Good day, and welcome to the Unum Group second quarter earnings results conference call. Today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Senior Vice President of Investor Relations, Mr. Tom White. Please go ahead, sir.
Great. Thank you, Lisa. Good morning, everyone, and welcome to the second quarter 2015 earnings conference call for Unum. Our remarks today will include forward-looking statements, which are statements that are not of current or historical fact. As a result, actual results might differ materially from results suggested by these forward-looking statements. Information concerning factors that could cause results to differ appears in our filings with the Securities and Exchange Commission and are also located in the section titled "Cautionary Statement regarding forward-looking statements and risk factors" in our annual report on Form 10-K for the fiscal year ended December 31, 2014, and also our subsequently filed Form 10-Q. Our SEC filings can be found on the investor section of our website at unum.com. I remind you.
I remind you that statements in today's call speak only as of the date they are made, and we undertake no obligation to publicly update or revise any forward-looking statements. As we discuss our financial results this quarter, I'll remind you that prior period results have been adjusted for our retrospective adoption of the accounting standards update for tax credit partnership investments in qualified affordable housing projects. Adjusted prior period results are available on our website in a supplemental exhibit. Also, a presentation of the most directly comparable GAAP measures and reconciliations of any non-GAAP financial measures included in today's presentation can be found in our statistical supplement on our website in the investor section.
Participating in this morning's conference call are Unum's President and CEO, Rick McKenney, our CFO, Jack McGarry, as well as the CEOs of our core business segments, Mike Simonds for Unum US, Peter O'Donnell for Unum UK, and Tim Arnold for Colonial Life. Now I'll turn the call over to Rick.
Thank you, Tom, and good morning, everyone. The second quarter was another solid one for Unum, with operating earnings per share of $0.89, slightly trailing the year ago result of $0.90 per share. While risk results showed somewhat higher volatility in some of our U.S. group lines this quarter, we also saw the continuation of many of the positive operating trends we have seen in the past, most notably strong premium growth in our core businesses. In addition, our statutory earnings remain healthy and capital position is strong, providing us with excellent financial flexibility. I want to cover a few of what I believe are the key highlights of the quarter, and then I'll turn to Jack to provide analysis of our results in greater detail.
I'll start first with sales, where, as expected, we experienced a moderation from the strong growth we've enjoyed over recent quarters to a more normal long-term level of growth. Unum US sales increased by 1% for the second quarter compared to the year ago quarter. By market segment, we saw continued momentum in the core segment, which we define as less than 2,000 employees with a year-over-year growth of 4%. We did see sales decline in the large case segment, which is a market we approach on an opportunistic basis and where sales can be more volatile. At Colonial Life, sales continued growth at very good levels, increasing almost 6%, with solid performance in the core commercial segment and public sector. Finally, Unum UK sales continued to gain momentum, increasing 6% for the quarter in local currency.
Second, with continued good sales momentum, along with healthy levels of persistency across all of our business lines, we continue to experience very good growth in our premium income. Our core business segments on a combined basis generated premium income growth of 5% over last year, with Unum US premium growth of 7%, Colonial Life at 6%, and Unum UK up 1% in local currency. Next, our benefits experience overall remains within our range of expectations, though we did experience some pressure this quarter, particularly in our U.S. group lines. On a year-to-date basis, our disability lines were in line with prior year, with the challenging second quarter mostly offsetting a very good first quarter. In group life and AD&D, we saw pressure as well. Other lines of business benefited from favorable results, especially the closed block in Colonial Life.
Importantly, our margins remain very healthy across our core business segments, and Jack will detail these trends by business segment in his commentary. With these ongoing solid results and good statutory results, we continue to maintain a very strong level of financial flexibility. This enables us to support our growth needs while also returning capital to our shareholders. This quarter, we repurchased over $100 million of our shares and will implement a 12% increase in our dividend effective with the payments to be made in the coming weeks. Finally, as we've discussed with you for some time, the primary challenge we continue to face is the ongoing low interest rate environment. Interest rates and investment spreads were somewhat higher in the second quarter. However, they remain well below historical levels.
I'm pleased, however, with how we've been able to manage through this low rate environment over the past few years and with the actions we've been able to implement to maintain healthy profit margins in our business segments. With those highlights on our second quarter performance, I'll now ask Jack to cover our results in greater detail. Jack?
Thank you, Rick, and good morning, everyone. Rick gave you a high-level view of what we believe is a solid second quarter, and I'd like to review in more detail the operating and growth trends we saw in the quarter. I'll start with Unum US, where second quarter operating earnings were $202.8 million, a decline of 6%
In the year-ago quarter of $215.8 million. Premium income growth was strong, increasing 6.8% over the year-ago quarter. The benefit ratio for the U.S. segment increased slightly to 71.2% in the second quarter, compared to 70.4% in the year-ago quarter, as we experienced negative volatility in our U.S. group lines of business. In addition, net investment income declined by 1.1%, primarily reflecting the ongoing decline in yields on our invested assets. Within the Unum US segment, operating income in our group disability business was $61.2 million, a decline of 15.8% from the year-ago quarter of $72.7 million. While premium income continues to build momentum, increasing by 7.1% over the year-ago quarter, we saw continued pressure on net investment income, which declined by 1.8% in the quarter. In the higher benefit ratio, which increased to 83.4% in the second quarter, compared to 81.9% in the year-ago quarter.
The benefit ratio was impacted by higher new claim incidents and a higher average size claim in our LTD product line, driven in part by the 50 basis point reduction in the discount rate for new claim incurrals implemented in the fourth quarter of 2014. We believe this quarter's results reflect negative volatility that will occur in this line from quarter to quarter. Including the very favorable first quarter experience, the benefit ratio for the first half of 2015 is 81.8%, compared to 82.5% for the first half of 2014. Group Life and AD&D operating income was $52.5 million for the second quarter, a decline of 13.4% from the year-ago quarter. Premium income continues to grow at very healthy levels, increasing 7.3% for the second quarter.
Earnings were negatively impacted by the increase in the benefit ratio to 73.1% for the quarter, up from 70.1% a year ago, primarily driven by an increase in the average paid claim size for the Group Life line. Again, this appears to be normal volatility and does not change our outlook going forward. Trends in the supplemental and voluntary lines were favorable, with operating income at $89.1 million for the second quarter, an increase of 8% compared to the $82.5 million a year ago. Premium income growth trends also remain favorable for this segment, increasing 5.8% in the quarter compared to last year. From a risk perspective, the Individual Disability line had a favorable quarter, as overall risk results remained stable.
The voluntary benefit ratio declined to 43.1% in the second quarter, compared to 48.2% a year ago, as mortality experience was favorable in the Life product line and higher policy terminations in the Critical Illness product line generated a release of related active life reserves. Moving to Unum UK, operating income was £25 million for the second quarter, an increase of 5.9% over the year-ago quarter of £23.6 million. The benefit ratio improved to 70.7% for the second quarter compared to 74% in the year-ago quarter, as risk experience in the Group Life line of business was favorable, benefiting from lower new claim incidents and average claim size. Unfortunately, mortality negatively impacted results in the Group Disability line, although the risk results remained within our long-term expectations.
Margins remain in very good shape for Unum UK for the quarter and first half of the year, and the operating ROE was 19.1% for the quarter. Colonial Life also continues to generate strong results, with operating income of $77.6 million, a 3.6% increase over the year-ago quarter of $74.9 million. Risk experience was favorable over the year-ago quarter, primarily driven by favorable mortality experience in the Life line, as the benefit ratio declined to 50.4% from 52% in the year-ago quarter. Margins remained strong for Colonial Life, with an operating ROE of 16.6% for the quarter. The closed block operating income was $36.6 million in the second quarter, flat with the very strong results from the year-ago quarter. This year's results were strong relative to our long-term expectations for both the Long-Term Care line and the Closed Disability block, with good underlying risk experience in both business lines.
In the Long-Term Care block, the interest-adjusted benefit ratio was 83.4% for the second quarter, favorable relative to our longer-term expectations of an 85%-90% benefit ratio. Long-Term Care had less favorable claims incidence rates in the second quarter of 2015 compared to the very favorable experience in the prior year second quarter. In the Closed Disability block, we had a strong improvement relative to the results of the second quarter of 2014. The interest-adjusted benefit ratio improved to 83.6% this quarter, compared to 89.4% a year ago, primarily driven by more favorable claims incidents and mortality experience. I'll now move to the growth trends we experienced across the company. As Rick pointed out, we saw a moderation in our rate of sales growth this quarter.
This was to be expected, particularly in Unum US, where we continue to implement rate increases in the market to offset the effects of the low interest rate environment. It's important to note that while sales growth levels may have moderated, we continue to see a very strong absolute level of sales. I'd remind you that it's the relationship between the size of our in-force business and the volume of sales that drives growth in our premium income. Starting with Unum US, total sales increased by 1% in the second quarter compared to a year ago. While this moderated from recent quarterly sales trends, we continue to see good trends in the group disability lines, where LTD sales increased by 11% and STD sales increased by 39%. We saw a decline in the group life and AD&D sales by 22% against a very strong second quarter 2014.
By comparison, the second quarter of 2014 sales increased by 71% over the second quarter of 2013 on very active large case sales activity. Overall, for these lines of business, core market sales continue to show positive momentum, advancing by about 4% for the second quarter. Large case sales declined by 7% overall, which is typical of the volatile pattern we experience in this market segment. Growth in voluntary benefit sales have also been volatile, with sales declining a little over 1% for the second quarter compared to the year-over-year increase of 20% plus for the previous two quarters. In addition, sales in individual disability line increased 11% for the second quarter. Persistency for Unum US remains at very healthy levels. For the group lines, combined persistency was 89.3% for the first half of 2015.
With these sales trends and persistency levels, along with underlying management of in-force renewals, we generated premium income growth for Unum US this quarter of 6.8%. At Colonial Life, new sales continued to grow at a strong pace in the second quarter, increasing 6% relative to last year. The composition of this growth was encouraging as the core commercial market produced an increase of over 4% and the public sector increased 15%, offsetting a slight decline in our large case sector business. New account sales declined slightly this quarter, the growth over Colonial Life was overall primarily driven by sales to existing accounts. In addition, new rep contracts increased by about 7% as we focus on building the pipeline of producers.
Persistency for Colonial Life was higher year over year at 79.2%, helping to generate overall premium growth of 6% in the second quarter, our highest rate of growth in several years. Sales in Unum UK increased by 6% again in the second quarter in local currency. Persistency remains stable in the group disability line at 87.5% and continues on an improving trend in the group life line, up to 79.9% for the first half of 2015. Overall, we remain very pleased with the growth trends we see in our core business segments. Quickly looking at investment results, interest rates and investment spreads were higher in the second quarter compared to the first quarter, and as a result, our new money yields were slightly higher as well.
Our new money yields remain well below our existing portfolio yields, the downward pressure on our portfolio yields and net investment income continues to impact our profitability. We are actively raising prices in the markets as a primary means of managing this impact. Moving to capital management, the weighted average risk-based capital ratio for our traditional U.S. life insurance companies continues to be stable from quarter to quarter and remains at approximately 400%. Holding company cash and marketable securities was $481 million at quarter end, which reflects $103 million of share repurchases in the quarter. Statutory operating earnings were $160 million for the second quarter, for the past four quarters, statutory operating income totaled $633 million, a healthy level of earnings, which has also remained stable over time.
Wrapping up, I want to affirm our 2015 outlook for growth in operating earnings per share in a range of 2%-5% off of $3.51 in operating earnings for 2014 as adjusted for the accounting update. Given our first half results, we would expect to be towards the lower end of that range, we'll need to continue to see how business trends and interest rates play out for the remainder of the year. Overall, it was another solid second quarter for the company, now I'll turn it back to Rick.
Thanks, Jack. I'll reiterate, we're pleased with the second quarter results. Our premium growth remains strong, our margins are healthy. These solid results continue to drive good capital generation and strong financial flexibility for the company. This allows us to continue to invest in the growth of our business while we return capital to our shareholders. We're happy with the results, now we'll move to your questions. I'll ask the operator to begin the Q&A session.
Thank you, sir. Ladies and gentlemen, if you would like to ask a question, please signal by pressing *1 on your telephone keypad. If you are using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again, that is *1 to ask a question. We will take our first question from Suneet Kamath from UBS.
Thanks. Good morning. I want to start with the rate actions that you're taking in the U.S. Are you now sort of pricing your business to reflect the current interest rate environment, all that's kind of baked in the cake at this point? Is there another round of rate action that you need to take on a go-forward basis?
Mike, you want to take this?
Sure. Good morning, Suneet. I think on two fronts. First is new business pricing and where we would say absolutely new business pricing reflects our best view on interest rates, underlying risk, aging of the population, et cetera. The renewal is, as you know, it takes a little bit of time to work through that. Just to give you a sense, in the larger end of the market, we see about a third of all of our large employers come through each year. In the core market, it's closer to 20%-22% that we put through a renewal program.
Each batch that comes through reflects the current view of interest rates. We're making good progress, but even as we saw rates fall a bit last year, that would get reflected in the renewal program this year and in the next two years to come.
Okay, got it. Then I guess for Jack, on your comment about the, I think what you're getting at was the nominal level of sales relative to the in-force. I guess, is the takeaway from that even if the growth rate of sales starts to moderate because just of the law of large numbers, that we should still expect premium growth because essentially you're outselling your lapses. Is that kind of where you're going with that?
Yeah. That's pretty much. If you get to that point, normal growth in sales will be reflected in normal growth in premium. We've gotten over the tipping point where the size of our sales is big enough to overcome the lapses and generate some really good top-line growth.
Got it. My last question on top line is it still fair to say that you're not really getting much of a benefit from either employment growth or wage inflation?
Yeah. It had been negative in the past. It's positive. It's in the 1%-1.5% range. We haven't seen the rise in wage growth that perhaps the general economy has seen as yet.
In a normal period, that 1-1.5 is typically what again? Could you remind us?
I mean, 2-4, depending.
I think one thing to add to that, Suneet, is we were seeing the lives grow. We really haven't seen the wage inflation. That's something that I think is true pretty much across the economy. It's very true in our books. We're getting better employment, but not seeing what we would expect from an overall wage inflation. That's something to look forward to.
All right. Thanks.
We'll take our next question from John Nadel from Piper Jaffray.
Hi. Good morning, everybody. Maybe two quick questions for you. There are some who are reading the DOL proposal to potentially even have an impact on group insurance sales. Do you read it that way? If so, do you guys have a view on this? Obviously, there's a lot of focus amongst the annuity writers and others selling business into qualified plans, but I'm curious whether Unum has a similar view that this could potentially stream over into the group insurance business.
Hey, John, this is Rick. Thanks for the question. I think when you think about the overall, what's going on with the Fiduciary Rule from the Department of Labor, one, it's early days. I think like anything that we look at in Washington, we stay very involved with the discussion that's going on out there and making sure that we have our views around that is, around what's going on and where those different rules might go. I think we have to stay abreast of it, early days. I think it's very clear, though, from the discussion, the questions, and the guidance coming out of the Department of Labor, that this is very much about investment advice that goes on out there, which doesn't include us. It's one of those things that we stay on top of.
We don't think it's going to, and we don't think it should apply to anything that we do in the business, but it's one of those things, as you deal with the ways of Washington, we stay on top of.
Totally. I totally agree with your view. The second question, I guess is, there's been M&A activity. There's at least one group insurance business on the block that's very publicly out there. Potentially other transactions that we don't necessarily hear about, but bankers might be bringing to you. Should we read into the fact that your buybacks continue, that M&A is something you're not really looking hard at at this point, or are they mutually exclusive?
John, appreciate the question. I think we've been very clear all along, M&A is a core part of our strategy when you think about that. You wouldn't have seen us do any deals, but there wasn't a lot going on in the market, and that's how we would have voiced that. As you mentioned, the market is seeing greater momentum. We are definitely going to partake in that view of what we have out there. We'll be close to whatever action is going on out there. I think that we're well known in the market at least that we're interested in growing our business through M&A, and that's a core part of our strategy. That M&A could look like adding capabilities, it could look like expansion of our overall portfolio. To be very clear, M&A is a key part.
Your second piece of the question is around the capital to do so. I think that as we look at it, we've been able to return capital to shareholders through share repurchase and through dividends. At the same time, we've kept our balance sheet in the space that we can react to an environment where M&A becomes better. That's been consistent. We think we have the firepower to participate in these markets, and we'll be very active on that front. They're not mutually exclusive. We think they're both.
Okay. As a quick follow-up along those lines, obviously you're carrying a risk-based capital ratio that at least for your business mix is significantly above, I think some peers and significantly above your historical levels. Should we think about that, Rick, as that's part of the capacity if it were to be used for M&A as opposed to retiring equity, that the risk-based capital ratio could be a source, if you will, of funds?
I think we've been clear on that over time, that when we've been running at 400%, we've been at the top of our ranges that we've communicated externally. There's room there. We carry a holding company cash, as Jack mentioned, at just under $500 million. There's room there. When we look to our leverage ratio, we have a very clean debt leverage structure that provides us capacity as well. We think we have a lot of capacity. I'd take you back to the capital generation model. Every quarter, we keep generating capital as well that can buy back stock or go towards certain type of transactions.
No question. Statutory earnings have been terrific. The last one I have real quick is, it's just a question, I guess, for Mike. There's been some other companies talking about some modest shifts in the competitive environment, in U.S. group insurance. I think most notably this morning was more of a commentary from MetLife around the dental business, which I know is not necessarily something you're focused on. Can you give us an update on your views on the competitive dynamics?
Sure, John. Thanks for the question. What I'd say is, in comparison, we certainly saw more favorable market conditions in 2014 than we had seen in a little while. We had a few carriers that needed to address profitability issues. That created some opportunity. We saw the market shake off some of the distraction from ACA that we had felt at the end of 2012 and into 2013. I'd say, as I look at 2015, we probably see a little bit more of an aggressive stance around pricing in the market than we saw in 2014, still reasonably good and I would say pretty typical conditions.
Thanks very much. That's all I've got.
Thanks, John.
We'll take our next question from Jimmy Bhullar from J.P. Morgan.
Hi, good morning. I had a few questions. First on, if you could go into a little bit more detail on the two businesses where you saw weak margins, Group Disability and then Group Life. Just talking about what you saw in terms of incidents and severity trends, and how do you expect the loss ratios to, or margins to emerge in those businesses in the second half of the year? Also on long-term care, you had pretty good results this quarter, but given the level of rates that we're at right now, if we stay at this level through the end of the year, would you expect to add to your New York statutory reserves again this year? Because you've been doing that in the past for the last few years.
Okay.
Jack, you want to take that? Yeah. Morning, Jimmy. First, from the Group Disability and Group Life, we've taken a look at it. It really looked like just normal volatility on the Group Disability side. The new claim incidence rate was up slightly. Average size was up, it was a combination of those two things that drove the results. We'd again point you to the first half of the year. We had a very good first quarter, a less good second quarter, but year to date, we're pretty much where we would expect to be, and our outlook has not changed going forward. Group Life, it was absolutely an average claim size. Just higher-paid people happen to be the people that submitted claims. The claim size was up 6% for the quarter.
Again, that's something that we wouldn't view as being a trend, and wouldn't view as changing our outlook going forward. From the long-term care side, where rates are, and in the guidance that we've given in the past, we've talked about New York being kind of a steady thing. So we would expect to have contributions to New York at a similar level that we've had in the past. Actually, rates are a little better than they were at year-end, and so there's been a little modest improvement in that. Again, we'd expect it to be at similar levels. It's clearly something that has been baked into our capital plans.
Okay, thank you.
Thanks, Jimmy.
We'll take our next question from Steven Schwartz from Raymond James & Associates.
Yeah. Hey, everybody. No, I'm not going to take up any time or much time. Most were asked and answered, so thank you.
Thanks, Steven.
Ladies and gentlemen, if you do find that your question has been answered, you may remove yourself from the queue by pressing star two. We will now go to Colin Devine from Jefferies.
Okay, thanks very much. A couple things, just to clarify on the DOL situation, because I don't believe Unum submitted a comment letter on it, but I presume then you're just sort of participating with the ACLI and you assume the welfare benefit plans will be carved out as number 1. Number 2, with respect to Group Life, in terms of if you look back over the last 6-7 years, and I appreciate you saying it was just a severity issue, how many standard deviations were we sort of off your average? Lastly, on the capital management, because getting this ROE up seems to be an ongoing challenge. My understanding is rolling over the closed block securitization doesn't make a lot of economic sense. Can you just sort of walk us through why that is as that thing is getting paid down fairly rapidly? Thanks.
Good. Thanks, Colin. Let me just follow up on your first question. We are actually participating. When I talked about our activities in Washington, one, there's direct conversation that we have. The second is through our trade associations. ACLI would be one of those. We do not submit our own comment letter, but we're very much part of that process. Let me turn over to Jack to talk a little bit about group life.
The group life standard deviation.
Yeah.
We did do an analysis of that. It was close to within one standard deviation, we were clearly within a 75% confidence interval on the group life. It was high, but not out of the realm. On the securitization of the closed block, we're aware that's being paid down. We will continue to look at capital options for both the closed disability block, and we're actively looking for capital options on the long-term care block as well. It's clearly something that we consider. We will look for opportunities going forward.
Jack, could we just drill a little deeper, though, into the closed block securitization? If I recall when it was done in time, obviously Tom White's there and those guys as well, you freed up, I think it was about $800 million in capital. My understanding now is if you rolled it, the number might be $100 or something. What's changed? Is it the way you can use reinsurance, and how the NAIC regulators are looking at it? What's the difference today versus when you did it? If you could be more specific, that'd be helpful.
Colin, this is Rick. Just a couple of things. One is the size of the relative blocks. I think the cash flows coming off that block have reduced significantly as that block has run down, particularly as you look back seven years. The cash that comes off that, which generally is part of the securitization, is what you're really securitizing, is roughly half of what it was back then. That's the biggest thing. There's no change in the rules, no change in the views around that. The second piece is the opportunity around it. It's a much lower interest rate environment, you'd think you'd have much better debt ability to much lower financing cost. It was done on a floating rate basis, that was matched up early on with floating rate assets.
You don't have that juice, if you will, as well. There is benefit, and I think there would be some benefits to re-looking at that. It's more what is the magnitude of those sizes that we have out there.
If that's not the option for you, practically speaking, are you exploring selling off, if you can, part of the long-term care block? Since that, to me, seems to be the only way the ROE is really going to start to move up.
We would certainly entertain selling the long-term care block or reinsuring it we're active. We're listening to the market. There are not a lot of buyers currently, particularly for big long-term care blocks. There've been a couple of very small transactions. They've tended to be much older, more mature blocks. We're actively there. Particularly if interest rates continue to rise, it makes that a more plausible option in the market. From what we've seen, there just aren't the buyers yet on it.
Okay, thanks very much.
Thanks, Colin.
I'll go now to Humphrey Lee from Dowling Partners.
Thanks. Good morning. Just a quick follow-up on your buybacks. For year to date, you're running it a little bit north of $200 million and towards the lower end of your $400 million-$600 million target. How should we think about the pace of the buyback for the remaining of the year, and what would make you maintain a similar pace as of the first two quarters, or what would push you more towards the upper end of the guidance?
Thanks, Humphrey. Jack, do you want to take that?
Yeah. We are very comfortable with our pace of buybacks currently. It is toward the lower end of the range. I think given our current stock price, given the current interest rate environment, and given the activity that's going on within the insurance space, we think our current level of share repurchases strikes a good balance between financial flexibility at the company, and good management of our capital levels.
Okay. Got it. Then just to follow up on the long-term care part, you mentioned you've been actively looking, but there's still not too many buyers. In your estimate, are we still talking about the price difference is still ways apart, and how does that trend over the years? Do you see it at least getting closer?
I think from my perspective, certainly as interest rates rise, the price difference gets closer. In addition, we've had two reductions in our discount rate on long-term care, so the spread between current rates and our discount rate gets closer. That makes that option more viable. I frankly think that it has less to do with interest rates right now and more to do with comfort with the liability side. I think it's going to take some time in maturing of those blocks for people to get comfortable enough with it that they would consider a purchase.
Okay. Got it. Just on the interest rate part for long-term care, I remember a couple of years ago, you guys were thinking about potentially putting in some interest rate hedges for your long-term care block, but as the rates fell, it kind of didn't come through. If we do see rates improve again, at what level would you consider actually putting in some interest rate hedges to shield some of the interest rate sensitivity to your long-term care block?
I think interest rates need to rise some more. I think we were probably close at the end of 2014. We remember that the 10-year was just north of 3%. It's within the realm. Again, as we've lowered the discount rate, the hurdle rate for putting hedges on gets lower as well.
Okay, got it. Thanks.
We'll take our next question from Thomas Gallagher from Credit Suisse.
Good morning. Just a question on the relationship, and if there is any one on the 2014 very strong sales growth you had in US Group and whether or not that's contributing at all to the elevated benefit ratios this quarter. Do you see that as a pricing issue at all, or do you still have, even if we remain around this level, is that still a good enough return where you wouldn't necessarily need to see rate action?
Yeah. We actually looked at claims by year of issue, and there was no evidence that any of the problems that we saw in the group lines were the result of recent sales. It was pretty random where that stuff showed up by year of issue. Mike, you want to talk a little bit about the pricing? Yeah, no. As Jack said, you look at it by issue age or issue year, look at it by industry, geography, and no concentration that would suggest that you had, Tom, a underwriting quality or pricing issue. In terms of what the trajectory of rates, if we look at, particularly, I think the disability market, you look at it and say, look, there's still work to be done pretty consistently on the interest rate front through the renewal program. Persistency has held up really nicely.
We would certainly plan to see that continue, but we'll be at it from a rate increase perspective to existing clients for the next two or three years. On new business, we moved rates up at the end of 2014 and nudged them up again here at the mid-year, and that's just to get as current as possible on interest rates and also just to reflect that we've got a slightly aging population, and that's going to drive incidents down the road for us.
Can you give some perspective on magnitude of rate for the renewals as they come through?
It's mid to high single digits is pretty typical. Then, for any particular pocket or client, you know you're going to see variance around that. On average, that's where we are.
Has that changed from where it's been, say, last year or the year before, the mid to high single digits?
Similar. It's edged up a bit. Actually, what we've done is expanded the program, we're touching more clients than we had a year or two ago, the average size increase is still pretty much in the range.
Okay. Then I also just had a question on the supplementary and voluntary business. Margins there have been quite good. First question is that do you think that's a reasonable run rate from a margin standpoint, whether you look at the loss ratio or just the pre-tax earnings margin that you've been experiencing there? I guess the second question is just trying to wrap my head around looking at how good these loss ratios are, individual disability, 30% interest-adjusted loss ratio. Granted, it's a much different business than your closed block, which is running in the 80s. I'm just trying to think about, is that a number that is going to go up a lot over time, or is that kind of where the business is from a pricing standpoint?
Yeah, sure. It's Mike. In that supplemental segment and across both the voluntary and individual, it's actually quite different businesses, but with a similar trend around your question, which I'd say wouldn't expect any dramatic movement. I would say in general, over time, we would see loss ratios about at that level to slightly increasing over time, and that would be offset by efficiencies gained. We'd see operating expenses come down a bit in those lines. The net impact is, to your question, is those are good, healthy margins. We'd seek to maintain those, but the mix will shift a bit over time.
Are there, just looking at the 43% voluntary benefits loss ratio, are there minimum loss ratio considerations at all, or is that not applicable to these lines of business?
Yeah, I think we're in good shape there. I'd say in the quarter in particular, we had elevated lapses in voluntary benefits, there was a release of active life reserves that pushed a more favorable benefit ratio there. That's at play in the quarter in particular. No, I think in general, we're in pretty good shape. In that voluntary benefits portfolio, there's products releases that are going on in a pretty regular stream, and those are going through all 50 state filings and looking at experience, and don't really see issues there.
Okay, thanks.
Sure, Tom.
I will go now to Yaron Kinar from Deutsche Bank.
Good morning, everybody. I want to go back to the elevated disability claims this quarter. Just want to get a sense, are there any pockets of the market where you're seeing the claim size or incidence rate picking up?
Really, as we look at it by industry, by size, there wasn't really a pattern to it. It appeared to us to be pretty much pure volatility. The underlying piece, too, is the 50 basis point increase in the discount rate is going to drive your average size up in and of itself. It was a little bit elevated above that, but that had a role to play in it as well.
Got it. Can you also maybe explain why the assets supporting group disability declined? I would've thought they'd be up just given the sales growth and high persistency.
Yeah. They declined because the assets are more related to the reserves behind the business than it is the premium. Claim runoffs with good recoveries, the actual reserves behind the business have been declining slightly, and so the assets have been declining as well.
Okay. Finally, persistency is clearly still strong, but still in the U.S., we're starting to see some declines in 2015 in short-term disability, group life, voluntary benefits. Do you see this as part of a broader trend or just normal volatility?
Yeah, I think it's normal volatility. It's something that we're going to watch very closely because linking it back again to the repricing for interest rates as we work through the block, it's the balance between placing the rate increases and retaining clients through that process. At 89.3%, feel very good about where it sits at the moment, but we'll continue to watch it really closely.
Great. Thank you very much.
Great. Thank you.
We'll take our next question from Ken Billingsley from Compass Point.
Good morning. I wanted to just follow up on your comments about benefits or not getting the benefit from employment growth and particularly wage inflation. As employers and insurance brokers are not as focused on ACA, are you seeing a shift in maybe their interest in pushing the benefit products, or has that not actually translated yet?
Sure. It's Mike. Thanks for the question. I'd say, actually demand for our products, if you sort of think of them as financial protection benefits, is growing. Generally what we see is, ACA has just been part of a long-term trend toward the consumer, the employee driving benefits decisions. What we see is when you put an employee in front of a healthcare decision, they're going to buy down on the healthcare, and usually that means higher deductible, higher co-pays type insurances, lower monthly premiums. They use some of that savings to buy products that help fill some of those gaps. In general, we see consumers with more interest in living benefits, in particular supplemental health products, short-term disability and the like.
Employers, I think just as the economy's improving, there's some of that slack coming out of the labor market, the need to attract, retain talent is heightened. Doing so with employee choice option is an economic way to do it, demand on the employer front is good. I think to your point in the question, what we've seen in the distribution channel with brokers is a pretty strong interest to diversify away their revenue from such a dependence on healthcare commissions. I would say even as consolidation continues in that health market, that's going to put further downward pressure on healthcare commissions and create a demand for other sources of revenue, and that's where Colonial Life Unum products fit very nicely.
Now with the penetration in some of these employers from ACA because they had to, are you seeing that this is in transition in opening more doors for your products where maybe they weren't considered before, or has demand not necessarily increased?
Yeah, I think it's not an overnight sensation, but I'd say it's been a building sense of demand. One interesting kind of corollary is ACA has brought a pretty stiff set of compliance and regulatory requirements, particularly around keeping track of time. What more and more employers are looking to technology, benefit administration, cloud-based HRIS solutions and the like. Those are platforms that we've worked hard to build a relationship over time with, that's opening up some interesting channels for us, that sort of technology-driven distribution of benefits. Again, I don't think that's an overnight explosive growth, but it's a slow burn, which I think is getting us the parts of the market we hadn't been to before.
Great. Thank you for taking my question.
Okay.
We'll take our next question from Erik Bassi from Citi.
Good morning. Thank you. I guess given where interest rates are currently, do you anticipate there would be any need to make further adjustments to the new claims discount rate in the second half of this year?
We'll look at it. We'll come to the end of the year. We do our annual claim reserve review in the fourth quarter. Currently in our interest margin, it's north of 90 basis points, there's some room in there. We are optimistic that if perhaps the Fed begins to move in the second half of the year, that a little lift in the interest rates would help that a lot. It's something that we're going to wait and see, but we're comfortable with where we are, we're comfortable with our margin being at the higher end of where we would like to see it. I think we have some flexibility coming into the end of the year.
Got it. Thank you. I guess just one question, maybe for Mike, going back to the competitive dynamic, are you seeing or do you anticipate any impact from the recent or expected M&A in the group market?
Time will tell, I guess, would be the quick answer. Generally, though, when you see M&A, it's going to be a pretty considerable distraction, both to acquiree and acquirer. That usually creates some uncertainty and opportunity for players to stay focused through the period. Again, time will tell.
Got it. Thank you.
Thanks, Erik.
We'll take a question now from Mark Hughes from SunTrust.
Thank you. Good morning. The voluntary benefits sales down a little bit. Was that consistent with the broader competitive pressure, or was there just less take rate from individuals? What was the dynamic going on there?
Yeah, great. Thanks. I think it's a little bit of just quarter-to-quarter movement in sales trends. We had a really strong first quarter. I think year-to-date, we're up 20% in voluntary benefit sales. I wouldn't read too much into it. Second quarter tends to be a light quarter in terms of seasonality for that particular line. In general, we feel good. If you look at the pipeline, it looks good. I think demand for choice products is high, and we continue to invest in capabilities around product and distribution, and probably have done a little bit more investing than we have in years past around consumer-centric capabilities and driving up take rates, participation rates for new and for existing plans. We're starting to see some pretty encouraging things there. A little bit of oscillating in the second quarter, but I think the long-term trends are healthy.
Thank you.
Sure.
We'll now take a question from Ryan Krueger from KBW.
Hey, thanks. Good morning. I just wanted to follow up on the M&A commentary. I think you mentioned that you might have some debt capacity. Your debt-to-cap ratio is around 25%. Can you help us think about how high you could bring that up if you found a deal that was attractive that required additional capital to finance?
Sure, Ryan. When you think about the 25% we have today, that's kind of pure senior debt relative to our overall capital position. There are different forms that it could take on. I think that the key about us being able to take it up from there is it's something we can do, but it's also about what the longer-term plan is. We've said we feel good about 25% longer term. If we take it up for a period of time for M&A and it comes back down in a pretty rapid basis, we think that's just fine. I wouldn't want to throw a top-end range out there. It's much more about the trajectory and how we want to run it.
Understood. Then it's been a while since you've done any M&A. Can you talk about your philosophy when it comes to evaluating M&A and accretion versus buyback, and how you analyze that?
I think the first thing, Ryan, is when we look at M&A, it's got to be about what is the strategic fit that we have with the overall company. You always have to start there and then very quickly go to the economics of the deal that you see out there. Think about IRR, think about those things. You think about relative use of capital. We do compare it to share repurchase, which has been very good for us over time. We're going to be doing that as well. When you look at accretion and dilution, I think those are all important metrics for shareholders. Those will be part of the mix as well. I'd take you back to number one is where does it fit in the strategy? Number two, do the economics of the deal look good?
Is it also fair to assume that if you were evaluating an M&A deal relative to buyback, that you could probably deploy more capital into an M&A transaction and bring down your balance sheet metrics a little bit lower in an M&A deal than with buyback given how rating agencies tend to look at this?
I think it goes back to the comment about it is about the longer term, too. It's not about metrics on day one, it's about what their expectations of those trends look like as well. I think there is flexibility in there. It's not an exact science relative to share repurchase and things like that, but I think those are key barometers we'd use to help us think about different M&A transactions.
Okay. Thanks. Appreciate it.
Okay. We'll now take a follow-up question from Humphrey Lee from Dowling Partners.
Thanks. Just a quick follow-up on M&A. You talked about you kind of looked at different things, I was just kind of curious, is there any particular business type that you'll be more interested in over another? Maybe prefer more voluntary over fiduciary group or anything in terms of the business that would be more interest to Unum?
Humphrey, as I said, we're looking at how does it fit in with the overall strategy. All those things that you mentioned are all part of our strategy. We are figuring out how we can reach more customers through the employer. When you take that as a broad scope, that's what we're going to look at. I wouldn't want to get more specific than that, but we're going to stay true to working through the employer. There are a lot of needs that can be provided through the employer, which we'll explore all of those.
Okay. Thanks. Another thing about your critical illness book. I know one of your peers talked about seeing unfavorable claims experience related to critical illness, especially in the cancer coverage. Do you see anything kind of unusual or anything adverse or kind of developing trend with respect to coverage for cancer treatment?
Maybe the best thing to go to Tim Arnold, talk about our Colonial Life view around our cancer product in voluntary.
Yeah. The cancer product continues to perform very well. We certainly stay abreast of developments in the medical field around cancer treatment and the impact that that might have on our benefits costs. At this moment, we're pleased with the direction of that product. Increasingly, it's a differentiator for us because there aren't as many companies out there offering that specific product line.
Okay. Overall, the claims experience are largely in line with your expectation, at least you don't see that kind of elevated cost related to treatment?
Correct. No.
Okay. All right. Thank you.
Thanks, Humphrey.
Ladies and gentlemen.
I think, operator, we're coming up on time, so I think we'll thank everybody for taking the time to join us this morning. Operator, that now completes our second quarter 2015 earnings call.
Thank you, sir. Ladies and gentlemen, once again, this does conclude today's conference, and we do thank you for your participation today.