Unum Group quarterly report, Q2 FY2011

Unum Group 2011 Second-Quarter Form 10-Q Summary

Business Context and Reporting Period

Unum Group is an insurance provider focused primarily on disability insurance, with complementary group life, accidental death and dismemberment, long-term care, voluntary, accident, sickness, cancer, and critical illness products. Operations are reported through Unum US, Unum UK, Colonial Life, Individual Disability—Closed Block, and Corporate and Other.

This unaudited Form 10-Q covers the quarter and six months ended June 30, 2011, with comparisons to the corresponding 2010 periods. The filing was reviewed by Ernst & Young LLP and filed August 3, 2011.

Key Financial Metrics

Metric	Three Months Ended June 30	Six Months Ended June 30
Total revenue	$2,564.5 million, up 2.1%	$5,127.6 million, up 1.1%
Premium income	$1,875.0 million, up 1.4%	$3,744.5 million, up 0.8%
Net investment income	$637.1 million, up 1.2%	$1,255.8 million, up 1.0%
Income before tax	$338.0 million, up 9.7%	$668.2 million, down 0.2%
Net income	$229.8 million, up 9.6%	$455.2 million, up 3.6%
Diluted EPS	$0.75, versus $0.63	$1.46, versus $1.32
After-tax operating income	$232.0 million, or $0.75 per diluted share	$447.7 million, or $1.44 per diluted share
Net cash from operating activities	Not separately presented	$615.7 million, versus $668.4 million

Net income margins were approximately 9.0% for the quarter and 8.9% for the six-month period. The consolidated benefit ratio was 85.3% in both periods, compared with 85.4% in the 2010 second quarter and 84.8% in the 2010 first half.

At June 30, 2011, total assets were $58.0 billion, stockholders’ equity was $9.1 billion, and total liabilities were $48.9 billion. Fixed maturity securities were $40.8 billion at fair value, including $3.9 billion of net unrealized gains. Cash and bank deposits were $71.2 million.

Debt, Liquidity, and Capital

Short-term debt was $140.4 million, consisting entirely of securities lending transactions.
Long-term debt was $2.589 billion, down from $2.631 billion at December 31, 2010.
The remaining $225.1 million of 7.625% senior notes matured in March 2011.
Consolidated debt-to-capital leverage was 24.8%, compared with 25.9% at year-end 2010. Excluding non-recourse debt and securities-lending debt, leverage was 20.8%, compared with 22.8%.
Holding-company cash and marketable securities were approximately $926.7 million, down from approximately $1.2 billion at year-end 2010.
The weighted-average risk-based capital ratio for traditional U.S. insurance subsidiaries was approximately 394%, versus 398% at year-end 2010.
Cash used in financing activities was $551.9 million, primarily reflecting $369.7 million of share repurchases, debt repayments, and $58.3 million of dividends.

Material Changes Versus the Prior Comparable Period

Second-quarter net income rose $20.1 million, while six-month net income rose $15.7 million.
Second-quarter performance benefited from a substantially smaller net realized investment loss: $3.6 million versus $29.5 million in 2010. Six-month results included an $11.6 million realized gain versus a $3.9 million loss.
Other-than-temporary impairment losses on fixed maturity securities declined to $0.7 million for the quarter and $3.0 million for the six months, compared with $10.2 million and $10.4 million, respectively.
After-tax operating income increased 1.5% in the quarter but declined 1.0% for the first six months. Operating income by segment increased 1.2% in the quarter but declined 2.5% year to date.
Unum US operating income increased 1.0% in the quarter and 2.9% year to date, supported by stable risk experience and higher sales.
Unum UK operating income declined 5.6% in local currency in the quarter and 14.1% year to date. Its benefit ratio increased to 69.8% for the quarter and 69.6% year to date from 66.0% and 64.5%.
Colonial Life operating income increased 1.8% in the quarter but declined 1.8% year to date. Its benefit ratio increased to 51.2% for the quarter and 51.3% year to date.
The Individual Disability—Closed Block segment continued its expected runoff; operating income declined 16.1% in the quarter and 15.8% year to date.
Operating cash flow declined $52.7 million year to date, while investing cash outflows narrowed substantially to $46.2 million from $429.1 million.

Management Commentary, Outlook, and Unusual Items

Management emphasized disciplined profitable growth, capital management, financial flexibility, investment in core businesses, and continued expense management. High unemployment, weak wage growth, and competitive pricing were limiting premium growth, particularly growth from existing accounts. Management expected marginal year-over-year premium growth in Unum US during 2011 and continued modest growth at Colonial Life.

Management expected Unum UK premium growth and earnings to remain pressured in the near term, with 2011 earnings growth expected to be negative relative to 2010. Unum UK’s benefit ratio was expected to remain generally consistent with 2010, although inflation-linked claim reserves could adversely affect comparisons. Net investment income was expected to remain volatile because of bond calls, prepayments, interest rates, and inflation.

Unum US sales increased 8.6% in the quarter and 9.6% year to date; Unum UK sales declined 27.7% and 27.5%, respectively, in U.S. dollars.
Rate-increase requests had been submitted for certain individual long-term care policies; 28 states had accepted the requests by June 30, 2011, with related premium benefits expected to emerge beginning in 2012.
Unum US planned an initial group dental offering through a United Concordia partnership in the fourth quarter of 2011.
The company repurchased 14.3 million shares for $369.7 million during the first six months. Approximately $774.8 million remained under the $1.0 billion authorization at June 30.
Adoption of an insurance accounting update concerning deferred acquisition costs was expected to reduce the deferred acquisition cost asset and produce a cumulative reduction to opening retained earnings of approximately $400 million to $600 million in the adoption year. Management expected an immaterial effect on 2012 and prior-period net income.
A July 2011 U.K. tax-rate reduction was expected to reduce third-quarter 2011 income tax expense by approximately $5 million to $7 million.
Fixed maturity securities had $172.2 million of gross unrealized losses, including $88.8 million on securities in a loss position for at least 12 months. Management recorded no related other-than-temporary impairments in accumulated other comprehensive income at June 30.

Risks, Contingencies, and Commitments

Key risks include economic conditions, unemployment, claim incidence and recovery rates, reserve adequacy, sustained low interest rates, credit spreads, investment impairments, competition, regulation, litigation, currency movements, ratings, reinsurer performance, and restrictions on subsidiary dividends.
Management reported one commercial mortgage loan, with a carrying value of $10.1 million, that was 90 days past due and on nonaccrual status at June 30, 2011. The mortgage portfolio allowance for credit losses was $1.5 million.
Legally binding unfunded commitments included $177.8 million for tax credit partnerships and $18.1 million for transferable state tax credits. Non-binding commitments included $105.1 million for private-placement securities, $61.2 million for private equity partnerships, $30.1 million for commercial mortgage loans, and $1.9 million for underlying partnerships.
The company remained involved in litigation, regulatory inquiries, retained-asset-account matters, unclaimed-property examinations, and a multi-state review of life insurance records. Management believed pending matters should not materially affect financial position, but acknowledged that an unfavorable outcome could materially affect results or cash flows in a particular period.
Derivative counterparty credit exposure was $2.3 million. Certain derivative agreements could require termination and immediate payment if specified credit or financial-strength ratings were breached.
Management stated that disclosure controls and procedures were effective as of June 30, 2011, with no material changes in internal control over financial reporting.

Important Facts for Investors to Verify

Whether premium growth improves as employment and wage trends recover, particularly in Unum US and Colonial Life.
Whether Unum UK’s elevated benefit ratio, lower sales, and negative earnings outlook stabilize.
The effect of long-term care rate increases, claims experience, persistency, and reserve assumptions on future earnings.
The scale and timing of the deferred acquisition cost accounting adjustment, including the estimated $400 million to $600 million retained-earnings reduction.
The sustainability of share repurchases relative to holding-company liquidity, statutory capital, and subsidiary dividend capacity.
Changes in unrealized investment losses, credit impairments, below-investment-grade exposure, mortgage-loan delinquencies, and interest-rate sensitivity.
Developments in litigation, regulatory investigations, unclaimed-property examinations, and retained-asset-account matters.
Future ratings actions and compliance with insurance subsidiary capital requirements and debt obligations.