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  • 10-K (Feb 26, 2013)
  • 10-K (Feb 25, 2011)
  • 10-K (Feb 25, 2010)
  • 10-K (Feb 27, 2009)
  • 10-K (Feb 27, 2008)

 
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StanCorp Financial Group 10-K 2011
Form 10-K
Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2010

 

or

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from              to             

 

Commission File Number: 1-14925

 

STANCORP FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Oregon   93-1253576
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

1100 SW Sixth Avenue, Portland, Oregon, 97204

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code: (971) 321-7000

 

Securities registered pursuant to Section 12(b) of the Act:

 

TITLE OF EACH CLASS   NAME OF EACH EXCHANGE ON WHICH REGISTERED

Common Stock

  New York Stock Exchange

Series A Preferred Share Purchase Rights

  New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2010, was $1,891,667,021 based upon the closing price of $40.54 on June 30, 2010. For this purpose, directors and executive officers of the registrant are assumed to be affiliates.

 

As of February 18, 2011, there were 45,942,713 shares of the registrant’s common stock, no par value, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement for its 2011 Annual Meeting of Shareholders are incorporated by reference in Part III.

 


Table of Contents

 

 

ITEM         PAGE  
Part I   
  Item   
1.    Business      1   
1A.    Risk Factors      10   
1B.    Unresolved Staff Comments      14   
2.    Properties      14   
3.    Legal Proceedings      15   
4.    (Removed and Reserved)      15   
4A.    Executive Officers of the Registrant      15   
Part II   
  Item   
5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      17   
6.    Selected Financial Data      20   
7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      21   
7A.    Quantitative and Qualitative Disclosures about Market Risk      59   
8.    Financial Statements and Supplementary Data      60   
9.    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      120   
9A.    Controls and Procedures      120   
9B.    Other Information      122   
Part III   
  Item   
10.    Directors, Executive Officers and Corporate Governance      123   
11.    Executive Compensation      123   
12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      123   
13.    Certain Relationships and Related Transactions, and Director Independence      124   
14.    Principal Accountant Fees and Services      124   
Part IV   
  Item   
15.    Exhibits and Financial Statement Schedules      125   
     Signatures      127   
     Exhibits Index         

 


Table of Contents

Part I

 

Item 1.   Business

 

GENERAL

StanCorp Financial Group, Inc. was incorporated in 1998 in Oregon. As used in this report, the terms “StanCorp,” “Company,” “we,” “us” and “our” refer to StanCorp Financial Group, Inc. and its subsidiaries, unless the context indicates otherwise. Our investor website is www.stancorpfinancial.com. We post on our investor website our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”), as amended, as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). The filings on our investor website are available free of charge. We also make available on our investor website our Corporate Governance Guidelines, our Codes of Business Ethics (including any waivers granted to executive officers or directors), and the charters of the Audit, Organization & Compensation, and Nominating & Corporate Governance Committees of our Board of Directors. These documents are also available in print without charge to any person who requests them by writing or telephoning our Shareholder Services Department, StanCorp Financial Group, Inc., 1100 SW Sixth Avenue, Portland, OR 97204, (800) 378-8360.

We are headquartered in Portland, Oregon and are a holding company for our insurance and asset management subsidiaries as well as for the subsidiaries included in our Other category. Our insurance businesses offer group and individual disability insurance, group life and accidental death and dismemberment (“AD&D”) insurance, group dental and group vision insurance, and absence management services. Through our insurance subsidiaries, we have the authority to underwrite insurance products in all 50 states as well as the District of Columbia and the U.S. territories of Guam and the Virgin Islands. Our asset management businesses offer full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. Our asset management businesses also offer investment advisory and management services, financial planning services, commercial mortgage loan origination and servicing, individual fixed-rate annuity products, group annuity contracts and retirement plan trust products, and manage certain real estate properties. The subsidiaries included in our Other category own and manage certain real estate properties held for sale as well as operate our online financial life planning and management service.

 

MISSION AND STRATEGY

Our mission is to exceed customers’ needs for financial products and services in growing markets where the application of specialized expertise creates potential for superior shareholder returns. Our vision is to lead the financial services industry in integrity, expertise and customer service. We operate in select financial products and services markets and seek to compete on expertise, differentiation and customer service, while maintaining a strong financial position.

Our long-term strategy includes:

   

Return value to shareholders through strategic uses of capital.

   

Maintaining strong growth rates in traditional risk acceptance businesses (disability and group life insurance).

   

Seeking to expand growth opportunities by increasing penetration in markets where we have limited presence.

   

Further diversifying our earnings base, and taking advantage of market opportunities, demographic trends and capital synergies by increasing our asset management businesses.

Our ability to accomplish this strategy is dependent on a number of factors, some of which involve risks or uncertainties. See “Competition” and “Key Factors Affecting Results of Operations” below and Item 1A, “Risk Factors,” of this Report.

 

STANCORP AND SUBSIDARIES

StanCorp, headquartered in Portland, Oregon, is a holding company and conducts business through wholly-owned operating subsidiaries throughout the United States. Through our subsidiaries, we have the authority to underwrite insurance products in all 50 states as well as the District of Columbia and the U.S. territories of Guam and the Virgin Islands.

Standard Insurance Company (“Standard”), our largest subsidiary, underwrites group and individual disability insurance and annuity products, group life and AD&D insurance, and provides group dental and group vision insurance, absence management services and retirement plan products. Founded in 1906, Standard is domiciled in Oregon, licensed in all states except New York, and licensed in the District of Columbia and the U.S. territories of Guam and the Virgin Islands.

 

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The Standard Life Insurance Company of New York was organized in 2000 and is licensed to provide group long term and short term disability, life, AD&D and dental and individual disability insurance in New York.

The Standard is a service mark of StanCorp and its subsidiaries and is used as a brand mark and marketing name by Standard and The Standard Life Insurance Company of New York.

Standard Retirement Services, Inc. (“Standard Retirement Services”) administers and services our retirement plans group annuity contracts and trust products. Retirement plan products are offered in all 50 states through Standard or Standard Retirement Services.

StanCorp Equities, Inc. (“StanCorp Equities”) is a limited broker-dealer and member of the Financial Industry Regulatory Authority. StanCorp Equities serves as principal underwriter and distributor for group variable annuity contracts issued by Standard and as the broker of record for certain retirement plans using the trust platform. StanCorp Equities carries no customer accounts but provides supervision and oversight for the distribution of group variable annuity contracts and of the sales activities of all registered representatives employed by StanCorp Equities and its affiliates.

StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”) originates and services fixed-rate commercial mortgage loans for the investment portfolios of our insurance subsidiaries. StanCorp Mortgage Investors also generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors.

StanCorp Investment Advisers, Inc. (“StanCorp Investment Advisers”) is an SEC-registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment advisory, financial planning and investment management services to its retirement plans clients, individual investors and subsidiaries of StanCorp.

StanCorp Real Estate, LLC is a property management company that owns and manages our Hillsboro, Oregon home office properties and other properties held for investment and held for sale and manages our Portland, Oregon home office properties.

Standard Management, Inc. owns and manages certain real estate properties held for sale.

Adaptu, LLC provides an online service to help users plan and manage their financial lives.

 

MARKET POSITION

Based on the United States insurance industry in force premium statistics, we have leading market positions with single digit market share in group long term and short term disability insurance, group life insurance and individual disability insurance. These statistics were based on the most recent JHA and LIMRA International insurance industry reports available as of January 2011. The positions are as follows:

   

5th largest provider of group long term disability insurance.

   

6th largest provider of group short term disability insurance.

   

9th largest provider of group life insurance.

   

9th largest provider of individual disability insurance.

 

FINANCIAL STRENGTH AND CREDIT RATINGS

Financial strength ratings, which we believe are gauges of our claims paying ability, are an important factor in establishing the competitive position of insurance companies. Ratings are important in maintaining public confidence in our company and in our ability to market our products. Rating organizations regularly review the financial performance and condition of insurance companies, including ours. In addition, credit ratings on our 10-year senior notes (“Senior Notes”) and junior subordinated debentures (“Subordinated Debt”) are tied to our financial strength ratings. A ratings downgrade could increase surrender levels for our annuity products, adversely affect our ability to market our products and increase costs of future debt issuances.

Standard & Poor’s (“S&P”), Moody’s Investors Service, Inc. (“Moody’s”) and A.M. Best Company (“A.M. Best”) provide financial strength ratings on Standard.

 

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Standard’s financial strength ratings as of January 2011 were:

 

S&P    Moody’s    A.M. Best

AA- (Very Strong)

   A1 (Good)    A (Excellent(1)

4th of 20 ratings

   5th of 21 ratings    3rd of 13 ratings
Outlook: Stable    Outlook: Stable    Outlook: Stable

 

  (1)  

Also includes The Standard Life Insurance Company of New York

 

Credit ratings assess credit quality and the likelihood of issuer default. S&P, Moody’s and A.M. Best provide ratings on StanCorp’s Senior Notes and Subordinated Debt. S&P and A.M. Best also provide issuer credit ratings for both Standard and StanCorp.

Our debt ratings and issuer credit ratings as of January 2011, which we believe are indicators of our liquidity and ability to make payments and which remained unchanged from our 2009 ratings, were:

 

     S&P      Moody’s      A.M. Best  

StanCorp debt ratings:

                          

Senior Notes

     A-         Baa1         bbb+   

Subordinated Debt

     BBB         Baa2         bbb-   

Issuer credit ratings:

                          

Standard

     AA-                 a+(1)   

StanCorp

     A-                 bbb+   
Outlook      Stable         Stable         Stable(1)   

 

  (1)   Also includes Standard Life Insurance Company of New York

 

We believe our well-managed underwriting and claims operations, high-quality invested asset portfolios, enterprise risk management processes and strong capital position will continue to support our financial strength ratings and strong credit standing. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Asset-Liability and Interest Rate Risk Management” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Management.” In addition, we remain well within our financial covenants. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Financing Cash Flows.”

 

SEGMENTS

We operate through two reportable segments: Insurance Services and Asset Management, as well as an Other category. Subsidiaries, or operating segments, have been aggregated to form our reportable segments. Resources are allocated and performance is evaluated at the segment level.

Of our total $2.77 billion in revenues for 2010, revenues of $2.41 billion were from our Insurance Services segment, revenues of $414.0 million were from our Asset Management segment and losses of $53.6 million were from our Other category. Revenues from the Other category included net capital losses of $51.6 million. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Consolidated Results of Operations—Revenues” and Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 5—Segments” for segment information regarding revenues, expenses and total assets for the years 2010, 2009 and 2008.

 

Insurance Services Segment

The Insurance Services segment offers group and individual disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services to individuals and employer groups ranging in size from two lives to more than 209,000 lives. We have approximately 31,000 group insurance policies in force, covering approximately 6.8 million employees as of December 31, 2010.

Our group insurance products are sold by sales representatives through independent employee benefit brokers and consultants. The sales representatives, who are employees of the Company, are compensated through salary and incentive

 

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compensation programs and are located in 41 field offices in principal metropolitan areas of the United States. The field offices also provide sales support and customer service through field administrative staff. Our arrangements with brokers include compensation established at the time of sale (commissions or fees) and, in some situations, also include compensation related to the overall performance of a block of business (performance-related compensation). In most cases, the overall performance of a block of business is measured in terms of volume and persistency (customer retention).

Group long term disability insurance contributed 38.1% of 2010 premiums for the segment. Group long term disability insurance provides partial replacement of earnings to insured employees who become disabled for extended periods of time.

Our basic long term disability product covers disabilities that occur during the policy period at both work and elsewhere. In order to receive long term disability benefits, an employee must be continuously disabled beyond a specified waiting period, which generally ranges from 30 to 180 days. The benefits are usually reduced by other income that the disabled employee receives from sources such as social security disability, workers compensation and sick leave. The benefits may also be subject to certain maximum amounts and benefit periods. Historically, approximately 50% of all claims filed under our long term disability policies close within 24 months. However, claims caused by more severe disabling conditions may be paid over longer periods, including up to normal retirement age or longer.

Generally, group long term disability policies offer rate guarantees for periods from one to three years. While we can prospectively re-price and re-underwrite coverage at the end of these guarantee periods, we must pay benefits with respect to claims incurred during these periods without being able to increase guaranteed premium rates during the same periods.

Group short term disability insurance contributed 9.9% of 2010 premiums for the segment. Our basic short term disability products generally cover only disabilities occurring outside of work. Short term disability insurance generally requires a short waiting period, ranging from one to 30 days, before an insured employee may receive benefits, with maximum benefit periods generally not exceeding 180 days. Group short term disability benefits may also be reduced by other income, such as sick leave that a disabled insured employee may receive.

Individual disability insurance contributed 7.9% of 2010 premiums for the segment. The products include non-cancelable disability coverage that provides insurance at a guaranteed fixed premium rate for the life of the contract, and guaranteed renewable coverage where premium rates are guaranteed for limited periods and are subject to change thereafter. We also offer a product with features that provide coverage in the event of partial disability or loss of income while caring for a family member with a serious health condition as well as medical and legal specialty protection. This segment also sells business overhead expense coverage that reimburses covered operating expenses when the insured is disabled, and business equity buy-out coverage that provides payment for the purchase, by other owners or partners, of the insured’s ownership interest in a business in the event of total disability. Non-cancelable disability insurance policies represented 68.6% of individual disability sales for 2010.

Our individual disability insurance products are sold nationally by brokers through master general agents, primarily to physicians, lawyers, executives, other professionals and small business owners. The compensation paid to brokers and master general agents is based primarily on a percentage of premiums. Some brokers and master general agents are eligible for a bonus based on sales volume and persistency of business they have written.

Group life and AD&D insurance contributed 40.1% of 2010 premiums for the segment. Group life insurance products provide coverage to insured employees for a specified period and have no cash value (amount of cash available to an insured employee on the surrender of, or withdrawal from, the life insurance policy). Coverage is offered to insured employees and their dependents. AD&D insurance is usually provided in conjunction with group life insurance, and is payable after the accidental death or dismemberment of the insured in an amount based on the face amount of the policy or dismemberment schedule.

Our other insurance premiums include group dental and group vision insurance and contributed 4.0% of 2010 premiums for the segment. Group dental products provide coverage to insured employees and their dependents for preventive, basic and major dental expenses, and also include an option to purchase orthodontia benefits. We offer three dental plans including a traditional plan, a reduced cost plan and a cost containment plan that are differentiated by levels of service and cost. Standard has a strategic marketing alliance with Ameritas Life Insurance Corp. (“Ameritas”), which offers Standard’s policyholders flexible dental coverage options and access to Ameritas’ nationwide preferred provider organization panel of dentists.

 

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Our group vision products provide coverage to insured employees and their dependents for essential eye care services including exams, frames, a variety of lens options and contact lenses. We offer three vision plans that are differentiated by vision-care provider network coverage.

We also offer absence management services that allow employers to outsource administrative services and compliance support for short term disability, family medical leave, leave of absence, paid time off, and other employer-specific leave programs.

 

Asset Management Segment

The Asset Management segment offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services through an affiliated broker-dealer. This segment also offers investment advisory and management services, financial planning services, commercial mortgage loan origination and servicing, individual fixed-rate annuity products, group annuity contracts and retirement plan trust products.

Retirement plans contributed 43.9% of 2010 revenues for the segment. Investment services for 401(k), defined benefit plans and governmental 457 plans are provided through a non-registered group annuity contract with third-party brand name mutual funds through a separate account and, for certain plans, a stable value investment option managed by Standard. These plan services also are provided through an open architecture (NAV) platform offering mutual funds and collective trusts. Plans on the NAV platform can choose from any mutual fund that our trading partners are able to trade. Retirement plan assets under administration were $15.28 billion at December 31, 2010.

Mutual funds offered through the group annuity separate account as of December 31, 2010 are limited to those funds that have been evaluated through a due diligence process. Representative fund companies are: Davis Funds, Dodge & Cox, Federated Investors Funds, Harbor Funds, Oppenheimer Funds, T. Rowe Price and Vanguard Funds. Funds offered in our group annuity retirement plans are regularly evaluated for performance, expense ratios, risk statistics, style consistency, industry diversification and management through the investment advisory service we provide to our customers. Funds are added and removed as part of this evaluation process. StanCorp Investment Advisers provides fund performance analysis and selection support to 86% of our group annuity plan sponsors. All group annuity contracts are distributed through StanCorp Equities.

Services for 403(b) and non-qualified deferred compensation plans are available on the NAV platform and have been provided through a registered group variable annuity contract, with a stable value investment option managed by Standard and separate account investment options. Representative fund companies utilized in the registered group annuity product are: American Century Investments, Black Rock Funds, Davis Funds, Delaware Investments Mutual Funds, Federated Investors Funds, T. Rowe Price and Vanguard Funds.

Our target market for retirement plans is primarily businesses with $1 million to $10 million in plan assets. Our retirement plans products and services are sold primarily through registered investment advisors, brokers, employee benefit consultants and other distributors served by our sales representatives throughout the United States. These distributors are usually compensated based on a percentage of the deposits or assets under administration. Compensation is disclosed to the customer by either Standard or Standard Retirement Services. Most of our retirement plan customers receive financial, record keeping and administrative services, although the option is available to receive only financial and record keeping services or financial services only through the group annuity product.

The primary sources of revenue for the retirement plans business include plan administration fees, asset-based fees and investment income on general account assets under administration, a portion of which is credited to policyholders. In addition, premiums and benefits to policyholders reflect the conversion of retirement plan assets into life-contingent annuities, which is an option that can be selected by plan participants at the time of retirement.

The Standard earned a total of three Best in Class awards in PlanSponsor Magazine’s 2010 Defined Contribution Survey. All of the Best in Class awards were in the $5 million to $50 million in plan assets category.

Individual annuities contributed 46.1% of 2010 revenues for the segment. The individual annuity products sold by this segment are primarily fixed-rate and indexed deferred annuities. This segment also sells immediate annuities. Our target market for annuities is any individual seeking conservative investments to meet their retirement or other financial goals. The fixed-rate annuity product portfolio includes deferred annuities with initial interest rate guarantees generally ranging

 

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from one to six years and a full array of single premium immediate annuity income payment options. We offer an indexed annuity product that uses over the counter call-spread options to hedge the index performance of the policies.

Fixed-rate annuities are distributed through national marketing organizations, brokers and financial institutions and compensation is primarily based on a percentage of premiums and deposits related to the business sold. Master General Agents are eligible for a bonus based on the volume of annuity business sold by financial institutions and brokers they coordinate.

Most of our annuity business deposits are not recorded as premiums, but rather are recorded as liabilities. Individual fixed-rate annuity deposits earn investment income, a portion of which is credited to policyholders. Annuity premiums consist of premiums on life-contingent annuities, which are a small portion of total sales.

Our other financial services business includes our investment advisory, real estate management and commercial mortgage loan origination businesses. These businesses contributed 10.0% of 2010 revenues for the segment.

Our investment advisory business, StanCorp Investment Advisers, is an SEC-registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment advisory and investment management services. Our target market is our retirement plan clients and individual investors with a minimum of $250,000 in portfolio assets.

Our commercial mortgage loans subsidiary, StanCorp Mortgage Investors, underwrites, originates and services fixed-rate commercial mortgage loans, generally between $250,000 and $5 million per loan for the investment portfolios of our insurance subsidiaries. It also generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors. The target market for commercial mortgage loans is small retail, office, and industrial properties located throughout the continental United States.

 

Other

In addition to our two segments, we report our holding company and corporate activities in the Other category. This category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, other unallocated expenses including costs incurred during our 2009 operating expense reduction initiatives, net capital gains and losses related to the impairment or the disposition of our invested assets and adjustments made in consolidation.

 

COMPETITION

Competition for the sale of our products comes primarily from other insurers and financial services companies such as banks, broker-dealers, mutual funds, and managed care providers for employer groups, individual consumers and distributors. Some competitors have greater financial resources, offer a broader array of products and have higher financial strength ratings. Pricing is competitive in the markets we serve. We do not seek to compete primarily on price. While we believe our products and service provide superior value to our customers, a significant price difference between our products and those of some of our competitors may result in periods of declining new sales, reduced persistency represented by customer retention, declining premium levels and increased sales force attrition. See “Key Factors Affecting Results of Operations—Pricing.”

 

KEY FACTORS AFFECTING RESULTS OF OPERATIONS

Our Insurance Services segment represented approximately 85%, 91% and 91% of total income before income taxes, excluding the Other category, for the years ended December 31, 2010, 2009 and 2008, respectively. In addition to competition, four primary factors can have a critical impact on the financial results of our Insurance Services segment operations: pricing; claims experience; wage, employment and benefit levels; and interest rates.

Our Asset Management segment represented approximately 15%, 9% and 9% of total income before income taxes, excluding the Other category, for the years ended December 31, 2010, 2009 and 2008, respectively. The financial results of the Asset Management segment are primarily impacted by employment and benefit levels, interest rates and equity market performance.

Pricing. One of the key components of our pricing decisions for many of our insurance products is the investment return available to us. In periods of decreasing or low interest rates, the returns available to us from our primary investments, fixed maturity securities—available-for-sale (“fixed maturity securities”) and commercial mortgage loans, decline. This may

 

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require us to increase the price of some of our products in order to maintain our targeted returns. If our competitors do not make similar adjustments to their product pricing or if they have a higher return on investments, our products may be more expensive than those offered by competitors. Alternatively, in periods when interest rates are increasing, we may be able to reduce premium rates, and therefore reduce pricing pressure to customers. Given the negative financial consequences of under-pricing, we believe that our practice of maintaining a disciplined approach to product pricing provides the best long-term pricing strategy, stable renewal pricing for our customers, higher levels of persistency, and therefore, the best long-term financial success for our company.

Claims Experience. We have a large and well-diversified insurance business. However, claims experience can fluctuate widely, particularly from quarter to quarter. The predominant factors affecting claims experience are incidence, represented by the number of claims, and severity, represented by the length of time a disability claim is paid and the size of the claim. These factors can fluctuate widely within and between our insurance products.

Wage, Employment and Benefit Levels. In our insurance businesses, premium rates are based, in part, on total salaries covered. The rate of wage and employment growth can influence organic growth of premiums. In addition, economic conditions can impact demand for the group insurance products we offer, and can increase competition as insurers compete for market share as overall market growth declines.

In our retirement plans business, the growth in wages and employment levels affects the level of new deposits for the retirement plans we administer, which affects the amount of administrative fee revenues we earn.

Interest Rates. Our financial results are sensitive to changing interest rates. Changes in interest rates affect product pricing for our insurance businesses because premiums collected today must be invested to provide a return sufficient to meet the future claims of policyholders. Therefore, we closely monitor changes in interest rates and make changes to our pricing, as appropriate. Interest rates also affect the discount rates we use to establish reserves.

For those products in our asset accumulation businesses where deposits are invested in securities managed by us, achieving adequate interest rates is important to meet customer obligations, including our annuity obligations.

Equity Market Performance. Changes in equity market performance affect the value of the assets under administration for our retirement plans business, which is a primary driver of administrative fee revenues we earn.

 

RISK MANAGEMENT

We manage our insurance risk through the following practices:

   

Sound product design and underwriting.

   

Effective claims management.

   

Pricing discipline.

   

Broad diversification of risk by customer geography, industry, size and occupation.

   

Maintenance of a strong financial position.

   

Maintenance of reinsurance and risk pool arrangements.

   

Sufficient alignment of assets and liabilities to meet financial obligations.

 

Diversification of Products

We achieve earnings diversification by offering multiple insurance products such as group and individual disability insurance, group life and AD&D insurance, and group dental insurance. These products have differing price, market and risk characteristics. Our strategy is to further diversify our earnings base and take advantage of market opportunities, demographic trends and capital synergies by increasing our asset accumulation and asset administration businesses.

 

Diversification by Customer Industry, Geography and Size

We seek to diversify risk by customer industry, geography and size measured by the number of insured employees. Over half of our group long term disability and group life insurance premiums come from industries in which we have expertise and a competitive advantage. These industries include the public sector, education, health care and utilities.

 

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The following tables set forth in force premium distribution by customer industry, geography and size for group long term disability and group life insurance products:

 

Customer Industry    December 31, 2010  

Public

     26

Education

     22   

Professional

     10   

Health Care

     9   

Manufacturing

     9   

Finance

     8   

Transportation

     2   

Services

     2   

Retail

     1   

Utilities

     1   

Other

     10   
          

Total

     100

 

Customer Geography    December 31, 2010  

West

     36

Central

     32   

Southeast

     17   

Northeast

     15   
          

Total

     100

 

Customer Size (Employees)    December 31, 2010  

2-99

     12

100-2,499

     37   

2,500-7,499

     18   

7,500 and above

     33   
          

Total

     100

 

Reinsurance

In order to limit our losses from large claim exposures, we enter into reinsurance agreements with other insurance companies. We review our retention limits based on size and experience. The maximum retention limit per individual for group life and AD&D is $750,000. Our maximum retention limit per individual for group disability insurance is $15,000 of monthly benefit. Our maximum retention limit per individual for individual disability insurance is $6,000 of monthly benefit.

Standard maintains a strategic marketing alliance with Ameritas that offers Standard’s policyholders more flexible dental coverage options and access to Ameritas’ nationwide preferred provider organization panel of dentists. As part of this alliance, Standard and Ameritas entered into a reinsurance agreement. In 2010, the agreement provided for 23.0% of the net dental premiums written by Standard and the risk associated with this premium to be ceded to Ameritas.

Standard participates in a reinsurance and third-party administration arrangement with Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) under which Northwestern Mutual group long term and short term disability products are sold using Northwestern Mutual’s agency distribution system. Generally, Standard assumes 60% of the risk, and receives 60% of the premiums for the policies issued. If Standard were to become unable to meet its obligations, Northwestern Mutual would retain the reinsured liabilities. Therefore, in accordance with an agreement with Northwestern Mutual, Standard established a trust for the benefit of Northwestern Mutual with the market value of assets in the trust equal to Northwestern Mutual’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust at December 31, 2010, was $226.5 million. Premiums assumed by Standard for the Northwestern

 

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Mutual business accounted for 3.0% of our total premiums for each of the three years 2010, 2009 and 2008. In addition to assuming risk, Standard provides product design, pricing, underwriting, legal support, claims management and other administrative services under the arrangement.

We also maintain reinsurance coverage for certain catastrophe losses related to group life and AD&D, with partial coverage of nuclear, biological and chemical acts of terrorism. Through a combination of this agreement and our participation in a catastrophe reinsurance pool discussed below, we have coverage of up to $450.9 million per event.

We are part of a catastrophe reinsurance pool with other insurance companies. This pool spreads catastrophe losses from group life and AD&D over 23 participating members. The annual fee we paid in 2010 to participate in the pool was less than $30,000. As a member of the pool, we are exposed to maximum potential losses experienced by other participating members of up to $103.2 million for a single event for losses submitted by a single company and a maximum of $258.1 million for a single event for losses submitted by multiple companies. Our percentage share of losses experienced by pool members will change over time as it is a function of our group life and AD&D in force relative to the total group life and AD&D in force for all pool participants. The reinsurance pool does not exclude war or nuclear, biological and chemical acts of terrorism.

The Terrorism Risk Insurance Act of 2002 (“TRIA”), which has been extended through 2014, provides for federal government assistance to property and casualty insurers in the event of material losses due to terrorist acts on behalf of a foreign person or foreign interest. Due to the concentration of risk present in group life insurance and the fact that group life insurance is not covered under TRIA, an occurrence of a significant catastrophe or a change in the on-going nature and availability of reinsurance and catastrophe reinsurance could have a material adverse effect on us.

 

Asset-Liability and Interest Rate Risk Management

See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Asset-Liability and Interest Rate Risk Management.”

 

INVESTMENTS

Investment management is an integral part of our business. Investments are maintained to ensure that asset types and maturities are appropriate for our policy reserves and other liabilities so that we can meet our obligations to policyholders under a wide variety of economic conditions. A substantial portion of our insurance subsidiaries’ policy liabilities result from long term disability reserves that have proven to be very stable over time, and annuity products on which interest rates can be adjusted periodically, subject to minimum interest rate guarantees. Policyholders or claimants may not withdraw funds from the large block of disability reserves. Instead, claim payments are issued monthly over periods that may extend for many years. Holding these stable long-term reserves makes it possible to allocate a significant portion of invested assets to long-term fixed-rate investments, including commercial mortgage loans and low-income housing tax credit investments. StanCorp Mortgage Investors’ unique expertise with respect to its market niche for small fixed-rate commercial mortgage loans, allows us to enhance the yield on the overall investment portfolio beyond that available through fixed maturity securities with an equivalent risk profile. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Investing Cash Flows” and Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 10—Investments.”

 

REGULATION

State and Federal Laws and Regulations

Standard sells its products in and is regulated by the District of Columbia and all states except New York. The Standard Life Insurance Company of New York sells its products in and is regulated by the state of New York. The insurance industry in the United States is subject to extensive regulation. Such regulation relates to, among other things, terms and provisions of insurance policies, market conduct practices, maintenance of capital and payment of distributions, and financial reporting on a statutory basis of accounting.

We maintain registered group variable annuity products, which are part of a registered investment company under the Investment Company Act of 1940. This Act regulates the relationship between a registered investment company and its investment adviser.

 

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As registered investment advisers, StanCorp Investment Advisers is subject to regulation under the Investment Advisers Act of 1940. This Act establishes, among other things, recordkeeping and reporting requirements, disclosure requirements, limitations on transactions between the adviser’s account and an advisory client’s account, limitations on transactions between the accounts of advisory clients and general anti-fraud provisions.

Violation of applicable laws and regulations can result in legal or administrative proceedings, which can result in fines, penalties, cease and desist orders or suspension or expulsion of our license to sell insurance in a particular state.

 

Capital Requirement—Risk-Based Capital

The National Association of Insurance Commissioners uses Risk-based Capital (“RBC”) to aid in the assessment of the statutory capital and surplus of life and health insurers. RBC employs a risk-based formula that applies prescribed factors to the various risk elements inherent in an insurer’s business to arrive at minimum capital requirements in proportion to the amount of risk assumed by the insurer. The RBC model determines an appropriate Company Action Level based on our business and assets. Capital below the Company Action Level RBC would require us to prepare and submit an RBC plan to the commissioner of the state of domicile outlining the capital level we plan on maintaining. Capital below the Authorized Control Level RBC, which is 50% of the Company Action Level RBC, is the capital level at which the state of domicile is authorized to take whatever regulatory actions it considers necessary to protect the best interests of the policyholders and creditors of the insurer.

At December 31, 2010, the capital of our insurance subsidiaries was approximately 331% of the Company Action Level RBC required by regulators, which was 661% of the Authorized Control Level RBC required by our states of domicile. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Management.”

 

EMPLOYEES

At December 31, 2010, StanCorp and its subsidiaries had 3,091 full-time equivalent employees, 78% of which were located in Portland, Oregon and the surrounding metropolitan area. At December 31, 2010, none of our employees were represented by unions.

 

Item 1A.   Risk Factors

 

FORWARD-LOOKING STATEMENTS

From time to time StanCorp or its representatives make written or oral statements, including some of the statements contained or incorporated by reference in this Annual Report on Form 10-K and in other reports, filings with the Securities and Exchange Commission (“SEC”), press releases, conferences or otherwise, that are other than purely historical information. These statements, including estimates, projections, statements related to business plans, strategies, objectives and expected operating results and the assumptions upon which those statements are based, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements also include, without limitation, any statement that includes words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “seeks,” “will be,” “will continue,” “will likely result” and similar expressions that are predictive in nature or that depend on or refer to future events or conditions. Our forward-looking statements are not guarantees of future performance and involve uncertainties that are difficult to predict. They involve risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. The risks and uncertainties are detailed in reports filed by StanCorp with the SEC, including Forms 8-K, 10-Q and 10-K, which may include, but are not limited to, the factors listed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward-Looking Statements” of this Form 10-K.

As a provider of financial products and services, our actual results of operations may vary significantly in response to economic trends, interest rates, investment performance, claims experience, operating expenses and pricing. Given these uncertainties or circumstances, investors are cautioned not to place undue reliance on such statements as a predictor of future results. We assume no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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RISK FACTORS

Risk factors that may affect our business are as follows:

   

Our reserves for future policy benefits and claims related to our current and future business, as well as reserves related to businesses we may acquire in the future, may prove to be inadequate—For certain of our product lines, we establish and carry, as a liability, actuarially determined reserves to meet our obligations for future policy benefits and claims. These reserves do not represent an exact calculation of our future benefit liabilities but are instead estimates based on assumptions, which can be materially affected by changes in the economy, changes in social perceptions about work ethics, emerging medical perceptions regarding physiological or psychological causes of disability, emerging or changing health issues and changes in industry regulation. Claims experience on our products can fluctuate widely from period to period. If actual events vary materially from our assumptions used when establishing the reserves to meet our obligations for future policy benefits and claims, we may be required to increase our reserves, which could have a material adverse effect on our business, financial position, results of operations or cash flows.

   

Differences between actual claims experience and underwriting and reserving assumptions may adversely affect our financial results—Our long term disability products provide coverage for claims incurred during the policy period. Generally, group policies offer rate guarantees for periods from one to three years. While we can prospectively re-price and re-underwrite coverages at the end of these guarantee periods, we must pay benefits with respect to claims incurred during these periods without being able to increase guaranteed premium rates during these periods. Historically, approximately 50% of all claims filed under our long term disability policies close within 24 months. However, claims caused by more severe disabling conditions may be paid over much longer periods, including, in some cases, up to normal retirement age or longer. Longer duration claims, in addition to a higher volume of claims than we expect, expose us to the possibility that we may pay benefits in excess of the amount that we anticipated when the policy was underwritten. The profitability of our long term disability products is thus subject to volatility resulting from the difference between our actual claims experience and our assumptions at the time of underwriting.

   

We are exposed to concentration risk on our group life insurance business—Due to the nature of group life insurance coverage, we are subject to geographical concentration risk from the occurrence of a catastrophe.

   

Catastrophe losses from a disease pandemic could have an adverse effect on us—Our life insurance operations are exposed to the risk of loss from an occurrence of catastrophic mortality caused by a disease pandemic, which could have a material adverse effect on our business, financial position, results of operations or cash flows.

   

Catastrophe losses from terrorism or other factors could have an adverse effect on us—An occurrence of a significant catastrophic event, including terrorism, natural or other disasters, or a change in the nature and availability of reinsurance and catastrophe reinsurance, could have a material adverse effect on our business, financial position, results of operations or cash flows.

   

We may be exposed to disintermediation risk during periods of increasing interest rates—In periods of increasing interest rates, withdrawals of annuity contracts may increase as policyholders seek investments with higher perceived returns. This process, referred to as disintermediation, may lead to net cash outflows. These outflows may require investment assets to be sold at a time when the prices of those assets are adversely affected by the increase in interest rates, which may result in realized investment losses. A significant portion of our investment portfolio consists of commercial mortgage loans, which are relatively illiquid, thus increasing our liquidity risk in the event of disintermediation during a period of rising interest rates.

   

Our profitability may be adversely affected by declining or low interest rates—During periods of declining or low interest rates, annuity products may be relatively more attractive investments, resulting in increases in the percentage of policies remaining in force from year to year during a period when our new investments carry lower returns. During these periods, actual returns on our investments could prove inadequate for us to meet contractually guaranteed minimum payments to holders of our annuity products. In addition, the profitability of our life and disability insurance products can be affected by declining or low interest rates. A factor in pricing our insurance products is prevailing interest rates. Longer duration claims and premium rate guarantees can expose us to interest rate risk when portfolio yields are less than those assumed when pricing these products. Mortgages and bonds in our investment portfolio are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates, and we may be required to reinvest those funds in lower interest-bearing investments.

 

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Our investment portfolio is subject to risks of market value fluctuations, defaults, delinquencies and liquidity—Our general account investments primarily consist of fixed maturity securities—available-for-sale (“fixed maturity securities”), commercial mortgage loans and real estate. The fair values of our investments vary with changing economic and market conditions and interest rates. In addition, we are subject to default risk on our fixed maturity securities portfolio and its corresponding impact on credit spreads, and delinquency and default risk on our commercial mortgage loans. Related declines in market activity due to overall declining values of fixed maturity securities may result in our fixed maturity securities portfolio becoming less liquid. Also, our commercial mortgage loans are relatively illiquid and the demand for our real estate owned may remain low due to macroeconomic conditions. We may have difficulty selling our fixed maturity securities, commercial mortgage loans and real estate owned at attractive prices, in a timely manner, or both if we require significant amounts of cash on short notice.

   

Our business is subject to significant competition—Each of our business segments faces competition from other insurers and financial services companies, such as banks, broker-dealers, mutual funds, and managed care providers for employer groups, individual consumers and distributors. Since many of our competitors have greater financial resources, offer a broader array of products and, with respect to other insurers, may have higher financial strength ratings than we do, the possibility exists that any one of our business segments could be adversely affected by competition, which in turn could have a material adverse effect on our business, financial position, results of operations or cash flows.

   

A downgrade in our financial strength ratings may negatively affect our business—Financial strength ratings, which are an indicator of our claims paying ability, are an important factor in establishing the competitive position of insurance companies. Ratings are important to maintaining public confidence in our company and in our ability to market our products. Rating organizations regularly review the financial performance and condition of insurance companies, including our company. A ratings downgrade could increase our surrender levels for our annuity products, could adversely affect our ability to market our products, could increase costs of future debt issuances, and could thereby have a material adverse effect on our business, financial position, results of operations or cash flows.

   

Our profitability may be affected by changes in state and federal regulation—Our business is subject to comprehensive regulation and supervision throughout the United States (“U.S.”) including rules and regulations relating to income taxes and accounting principles generally accepted in the U.S. While we cannot predict the impact of potential or future state or federal legislation or regulation on our business, future laws and regulations, or the interpretation thereof, could have a material adverse effect on our business, financial position, results of operations or cash flows.

   

Our business is subject to litigation risk—In the normal course of business, we are a plaintiff or defendant in actions arising out of our insurance business and investment operations. We are from time to time involved in various governmental and administrative proceedings. While the outcome of any pending or future litigation cannot be predicted, as of the date hereof, we do not believe that any pending litigation will have a material adverse effect on our results of operations or financial condition. However, no assurances can be given that such litigation would not materially and adversely affect our business, financial position, results of operations or cash flows.

   

The concentration of our investments in California may subject us to losses resulting from the economic downturn—Our commercial mortgage loans are concentrated in the western region of the U.S., particularly in California. Currently, our California exposure is primarily in Los Angeles County, Orange County, San Diego County and the Bay Area Counties. We have a smaller concentration of commercial mortgage loans in the Inland Empire and the San Joaquin Valley where there has been greater economic decline. A continued decline in economic conditions in California could have a material adverse effect on our business, financial position, results of operations or cash flows.

   

The concentration of our investments in the western region of the U.S. may subject us to losses resulting from certain natural catastrophes in this area—Due to our commercial mortgage loan concentration in the western region of the U.S., particularly in California, we are exposed to potential losses resulting from certain natural catastrophes, such as earthquakes and fires, which may affect the region. Although we diversify our commercial mortgage loan portfolio within the western region by both location and type of property in an effort to reduce earthquake exposure, such diversification may not eliminate the risk of such losses, which could have a material adverse effect on our business, financial position, results of operations or cash flows.

 

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We may be exposed to environmental liability from our commercial mortgage loan and real estate investments—As a commercial mortgage lender, we customarily conduct environmental assessments prior to making commercial mortgage loans secured by real estate and before taking title through foreclosure or deeds in lieu of foreclosure to real estate collateralizing delinquent commercial mortgage loans held by us. Compliance costs associated with environmental laws and regulations or any remediation of affected properties could have a material adverse effect on our results of operations or financial condition.

   

As a holding company, we depend on the ability of our subsidiaries to transfer funds to us in sufficient amounts to pay dividends to shareholders, make payments on debt securities and meet our other obligations—We are a holding company for our insurance and asset management subsidiaries as well as for the subsidiaries that comprise our Other category and do not have any significant operations of our own. Dividends and permitted payments from our subsidiaries are our principal source of cash to pay dividends to shareholders, make payments on debt securities and meet our other obligations. As a result, our ability to pay dividends to shareholders and interest payments on debt securities primarily will depend upon the receipt of dividends and other distributions from our subsidiaries.

Many of our subsidiaries are non-insurance businesses and have no regulatory restrictions on dividends. Our insurance subsidiaries, however, are regulated by insurance laws and regulations that limit the maximum amount of dividends, distributions and other payments that they could declare and pay to us without prior approval of the states in which the subsidiaries are domiciled. Under Oregon law, Standard Insurance Company may pay dividends only from the earned surplus arising from its business. Oregon law gives the Director of the Oregon Department of Consumer and Business Services—Insurances Division (“Oregon Insurance Division”) broad discretion regarding the approval of dividends in excess of certain statutory limitations. Oregon law requires us to receive the prior approval of the Oregon Insurance Division to pay such a dividend. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Management—Dividends from Standard.”

   

Our ability to refinance debt and raise capital in future years depends not only on contributions from our subsidiaries but also on market conditions and availability of credit in the market—We do not have any significant debt maturities in the near-term. Our 10-year senior notes of $250 million will mature in September 2012, and our junior subordinated debentures of $300 million will mature in 2067 with a call option in 2017. We maintain a $200 million senior unsecured revolving credit facility (“Facility”) for general corporate purposes. The Facility will remain at $200 million through June 15, 2012, and will decrease to $165 million thereafter until final maturity on June 15, 2013. We had no outstanding balance on the Facility at December 31, 2010. The Facility is composed of a syndication of six banks. Commitments from the banks toward the available line of credit range from $10.0 million to $52.5 million per bank. Should a bank from this syndication default, the available line of credit would be reduced by that bank’s commitment toward the line. For a full discussion of debt instruments See Part II, Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 18—Long-Term Debt.”

   

Our business continues to be affected by employment and wage levels—Factors influencing the growth of our group insurance and retirement plans businesses include the employment levels, benefit offerings, and salary and wage growth of our employer groups. Current economic conditions have caused our employer groups to experience lower levels of insured employees, to limit benefit offerings, to reduce work hours, or to reduce or slow the growth of wage levels. If economic conditions worsen, it could have a material adverse effect on premium levels for our group businesses and revenues for our retirement plans business.

   

Our profitability may be adversely affected by declining equity markets—U.S. and global equity markets heavily influence the value of our retirement plan assets under administration, which are a significant component from which our administrative fee revenues are derived. Sustained equity market declines could result in decreases in the value of the assets under administration in our retirement plans, which could reduce our ability to earn administrative fee revenues derived from the value of those assets.

   

Declining equity markets could affect the funding status of Company sponsored pension plans—Our estimates of liabilities and expenses for pension and other postretirement benefits incorporate significant assumptions including the rate used to discount the estimated future liability, the long-term rate of return on plan assets and the employee work force. Declines in the discount rate or the rate of return on plan assets resulting from the current economic downturn could increase our required cash contributions or pension-related expenses in future periods.

 

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Our ability to conduct business may be compromised if we are unable to maintain the availability of our systems and safeguard the security of our data in the event of a disaster or other unanticipated events—We use computer systems to store, retrieve, evaluate and utilize customer and company data and information. Our business is highly dependent on our ability to access these systems to perform necessary business functions. System failures, system outages or the failure or unwillingness of a supplier to perform could compromise our ability to perform these functions in a timely manner and could hurt our relationships with our business partners and customers. In the event of a disaster such as a natural catastrophe, fire, blackout, computer virus, terrorist attack or war, these systems may be inaccessible to our employees, customers or business partners for an extended period of time. These systems could also be subject to physical and electronic break-ins and subject to similar disruptions from unauthorized tampering. This may impede or interrupt our business operations and could have a material adverse effect on our business, financial position, results of operations or cash flows.

   

The U.S. economic downturn and disruption in global financial markets could continue to adversely affect us in the near term—The U.S. economic downturn and disruption in the global financial market present risks and uncertainties. In the current economic downturn, we face the following risks:

   

Declines in revenues or profitability as a result of lost wages or lower levels of insured employees by our customers due to reductions in workforce.

   

Increases in pricing pressure and competition resulting in a loss of customers or new business as customers seek to reduce benefit costs and competitors seek to protect market share.

   

Increases in commercial mortgage loan foreclosures.

   

Increases in holdings of real estate owned properties due to a decline in demand for these properties and the decline in value of these properties during our holding period.

   

If the U.S. economy and global financial markets do not continue to recover, it could have a lasting adverse effect on us—In addition to the risks we noted above that we are currently facing, if the U.S. economy and global financial markets do not continue to recover, we could be adversely affected in the following ways:

   

Increases in corporate tax rates to finance government spending programs.

   

Reductions in the number of our potential lenders or to our committed credit availability due to combinations or failures of financial institutions.

   

Loss of employer groups due to business acquisitions, bankruptcy or failure.

   

Declines in the financial health of reinsurers.

   

Reduction in the value of our general account investment portfolio.

   

Declines in revenues and profitability as a result of lower levels of assets under administration.

 

Item 1B.   Unresolved Staff Comments

 

None.

 

Item 2.   Properties

 

Principal properties owned by Standard Insurance Company (“Standard”) and used by StanCorp Financial Group, Inc. or its subsidiaries consist of two office buildings in downtown Portland, Oregon: the Standard Insurance Center, with approximately 460,000 square feet; and the Standard Plaza, with approximately 220,000 square feet. Both of our business segments use the facilities described above. We also own two buildings in Hillsboro, Oregon, each with 72,000 square feet of office space. The Hillsboro offices are used by StanCorp Mortgage Investors, LLC and our group insurance claims operations. In addition, Standard leases approximately 160,000 square feet of office space located in downtown Portland, Oregon, for home office and claims operations and 60,000 square feet of offsite storage. We lease 61 offices under commitments of varying terms to support our sales and regional processing offices throughout the United States. Management believes that the capacity and types of facilities are suitable and adequate for operations. See Part II, Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 1—Summary of Significant Accounting Policies—Property and Equipment, Net.”

 

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Item 3.   Legal Proceedings

 

In the normal course of business, we are involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending at December 31, 2010. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material adverse effect on our business, financial position, results of operations or cash flows.

 

Item 4.   (Removed and Reserved)

 

Item 4A.   Executive Officers of the Registrant

 

The following table sets forth the executive officers of StanCorp Financial Group (“StanCorp”) and Standard Insurance Company (“Standard”):

 

Name    Age (as of
February 25,
2011)
     Position

Floyd F. Chadee

     53       Senior Vice President and Chief Financial Officer of StanCorp and Standard

Katherine Durham*

     44       Vice President of Marketing and Communications of Standard

James B. Harbolt*

     48       Vice President, Insurance Services Group of Standard

Scott A. Hibbs*

     49       Vice President, Asset Management Group of Standard

Daniel J. McMillan*

     44       Vice President, Insurance Services Group of Standard

J. Gregory Ness

     53       President and Chief Executive Officer of StanCorp and Standard

David M. O’Brien*

     54       Senior Vice President, Information Technology of Standard
Karen M. Weisz*      43       Vice President, Human Resources and Corporate Services of Standard

 

  *   Denotes an officer of a subsidiary who is not an officer of StanCorp but who is considered an “executive officer” of StanCorp under the regulations of the Securities and Exchange Commission.

 

Set forth below is biographical information for the executive officers of StanCorp:

Floyd F. Chadee, Ph.D., FSA, has been Senior Vice President and Chief Financial Officer of StanCorp and Standard since April 2008. Prior to this position, Mr. Chadee served as Senior Vice President and Chief Financial Officer at Assurant Employee Benefits, a part of Assurant, Inc., and had been with Assurant Employee Benefits since 1998.

Katherine Durham has been Vice President, Marketing and Communications of Standard since March 2010. Prior to joining Standard, Ms. Durham served as Vice President of Marketing for Hewlett-Packard’s Americas Imaging and Printing Group. During nine years at HP, she moved into roles of increasing responsibility in a variety of functions including business planning, market insight, communication and operations.

James B. Harbolt has been Vice President, Insurance Services Group of Standard since October 2008. Mr. Harbolt co-leads the Insurance Services segment and is responsible for employee benefit sales, actuarial, underwriting, legal, individual disability insurance and the Standard Life Insurance Company of New York. Mr. Harbolt has been with the Company since June 1994 when he joined as Assistant Counsel. From 1997 until 2000 Mr. Harbolt was Second Vice President and Associate Counsel and then Assistant Vice President and Associate Counsel in Individual Insurance. He was named Vice President of Individual Disability Insurance in 2000, and in 2005 he became Vice President and Associate Counsel of Employee Benefits Law.

Scott A. Hibbs has been Vice President, Asset Management Group of Standard since January 2009. From September 2007 to January 2009, Mr. Hibbs was a Vice President for the Insurance Services segment, which included responsibility for the individual disability insurance area and The Standard Life Insurance Company of New York. From July 2005 to September 2007 Mr. Hibbs was Vice President for the Asset Management segment, which included responsibility for StanCorp Investment Advisers, Inc. From July 2004 to July 2005, Mr. Hibbs was Vice President of Corporate Strategy and Business Development. Prior to July 2004, Mr. Hibbs was Assistant Vice President of Investor Relations and Financial Planning. Mr. Hibbs has been with the Company since 2000.

 

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Daniel J. McMillan has been Vice President, Insurance Services Group of Standard since October 2008. Mr. McMillan co-leads the Insurance Services segment and is responsible for all claims services, customer support, premium administration, producer services, shared services, and the enterprise contact center. Mr. McMillan has been with Standard since July 1989 and has held a number of positions in the Insurance Services segment. In 2002 Mr. McMillan was named Business Program Executive at Standard, and in 2007 he was named Vice President of Shared Services.

J. Gregory Ness, LLIF, has been President and Chief Executive Officer of StanCorp and Standard since July 2009. From September 2008 until July 2009, Mr. Ness served as President and Chief Operating Officer of StanCorp and Standard. Prior to his appointment to President and Chief Operating Officer, Mr. Ness served as Senior Vice President, Insurance Services segment of Standard since the Company’s segment realignment in January 2006. From April 2004 to January 2006, Mr. Ness was Senior Vice President, group insurance division of Standard. From 1999 to April 2004, Mr. Ness was Senior Vice President, Investments of Standard.

David M. O’Brien has been Senior Vice President of Information Technology of Standard since June 2006. From May 2004 to June 2006, Mr. O’Brien was Vice President of Information Technology. Prior to joining Standard in 2004, Mr. O’Brien served as Chief Information Officer for FEI Company.

Karen M. Weisz has been Vice President of Human Resources and Corporate Services for Standard since January 2009. From January 2008 to January 2009, Ms. Weisz was Vice President of Human Resources. Prior to joining Standard, Ms. Weisz served as Human Resources Director of new and emerging platform business groups at Intel Corporation and served Intel in various other human resource functions for more than 12 years.

 

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Part II

 

Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock is listed on the New York Stock Exchange Euronext (“NYSE”) under the symbol “SFG.” As of February 18, 2011, there were 35,302 shareholders of record of common stock.

The following tables set forth the high and low sales prices as reported by the NYSE at the close of the trading day and cash dividends paid per share of common stock:

 

     2010  
     4th Quarter      3rd Quarter      2nd Quarter      1st Quarter  

High

   $ 46.06       $ 42.88       $ 50.19       $ 47.63   

Low

     38.34         35.47         40.54         39.42   
Dividend Paid      0.86                           

 

     2009  
     4th Quarter      3rd Quarter      2nd Quarter      1st Quarter  

High

   $ 42.10       $ 41.07       $ 32.47       $ 41.52   

Low

     36.04         27.39         22.55         13.96   
Dividend Paid      0.80                           

 

The declaration and payment of dividends in the future is subject to the discretion of our Board of Directors. It is anticipated that annual dividends will be paid in December of each year depending on our financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on the distributions from the insurance subsidiaries, the ability of the insurance subsidiaries to maintain adequate capital and other factors deemed relevant by our Board of Directors. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Management.” See also Part I, Item 1A, “Risk Factors.”

 

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The following graph provides a comparison of the cumulative total shareholder return on our common stock with the cumulative total return of the Standard & Poor’s (“S&P”) 500 Index, the S&P Life and Health Insurance Index and the S&P Insurance Group Index. The comparison assumes $100 was invested on December 31, 2005, in our common stock and in each of the foregoing indexes, and assumes the reinvestment of dividends. The graph covers the period of time beginning December 31, 2005, through December 31, 2010.

LOGO

 

 

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The following table sets forth share repurchase information:

 

     (a) Total Number of
Shares Purchased
     (b) Average Price
Paid per Share
     (c) Total Number
of Shares Purchased
as Part of Publicly
Announced Plans or
Programs
     (d) Maximum Number
of Shares that May Yet
Be Purchased Under
the Plans or Programs
 

Period:

                                   

October 1-31, 2010

     48,600       $ 39.08         48,600         2,308,900   

November 1-30, 2010

                             2,308,900   

December 1-31, 2010

                             2,308,900   
    


           


        

Total fourth quarter

     48,600       $ 39.08         48,600         2,308,900   

 

On February 8, 2010, the Board of Directors authorized a share repurchase program of up to 3.0 million shares of StanCorp common stock. The February 2010 repurchase program took effect upon the completion of the previous share repurchase program and expires on December 31, 2011. As of December 31, 2010, we had 2.3 million shares remaining under our current share repurchase authorization. Share repurchases under the repurchase program are made in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934. Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock and other potential growth opportunities or priorities for capital use. We also acquire shares of common stock from executive officers and directors to cover tax liabilities of those officers and directors upon the release of performance-based shares. Repurchases are made at market prices on the transaction date.

The following table sets forth share repurchase activity:

 

     Years ended
December 31,
 
(Dollars in millions except per share data)    2010      2009  

Share repurchases:

                 

Shares repurchased

         2,034,200             1,551,700   

Cost of share repurchases

   $ 81.8       $ 59.3   

Volume weighted-average price per common share

     40.19         38.20   

Shares remaining under repurchase authorizations

     2,308,900         1,343,100   

Shares acquired to cover tax liabilities:

                 

Shares acquired

     8,613         5,584   

Cost of share repurchases

   $ 0.4       $ 0.2   

Volume weighted-average price per common share

     43.01         31.34   

 

Information required by Item 5 with respect to securities authorized for issuance under equity compensation plans is contained in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

 

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Item 6.   Selected Financial Data

 

The following table sets forth selected financial data at or for the years ended December 31 and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data”:

 

(Dollars in millions—except share data)   2010     2009     2008     2007     2006  

Income Statement Data:

                                       

Revenues:

                                       

Premiums

  $ 2,097.7      $ 2,101.9      $ 2,140.2      $ 2,078.3      $ 1,935.0   

Administrative fees

    116.5        108.5        114.6        115.2        77.1   

Net investment income

    602.5        586.5        541.0        516.3        478.9   

Net capital gains (losses)

    (51.6     (26.9     (128.8     (0.6     1.9   
                                         

Total revenues

    2,765.1        2,770.0        2,667.0        2,709.2        2,492.9   
                                         

Benefits and expenses:

                                       

Benefits to policyholders and interest credited

    1,778.2        1,721.3        1,700.1        1,700.6        1,610.8   

Operating expenses*

    665.2        693.8        686.6        636.2        554.5   

Interest expense

    38.9        39.2        39.2        30.7        17.9   
                                         

Total benefits and expenses

    2,482.3        2,454.3        2,425.9        2,367.5        2,183.2   
                                         

Income before income taxes

    282.8        315.7        241.1        341.7        309.7   

Income taxes

    93.8        106.8        78.2        114.2        105.9   
                                         

Net income

  $ 189.0      $ 208.9      $ 162.9      $ 227.5      $ 203.8   

Benefit Ratios, including interest credited (% of total premiums):

                                       

Group insurance

    77.2     74.7     73.6     77.4     78.3

Individual disability

    66.8        69.3        78.7        69.3        79.4   

Per Common Share:

                                       

Basic net income

  $ 4.04      $ 4.27      $ 3.33      $ 4.39      $ 3.77   

Diluted net income

    4.02        4.26        3.30        4.35        3.73   

Market value at year end

    45.14        40.02        41.77        50.38        45.05   

Dividends declared and paid

    0.86        0.80        0.75        0.72        0.65   

Basic weighted-average shares outstanding

      46,774,277          48,932,908          48,917,235          51,824,050          54,079,033   

Diluted weighted-average shares outstanding

    47,006,228        49,044,543        49,292,240        52,344,950        54,688,114   

Ending shares outstanding

    46,159,387        47,744,524        48,989,074        49,155,131        53,592,178   

Balance Sheet Data:

                                       

General account assets

  $ 13,055.9      $ 12,395.0      $ 11,479.3      $ 10,596.5      $ 9,806.1   

Separate account assets

    4,787.4        4,174.5        3,075.9        4,386.4        3,832.5   
         

Total assets

  $ 17,843.3      $ 16,569.5      $ 14,555.2      $ 14,982.9      $ 13,638.6   
                                         

Long-term debt

  $ 551.9      $ 553.2      $ 561.5      $ 562.6      $ 261.1   

Total liabilities

    15,931.2        14,834.1        13,174.9        13,553.9        12,174.1   

Total equity

    1,912.1        1,735.4        1,380.3        1,429.0        1,464.5   

Statutory Data:

                                       

Net gain from operations before federal income taxes and realized capital gains (losses)

  $ 317.4      $ 375.0      $ 341.6      $ 309.3      $ 271.1   

Net gain from operations after federal income taxes and before capital gains (losses)

    202.4        251.4        235.0        197.2        172.8   

Capital and surplus

    1,226.8        1,243.2        1,154.6        1,047.8        967.5   

Asset valuation reserve

    95.6        89.7        78.8        102.2        96.6   

 

  *  

Includes operating expenses, commissions and bonuses, premium taxes, and the net increase in deferred acquisition costs, value of business acquired and other intangible assets.

 

20   STANCORP FINANCIAL GROUP, INC.


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following management assessment of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto contained in Item 8, “Financial Statements and Supplementary Data.” Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during each reporting period. The estimates most susceptible to material changes due to significant judgment are identified as critical accounting policies. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. See “Critical Accounting Policies and Estimates.”

Financial measures that exclude after-tax costs related to our 2009 operating expense reduction initiatives and after-tax net capital gains and losses are non-GAAP measures. To provide investors with a broader understanding of earnings, we provide net income per diluted share excluding after-tax costs related to our 2009 operating expense reduction initiatives and after-tax net capital gains and losses, along with the GAAP measure of net income per diluted share, because costs related to operating expense reduction initiatives occur infrequently and capital gains and losses are not likely to occur in a stable pattern.

This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements. See Part I, Item 1A, “Risk Factors–Forward-Looking Statements.”

 

EXECUTIVE SUMMARY

Financial Results Overview

The following table sets forth selected consolidated financial results:

 

    Years ended
December 31,

 
(Dollars in millions except share data)   2010     2009     2008  

Net income

  $ 189.0      $ 208.9      $ 162.9   

After-tax costs related to operating expense reduction initiatives

           (12.0       

After-tax net capital losses

    (32.1     (17.3     (83.4
                         

Net income excluding after-tax costs related to operating expense reduction initiatives and after-tax net capital losses

  $ 221.1      $ 238.2      $ 246.3   
                         

Diluted earnings per common share:

                       

Net income

  $ 4.02      $ 4.26      $ 3.30   

After-tax costs related to operating expense reduction initiatives

           (0.25       

After-tax net capital losses

    (0.68     (0.35     (1.70
                         

Net income excluding after-tax costs related to operating expense reduction initiatives and after-tax net capital losses

  $ 4.70      $ 4.86      $ 5.00   
                         
Diluted weighted-average common shares outstanding       47,006,228          49,044,543          49,292,240   

 

GAAP results for 2010 reflected less favorable claims experience in the Insurance Services segment and net capital losses recognized on real estate acquired in satisfaction of debt through foreclosure or the acceptance of deeds in lieu of foreclosure on commercial mortgage loans (“real estate owned”) and additional provisions to our commercial mortgage loan loss allowance. These factors were partially offset by higher earnings in the Asset Management segment, the effect of a decrease in diluted weighted-average common shares outstanding and a reduction in operating expenses reflecting the completion of our 2009 operating expense reduction initiatives and careful expense management during 2010.

The increase in GAAP net income for 2009 compared to 2008 reflected a decline in net capital losses and increased net investment income in the Asset Management segment, partially offset by costs associated with our 2009 operating expense reduction initiatives and declines in premiums in our group insurance businesses. Net investment income in the Asset

 

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Management segment increased due to increased individual annuity assets under administration. Premiums for the Insurance Services segment declined due to a group insurance market that reflected declines in employment levels and low wage growth as our customers navigated a challenging economy in a price-competitive sales environment.

 

Outlook for 2011

We will continue to focus on our long-term objectives and address challenges that arise with financial discipline and from a position of financial strength. We manage for long-term profitability by focusing on good business diversification, disciplined product pricing, sound underwriting, effective claims management and high-quality customer service.

We intend to remain focused on preserving the value of our business by continuing to provide excellent value to our customers, enhancing our financial strength and building value for our shareholders. We will continue to focus on optimizing shareholder value through sustainable profitability and investing in new product and service capabilities, which resonate in the group insurance marketplace, and adding value through strategic use of capital. We believe these actions position us well for growth as the economy recovers.

For 2011, we have established the following expectations:

   

Net income per diluted share, excluding after-tax net capital gains and losses, to be in the range of $4.80 to $5.10.

   

Return on average equity, excluding after-tax net capital gains and losses from net income and accumulated other comprehensive income and losses from equity, to be in the range of 12% to 13%.

Expectations and guidance for any specific year may vary due to short-term market trends, changes in the interest rate environment and other factors. More specifically, these expectations will be affected by the following items:

   

Premium growth—Given the challenging economic environment, including the prolonged effect on our group insurance customers, we expect premium growth to be relatively flat. However, our strong customer retention in the Insurance Services segment for 2010 has created the potential for organic growth in premiums as wage growth and employment levels improve.

   

Interest rates—The interest rate environment can affect our new money investment interest rate and the discount rate used to establish our long term disability reserves. Based on our current size, a 25 basis point change in the discount rate could result in a quarterly change of approximately $2 million in pre-tax income.

   

Benefit ratio—We expect our annual benefit ratio for our group insurance business to be consistent with the experience of the previous five years, during which it has ranged from 73.6% to 78.3%.

   

Share repurchases—We expect the level of share repurchases will remain consistent with 2010 activity.

 

CONSOLIDATED RESULTS OF OPERATIONS

Revenues

Revenues consist of premiums, administrative fees, net investment income and net capital gains and losses. Historically, premium growth in our Insurance Services segment and administrative fee revenues growth in our Asset Management segment have been the primary drivers of consolidated revenue growth.

The following table sets forth consolidated revenues:

 

     Years ended
December 31,


 
(Dollars in millions)    2010      Percent
Change
    2009      Percent
Change
    2008  

Revenues:

                                          

Premiums

   $     2,097.7         (0.2 )%    $     2,101.9         (1.8 )%    $     2,140.2   

Administrative fees

     116.5         7.4        108.5         (5.3     114.6   

Net investment income

     602.5         2.7        586.5         8.4        541.0   

Net capital losses

     (51.6      (91.8     (26.9      79.1        (128.8
    


          


          


Total revenues

   $     2,765.1         (0.2   $ 2,770.0         3.9      $ 2,667.0   

 

The slight decrease for 2010 compared to 2009 was primarily due to an increase in net capital losses, partially offset by an increase in administrative fee revenues and net investment income from our Asset Management segment. The increase for 2009 compared to 2008 reflected a decrease in net capital losses and an increase in net investment income. These increases

 

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in revenues were partially offset by declines in premiums from our Insurance Services segment and decreases in administrative fee revenues from our Asset Management segment. Net capital gains and losses are reflected in the Other category. See “Business Segments—Other—Net Capital Gains (Losses).”

 

Premiums

Premiums from our Insurance Services segment are the primary driver of consolidated premiums and are primarily affected by the following factors:

   

Sales.

   

Customer retention.

   

Organic growth in our group insurance businesses, which is derived from existing policyholders’ employment and wage growth.

   

Experience rated refunds (“ERRs”). ERRs represent a cost sharing arrangement with certain group contract holders that provides refunds to the contract holders when claims experience is better than contractual benchmarks, and provides for additional premiums to be paid when claims experience is below the contractual benchmarks. ERRs can fluctuate widely from quarter to quarter depending on the underlying experience of specific contracts.

The following table sets forth premiums by segment:

 

    Years ended
December 31,

 
(Dollars in millions)   2010      Percent
Change
    2009      Percent
Change
    2008  

Premiums:

                                         

Insurance Services

  $ 2,056.2         (0.5 )%    $ 2,067.2         (2.0 )%    $ 2,109.1   

Asset Management

    41.5         19.6        34.7         11.6        31.1   

Total premiums

  $     2,097.7         (0.2   $     2,101.9         (1.8   $     2,140.2   

 

The slight decrease in premiums for 2010 compared to 2009 was primarily driven by a few large case terminations in our group insurance businesses during 2009. These terminated customers contributed to premiums for a portion of 2009. In addition, premium growth was negatively affected by a lack of organic growth in our group insurance businesses, reflecting negative employment growth and lower wage growth as our customers continued to navigate a challenging economy. Also, individual disability premiums for the first quarter of 2009 included a single premium of approximately $18 million related to the termination of reinsurance agreements on certain individual disability insurance. These factors were mostly offset by strong sales and favorable persistency in 2010.

The decrease in premiums for 2009 compared to 2008 was attributable to our group insurance business, which was affected by a lack of organic growth due to negative employment growth, low wage growth and reduced persistency caused in part by competitive pressure on pricing as our customers continued to navigate a challenging economy that began in the second half of 2008. The increase in premiums in the individual disability business partially offset the decrease in premiums in the group insurance business. See “Business Segments—Insurance Services Segment.”

Premiums from our Asset Management segment are generated from sales of life-contingent annuities, which are a single-premium product. Due to the competitive nature of single-premium products, premiums in the Asset Management segment can fluctuate widely from quarter to quarter. See “Business Segments—Asset Management Segment.”

 

Administrative Fee Revenues

The primary driver for administrative fee revenues is the level of assets under administration in our Asset Management segment, which is driven by equity market performance and asset growth from net customer deposits. Administrative fee revenues from our Insurance Services segment are primarily derived from insurance products for which we provide only administrative services.

 

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The following table sets forth administrative fee revenues by segment:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010     Percent
Change
     2009     Percent
Change
    2008  

Administrative fee revenues:

                                         

Insurance Services

   $ 9.6        15.7    $ 8.3        (9.8 )%    $ 9.2   

Asset Management

         121.5        6.5             114.1        (3.6         118.3   

Other

     (14.6     (5.0      (13.9     (7.8     (12.9
    


          


         


Total administrative fee revenues

   $ 116.5        7.4       $ 108.5        (5.3   $ 114.6   

 

The increase in administrative fee revenues in our Asset Management segment for 2010 compared to 2009 was primarily due to improvements in equity market performance leading to increased asset-based administrative fee revenues from our retirement plans business, though equity market values have shown continued volatility. This increase was partially offset by net retirement plan withdrawals primarily due to the termination of a few large plans that were not meeting our profitability objectives. See “Business Segments—Asset Management Segment.”

The decrease in administrative fee revenues for 2009 compared to 2008 was due to lower levels of assets managed for retirement accounts during 2009, which was a result of a decline in equity markets. The recovery of equity markets during 2009 and new net deposits moderated the decrease in administrative fee revenues.

 

Net Investment Income

Net investment income is primarily affected by changes in levels of invested assets, interest rates, fluctuations in the fair value of our Standard & Poor’s (“S&P”) 500 Index call spread options (“S&P 500 Index options”) related to our indexed annuity product and commercial mortgage loan prepayment fees.

The following table sets forth net investment income by segment and associated key indicators:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010     Percent
Change
    2009     Percent
Change
    2008  

Net investment income:

                                        

Insurance Services

   $ 338.9        1.1   $ 335.1        (0.7 )%    $ 337.5   

Asset Management

     251.0        7.3        234.0        27.3        183.8   

Other

     12.6        (27.6     17.4        (11.7     19.7   
    


         


         


Total net investment income

   $ 602.5        2.7      $ 586.5        8.4      $ 541.0   
    


         


         


Key indicators of net investment income:

                                        

Contribution from the fair value adjustment of the S&P 500 Index options

   $ 8.4        78.7   $ 4.7        142.3   $ (11.1

Average invested assets

         10,858.2        8.9            9,969.9        10.1            9,052.5   

Portfolio yields:

                                        

Fixed maturity securities

     5.31             5.46             5.63

Commercial mortgage loans

     6.45                6.46                6.39   

 

The increase in net investment income for 2010 compared to 2009 was primarily due to an increase in average invested assets, which primarily resulted from individual annuity sales. Also contributing to the increase was an increase in the contribution from the change in fair value of our S&P 500 index options. Partially offsetting these increases was a decline in the portfolio yield for fixed maturity securities.

Since the third quarter of 2008, economic uncertainty has led to a period of significant widening and tightening of credit spreads. Given the uncertainty surrounding credit spreads and the direction of interest rates, we may experience lower new money interest rates in the future if credit spreads remain tight and interest rates remain low. New money interest rates are also affected by the current volume and mix of commercial mortgage loan originations and purchases of fixed maturity securities.

 

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The increase in net investment income for 2009 compared to 2008 was primarily due to an increase in average invested assets resulting from additional individual annuity assets under administration. Also contributing to the increase were higher average yields in our commercial mortgage loan portfolio. The increase in net investment income was supplemented by an increase in the fair value of our S&P 500 index options.

We originate commercial mortgage loans containing a provision requiring the borrower to pay a prepayment fee. The prepayment provision assures that our expected cash flow from commercial mortgage loan investments would be protected in the event of prepayment. As interest rates decrease, potential prepayment fees increase. These potentially larger prepayment fees deter borrowers from refinancing during a low interest rate environment. Approximately 98% of our commercial mortgage loan portfolio contains this prepayment provision. Commercial mortgage loans without a make whole prepayment provision generally contain fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flows in the event of prepayment. Commercial mortgage loan prepayment fees were $3.4 million, $2.8 million and $7.3 million for 2010, 2009 and 2008, respectively. The lower prepayment fees in 2010 and 2009 reflect fewer customer prepayments due to increases in fees charged for prepayment in a low interest rate environment.

 

Net Capital Gains (Losses)

Net capital gains and losses are reported in the Other category and are not likely to occur in a stable pattern. Net capital gains and losses primarily occur as a result of other-than-temporary impairments (“OTTI”) of assets in our bond portfolio, additional provisions to our commercial mortgage loan loss allowance, losses recognized due to impairment of real estate and low-income housing tax credit investments, and sales of our assets for more or less than carrying value.

The following table sets forth net capital gains and losses and associated key components:

 

    

Years ended

December 31,

 
(In millions)    2010     Dollar
Change
    2009     Dollar
Change
    2008  

Net capital losses

   $     (51.6   $     (24.7   $     (26.9   $     101.9      $ (128.8

Key components of net capital gains (losses):

                                        

Net capital gains (losses) on fixed maturity securities

   $ 15.4      $ 20.8      $ (5.4   $ 123.7      $     (129.1

Net capital gains (losses) on real estate investments

     7.0        7.5        (0.5     (2.7     2.2   

Net capital losses on real estate owned

     (22.9     (22.9                     

Net capital losses from additional provisions to our commercial mortgage loan loss allowance

     (48.1     (27.0     (21.1     (16.0     (5.1

 

Net capital losses for 2010 were primarily related to the foreclosure and restructuring of commercial mortgage loans with a single borrower during the second quarter of 2010 recorded as additional provisions to our commercial mortgage loan loss allowance. Capital losses were also recognized due to impairments on properties acquired from the above mentioned borrower resulting from the receipt of independent appraisals and on low-income housing tax credit investments. These losses were partially offset by net capital gains related to the sale of certain fixed maturity securities and from the sale of real estate investments. See “Liquidity and Capital Resources—Investing Cash Flows—Commercial Mortgage Loans” and “Business Segments—Other—Net Capital Gains (Losses).”

The decrease in net capital losses for 2009 compared to 2008 was primarily due to the recovery of the market value of certain fixed maturity securities. Net capital losses for 2009 were primarily due to the foreclosure and restructuring of commercial mortgage loans recorded as additional provisions to our commercial mortgage loan loss allowance, sales of fixed maturity securities that included losses on holdings in financial institutions, including holdings of certain insurance companies that were downgraded by rating agencies during 2009 and OTTI on fixed maturity securities. The capital losses for 2009 were partially offset by capital gains from the sale of certain fixed maturity securities.

 

Benefits and Expenses

Benefits to Policyholders

Consolidated benefits to policyholders is primarily affected by the following factors:

   

Reserves that are established in part based on premium levels.

 

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Claims experience – the predominant factors affecting claims experience are claims incidence, measured by the number of claims, and claims severity, measured by the magnitude of the claim and the length of time a disability claim is paid.

   

Assumptions used to establish related reserves – the assumptions used to establish the related reserves reflect expected incidence and severity, and the discount rate. The discount rate is affected by new money investment interest rates and the overall portfolio yield. See “Critical Accounting Policies and Estimates—Reserves for Future Policy Benefits and Claims.”

   

Growth of our in force block – the benefit ratio, calculated as benefits to policyholders and interest credited as a percentage of premiums, is utilized to provide a measurement of claims normalized for premium growth.

   

Current estimates for future benefits on life-contingent annuities.

The following table sets forth benefits to policyholders by segment:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010      Percent
Change
    2009      Percent
Change
    2008  

Benefits to policyholders:

                                         

Insurance Services

  $     1,566.4         2.4   $     1,530.3         (1.3 )%    $     1,549.7   

Asset Management

    53.4         17.6        45.4         14.4        39.7   
   


          


          


Total benefits to policyholders

  $ 1,619.8         2.8      $ 1,575.7         (0.9   $ 1,589.4   

 

The increase in benefits to policyholders for 2010 compared to 2009 was primarily due to higher incidence and fewer claim closures in the group long term disability insurance business and a few large claims in the group life insurance business. Benefits to policyholders for 2009 included approximately $18 million of additional individual disability insurance reserves recorded during the first quarter of 2009 due to the termination of reinsurance on certain reinsured policies and claims. See “Business Segments—Insurance Services Segment—Benefits and Expenses—Benefits to Policyholders (including interest credited).”

The decrease in benefits to policyholders for 2009 compared to 2008 was primarily due to a decline in business growth in our group insurance business, as evidenced by comparatively lower premiums, and comparatively favorable claims experience in our individual disability insurance businesses. The decrease in benefits to policyholders was partially offset by increased benefits to policyholders on life-contingent annuities in the Asset Management segment. See “Business Segments—Insurance Services Segment—Benefits and Expenses—Benefits to Policyholders (including interest credited)” and “Business Segments—Asset Management Segment—Benefits and Expenses—Benefits to Policyholders.”

 

Interest Credited

Interest credited represents interest paid to policyholders on retirement plan general account assets, individual fixed-rate annuity deposits and index-based interest guarantees embedded in indexed annuities (“index-based interest guarantees”) in the Asset Management segment and interest paid on life insurance proceeds on deposit in the Insurance Services segment.

Interest credited is primarily affected by the following factors:

   

Growth in general account assets under management.

   

Growth in individual fixed-rate annuity liabilities.

   

Changes in new investment interest rates and overall portfolio yield, which influence our interest crediting rate for our customers.

   

Changes in customer retention.

   

Changes in the fair value of the index-based interest guarantees. These changes may fluctuate from quarter to quarter due to changes in interest rates and equity market volatility. See “Business Segments—Asset Management Segment—Benefits and Expenses—Interest Credited” for information regarding the interest credited on our indexed annuity product.

 

26   STANCORP FINANCIAL GROUP, INC.


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The following table sets forth interest credited and associated key indicators:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010      Change     2009     Change     2008  

Interest credited

   $ 158.4       $ 12.8      $ 145.6      $ 34.9      $ 110.7   

Key factors of interest credited:

                                         

Contribution from the fair value adjustment of index-based interest guarantees

   $ 5.8       $ 6.2      $ (0.4   $ 8.8      $ (9.2

Average individual annuity assets under administration

         2,537.6         14.1         2,223.8        32.7         1,676.3   

 

The increases in interest credited for 2010 and 2009 primarily reflected growth in our average individual annuity assets under administration enhanced by the change in fair value of the index-based interest guarantees.

 

Operating Expenses

The following table sets forth operating expenses and costs incurred during our 2009 operating expense reduction initiatives:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010      Percent
Change
    2009      Percent
Change
     2008  

Operating expenses

   $     446.2         (6.3 )%    $     476.2         1.5    $     469.2   

Pre-tax costs related to operating expense reduction initiatives

             n/a        18.6         n/a           

 

The decrease in operating expenses for 2010 compared to 2009 was primarily related to the completion of our 2009 operating expense reduction initiatives and careful expense management during 2010. Operating expenses for 2009 included $18.6 million of costs related to our 2009 operating expense reduction initiatives. These costs were recorded in our Other category. The cost savings resulting from these initiatives were primarily reflected in the Asset Management segment for 2010. See “Business Segments.”

The increase in operating expenses for 2009 compared to 2008 was primarily due to costs related to operating expense reduction initiatives, partially offset by a decrease in compensation expense due to a reduction in employee headcount related to the 2009 operating expense reduction initiatives. The benefits from these enhanced efficiencies began in the second half of 2009. The run rate savings were partially offset by continuing product and capability enhancement expenses and the expected effects of employee medical cost inflation.

 

Commissions and Bonuses

Commissions and bonuses primarily represent sales-based compensation, which can vary depending on the product, the structure of the commission program and other factors such as customer retention, sales, growth in assets under administration and the profitability of business in each of our segments.

The following table sets forth commissions and bonuses:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010      Percent
Change
     2009      Percent
Change
    2008  
Commissions and bonuses    $     206.1         2.0    $     202.0         (11.2 )%    $     227.6   

 

The increase in commissions and bonuses for 2010 compared to 2009 was primarily due to an increase in our Insurance Services segment sales, partially offset by a change in our individual annuity product mix. The decrease for 2009 compared to 2008 was primarily due to lower maintenance commissions as a result of lower assets under administration in our retirement plans business for the first three quarters of 2009 and lower premium levels in our group insurance businesses.

 

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Net Change in Deferred Acquisition Costs (“DAC”), Value of Business Acquired (“VOBA”) and Other Intangible Assets

We normally defer certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. These costs are then amortized into expenses over a period not to exceed the life of the related policies, which for group insurance contracts is the initial premium rate guarantee period and averages 2.5 years. VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. A portion of VOBA is amortized each year to achieve matching against expected gross profits. Our other intangible assets, consisting of customer lists and marketing agreements, are also subject to amortization. Customer lists were obtained through acquisitions of Asset Management businesses and have a combined estimated weighted-average remaining life of approximately 9.3 years. The amortization for the individual disability marketing agreement with the Minnesota Life Insurance Company (“Minnesota Life”) is up to 25 years. See “Critical Accounting Policies and Estimates—DAC, VOBA and Other Intangible Assets.”

The following table sets forth the net increase in DAC, VOBA and other intangible assets:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010      Percent
Change
    2009     Percent
Change
    2008  
Net increase in DAC, VOBA and other intangible assets   $   21.8         17.2   $   18.6        (60.8 )%    $   47.5   

 

The net increase in DAC, VOBA and other intangible assets was higher for 2010 compared to 2009 primarily due to the following factors:

   

An increase in deferrals in our group insurance businesses resulting from higher sales.

   

A decrease in amortization driven by favorable persistency in our group and individual disability insurance businesses.

   

A decrease in amortization due to market fluctuations.

   

Changes in the interest rate environment.

   

Favorable lapse experience in the individual annuity segment.

The net increase in DAC, VOBA and other intangible assets decreased for 2009 compared to 2008 primarily due to lower individual annuity sales and an increase in DAC amortization resulting from derivative gains from our indexed annuities. In addition, net deferrals in the Insurance Services segment decreased for 2009, primarily due to lower individual disability sales and the termination of a small block of individual disability contracts.

 

Income Taxes

Income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% to pre-tax income because of the net result of permanent differences between book and taxable income and because of the inclusion of state and local income taxes, net of the federal tax benefit.

The following table sets forth the combined federal and state effective income tax rates:

 

   

Years ended

December 31,

 
    2010      2009      2008  
Combined federal and state effective income tax rates     33.2      33.8      32.4

 

During the first quarter of 2010, the 2010 Health Care Act, as amended by the 2010 Health Care Reconciliation Act, became law. Included among the provisions of the law is a change in the tax treatment of the Medicare Part D subsidy, which we participate in as a part of our postretirement medical plan. This change in the law resulted in additional tax expense of $1.0 million, which increased our effective tax rate for 2010 by 0.3%. The change in tax treatment for the subsidy was recorded in the first quarter of 2010 and will affect the tax rate for 2010 but will not have a similar effect on the tax rate in future years.

 

28   STANCORP FINANCIAL GROUP, INC.


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During 2010, capital losses due to increased foreclosures and the acceptance of deeds in lieu of foreclosure on commercial mortgage loans resulted in a decrease in the average effective state income tax rate, offsetting the increase as discussed above.

At December 31, 2010, the years open for audit by the Internal Revenue Service (“IRS”) were 2007 through 2010. See Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 7—Income Taxes” for more information on the change in the effective tax rate.

 

BUSINESS SEGMENTS

We operate through two reportable segments: Insurance Services and Asset Management, as well as an Other category. Resources are allocated and performance is evaluated at the segment level. The Insurance Services segment offers group and individual disability insurance, group life and accidental death and dismemberment (“AD&D”) insurance, group dental and group vision insurance, and absence management services. The Asset Management segment offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. This segment also offers investment advisory and management services, financial planning services, commercial mortgage loan origination and servicing, individual fixed-rate annuity products, group annuity contracts and retirement plan trust products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses including costs incurred during our 2009 operating expense reduction initiatives, net capital gains and losses and adjustments made in consolidation.

The following table sets forth segment revenues measured as a percentage of total revenues, excluding revenues from the Other category:

 

    

Years ended

December 31,

 
     2010      2009      2008  

Insurance Services

     85.3      86.3      88.1
Asset Management      14.7         13.7         11.9   

 

Insurance Services Segment

The Insurance Services segment is our largest segment and substantially influences our consolidated financial results.

The following table sets forth key indicators that we use to manage and assess the performance of the Insurance Services segment:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010     Percent
Change
    2009     Percent
Change
    2008  

Premiums

   $   2,056.2        (0.5 )%    $   2,067.2        (2.0 )%    $   2,109.1   

Total revenues

     2,404.7        (0.2     2,410.6        (1.8     2,455.8   

Income before income taxes

     313.8        (11.9     356.3        (2.8     366.4   

Sales (annualized new premiums)

     351.7        13.2        310.8        (2.5     318.9   

Benefit ratios, including interest credited (% of premiums):

                                        

Insurance Services segment

     76.4             74.3             74.0

Group insurance

     77.2                74.7                73.6   

Individual disability

     66.8                69.3                78.7   
Operating expense ratio (% of premiums)      16.1                16.2                16.0   

 

Income before income taxes decreased for 2010 compared to 2009 primarily due to less favorable claims experience and lower premiums. Results for 2009 reflected lower premiums in our group insurance business, partially offset by higher premiums and favorable claims experience in our individual disability business compared to 2008.

 

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Revenues

Revenues for the Insurance Services segment are driven primarily by growth in Insurance Services premiums. The slight decrease in revenues for 2010 compared to 2009 was primarily due to lower premiums in our individual disability insurance business due to a single premium of approximately $18 million received in the first quarter of 2009 related to the termination of reinsurance on certain individual disability reinsured policies and claims. Revenues decreased for 2009 compared to 2008 primarily due to decreased premiums in our group insurance business, partially offset by increased premiums in our individual disability business.

 

Premiums

The primary factors that affect premiums for the Insurance Services segment are sales and persistency for all of our insurance products and organic growth in our group insurance businesses derived from existing group policyholders’ employment and wage growth. Premium levels can also be influenced by ERRs. ERRs represent a cost sharing arrangement with certain group contract holders that provides refunds to the contract holders when claims experience is better than contractual benchmarks, and provides for additional premiums to be paid when claims experience is below the contractual benchmarks. ERRs can fluctuate widely from quarter to quarter depending on the underlying experience of specific contracts.

 

The following table sets forth premiums and sales by line of business for the Insurance Services segment:

 

(Dollars in millions)  

Years ended

December 31,

 
  2010     Percent
Change
    2009     Percent
Change
    2008  

Premiums:

                                       

Group life and AD&D

  $ 835.7        2.0   $ 819.6        (3.6 )%    $ 850.3   

Group long term disability

    799.9        (3.1     825.6        (4.3     862.9   

Group short term disability

    203.7        (1.0     205.7        (4.5     215.5   

Group other

    81.5        2.5        79.5        4.9        75.8   

Experience rated refunds

    (27.9     30.6        (40.2     9.9        (44.6
                                         

Total group insurance

    1,892.9        0.1        1,890.2        (3.6     1,959.9   

Individual disability

    163.3        (7.7     177.0        18.6        149.2   
                                         

Total premiums

  $   2,056.2        (0.5   $   2,067.2        (2.0   $   2,109.1   
                                         

Key indicators of premiums:

                                       

Total premiums excluding ERRs

  $ 2,084.1        (1.1 )%    $ 2,107.4        (2.1 )%    $ 2,153.7   

Group insurance sales (annualized new premiums) reported at contract effective date

    330.6        14.9        287.8        (1.6     292.5   

Individual disability sales (annualized new premiums)

    21.1        (8.3     23.0        (12.9     26.4   

 

The slight decrease in premiums for 2010 compared to 2009 was primarily due to a decrease in individual disability premiums and a few large case terminations in our group insurance businesses during 2009. The decrease in individual disability premiums for 2010 was primarily related to a single premium of approximately $18 million received in the first quarter of 2009 related to the termination of reinsurance on certain individual disability reinsured policies and claims. The premiums received from these terminations of reinsurance were offset by approximately $18 million in additional reserves assumed.

 

The decrease in premiums for 2009 compared to 2008 was attributable to our group insurance business, which was affected by a lack of organic growth due to negative employment growth and low wage growth. In addition, lower premiums were the result of reduced persistency caused in part by competitive pressure on pricing as our customers continued to navigate a challenging economy that began in the second half of 2008. The increase in individual disability premiums for 2009 compared to 2008 was primarily related to approximately $18 million received related to the termination of reinsurance on a small block of individual disability reinsured policies and claims, compared to $3.7 million received for a similar reinsurance termination in 2008. Offsetting the premiums received from these terminations of

 

30   STANCORP FINANCIAL GROUP, INC.


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reinsurance were approximately $18 million and $3.9 million in additional reserves assumed in 2009 and 2008, respectively. The termination of these agreements was made primarily for the purpose of gaining administrative efficiencies.

Sales. Sales of our group insurance products reported as annualized new premiums increased for 2010 compared to 2009, reflecting continued strong customer interest for our product and service enhancements. The group insurance market for 2010 continued to reflect a price-competitive sales environment.

Persistency. Persistency in our group insurance business increased to 88.7% for 2010, compared to 83.8% for 2009. Persistency in our group insurance business for 2010 was at the high end of our historical range. Persistency in our individual disability products remained above 90%.

Organic Growth. A portion of premium growth in our group insurance in force business is affected by employment and wage growth, changes in price per insured and the average age of employees. Unfavorable economic conditions have resulted in high unemployment levels, and have negatively affected both wage rate and job growth since the second half of 2008. Premiums for 2010 continued to reflect these negative effects on organic growth from negative employment growth and lower wage growth in our existing customer base.

 

Net Investment Income

The following table sets forth net investment income for the Insurance Services segment:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010      Percent
Change
    2009      Percent
Change
    2008  
Net investment income    $     338.9         1.1   $     335.1         (0.7 )%    $     337.5   

 

Net investment income is primarily affected by changes in levels of invested assets and interest rates. See “Consolidated Results of Operations—Revenues—Net Investment Income.”

 

Benefits and Expenses

Benefits to Policyholders (including interest credited)

Benefits to policyholders is primarily affected by the following factors:

   

Reserves that are established in part based on premium levels.

   

Claims experience – the predominant factors affecting claims experience are claims incidence, measured by the number of claims, and claims severity, measured by the magnitude of the claim and the length of time a disability claim is paid.

   

Assumptions used to establish related reserves – the assumptions used to establish the related reserves reflect claims incidence and severity, and the discount rate. The discount rate is affected by new money investment interest rates and the overall portfolio yield. See “Critical Accounting Policies and Estimates—Reserves for Future Policy Benefits and Claims.”

   

Growth in our in force block – the benefit ratio, calculated as benefits to policyholders and interest credited as a percentage of premiums, is utilized to provide a measurement of claims normalized for premium growth.

 

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The following table sets forth benefits to policyholders (including interest credited) and the benefit ratios for the Insurance Services segment:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010     Percent
Change
    2009     Percent
Change
    2008  

Benefits to policyholders, including interest credited

   $     1,571.2        2.4   $     1,535.0        (1.6 )%    $     1,560.5   

Benefit ratios, including interest credited (% of premiums):

                                        

Insurance Services segment

     76.4             74.3             74.0

Group insurance

     77.2                74.7                73.6   

Individual disability

     66.8                69.3                78.7   

 

The increase in Insurance Services benefits to policyholders (including interest credited) for 2010 compared to 2009 was primarily due to higher incidence and fewer claim closures in the group long term disability insurance business, a few large claims in the group life insurance business and an increase in individual disability claims reserves of $7.8 million recorded as part of our regular assessments of the adequacy of our reserves. Offsetting these factors was the reduction of reserves for group long term disability claims of $14.6 million, also recorded as part of our reserve assessments, and the inclusion of approximately $18 million of additional individual disability insurance reserves in 2009 benefits to policyholders recorded due to the termination of reinsurance on certain reinsured policies and claims.

The decrease in Insurance Services benefits to policyholders (including interest credited) for 2009 compared to 2008 was primarily due to comparatively lower premiums in our group insurance business, favorable claims experience in our individual disability insurance business and the release of group long term disability reserves of $16.6 million as a result of favorable incidence and recovery patterns compared to reserving assumptions. These factors were offset by an increase in reserves of approximately $18 million in 2009 related to the termination of reinsurance on a small block of reinsured policies and claims and an increase in individual disability claims reserves of $11.5 million reflecting unfavorable claim termination patterns compared to reserve assumptions on a small block of individual disability claims. There was also a termination of reinsurance in 2008 that resulted in an increase in reserves of $3.9 million.

The group insurance benefit ratio of 77.2% for 2010 was in line with our estimated annual range for 2010 of 73.6% to 78.3%. Group insurance claims experience and the corresponding benefit ratio can fluctuate widely from quarter to quarter, but tends to be more stable when measured on an annual basis.

We generally expect the individual disability benefit ratio to trend down over the long-term to reflect the growth in the business outside of the large block of individual disability business assumed in 2000 from Minnesota Life, and we expect there to be a corresponding shift in revenues from net investment income to premiums. The anticipated general decrease in the expected benefit ratio does not necessarily indicate an increase in profitability; rather it reflects a change in the mix of revenues from the business.

The decrease in the individual disability benefit ratio for 2009 was primarily due to a decline in the severity of new claims and favorable claims termination experience during 2009. The benefit ratios for 2009 and 2008 for our individual disability business included approximately $18 million and $3.7 million, respectively, of premiums and approximately $18 million and $3.9 million, respectively, of additional reserves related to the termination of reinsurance on certain reinsured policies and claims. Excluding the effects of this termination of reinsurance, the benefit ratio would have been 65.8% for 2009, compared to 78.0% for 2008. Due to the relatively small size of our individual disability business, individual disability claims experience and the corresponding benefit ratio tend to fluctuate widely from quarter to quarter.

In 2006, we adjusted the claim termination rate assumptions for the reserves on a small block of individual disability claims based on an industry table. These assumptions were further refined in 2008, 2009 and 2010 and resulted in increases in reserves of $2.5 million, $11.5 million and $12.5 million, respectively. Our block of business is relatively small, and, as a result, we view a blend of the released industry table and our own experience as a more appropriate method for establishing reserve levels compared solely to our own experience. We will continue to monitor the credibility of our developing experience and, if necessary, will adjust reserves accordingly.

 

32   STANCORP FINANCIAL GROUP, INC.


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We refined our reserve calculation for certain other individual disability claims in 2010 which resulted in a decrease in our individual disability reserves of $4.7 million. There were no similar calculation refinements in 2009 and 2008.

The following table sets forth the average discount rate used for newly incurred long term disability claim reserves and life waiver reserves:

 

     Years ended December 31,  
     2010     2009     2008  
Average discount rate      5.00     5.00     5.31

 

The discount rate is based on the average rate we receive on newly invested assets during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. Based on our current size, every 25 basis point decrease in the discount rate would result in an increase of approximately $2 million per quarter of benefits to policyholders. We do not adjust group insurance premium rates based on short-term fluctuations in investment yields. Any offsetting adjustments of group insurance premium rates due to sustained changes in investment yields can take from one to three years given that most new contracts have rate guarantees in place.

If investment rates prove to be lower than provided for in the margin between the new money investment rate and the reserve discount rate, we could be required to increase reserves, which could cause expense for benefits to policyholders to increase. Given the uncertainty of the movement of future interest rates, this may result in significantly higher or lower discount rates. A sustained low interest rate environment and lower commercial mortgage loan investments in future quarters could result in future reductions to the discount rate. The margin in our overall block of business for group insurance between the invested asset yield and the weighted-average reserve discount rate at December 31, 2010 and December 31, 2009 was 41 basis points. See “Liquidity and Capital Resources.”

 

Operating Expenses

The following table sets forth operating expenses for the Insurance Services segment:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010      Percent
Change
    2009      Percent
Change
    2008  
Operating expenses    $     331.8         (0.6 )%    $     333.9         (1.3 )%    $     338.4   

 

The decrease in Insurance Services operating expenses for 2010 compared to 2009 was primarily due to a decrease in lease obligations and compensation related expenses resulting from our 2009 operating expense reduction initiatives and careful expense management during 2010. This was partially offset by increased costs associated with several new customer service programs implemented in 2010. The decrease in operating expenses for 2009 compared to 2008 was primarily due to a decline in compensation related expenses as a result of cost reduction initiatives implemented in 2009 and a decline in consulting expenses. Costs related to our 2009 operating expense reduction initiatives are included in the Other category. See “Other.”

 

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Asset Management Segment

The following tables set forth key indicators that we use to manage and assess the performance of the Asset Management segment:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010     Percent
Change
    2009     Percent
Change
    2008  

Revenues:

                                       

Premiums

  $ 41.5        19.6   $ 34.7        11.6   $ 31.1   

Administrative fees

    121.5        6.5        114.1        (3.6     118.3   

Net investment income

    251.0        7.3        234.0        27.3        183.8   
   


         


         


Total revenues

  $     414.0        8.2      $     382.8        14.9      $     333.2   
   


         


         


Income before income taxes

  $ 56.8        52.3   $ 37.3        6.9   $ 34.9   

Sales (Individual annuity deposits)

    363.8        (8.8     398.8        (55.5     895.4   

Interest credited (% of net investment income):

                                       

Retirement plans

    56.5             57.5             57.0

Individual annuities

    69.0                68.4                64.2   

Retirement plans annualized operating expenses (% of average assets under administration)

    0.57                0.65                0.62   

 

     December 31,  
(Dollars in millions)    2010      2009      Percent
Change
 

Assets under administration:

                          

Retirement plans general account

   $ 1,587.2       $ 1,540.1         3.1

Retirement plans separate account

     4,787.4         4,174.5         14.7   
    


        

Total retirement plans insurance products

     6,374.6         5,714.6         11.5   

Retirement plans trust products

     8,907.1         10,065.7         (11.5

Individual annuities

     2,684.2         2,390.9         12.3   

Commercial mortgage loans for other investors

     2,697.3         2,588.8         4.2   

Private client wealth management

     1,224.5         1,093.9         11.9   
    


        

Total assets under administration

   $     21,887.7       $     21,853.9         0.2   

 

Income before income taxes increased for 2010 compared to 2009 primarily due to an increase in net investment income, an increase in administrative fee revenues and reduced operating expenses resulting from the implementation of our 2009 operating expense reduction initiatives. The increase for 2009 compared to 2008 reflected an increase in net investment income and lower operating expenses.

 

Revenues

Revenues for the Asset Management segment include retirement plan trust product administration fees, fees on investments held in separate account assets and private client wealth management assets under administration, and investment income on general account assets under administration. Premiums and benefits to policyholders reflect both the sale of immediate annuities by our individual annuity business and the conversion of retirement plan assets into life-contingent annuities. Most of the sales for this segment are recorded as deposits and are therefore not reflected as premiums. Individual fixed-rate annuity deposits earn investment income, a portion of which is credited to policyholders.

The increase in revenues for 2010 compared to 2009 was primarily due to an increase in net investment income, primarily related to an increase in average individual annuity assets under administration, and administrative fee revenues, primarily due to the effect of improved equity market performance on our retirement plan assets under administration. The increase in revenues for 2009 compared to 2008 was primarily due to an increase in net investment income related to an increase in average individual annuity assets under administration, higher average yields in our commercial mortgage loan portfolios and an increase in the fair value of our S&P 500 index options.

 

34   STANCORP FINANCIAL GROUP, INC.


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Premiums

Premiums for the Asset Management segment are generated from the sale of life-contingent annuities, which are primarily a single-premium product. Premiums and benefits to policyholders reflect both the sale of immediate annuities by our individual annuity business and the conversion of retirement plan assets into life-contingent annuities, which can be selected by plan participants at the time of retirement. Premiums for the segment can vary significantly from quarter to quarter due to low sales volume of life-contingent annuities and the varying size of single premiums. Increases or decreases in premiums for life-contingent annuities generally correlate with corresponding increases or decreases in benefits to policyholders.

The following table sets forth premiums by line of business for the Asset Management segment:

 

   

Years ended

December 31,

 
(In millions)   2010      Dollar
Change
     2009      Dollar
Change
    2008  

Premiums:

                                          

Retirement plans

  $ 1.6       $ 0.9       $ 0.7       $ (0.9   $ 1.6   

Individual annuities

    39.9         5.9         34.0         4.5        29.5   
                                            

Total premiums

  $     41.5       $     6.8       $     34.7       $     3.6      $     31.1   

 

Administrative Fee Revenues

Administrative fee revenues for the Asset Management segment include asset-based and plan-based fees related to our retirement plans and private client wealth management businesses, and fees related to the origination and servicing of commercial mortgage loans. The primary driver for administrative fee revenues is the level of assets under administration for retirement plans, which is driven by equity market performance and asset growth due to net customer deposits. Assets under administration that produce administrative fee revenues include retirement plan separate account, retirement plan trust products, private client wealth management and commercial mortgage loans under administration for other investors.

The following tables set forth administrative fee revenues by line of business and associated key indicators for the Asset Management segment:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010      Percent
Change
    2009      Percent
Change
    2008  

Administrative fee revenues:

                                         

Retirement plans

  $ 92.5         4.5   $ 88.5         (7.0 )%    $ 95.2   

Other financial services business

    29.0         13.3        25.6         10.8        23.1   
                                           

Total administrative fee revenues

  $     121.5         6.5      $     114.1         (3.6   $     118.3   

 

     December 31,
(Dollars in millions)    2010      2009      Percent
Change

Key indicators of administrative fee revenues:

                      

Assets under administration:

                      

Retirement plan separate account

   $     4,787.4       $     4,174.5       14.7%

Retirement plan trust products

     8,907.1         10,065.7       (11.5)

Commercial mortgage loans for other investors

     2,697.3         2,588.8       4.2

Private client wealth management

     1,224.5         1,093.9       11.9

 

The increase in administrative fee revenues for 2010 compared to 2009 was primarily due to the effect of improved equity market performance on our retirement plan assets under administration, higher commercial mortgage loans under administration and higher private client wealth management assets under administration. These increases occurred despite a decrease in retirement plan trust assets under administration. The decline in retirement plan trust assets under

 

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administration was primarily due to the termination of a few large trust retirement plans in the first six months of 2010 that did not meet our profitability objectives. The administrative fee revenues generated from these terminated plans were not significant. The decline in administrative fee revenues for 2009 compared to 2008 was due to lower average retirement plans assets under administration, which was a result of declining equity markets during the last half of 2008 and the first half of 2009.

 

Net Investment Income

The following table sets forth net investment income and associated key indicators for the Asset Management segment:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010     Percent
Change
    2009     Percent
Change
    2008  

Net investment income:

                                       

Retirement plans

  $ 87.4        1.9   $ 85.8        0.6   $ 85.3   

Individual annuities

    151.0        12.8        133.9        67.6        79.9   

Other financial services business

    12.6        (11.9     14.3        (23.1     18.6   
                                         

Total net investment income

  $ 251.0        7.3      $ 234.0        27.3      $ 183.8   
                                         

Key indicators of net investment income:

                                       

Average assets under administration:

                                       

Retirement plan general account

  $     1,563.7        3.6   $     1,510.0        2.5   $     1,473.5   

Individual annuities

    2,537.6        14.1        2,223.8        32.7        1,676.3   

Contribution from the fair value adjustment of the S&P 500 Index options

    8.4        78.7        4.7        142.3        (11.1

Commercial mortgage loan originations

    887.5        23.5        718.5        (47.7     1,373.8   

Portfolio yields:

                                       

Fixed maturity securities

    5.31             5.46             5.63

Commercial mortgage loans

    6.45                6.46                6.39   

 

The increase in net investment income for 2010 compared to 2009 was primarily due to an increase in average individual annuity assets under administration resulting from individual annuity sales, and an increase in average retirement plan general account assets under administration. These increases were enhanced by the change in fair value of our S&P 500 Index options. Partially offsetting these increases was a decline in the portfolio yield for our fixed maturity securities. See Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 11—Derivative Financial Instruments” for further derivatives disclosure.

The increase in net investment income for 2009 compared to 2008 was primarily due to an increase in average individual annuity assets under administration, higher average yields in our commercial mortgage loan portfolios enhanced by an increase in the fair value of our S&P 500 Index options. The fair value adjustment to derivative assets resulted in an increase to net investment income for 2009 compared to a decrease for 2008. See Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 11—Derivative Financial Instruments” for further derivative disclosures.

 

Benefits and Expenses

Benefits to Policyholders

Benefits to policyholders for the Asset Management segment primarily represent current and future benefits on life-contingent annuities. Changes in the level of benefits to policyholders will generally correlate to changes in premium levels because these annuities primarily are single-premium life-contingent annuity products with a significant portion of all premium payments established as reserves.

 

36   STANCORP FINANCIAL GROUP, INC.


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The following table sets forth benefits to policyholders for the Asset Management segment:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010      Percent
Change
    2009      Percent
Change
    2008  
Benefits to policyholders   $     53.4         17.6   $     45.4         14.4   $     39.7   

 

Interest Credited

Interest credited represents interest paid to policyholders on retirement plan general account assets, individual fixed-rate annuity deposits and index-based interest guarantees.

The following table sets forth interest credited and associated key indicators for the Asset Management segment:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010      Percent
Change
    2009     Percent
Change
    2008  

Interest credited

  $     153.6         9.0   $     140.9        41.0   $     99.9   

Key factors of interest credited:

                                        

Contribution from the fair value adjustment of index-based interest guarantees

  $ 5.8         1,550.0     $(0.4     95.7     $(9.2

 

The increase in interest credited for 2010 compared to 2009 was primarily due to growth in our individual fixed-rate annuity assets under administration enhanced by the change in fair value of the index-based interest guarantees. See Item 8, “Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 11—Derivative Financial Instruments” for further derivatives disclosure.

The increase in interest credited for 2009 compared to 2008 primarily reflected changes in the fair value of index-based interest guarantees and growth in average individual annuity assets under administration from individual annuity sales. Average assets under administration for individual fixed-rate annuities increased for 2009 compared to 2008. The increase in the contribution of the change in fair value of the index-based interest guarantees was primarily due to fluctuations in the S&P 500 Index.

 

Operating Expenses

The following table sets forth operating expenses for the Asset Management segment:

 

   

Years ended

December 31,

 
(Dollars in millions)   2010      Percent
Change
    2009      Percent
Change
    2008  
Operating expenses   $     119.0         (6.2 )%    $     126.9         (3.4 )%    $     131.4   

 

The decrease in Asset Management operating expenses for 2010 compared to 2009 was due to decreases in lease obligations and compensation related expenses resulting from our 2009 operating expense reduction initiatives and careful expense management during 2010. The decrease in operating expenses for 2009 compared to 2008 was primarily due to a decline in compensation related expenses as a result of our 2009 operating expense reduction initiatives. Costs related to operating expense reduction initiatives are included in the Other category. See “Other.”

 

OTHER

In addition to our two segments, we report our holding company and corporate activities in the Other category. This category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses including costs incurred during our 2009 operating expense reduction initiatives, net capital gains and losses and adjustments made in consolidation.

 

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The following table sets forth results for the Other category:

 

   

Years ended

December 31,

 
(In millions)   2010     2009     2008  

Loss before income taxes

  $     (87.8   $     (77.9   $     (160.2
Pre-tax costs related to operating expense reduction initiatives            18.6          

 

The increase in losses before income taxes for 2010 compared to 2009 was primarily due to higher net capital losses. The loss before income taxes for 2009 included costs related to our 2009 operating expense reduction initiatives, primarily related to severance costs and lease terminations. The benefits from these enhanced efficiencies began in the second half of 2009. See “Liquidity and Capital Resources—Financing Cash Flows.”

The decrease in losses before income taxes for 2009 compared to 2008 was primarily due to lower net capital losses partially offset by an increase in operating expenses related to our 2009 operating expense reduction initiatives.

 

Net Capital Gains (Losses)

Net capital gains and losses are not likely to occur in a stable pattern and primarily occur as a result of OTTI of assets in our bond portfolio, from additional provisions to our commercial mortgage loan loss allowance, from losses recognized due to impairment of real estate and from sales of our assets for more or less than amortized cost.

The following table sets forth net capital gains and losses and associated key components:

 

   

Years ended

December 31,

 
(In millions)   2010     2009     2008  

Net capital gains (losses):

                       

Fixed maturity securities

  $     15.4      $ (5.4   $     (129.1

Commercial mortgage loans

    (46.9     (20.3     (1.9

Real estate investments

    7.0        (0.5     2.2   

Real estate owned

    (22.9              

Other

    (4.2     (0.7       
                         

Total net capital losses

  $ (51.6   $ (26.9   $ (128.8
                         

Key components of net capital gains (losses):

                       

Additional provision in our commercial mortgage loan loss allowance

  $ (48.1   $     (21.1   $ (5.1

Other than temporary impairment on fixed maturity securities

    (0.7     (5.9     (104.9

Other than temporary impairment on real estate investments

    (25.7     (0.1     (0.4

 

Net capital losses for 2010 were primarily related to the foreclosure and restructuring of commercial mortgage loans with a single borrower during the second quarter of 2010 recorded as additional provisions to our commercial mortgage loan loss allowance. Capital losses were also recognized due to impairments on properties acquired from the above mentioned borrower resulting from the receipt of independent appraisals and on low-income housing tax credit investments. These losses were partially offset by net capital gains related to the sale of certain fixed maturity securities and from the sale of real estate investments.

Net capital losses for 2009 were primarily due to the foreclosure and restructuring of commercial mortgage loans recorded as additional provisions to our commercial mortgage loan loss allowance, sales of fixed maturity securities that included losses on holdings in financial institutions, including holdings of certain insurance companies that were downgraded by rating agencies during 2009 and OTTI on fixed maturity securities. The capital losses for 2009 were partially offset by capital gains from the sale of certain fixed maturity securities.

 

LIQUIDITY AND CAPITAL RESOURCES

Asset-Liability and Interest Rate Risk Management

Asset-liability management is a part of our risk management structure. The risks we assume related to asset-liability mismatches vary with economic conditions. The primary sources of economic risk are interest-rate related and include changes in interest rate term risk, credit risk and liquidity risk. It is generally management’s objective to align the characteristics of assets and liabilities so that our financial obligations can be met under a wide variety of economic

 

38   STANCORP FINANCIAL GROUP, INC.


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conditions. From time to time, management may choose to liquidate certain investments and reinvest in different investments so that the likelihood of meeting our financial obligations is increased. See “—Investing Cash Flows.”

We manage interest rate risk, in part, through asset-liability analyses. In accordance with presently accepted actuarial standards, we have made adequate provisions for the anticipated cash flows required to meet contractual obligations and related expenses through the use of statutory reserves and related items at December 31, 2010.

Our interest rate risk analysis reflects the influence of call and prepayment rights present in our fixed maturity securities and commercial mortgage loans. The majority of these investments have contractual provisions that require the borrower to compensate us in part or in full for reinvestment losses if the security or loan is retired before maturity. Callable bonds as a percentage of our fixed maturity security investments were 2.6% at December 31, 2010. We originate commercial mortgage loans containing a provision requiring the borrower to pay a prepayment fee. The prepayment provision assures that our expected cash flow from commercial mortgage loan investments would be protected in the event of prepayment. Approximately 98% of our commercial mortgage loan portfolio contains this prepayment provision. Almost all of the remaining commercial mortgage loans contain fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flow in the event of prepayment.

Our financial instruments are exposed to financial market volatility and potential disruptions in the market that may result in certain financial instruments becoming less valuable. Financial market volatility includes interest rate risk. We have analyzed the estimated loss in fair value of certain market sensitive financial assets held at December 31, 2010 and 2009, using a hypothetical 10% increase in interest rates and related qualitative information on how we manage interest rate risk. The interest rate sensitivity analysis was based upon our fixed maturity securities and commercial mortgage loans held at December 31, 2010 and 2009. Interest rate sensitivity of our financial assets was measured assuming a parallel shift in interest rates. All security yields were increased by 10% of the year-end 10-year U.S. Government Treasury bond yield, or 0.33% and 0.38% for the 2010 and 2009 analyses, respectively. The change in fair value of each security was estimated as the change in the option adjusted value of each security. Option adjusted values were computed using our payment models and provisions for the effects of possible future changes in interest rates. The analyses did not explicitly provide for the possibility of non-parallel shifts in the yield curve, which would involve discount rates for different maturities being increased by different amounts. The actual change in fair value of our financial assets can be significantly different from that estimated by the model. The hypothetical reduction in the fair value of our financial assets that resulted from the model was estimated to be $150 million and $144 million at December 31, 2010 and 2009, respectively.

Additionally, a cash management process is in place that anticipates short-term cash needs. Depending upon capital market conditions, anticipated cash needs may be covered by liquid asset holdings or a draw upon our line of credit. In almost all cases, borrowed funds can be retired from normal operating cash flows in conjunction with adjustments to long-term investing practice within half a year. For more information about our line of credit, see “—Financing Cash Flows,” and Part I, Item 1A, “Risk Factors.”

 

Operating Cash Flows

Net cash provided by operating activities is net income adjusted for non-cash items and accruals and was $355.1 million, $441.4 million and $361.8 million for 2010, 2009 and 2008, respectively.

 

Investing Cash Flows

We maintain a diversified investment portfolio primarily consisting of fixed maturity securities and fixed-rate commercial mortgage loans. Investing cash inflows primarily consist of the proceeds of investments sold, matured or repaid. Investing cash outflows primarily consist of payments for investments acquired or originated.

The insurance laws of the states of domicile and other states in which the insurance subsidiaries conduct business regulate the investment portfolios of the insurance subsidiaries. Relevant laws and regulations generally limit investments to bonds and other fixed maturity securities, mortgage loans, common and preferred stock and real estate. Decisions to acquire and dispose of investments are made in accordance with guidelines adopted and modified from time to time by the Boards of Directors of our insurance subsidiaries. Each investment transaction requires the approval of one or more members of senior investment staff, with increasingly higher approval authorities required for transactions that are more significant. Transactions are reported quarterly to the Audit Committee of the Board of Directors for Standard Insurance Company (“Standard”) and to the Board of Directors for The Standard Life Insurance Company of New York.

 

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Net cash used in investing activities was $493.1 million, $907.6 million and $1.03 billion for 2010, 2009 and 2008, respectively. The decrease in net cash used in investing activities for 2010 compared to 2009 was primarily due to lower net purchases of fixed maturity securities, which resulted from lower policyholder fund net deposits, the termination of a few large retirement plans and higher repurchases of common stock. The decrease in net cash used in investing activities for 2009 compared to 2008 was primarily due to lower commercial mortgage loan originations and lower individual annuity sales.

Our target investment portfolio allocation is approximately 60% fixed maturity securities and 40% commercial mortgage loans with a maximum allocation of 45% to commercial mortgage loans. At December 31, 2010, our portfolio consisted of 57.6% fixed maturity securities, 40.5% commercial mortgage loans, and 1.9% real estate.

 

Fixed Maturity Securities

We maintain prudent diversification across industries, issuers and maturities. We have avoided the types of structured products that do not meet an adequate level of transparency for good decision making. Our corporate bond industry diversification targets are based on the Bank of America Merrill Lynch U.S. Corporate Master Index, which is reasonably reflective of the mix of issuers broadly available in the market. We also target a specified level of government, agency and municipal securities in our portfolio for credit quality and additional liquidity. Our fixed maturity securities below investment grade are primarily managed by a third party.

Our fixed maturity securities portfolio generates unrealized gains or losses primarily resulting from market interest rates that are lower or higher relative to our book yield at the reporting date. In addition, changes in the spread between the risk-free rate and market rates for any given issuer can fluctuate based on the demand for the instrument, the near-term prospects of the issuer and the overall economic climate.

The following table sets forth fixed maturity securities and associated key indicators:

 

    December 31,     Percent
Change
 
(Dollars in millions)   2010     2009    

Fixed maturity securities

  $     6,419.1      $     6,167.3        4.1

Weighted-average credit quality of our fixed maturity securities portfolio (S&P)

    A        A           

Fixed maturity securities below investment grade:

                       

As a percent of total fixed maturity securities

    5.2     5.4        

Managed by a third party

  $     292.3      $ 257.8        13.4

Fixed maturity securities on our watch list:

                       

Fair value

    0.7        19.6        (96.4

Amortized cost after OTTI

    1.0        26.0        (96.2

Gross unrealized capital gains in our fixed maturity securities portfolio

    415.8        284.8        46.0   
Gross unrealized capital losses in our fixed maturity securities portfolio     19.7        41.1        (52.1

 

We recorded OTTI of $0.7 million for 2010. See “Critical Accounting Policies and Estimates—Investment Valuations—Fixed Maturity Securities.” We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2010. The unrealized capital losses for 2009 included $3.6 million related to noncredit losses that were reclassified from retained earnings to accumulated other comprehensive income.

 

Commercial Mortgage Loans

StanCorp Mortgage Investors, LLC originates and services fixed-rate commercial mortgage loans for the investment portfolios of our insurance subsidiaries and generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors. The level of commercial mortgage loan originations in any period is influenced by market conditions as we respond to changes in interest rates, available spreads and borrower demand.

 

40   STANCORP FINANCIAL GROUP, INC.


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The following table sets forth commercial mortgage loan originations:

 

    

Years ended

December 31,

 
(Dollars in millions)    2010      Percent
Change
    2009      Percent
Change
    2008  
Commercial mortgage loan originations    $     887.5         23.5   $     718.5         (47.7 )%    $     1,373.8   

 

The increase in commercial mortgage loan originations for 2010 compared to 2009 was primarily due to increased activity in the commercial real estate market. The decrease in commercial mortgage loan originations for 2009 compared to 2008 was primarily due to a reduction in demand from quality borrowers in the current credit environment.

The following table sets forth commercial mortgage loan servicing data:

 

     December 31,      Percent
Change
 
(Dollars in millions)    2010      2009     

Commercial mortgage loans serviced:

                          

For subsidiaries of StanCorp.

   $     4,509.7       $     4,279.8         5.4

For other institutional investors

     2,697.3         2,588.8         4.2   

Capitalized commercial mortgage loan servicing rights associated with commercial mortgage loans serviced for other institutional investors

     7.6         7.5         1.3   

 

The estimated average loan to value ratio for the overall portfolio was approximately 68% at December 31, 2010. The average loan balance of our commercial mortgage loan portfolio was approximately $0.8 million at December 31, 2010. We have the contractual ability to pursue personal recourse on approximately 70% of our loans and partial personal recourse on a majority of the remaining loans. The average capitalization rate for the portfolio at December 31, 2010 was approximately 9%. Capitalization rates are used internally to annually value our commercial mortgage loan portfolio.

At December 31, 2010, we did not have any direct exposure to sub-prime or Alt-A mortgages in our commercial mortgage loan portfolio. When we undertake mortgage risk, we do so directly through loans that we originate ourselves rather than in packaged products such as commercial mortgage-backed securities. Given that we service the vast majority of loans in our portfolios, we are prepared to deal with them promptly and proactively. Should the delinquency rate or loss performance of our commercial mortgage loan portfolio increase significantly, the increase could have a material adverse effect on our business, financial position, results of operations or cash flows.

 

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The following table sets forth our commercial mortgage loan portfolio by property type, by geographic region within the U.S., and by U.S. state:

 

<
   

December 31,

2010

   

December 31,

2009

 
(Dollars in millions)   Amount      Percent     Amount      Percent  

Property type:

                                 

Retail

  $     2,186.4         48.4   $     2,068.1         48.3

Office

    855.2         18.9        802.6         18.7   

Industrial

    829.0         18.4        777.4         18.1   

Hotel/motel

    301.8         6.7        326.1         7.6   

Commercial

    179.5         4.0        175.8         4.1   

Apartment and agricultural

    161.7         3.6        134.8         3.2   
                                   

Total commercial mortgage loans

  $     4,513.6         100.0   $     4,284.8         100.0
                                   

Geographic region:

                                 

Pacific

  $     1,558.5         34.5   $     1,453.6         33.9

South Atlantic

    838.9         18.6        860.8         20.1   

Mountain

    541.1         12.0        545.4         12.7   

West South Central

    547.2         12.1