, if you think about our closed block, it's really two blocks. One is our individual disability block, the other half of it, which is long-term care. In the long-term care, comprised of two pieces. One is the individual business, which was kind of the traditionally written through distribution, one-on-one type underwriting process. Half of it is also the group business. We have more policies, actually, on the group side because this was issued at the employer. Generally, the employer provided that coverage to their employees. As a result of that, you had good spread of risk overall portfolio. The benefit sizes are much smaller than you would see on the individual business.
I think that from a risk mitigation perspective at day one, as well as that spread of risk really helps a lot. It's also a younger block of business, as we think about price increases, we have opportunity to continue to improve the profitability on that side of the business, which is something we're actively working on across our entire long-term care block, but probably more true on the group side as well. Very different characteristics in how it was underwritten, issued, and how it behaves today. It's going to play out over a period of time in conjunction with those price increases that we talked about. You have to get into the details a little bit when you think about our closed block and then more specifically in our long-term care block as well.
With regards to pricing increases, is the process different whether it's in the group or individual, or is it going through the same approval process with the regular?
It's working in the same approval process with the regular.
Okay. As far as the pricing approval process goes, where are we today? You've already executed a few rounds of pricing increases.
Yes.
What round are we in today? Is the rate of requested increases coming down a bit over time? Is it the rate of approvals coming in or staying relatively stable?
Yeah. It's hard to think of it in terms of rounds. You can think about that in filings that have gone in because it is a state-by-state, regulator-by-regulator type discussion that you have around how they want to approve rate increases, whether it's on a one-time basis, whether it's feathered in over a couple of years, whether it's something they don't want to approve today, but you have to come back in a couple of years. It's hard to identify those rounds. What I would tell you is that we have achieved our expectations of price increases, which have not been 100%.
We think we're pretty rationed in terms of what we expect, but it's something we're going to stay at for a longer period of time until we can get to a point where the block is priced at a level that we would expect it, and that will take some time. I wouldn't say it's on the rounds. I wouldn't even talk about particular to are we getting what we expected on any one rate increase. What I would tell you in aggregate is we're achieving our expectations, both in the first couple of rounds that we did, as well as in our current construct. One of the newer things that we did in the latest round of increases was actually go to adjusting our benefits.
We talk about it as a landing spot, which is actually instead of a customer paying a premium increase, they can choose to take a benefit reduction. In some cases, that's actually a good alternative for the customer because they are effectively over-insured with what they have today. That's something that comes in as well. That kind of keeps the picture fluid as well in terms of what those rate increases look like.
Is the regulator indifferent, whether it's the shrinking of the benefit base or the higher pricing?
Oftentimes they are. It really gives the consumer choice. I think that's the positive thing from a regulator perspective, is you provide that consumer choice in terms of how they want to deal with the price or relative to reducing their benefits.
I guess the other aspect or the other angle of the long-term care block, it can even be the individual disability block, is potential reinsurance deals or M&A deals of just selling the block.
Yes.
In this market environment, do you see opportunities or do we really have to wait for maybe a better interest rate environment?
Interest rates are one piece. I think you have seen a couple of transactions with people that have reinsured blocks out there. There are situations where you have buyers meeting sellers effectively in that block of business. I can tell you we're very active in the markets, but that has not come to fruition. Interest rates is one piece of it, but that's something that's quite quantifiable. I think when you're meeting with buyers and sellers, it's also how you look at the overall construct of the liabilities and things like that. One of the good things on that front is that more data has come in. As data continues to build in this block of business, because although it has been around for a few decades, there's still data that's building up, certainly in the older ages around this block.
As that builds up, you'll have more data with which people can make buying and selling decisions on a more constructive basis. That's what we look forward to. Reinsurance will be one way to do that. You talk about M&A, that would be something we would be focused on as well. It's probably going to be a number of smaller things that works through this problem. Ultimately, it's something that we would like to be out of this risk, and are working diligently to figure out how we do that.
With regards to the data point, I think that's a very interesting point. A couple of years ago, I think you switched from industry data to company-specific data in your buildup of reserve assumptions. Is that true both for the individual and the group, or because the group is relatively young, you're not quite at that?
Yeah, I don't think there's a switch one from the other. I think that if you go back, it's actually been five years ago, maybe six years ago now.
20. I got the years wrong.
Yeah, time flies, doesn't it? We actually went and had to use more industry data back then because we didn't have some of the older age mortality and expectations that the industry had. As we get through our own data, that will shift more towards company-specific data. That would be true both in the individual and group block, but we still are triangulating. We're looking between industry data and our data as well, just making sure we have a robust data set with which to make decisions and expectations of what we see in the future.
Okay. Moving on to investments. Where do you see opportunities today? Where are you putting money to use?
I think it's a challenging environment, so I think everyone would recognize that. We still continue to stick to what we have always done. Although markets and product allocations will change, we still see very much we're a core credit shop. We think about corporate bonds in scale both on a public and private basis. We do some things on the commercial mortgage loan side, and so we have a reasonable size portfolio of that. We'll continue to make sure we're looking at alternatives that are interesting to us. When I say alternatives, it's a broad category. I'd take you back to going back five years ago, Build America Bonds, we had a big allocation there, which has since gone away for new money. Low-Income Housing Tax Credits is a place that we've gone.
We're always looking for that asset class which fits very well with our products and might be an area which would be good to us. Right now, there's not that many of those, to be quite fair. We're sticking to corporate bonds and public bonds for the most part.
Going back a second to the alternative portfolio. We saw a lot of companies in the industry going through some challenges the last couple of quarters with alternatives. Clearly, that was not something that Unum had. Nonetheless, I would say longer-term returns from these alternative portfolios have been attractive for some of these companies. Is that something that you'd consider building up over a longer period of time?
Yeah, I think alternatives is a very broad category. When you think of the different types, the subsets of that, we actually do have some areas which would be classed as alternatives that we invest in today. I would say they're much more akin to what bonds look like. Cash flows are stable, things like that. Some private equity allocation. It's all quite small, quite well-managed. I think that we'll look to increase that over time, but it's got to have the right characteristics. It's not going to be a wholesale move. It's got to work for us. It's got to work for our products. We continue to look at that as we have over the last several years.
With the concentration in corporate bonds. Ultimately, there are risks involved there as well. How do you manage the credit risk there? We saw early this year oil prices dipping to around 30. How do you manage the energy exposure? How do you manage the high yield exposure?
Name by name. I think that as we go through the portfolio, we have a credit team focused on us, so it's something that we do inside the company. A very strong, seasoned credit team that looks across the portfolios and has the overlays of good risk management in terms of what the overall portfolio allocation looks like. They think about investing behind our products. They don't invest just to invest. They think about how those characteristics of the bonds that we buy match up to the liabilities that we write. I think that's a very good process for us to have. That's how we think about it. We manage across concentrations, across names. I think that we do a good job from an overall risk management perspective. Now, more recently, you talked about energy exposure.
If you look at our energy exposure, because we are a large corporate bond shop and that's the majority, relative to the size of the market, we were slightly overweight. It was only slightly in terms of what our energy exposure was. I think if you drill down into that, our exposures within the energy sector were much more infrastructure-related as opposed to exploration and some of the things that are more dependent on oil prices. We felt a little bit of the pressure of that. It's quite manageable for us. You would have seen that coming through our first quarter results. As we look at our portfolio today, it's something that certainly $50 oil helps on that front. We still think and embrace our portfolio that if oil is a little bit lower than that.
We feel good with our energy exposure today, and I think it won't be any different message than we would've told you three or four months ago.
It's not like with energy or with oil prices at 50, you're looking to increase or decrease the exposure. You're comfortable with it?
No, I think when we decrease the exposure, it's going to be on the margin. Like I say, it's a name-by-name thing, and we will take the opportunity to sell out of positions that maybe have traded up, and we, for whatever reason, don't like. At the same time, we don't see ourselves increasing our allocation to energy in this market.
Okay. The interest margin that you keep between the long-term disability reserves or the discount rate, I guess, and the income rate. It's about 80, 90 basis points.
That's right.
It seems to me like that's a pretty substantial margin with interest rates being as low as they are today. Can you maybe explain why you keep it at that level and not maybe allow it to come in a bit?
Yeah. It's something we manage over the longer term. We actually have seen margins that have been wider than that. We've seen margins that have been lower than that if you went back seven or eight years. We think about that looking on a forward basis. I think that's the important thing is we look how our portfolio rate's going to come down over time as we expect, given where rates are and credit spreads are. We also look at what our book of discount rates and our block of business look like and manage that to make sure that we sustain a margin which is in excess of, I think we've said 40-60 basis points there. We've been managing it over that for a period of time, just given what we see from an interest rate pressure perspective.
Could that come down over time? Maybe. Will it come down? It's hard to predict, but it's something we manage quite actively. You would have seen us over the last six years or so decrease our discount rates a number of times to help manage that spread.
Okay. I want to open up and give the floor to the audience if the audience has any questions. All right. I'll continue. We talked about top line and the ongoing business. Can we talk a little bit about margins? I think we saw a little bit of an uptick in the expense ratio just because you were growing business, which is probably positive. Are there any expense management initiatives in place, just to maintain a healthy level state?
Yeah, you mentioned expenses went up a little bit, given sales. We kind of think about that on the side. You will have higher acquisition costs as you're growing the business, and that's something that we're happy about. We're happy to pay more out to the front office of our business to actually grow the company. In terms of an overall expense efficiency perspective, it's something that we do day in and day out. One of the benefits of having an expense ratio that is well managed, well understood, is it allows you to, and causes you to do things around the expense line where you're investing in certain areas and you're disinvesting in other areas. I think that that's one of the things you'd see from us. There won't be any wholesale changes or any radical moves. It's something we think about doing every day.
We always do. Because it is so, I'll call it slow moving, because we're doing it every day, it doesn't take a lot of note as you model our company or look at what our earnings look like, but it's something behind the scenes or if you talk to the employees and the management of our company, it's something that we do on a very proactive basis, making sure we have the right expense base for our company and managing the overall margins from that perspective.
When it comes to the benefits ratio, they've been phenomenally strong and steady. Is there a cycle there or is there I guess, A, is there a cycle? B, how is it that Unum has been able to keep those margins so steady?
Well, there doesn't have to be a cycle. The reason I say that is there's two elements to your benefit ratio. One is the premium, so the top line that you're charging, how much you're charging per element of risk, and the second is what's actually coming through in claims experience. If you do a good job on the premium side, you actually have a good chance of having a very steady benefit ratio or something that's quite predictable. I think that that's something that we've continued to do over a period of time. Our practices around how we manage claims and get people back to work are very steady, very stable. You won't see a lot of volatility in how we think about managing that process. At the same time, our pricing or our premium levels are very steady and stable.
We think that's important to our customers, that we're not coming in and out of large price increases or decreases. All of that lends to a well-managed business that produces results that come out of that are also quite stable.
I think I have time for one more. We talked about long-term care. The other side of that closed block is the individual disability where I think you had done some reserve financing in the past. What are your thoughts on the possibility of doing another round of such financing?
Yeah. The financing we did goes all the way back to 2007. As the structure's coming up on 10 years old, things transpire over time. That structure's worked out incredibly well, considering the cycle that it went through in 2008 and 2009. It held up very well. It's something we need to look at because, as I said, there's two parts of our closed block, the long-term care we've talked a lot about, but also on the individual disability side, making sure that's in an efficient capital structure as we can have it. The team is certainly working on that, and we'll have that come out as we're ready to take it forward. It is a place where we think there is opportunity around that business.