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Unum Group 10-Q 2007 Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One)
For the quarterly period ended September 30, 2007
For the transition period from to Commission file number 1-11294 Unum Group (Exact name of registrant as specified in its charter)
1 Fountain Square Chattanooga, Tennessee 37402 (Address of principal executive offices) 423.294.1011 (Registrant’s telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer x Accelerated Filer ¨ Non-accelerated Filer ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ Nox 360,830,497 shares of the registrant’s common stock were outstanding as of September 30, 2007.
Table of ContentsTABLE OF CONTENTS
Table of ContentsCautionary Statement Regarding Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” to encourage companies to provide prospective information, as long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those included in the forward-looking statements. We desire to take advantage of these safe harbor provisions. Certain information contained in this discussion, or in any other written or oral statements made by us in communications with the financial community or contained in documents filed with the Securities and Exchange Commission (SEC), may be considered forward-looking. Forward-looking statements are those not based on historical information, but rather relate to future operations, strategies, financial results, or other developments and speak only as of the date made. These statements may be made directly in this document or may be made part of this document by reference to other documents filed by us with the SEC, which is known as “incorporation by reference.” You can find many of these statements by looking for words such as “will,” “may,” “should,” “could,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “projects,” “goals,” “objectives,” or similar expressions in this document or in documents incorporated herein. These forward-looking statements are subject to numerous assumptions, risks, and uncertainties, many of which are beyond our control. We caution readers that the following factors, in addition to other factors mentioned from time to time, may cause actual results to differ materially from those contemplated by the forward-looking statements:
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Table of Contents
For further discussion of risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see Part I, Item 1A of our annual report on Form 10-K for the year ended December 31, 2006. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.
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Table of ContentsPART I ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS Unum Group and Subsidiaries
See notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED BALANCE SHEETS - Continued Unum Group and Subsidiaries
See notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Unum Group and Subsidiaries
See notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED) Unum Group and Subsidiaries
See notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Unum Group and Subsidiaries
See notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED) Unum Group and Subsidiaries
See notes to consolidated financial statements.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Unum Group and Subsidiaries September 30, 2007 Note 1 - Basis of Presentation The accompanying consolidated financial statements of Unum Group and its subsidiaries (the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2006. During the first quarter of 2007, we closed the sale of our wholly-owned subsidiary GENEX Services, Inc. (GENEX). The financial results of GENEX are reported as discontinued operations in the consolidated financial statements. Except where noted, the information presented in the notes to the consolidated financial statements excludes GENEX. See Note 3 for further discussion. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2007, are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. Note 2 - Accounting Pronouncements Accounting Pronouncements Adopted: Effective January 1, 2007, we adopted the provisions of Statement of Position 05-1 (SOP 05-1), Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs (DAC) on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. An internal replacement is defined as a modification in product benefits, features, or coverages that occurs by the exchange or replacement of an existing insurance policy for a new policy. If the modification does not substantially change (as defined by SOP 05-1) the policy, we retain the unamortized DAC from the original policy and amortize its remaining balance over the expected life of the new policy, and the costs of replacing the policy are accounted for as policy maintenance costs and expensed as incurred. If the internal replacement results in a policy that is substantially changed, we account for the replacement as an extinguishment of the original policy and the issuance of a new policy. Unamortized DAC on the original policy that was replaced is immediately expensed, and the costs of acquiring the new policy are capitalized and amortized in accordance with our accounting policies for DAC. The cumulative effect of applying the provisions of SOP 05-1 decreased our 2007 opening balance of retained earnings $445.2 million.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 2 - Accounting Pronouncements - Continued Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109 (SFAS 109). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. Unlike SFAS 109, FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The cumulative effect of applying the provisions of FIN 48 increased our 2007 opening balance of retained earnings $22.7 million. Effective January 1, 2007, we adopted the provisions of Statement of Financial Accounting Standards No. 155 (SFAS 155), Accounting for Certain Hybrid Financial Instruments, an amendment of Statement of Financial Accounting Standards Nos. 133 (SFAS 133) and 140 (SFAS 140). SFAS 155: (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (c) establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and, (e) eliminates restrictions on a qualifying special-purpose entity’s ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. The adoption of SFAS 155 did not have a material effect on our financial position or results of operations. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (SFAS 123(R)), Share-Based Payment, which is a revision to Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee service in exchange for share-based payments. Under SFAS 123(R), share-based awards that do not require future service (i.e., vesting awards) are expensed immediately. Share-based employee awards that require future service are amortized over the relevant service period. We adopted SFAS 123(R) using the modified prospective transition method. In accordance with the modified prospective transition method, the provisions are generally applied only to share-based awards granted subsequent to adoption. Prior to adoption of SFAS 123(R), the unrecognized compensation cost related to nonvested stock awards was reported as additional paid-in capital and deferred compensation, a contra equity account. The value of this contra equity account at the adoption of SFAS 123(R) was $13.8 million. The adoption of SFAS 123(R) did not have a material effect on our financial position or results of operations. Accounting Pronouncement Outstanding: Statement of Financial Accounting Standards No. 157 (SFAS 157), Fair Value Measurements, was issued in September 2006. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. We will adopt the provisions of SFAS 157 effective January 1, 2008. The adoption of SFAS 157 will not have a material effect on our financial position or results of operations.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued) Unum Group and Subsidiaries September 30, 2007 Note 3 - Discontinued Operations As discussed in Note 1, the sale of GENEX closed effective March 1, 2007, and we recognized an after-tax gain of $6.2 million on the sale. We intend to continue to purchase certain disability management services for a period of up to five years from the effective date of the sale. The cost of the services to be purchased was negotiated in an arms-length transaction. Intercompany amounts paid to GENEX for these types of services were $2.3 million for the two month period ended February 28, 2007, and $4.1 million and $11.8 million for the three and nine month periods ended September 30, 2006. The estimated future cost of purchases of these services is not significant to our results of operations. GENEX was accounted for as an asset held for sale at December 31, 2006. The results of GENEX, which were previously reported in the Other segment, are reported as discontinued operations and excluded from segment results for all periods shown. Selected results for GENEX are as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 4 - Segment Information Premium income by major line of business within each of our segments is presented as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 4 - Segment Information - Continued Selected operating statement data by segment is presented as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 4 - Segment Information - Continued A reconciliation of total operating revenue and operating income (loss) by segment to revenue and net income (loss) as reported in our consolidated statements of operations is as follows:
Assets by segment are as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 5 - Pensions and Other Postretirement Benefits The components of net periodic benefit cost related to the Company sponsored defined benefit pension and postretirement plans for our employees are as follows:
As a result of the sale of GENEX, we froze the pension plan benefits for the employees of GENEX during the first quarter of 2007, which resulted in the recognition of a curtailment loss of $0.2 million and a $7.2 million reduction in our pension liability. The curtailment loss was comprised of a $0.6 million increase in our pension liability related to a termination benefit and a $0.4 million recognition of unamortized prior service credits. As of the date of the curtailment, we remeasured our U.S. pension plan obligation. The weighted average discount rate assumption used in the measurement of our U.S. pension plan benefit obligation changed from 6.10 percent as of our December 31, 2006 measurement date to 5.90 percent as of the measurement date of March 1, 2007. No other assumptions were materially changed. As a result of the remeasurement, our pension plan liability increased $35.6 million. The net effect of the curtailment and remeasurement was an increase in our pension plan liability of $29.0 million, a decrease in deferred income tax of $10.1 million, a decrease in income from discontinued operations of $0.2 million, and a decrease in accumulated other comprehensive income of $18.7 million.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 5 - Pensions and Other Postretirement Benefits - Continued In the third quarter of 2007, we terminated the Canadian defined benefit pension plans which were frozen in 2004. The termination of these plans did not have a material effect on our financial position or results of operations. We have no regulatory contribution requirements for our U.S. qualified defined benefit plan in 2007; however, we elected to make voluntary contributions of $110.0 million during the second quarter of 2007. For our U.K. operation, which maintains a separate defined benefit plan, we made required contributions totaling $2.6 million and $7.7 million for the third quarter and first nine months of 2007, respectively. Note 6 - Debt In May 2004, Unum Group issued 12.0 million 8.25% adjustable conversion-rate equity security units (units) in a private offering for $300.0 million. We subsequently registered the privately placed securities for resale by the private investors. Each unit had a stated amount of $25 and initially consisted of (a) a contract pursuant to which the holder agreed to purchase, for $25, shares of Unum Group’s common stock on May 15, 2007 and which entitled the holder to contract adjustment payments at the annual rate of 3.165 percent, payable quarterly, and (b) a 1/40 or 2.5 percent ownership interest in a senior note issued by Unum Group due May 15, 2009 with a principal amount of $1,000, on which Unum Group paid interest at the initial annual rate of 5.085%, payable quarterly. The scheduled remarketing of the senior note element of the units issued in May 2004 occurred in February 2007, as stipulated by the terms of the original offering, and we reset the interest rate on $300.0 million of senior notes due May 15, 2009 to 5.859%. We purchased $150.0 million of the senior notes in the remarketing which were subsequently retired. The associated write-off of deferred debt costs decreased first quarter of 2007 income by $2.4 million before tax, or $1.6 million after tax. In May 2007, we settled the purchase contract element of the units by issuing 17.7 million shares of common stock. We received proceeds of approximately $300.0 million from the transaction. During the first nine months of 2007, we made principal payments of $15.0 million on our senior secured non-recourse variable rate notes due 2036 which were issued by Tailwind Holdings, LLC. During the second quarter of 2007, we purchased $34.5 million aggregate principal amount of our outstanding 6.85% notes due 2015. The costs associated with this debt reduction decreased our second quarter 2007 income approximately $0.8 million before tax, or $0.6 million after tax.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 7 - Stockholders’ Equity and Earnings Per Common Share Net income (loss) per common share is determined as follows:
We use the treasury stock method to account for the effect of the purchase contract element of the units, outstanding stock options, and nonvested stock awards on the computation of dilutive earnings per share. Under this method, these potential common shares will each have a dilutive effect, as individually measured, when the average market price of Unum Group’s common stock during the period exceeds the threshold appreciation price of the purchase contract element of the units, the exercise price of the stock options, or the grant price of the nonvested stock awards. The purchase contract element of the units issued in 2004 and 2003 had a threshold appreciation price of $16.95 per share and $13.27 per share, respectively. We settled the purchase contract element of the 2004 and 2003 units in May 2007 and 2006 and issued 17.7 million and 43.3 million shares of common stock, respectively. The outstanding stock options have exercise prices ranging from $12.23 to $58.56, and the nonvested stock awards have grant prices ranging from $19.18 to $27.18. In computing earnings per share assuming dilution, only potential common shares that are dilutive (those that reduce earnings per share) are included. Potential common shares are not used when computing earnings per share assuming dilution if the result would be antidilutive, such as when a net loss is reported. For the three month period ended September 30, 2006, approximately 0.9 million issuable shares related to the purchase contract elements of the units and approximately 2.3 million issuable common shares for the assumed exercise of stock options and other dilutive securities were not used in the calculation of earnings per share due to the antidilutive effect when a net loss is reported. Potential common shares not included in the computation of dilutive earnings per share because their impact would be antidilutive based on current market prices approximated 6.1 million and 6.3 million shares of common stock for the three and nine month periods ended September 30, 2007, and 8.2 million and 8.3 million common shares for the three and nine month periods ended September 30, 2006. Unum Group has 25,000,000 shares of preferred stock authorized with a par value of $0.10 per share. No preferred stock has been issued to date.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 8 - Income Tax The cumulative effect of applying the provisions of FIN 48 as of January 1, 2007 resulted in a $22.7 million decrease in our liability for unrecognized tax benefits, net of associated deferred tax assets. The balance in our liability for unrecognized tax benefits as of January 1, 2007 and September 30, 2007 was $67.4 million and $126.1 million, respectively. Included at January 1, 2007 and September 30, 2007 are liabilities of approximately $19.2 million and $21.7 million, respectively, that if recognized, would impact our effective tax rate. The total increase in unrecognized tax benefits is $56.7 million and $58.7 million for the three and nine month periods ended September 30, 2007, respectively. We recognize interest expense and penalties related to unrecognized tax benefits in tax expense. The total amount of accrued interest and penalties in the consolidated balance sheets as of January 1, 2007 and September 30, 2007 is $5.5 million and $8.2 million, respectively. The interest expense and penalties related to unrecognized tax expense in the consolidated statements of operations are $1.0 million and $2.7 million for the three and nine month periods ended September 30, 2007, respectively. We file federal and state income tax returns in the United States and in foreign jurisdictions. We are under continuous examination by the Internal Revenue Service (IRS) with regard to our U.S. federal income tax returns. The current IRS examination covers our tax years 2002 through 2004. Tax years subsequent to 2004 remain subject to examination by tax authorities in all major jurisdictions. We believe it is reasonably possible that within the next 12 months a foreign subsidiary’s tax return for tax year 2005 will either be accepted without examination or will be examined and closed, resulting in a reduction in our liability for unrecognized tax benefits of as much as $6.6 million. We believe sufficient provision has been made for all proposed and potential adjustments for all years that are not closed by the statute of limitations in all major tax jurisdictions and that any such adjustment would not have a material adverse effect on our financial position, liquidity, or results of operations. However, it is possible that the resolution of a proposed adjustment by a taxing authority could impact our results of operations in a future period. Note 9 - Commitments and Contingent Liabilities We are a defendant in a number of litigation matters. In some of these matters, no specified amount is sought. In others, very large or indeterminate amounts, including punitive and treble damages, are asserted. There is a wide variation of pleading practice permitted in the United States courts with respect to requests for monetary damages, including some courts in which no specified amount is required and others which allow the plaintiff to state only that the amount sought is sufficient to invoke the jurisdiction of that court. Further, some jurisdictions permit plaintiffs to allege damages well in excess of reasonably possible verdicts. Based on our extensive experience and that of others in the industry with respect to litigating or resolving claims through settlement over an extended period of time, we believe that the monetary damages asserted in a lawsuit or claim bear little relation to the merits of the case, or the likely disposition value. Therefore, the specific monetary relief sought is not stated. The lawsuits described below are for the most part in very preliminary stages, and the outcome of the matters is uncertain. An estimated loss is accrued when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Unless indicated otherwise, reserves have not been established for these matters.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 9 - Commitments and Contingent Liabilities - Continued Claims Handling Matters Multidistrict Litigation On September 2, 2003, the Judicial Panel on the Multidistrict Litigation entered an order transferring more than twenty putative class actions and derivative suits, described below, filed in various courts against the Company, several of its subsidiaries, and some of our officers, to the U.S. District Court for the Eastern District of Tennessee for coordinated or consolidated pretrial proceedings. The defendants strongly deny the allegations in each of these actions and will vigorously defend the substantive and procedural aspects of the litigations, except as noted below with respect to settlement discussions. Shareholder Derivative Actions On November 22, 2002, the first of five purported shareholder derivative actions was filed in the Tennessee Chancery Court. Between December 27, 2002 and March 11, 2003, four additional purported derivative actions were filed in state and federal courts in Tennessee. The defendants removed each of the actions that were filed in Tennessee state court to the U.S. District Court for the Eastern District of Tennessee. Each of these actions purports to be brought on behalf of the Company against certain current and past members of our Board of Directors and certain executive officers alleging breaches of fiduciary duties and other violations of claims paying law by defendants. Plaintiffs allege, among other things, that the individual defendants breached their duties of good faith and loyalty by establishing or permitting to be established an unlawful policy of denying legitimate disability claims and improper financial reporting, and that certain defendants engaged in insider trading. The district court consolidated these actions under the caption In re UnumProvident Corporation Derivative Actions. The plaintiffs then filed a single consolidated amended complaint. We deny the allegations of the complaint and will vigorously contest them. Federal Securities Law Class Actions On February 12, 2003, the first of six virtually identical putative securities class actions was filed in the U.S. District Court for the Eastern District of Tennessee, later consolidated under the caption In re UnumProvident Corp. Securities Litigation. The Lead Plaintiff filed a consolidated amended complaint alleging claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 on behalf of a putative class of purchasers of UnumProvident stock between March 30, 2000 and April 24, 2003. The amended complaint alleges, among other things, that we issued misleading financial statements, improperly accounted for certain impaired investments, failed to properly estimate our disability claim reserves, and pursued certain improper claims handling practices. On July 30, 2007, we entered into a Stipulation of Settlement with the plaintiffs to resolve the litigation. Under the terms of the settlement, which is subject to, among other things, approval by the court, we have agreed to pay $40.0 million to settle all claims that were or could have been asserted by the class in the action. After the receipt of insurance proceeds, the net cost to us was $11.6 million before tax and was included in our second quarter of 2007 operating results.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 9 - Commitments and Contingent Liabilities - Continued Policyholder Class Actions On July 15, 2002, Rombeiro v. Unum Life Insurance Company of America, et al., was filed in the Superior Court of California and subsequently was removed to federal court, alleging that the plaintiff was wrongfully denied disability benefits under a group long-term disability plan. On January 21, 2003, an Amended Complaint was filed on behalf of a putative class of individuals that were denied or terminated from benefits under group long-term disability plans, seeking injunctive and declaratory relief and payment of benefits. On April 30, 2003, the court granted in part and denied in part the defendants’ motion to dismiss the complaint. On May 14, 2003, the plaintiff filed a Second Amended Complaint seeking similar relief. Between November 2002 and November 2003, six additional similar putative class actions were filed in (or later removed to) federal district courts in Illinois, Massachusetts, New York, Pennsylvania, and Tennessee. The complaints alleged that the putative class members’ claims were evaluated improperly and allege that the Company and its insurance subsidiaries breached certain fiduciary duties owed to the class members under the Employee Retirement Income Security Act (ERISA), Racketeer Influenced Corrupt Organizations Act (RICO), and/or various state laws. The complaints sought various forms of equitable relief and money damages, including punitive damages. These actions all were transferred to the Eastern District of Tennessee multidistrict litigation. On December 22, 2003, the Tennessee Federal District Court entered an order consolidating all of the above actions for all pretrial purposes under the caption In re UnumProvident Corp. ERISA Benefit Denial Actions and appointed a lead plaintiff. A consolidated amended complaint was filed on February 20, 2004. Court ordered mediation has concluded with the settlement of all individual claims brought by seven of the fifteen named plaintiffs. An eighth plaintiff has subsequently resolved her claims through the process established under the regulatory settlement agreements. On September 4, 2007, the District Court certified a (b)(2) class consisting of “all plan participants and beneficiaries insured under ERISA governed long-term disability insurance policies/plans issued by UnumProvident and the insuring subsidiaries of UnumProvident throughout the United States who have had a long-term disability claim denied, terminated, or suspended on or after June 30, 1999 by UnumProvident or one or more of its insuring subsidiaries after being subjected to any of the practices alleged in the complaint.” The Company has filed a petition with the Sixth Circuit Court of Appeals seeking leave to appeal the certification order now, without awaiting rulings on the merits of the claims. The class as certified seeks, among other forms of relief, an opportunity to have denied or terminated claims re-assessed by so-called independent reviewers. The court has yet to rule on pending motions by the Company for judgment on the pleading, or for summary judgment. On April 30, 2003, a separate putative class action, Taylor v. UnumProvident Corporation, et al., was filed in the Tennessee Circuit Court and subsequently removed to federal court. The complaint alleges claims against UnumProvident and certain subsidiaries on behalf of a putative class of long-term disability insurance policyholders who did not obtain their coverage through employer sponsored plans and who had a claim denied, terminated, or suspended by a UnumProvident subsidiary after January 1, 1995, seeking equitable and monetary relief. Plaintiff alleges that the defendants violated various state laws by engaging in unfair claim practices and improperly denying claims. The court subsequently granted in part our motion for summary judgment in Taylor, dismissing plaintiff’s request for equitable relief on her breach of contract claim and dismissing any claim plaintiff may make for punitive damages under the Tennessee Consumer Protection Act. The former claim is the principal claim upon which class
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 9 - Commitments and Contingent Liabilities - Continued certification is sought. The court reserved ruling on the remainder of the pending motion for summary judgment pending further mediation of the Taylor action. Plan Beneficiary Class Actions During the first quarter of 2007, we executed a settlement agreement resolving the plan beneficiary class action, or 401(k) Retirement Plan case, entitled Gee v. UnumProvident Corporation, et al. The settlement agreement, the net cost of which is immaterial, is subject to notice to the proposed settlement class and Court approval following a fairness hearing. On September 19, 2007, the Court granted preliminary approval of the settlement and ordered that notice be sent to the proposed settlement class. A fairness hearing is scheduled for December 19, 2007. Examinations and Investigations During 2004 and 2005, certain of our insurance subsidiaries entered into settlement agreements with various regulators related to disability claims handling practices. The agreements provide for changes in certain of our claims handling procedures and a claim reassessment process available to certain claimants whose claims were denied or closed during specified periods. The agreements will remain in place until the later of January 1, 2007, or the completion of an examination of claims handling practices and an examination of the reassessment process, both of which will be conducted by the lead state regulators. The settlement agreements also provide for a contingent fine of up to $145.0 million on our U.S. insurance subsidiaries in the event that we fail to satisfactorily meet the performance standards in the settlement agreements relating to the examinations referred to above. The parties to the agreements subsequently agreed to extend the reassessment process until December 31, 2007. In the first quarter of 2006, we completed an analysis of our assumptions related to the reserves we established for the claim reassessment process. Our analysis was based on preliminary data as of the end of the first quarter of 2006, when actual results to date were considered credible enough to enable us to update our initial expectations of costs related to the reassessment process. We concluded that a change in our initial assumptions, primarily related to the number of claimants for whom payments will continue because the claimant remains eligible for disability payments, was warranted. We based our conclusion and our revised estimate on the information that existed at that time, which was the actual cost related to approximately 20 percent of the projected ultimate total number of claims expected to be reassessed. The characteristics, profile, and cost of those initial 20 percent of claims were more statistically credible than the information on which we based the initial charges in 2004 and 2005. Based on our analysis, in the first quarter of 2006 we recorded a charge of $86.0 million before tax, or $55.9 million after tax, to reflect our then current estimate of future obligations for benefit costs for claims reopened in the reassessment. In the third quarter of 2006, we increased our provision for the cost of the reassessment process $325.4 million before tax and $211.5 million after tax based on changes in our emerging experience for the number of decisions being overturned by the reassessment process and the average cost per reassessed claim. The revised third quarter estimate was based on the cost of approximately 55 percent of the projected ultimate total number of claims expected to be reassessed. The third quarter charge was comprised of $310.4 million to reflect our revised estimate of future obligations for benefit costs for claims reopened in the reassessment and $15.0 million for additional incremental direct claim reassessment operating expenses because of the additional time now estimated to complete the process. Our best estimate of $310.4 million for the reopened claims assumed that the nature and characteristics of the approximately 45 percent remaining claims estimated to be reassessed at that time would be similar to the average profile of the 55 percent already reviewed at that time.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 9 - Commitments and Contingent Liabilities - Continued In the second quarter of 2007, we increased our provision for the estimated cost of the claim reassessment process $53.0 million before tax and $34.5 million after tax based on changes in our emerging experience for the number of decisions being overturned and the average cost per reassessed claim. The revised second quarter of 2007 estimate was based on the cost of approximately 99 percent of the potential inventory of claim reassessment information forms returned to us, with our claim reassessment on approximately 88 percent of the forms completed at that time. We had not at that time yet finalized our claim reassessment on the remaining forms but had performed a financial review and included that information in our analysis of emerging experience. We have now substantially completed the claims reassessment process, as required by the regulatory settlement agreements. Any remaining claim reassessment costs will not have a material effect on our financial position or results of operations. The final examination under the multistate regulatory settlement agreement has commenced and is expected to be completed by mid-year 2008. Due to the changes we have made to our claims operations to enhance our oversight functions, we expect to meet the performance standards in the agreements when these examinations are concluded. Other Claim Litigation We and our insurance company subsidiaries, as part of our normal operations in managing disability claims, are engaged in claim litigation where disputes arise as a result of a denial or termination of benefits. Most typically these lawsuits are filed on behalf of a single claimant or policyholder, and in some of these individual actions punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. For our general claim litigation, we maintain reserves based on experience to satisfy judgments and settlements in the normal course. We expect that the ultimate liability, if any, with respect to general claim litigation, after consideration of the reserves maintained, will not be material to our consolidated financial condition. Nevertheless, given the inherent unpredictability of litigation, it is possible that an adverse outcome in certain claim litigation involving punitive damages could, from time to time, have a material adverse effect on our consolidated results of operations in a period, depending on the results of operations for the particular period. We are unable to estimate a range of reasonably possible punitive losses. From time to time class action allegations are pursued where the claimant or policyholder purports to represent a larger number of individuals who are similarly situated. Since each insurance claim is evaluated based on its own merits, there is rarely a single act or series of actions, which can properly be addressed by a class action. Nevertheless, we monitor these cases closely and defend ourselves appropriately where these allegations are made. Broker Compensation, Quoting Process, and Related Matters Examinations and Investigations Since October 2004, we and/or our insurance subsidiaries have received subpoenas or information requests from a Federal Grand Jury in San Diego, the District Attorney for the County of San Diego, and the U.S. Department of Labor, as well as insurance departments and/or other state regulatory or investigatory agencies of at least seven additional states including Connecticut, Florida, Maine, Massachusetts, North Carolina, South Carolina, and Tennessee. The subpoenas and/or information requests relate to, among other things, compliance with ERISA
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 9 - Commitments and Contingent Liabilities - Continued relating to our interactions with insurance brokers and to regulations concerning insurance information provided by us to plan administrators of ERISA plans, as well as compliance with state and federal laws with respect to quoting processes, producer compensation, solicitation activities, policies sold to state or municipal entities, and information regarding compensation arrangements with brokers. We will continue to cooperate fully with all investigations. Broker-Related Litigation We and certain of our subsidiaries, along with many other insurance brokers and insurers, have been named as defendants in a series of putative class actions that have been transferred to the U.S. District Court for the District of New Jersey for coordinated or consolidated pretrial proceedings as part of multidistrict litigation (MDL) No. 1663, In re Insurance Brokerage Antitrust Litigation. The plaintiffs in MDL No. 1663 filed a consolidated amended complaint in August 2005, which alleges, among other things, that the defendants violated federal and state antitrust laws, RICO, ERISA, and various state common law requirements by engaging in alleged bid rigging and customer allocation and by paying undisclosed compensation to insurance brokers to steer business to defendant insurers. Defendants filed a motion to dismiss the complaint on November 29, 2005. On April 5, 2007, defendants’ motion to dismiss was granted without prejudice as to all counts except the ERISA counts. Plaintiffs were granted a last opportunity to file an amended complaint, and they did so on May 22, 2007. On June 21, 2007, defendants filed a motion to dismiss and for summary judgment on all counts. On August 31, 2007 and September 28, 2007, plaintiffs’ federal antitrust and RICO claims were dismissed with prejudice. Defendants’ motion for summary judgment on the ERISA counts is pending. All further discovery in these actions has been stayed pending the resolution of the motion to dismiss and for summary judgment. We are a defendant in an action styled, Palm Tree Computers Systems, Inc. v. ACE USA, et al., which was filed in the Florida state Circuit Court on February 16, 2005. The complaint contains allegations similar to those made in the multidistrict litigation referred to above. The case was removed to federal court and, on October 20, 2005, the case was transferred to the District of New Jersey multidistrict litigation. A motion to remand the case to the state court in Florida remains pending, but no further action has been taken in the case subsequent to the transfer. During the first quarter of 2007, we reached an agreement in principle to resolve the claims asserted in the putative derivative action styled Leonard v. UnumProvident Corporation, et al. The proposed settlement, the terms of which are not expected to be material to us, was approved by the court on September 11, 2007. Miscellaneous Matters In September 2003, United States of America ex. rel. Patrick J. Loughren v. UnumProvident Corporation and GENEX Services, Inc. was filed in the United States District Court for the District of Massachusetts. This is a qui tam action to recover damages and civil penalties on behalf of the United States of America alleging violations of the False Claims Act by us and our GENEX subsidiary. In accordance with the False Claims Act, the action was originally filed under seal to provide the government the opportunity to investigate the allegations and prosecute the action if they believed that the case had merit and warranted their attention. The government declined to prosecute the case and the case became a matter of public record on December 23, 2004. The complaint alleges that we defrauded the government by inducing and or assisting disability claimants to apply for disability benefits from the Social Security Administration (SSA) when we allegedly knew that the claimants were not disabled under SSA criteria. A motion to dismiss the complaint was unsuccessful. We intend to vigorously defend the action.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries September 30, 2007 Note 9 - Commitments and Contingent Liabilities - Continued In May 2007, Roy Mogel, Todd D. Lindsay and Joseph R. Thorley individually and on behalf of those similarly situated v. Unum Life Insurance Company, was filed in the United States District Court for the District of Massachusetts. This is a putative class action alleging that we breached fiduciary duties owed to certain beneficiaries under group life insurance policies when we paid certain life insurance proceeds by establishing interest-bearing Retained Asset Accounts rather than checks. We have filed a motion to dismiss the complaint and believe that the allegations are without merit. We intend to vigorously defend the action. Summary Various lawsuits against us, in addition to those discussed above, have arisen in the normal course of business. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning our compliance with applicable insurance and other laws and regulations. Given the complexity and scope of our litigation and regulatory matters, it is not possible to predict the ultimate outcome of all pending investigations or legal proceedings or provide reasonable estimates of potential losses, except where noted in connection with specific matters. It is possible that our results of operations or cash flows in a particular period could be materially affected by an ultimate unfavorable outcome of pending litigation or regulatory matters depending, in part, on our results of operations or cash flows for the particular period. We believe, however, that the ultimate outcome of all pending litigation and regulatory matters, after consideration of applicable reserves and rights to indemnification, should not have a material adverse effect on our financial position. Note 10 - Subsequent Events On October 31, 2007, Northwind Holdings, LLC (Northwind Holdings), a newly formed Delaware limited liability company and a wholly-owned subsidiary of Unum Group, issued $800.0 million of floating rate, insured, senior, secured notes due 2037 in a private offering. The notes bear interest at a floating rate equal to the three month London Interbank Offered Rate (LIBOR) plus 0.78%. Recourse for the payment of principal, interest, and other amounts due on the notes will be dependent principally on the receipt of dividends from Northwind Reinsurance Company (Northwind Re), the sole subsidiary of Northwind Holdings. The ability of Northwind Re to pay dividends to Northwind Holdings will depend on its satisfaction of applicable regulatory requirements and on the performance of the business of The Paul Revere Life Insurance Company, Provident Life and Accident Insurance Company, and Unum Life Insurance Company of America (collectively, the ceding insurers) reinsured by Northwind Re. None of Unum Group, the ceding insurers, Northwind Re, or any other affiliate of Northwind Holdings is an obligor or guarantor on the notes. On October 31, 2007, we announced our intent to call for an early redemption all $150.0 million principal amount of our outstanding 7.25% notes scheduled to mature in 2032. We also announced that we intend to offer to purchase up to $400.0 million aggregate principal amount of other of our outstanding long-term debt. In October 2007, our board of directors authorized the repurchase of up to $700.0 million of Unum Group’s common stock. The share repurchase program does not have an expiration date, and the pace of repurchase activity, if commenced, will depend upon various factors such as the level of available cash, alternative uses for cash, and our stock price. The authorization may be modified, extended, or terminated by our board of directors at any time.
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Table of ContentsReport of Independent Registered Public Accounting Firm Board of Directors and Stockholders Unum Group and Subsidiaries We have reviewed the consolidated balance sheet of Unum Group and subsidiaries as of September 30, 2007, and the related consolidated statements of operations and comprehensive income (loss) for the three-month and nine-month periods ended September 30, 2007 and 2006, and the consolidated statements of stockholders’ equity and cash flows for the nine-month periods ended September 30, 2007 and 2006. These financial statements are the responsibility of the Company’s management. We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, Unum Group changed its method of accounting for deferred acquisition costs and income taxes as of January 1, 2007 in accordance with adoption of Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts, and Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109. We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Unum Group and subsidiaries as of December 31, 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated February 26, 2007, we expressed an unqualified opinion on those consolidated financial statements. /s/ ERNST & YOUNG LLP Chattanooga, Tennessee October 31, 2007
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Table of ContentsITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction Unum Group, a Delaware general business corporation, and its insurance and non-insurance companies, which collectively with Unum Group we refer to as the Company, operate in the United States, the United Kingdom, and, to a limited extent, in certain other countries around the world. The principal operating subsidiaries in the United States are Unum Life Insurance Company of America (Unum America), Provident Life and Accident Insurance Company (Provident), The Paul Revere Life Insurance Company (Paul Revere Life), and Colonial Life & Accident Insurance Company (Colonial), and in the United Kingdom, Unum Limited. We are the largest provider of group and individual income protection insurance products in the United States and the United Kingdom. We also provide a complementary portfolio of other insurance products, including long-term care insurance, life insurance, employer- and employee-paid group benefits, and other related services. We have three major business segments: Unum US, Unum UK, and Colonial. Our other segments are the Individual Income Protection – Closed Block segment, the Other segment, and the Corporate segment. These segments are discussed more fully under “Segment Results” included herein in Item 2. As one of the leading providers of employee benefits, we offer a comprehensive portfolio of products and services to meet the diverse needs of the marketplace. We try to achieve a competitive advantage by offering group, individual, and voluntary workplace products that can be offered as stand alone products or that can be combined with other coverages to provide integrated and individualized product solutions for customers. We offer businesses of all sizes competitive benefit plans to protect the incomes and lifestyles of employees and their families in the event of illness, injury, or death. We believe that our benefit programs can help businesses attract and retain quality employees, reduce the cost of absenteeism, and return employees to work after an illness or injury, thereby creating a more satisfied and productive workforce. We believe that we are a well positioned and competitive force in our sector. However, due to the nature of our business, we are sensitive to economic and financial market movements, including consumer confidence, employment levels, and the level of interest rates. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto in Part I, Item 1 contained in this Form 10-Q and with the discussion, analysis, and consolidated financial statements and notes thereto in Part I, Items 1 and 1A, and Part II, Items 6, 7, 7A, and 8 of our annual report on Form 10-K for the year ended December 31, 2006. Executive Summary We believe that the actions we have taken during the past several years have improved the effectiveness of the basic functions of our businesses, reduced our business volatility, and led to a greater consistency in the execution of our business plan. Our goal is to build further momentum by focusing on our strengths and serving our customers well. Our four primary objectives for 2007 have been and continue to be as follows:
In commenting on our results for the third quarter and first nine months of 2007, we will discuss three major topics: operating performance of our three major business segments, our capital management strategy, and our outstanding legal and regulatory issues.
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Table of ContentsOperating Performance of our Major Business Segments We reported solid operating results for our Unum US segment for the third quarter of 2007, with an increase in segment operating income of 39.0 percent compared to the prior year third quarter, excluding the third quarter of 2006 increase in our claim reassessment cost estimate. Our primary focus for Unum US during 2007 has been continued improvement of our claims management performance in our group income protection line of business, and we are pleased with the progress made during the first nine months of the year. Our reported group income protection benefit ratio was 92.1 percent for the third quarter of 2007, consistent with the goals we established for improved claim operational effectiveness. Our 2007 priorities also include improved profitability in certain of our supplemental products and the maintenance of current performance levels in our other lines, and our third quarter operating results generally reflect achievement of these priorities. Although our third quarter of 2007 supplemental and voluntary product lines operating income declined 1.9 percent relative to the third quarter of last year, our group life and accidental death and dismemberment product lines improved 30.7 percent. For the first nine months, operating income improved 8.5 percent in 2007 over the prior year in our supplemental and voluntary product lines and 19.3 percent in our group life and accidental death and dismemberment product lines. Positive trends for our Unum US group lines of business include favorable pricing trends, renewal profit improvement, and the management of case persistency. For all of our Unum US lines of business, we are aggressively managing our operating expenses and are continuing to make improvements in our operating effectiveness. Although sales for Unum US for the first nine months of 2007 were lower than 2006, sales in the third quarter of 2007 increased 4.4 percent over the prior year comparable period. We have throughout the year maintained our disciplined pricing, and our overall sales mix continues to be generally in line with our target mix. The number of new accounts in the group core market segment, which we define for Unum US as employee groups with less than 2,000 lives, increased over the prior year first nine months, which we believe is a clear indication of our strong focus in this segment. We anticipate that sales for our group core market segment and our supplemental lines will increase in the fourth quarter of 2007 relative to the prior year fourth quarter. During the third quarter of 2007, Unum US introduced Simply Unum, a new product offering and administrative platform designed to better meet the needs of our group core market segment and our voluntary market. The new platform represents substantial changes in existing technologies and workflow processes, from quote and proposal to billing and administration and ultimately to the payment of claims. The initial market rollout was limited to four pilot sales offices, with the full rollout expected to occur during the first quarter of 2008. Our Unum UK segment continues to produce excellent operating results, with an increase in segment operating income of 43.3 percent for the third quarter of 2007 and 31.9 percent for the first nine months of 2007, as measured in Unum UK’s local currency, compared to the comparable periods of 2006. Sales in Unum UK declined in the third quarter of 2007 relative to the prior year, but on a year-to-date basis improved in 2007 relative to the prior year comparable period. This improvement was most apparent in the core market segment, which we now define for Unum UK as employee groups with less than 500 lives. The core market segment reported increases relative to the prior year in both the third quarter and the first nine months of 2007. Changes in pension legislation created a distraction in the market for employee benefits and negatively impacted sales during 2006. However, other U.K. legislative changes that became effective in October 2006 extended the legal retirement age and made it illegal for employers to discriminate on the basis of age, thereby encouraging the extension of insurance coverage. As a result and as expected, Unum UK sales have increased during the first nine months of 2007 relative to the 2006 levels, and we expect this trend to continue throughout the remainder of the year, although to a lesser extent as sales in the fourth quarter of 2006 were positively impacted by the legislative changes. We are focused on increasing market awareness and demand for income protection products in the U.K. market. Our Colonial segment also had excellent operating results for the third quarter of 2007, with an increase in segment operating income of 20.0 percent compared to the prior year. For the first nine months of 2007, Colonial’s segment operating income increased 26.2 percent over the comparable prior year period. Colonial’s sales improved in the third quarter and first nine months of 2007, with increases of 2.2 percent and 3.5 percent over the same prior year periods. Most notable were sales increases in the public sector market for educators and in the commercial market segment for employee groups with less than 100 lives. The number of new accounts increased over the prior year first nine months, although the average new case size was smaller than expected. We anticipate that our sales growth will continue to increase year over year during the remainder of 2007, as positive trends have emerged in our agency sales force recruiting and productivity levels and in our targeted market segments. We are focused on
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Table of Contentsmaintaining profitable and sustainable sales growth for this segment. During the third quarter of 2007, we introduced a new hospital confinement indemnity insurance plan that gives businesses the opportunity to offer their employees a solution to help fill coverage gaps in their major medical plan and help protect employees against increasing out-of-pocket expenses. In October 2007, we introduced a group limited benefit plan that provides businesses a product offering for their employees who do not have major medical coverage. Capital Management Strategy Our capital planning objectives for 2007 were: maintain our risk-based capital (RBC) ratio for our traditional U.S. insurance subsidiaries, calculated on a weighted average basis using the National Association of Insurance Commissioners (NAIC) Company Action Level formula, at the current level of approximately 300 percent; maintain our leverage ratio at current levels while exploring the potential benefits of further reductions; maintain holding company liquidity to cover at least one year of fixed charges; and evaluate opportunities for the effective use of holding company liquidity in excess of our target. At the end of the third quarter of 2007, the RBC ratio for our traditional U.S. insurance subsidiaries remained consistent with our target level for the combined RBC ratio, and our holding company liquidity met our planning objectives. In the first quarter of 2007, we purchased and retired $150.0 million of our adjustable conversion-rate equity security units, and in the second quarter of 2007, we redeemed $34.5 million of our 6.85% senior debentures. During the first nine months of 2007, we made principal payments of $15.0 million on our senior secured non-recourse notes issued by our wholly-owned subsidiary Tailwind Holdings, LLC (Tailwind Holdings). Our debt to total capital ratio was 25.1 percent at the end of the third quarter of 2007, compared to 28.8 percent at the beginning of 2007, subsequent to our cumulative effect adjustment to equity for the adoption of the new accounting policies related to deferred acquisition costs and income taxes. We define total capital as debt plus stockholders’ equity, excluding the net unrealized gain or loss on securities and the net gain or loss on cash flow hedges. The debt to total capital ratio, when calculated excluding the non-recourse debt and associated equity of Tailwind Holdings and allowing 50 percent equity credit for the adjustable conversion-rate equity security units that were still outstanding at the beginning of the year, was 24.2 percent at the end of the third quarter of 2007, compared to 26.2 percent at the beginning of 2007. On October 31, 2007, we announced the completion of a securitization of our closed block of individual income protection reserves through the issuance of $800.0 million floating rate, insured, senior, secured notes by our wholly-owned subsidiary Northwind Holdings, LLC (Northwind Holdings). The transaction also includes the intercompany reinsurance of $11.1 billion of statutory reserves, representing approximately 95 percent of our Individual Income Protection – Closed Block segment, to Northwind Reinsurance Company (Northwind Re), a newly formed special purpose financial captive insurance company domiciled in Vermont and owned by Northwind Holdings. With the risk transfer to Northwind Re, our traditional U.S. insurance subsidiaries will be able to release excess statutory capital previously supporting this reinsured closed block business. The excess capital will be transferred to Unum Group from the ceding companies through extraordinary dividends. This capital structure allows us to continue to fully support the risk profile of this closed block of business while we redeploy excess capital to other uses. As a result of the build-up of excess capital from improved operating trends and in anticipation of the securitization transaction, we recently formalized our capital management goals and objectives. The first priority is to maintain sufficient financial flexibility to support our operations over various economic cycles and to respond to opportunities in the marketplace while positioning our Company for improvements in its credit ratings. We have set in place several financial targets which will guide our capital management decisions including:
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We consider any capital above that needed to achieve and maintain these metrics to be excess capital available to fund share repurchases, business growth, or acquisitions. Our goal in allocating excess capital is to maximize risk-adjusted shareholder returns over a three to five year time period, with share repurchase used as the benchmark for evaluating uses for excess capital. See “Liquidity and Capital Resources” contained herein for further detail on anticipated capital deployment during the remainder of 2007 and into 2008. Outstanding Legal and Regulatory Issues During the first nine months of 2007, we continued to make progress in resolving our outstanding legal and regulatory issues as described in Note 9 of the “Notes to Consolidated Financial Statements” contained herein in Item 1. During the third quarter of 2007, we received two favorable rulings dismissing, with prejudice, both the antitrust and RICO causes of action in the case entitled In re Insurance Brokerage Antitrust Litigation. A motion to dismiss the remaining cause of action regarding alleged violations of ERISA remains outstanding. In the meantime, discovery in the case remains stayed. During the second quarter of 2007, we executed a settlement agreement resolving the plan beneficiary class action, or 401(k) case, which is one of the multidistrict litigation matters discussed in our litigation footnote. The settlement agreement has been finalized but is subject to further court approval. The entire cost of the settlement was covered by insurance proceeds. In addition, we executed an agreement, subject to court approval, to settle all claims in the case entitled In re UnumProvident Corp. Securities Litigation. The amount of the settlement was $40.0 million, of which $28.4 million was covered by insurance proceeds. The net expense of $11.6 million was included in our second quarter of 2007 operating results. During the first quarter of 2007, we reached an agreement in principle to resolve the putative derivative action in Leonard v. UnumProvident Corporation, et. al. which asserts claims against us and various members of our board of directors. The proposed settlement, the terms of which are not expected to be material to us, was approved by the court during the third quarter of 2007. We have now substantially completed the claims reassessment process, as required by the regulatory settlement agreements. Any remaining claim reassessment costs will not have a material effect on our financial position or results of operations. The final examination under the multistate regulatory settlement agreement has commenced and is expected to be completed by mid-year 2008. First Nine Months 2007 Significant Transactions and Events Revised Claim Reassessment Reserve Estimate In the second quarter of 2007, we increased our provision for the estimated cost of the claim reassessment process $53.0 million before tax and $34.5 million after tax based on changes in our emerging experience for the number of decisions being overturned and the average cost per reassessed claim. The claim reassessment process was implemented as a result of the settlement agreements we entered into with various state insurance regulators in 2004 and 2005. See Item 7 of our annual report on Form 10-K for the year ended December 31, 2006 for a discussion of these settlement agreements. The revised second quarter estimate was based on the cost of approximately 99 percent of the potential inventory of claim reassessment information forms returned to us, with our claim reassessment on approximately 88 percent of the forms completed at that time. At the time of our second quarter of 2007 revision, we had not yet finalized our claim reassessment on the remaining forms but had performed a financial review and included that information in
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Table of Contentsour analysis of emerging experience. Additional information regarding the second quarter revision to our estimate is as follows:
Financing The scheduled remarketing of the senior note element of the 2004 adjustable conversion-rate equity units (units) occurred in February 2007, as stipulated by the terms of the original offering, and we reset the interest rate on $300.0 million of senior notes due May 15, 2009 to 5.859%. We purchased $150.0 million of the senior notes in the remarketing which were subsequently retired. The associated write-off of deferred debt costs decreased first quarter of 2007 income by $2.4 million before tax, or $1.6 million after tax. In May 2007, we settled the purchase contract element of the 2004 units by issuing 17.7 million shares of common stock. We received proceeds of approximately $300.0 million from the transaction. During the first nine months of 2007, we made principal payments of $15.0 million on our senior secured non-recourse variable rate notes due 2036 which were issued by Tailwind Holdings. During the second quarter of 2007, we purchased $34.5 million aggregate principal amount of our outstanding 6.85% notes due 2015. The costs associated with this debt reduction decreased our first nine months 2007 income approximately $0.8 million before tax, or $0.6 million after tax. On October 31, 2007, Northwind Holdings, a newly formed Delaware limited liability company and a wholly-owned subsidiary of Unum Group, issued $800.0 million of floating rate, insured, senior, secured notes due 2037 in a private offering. The notes bear interest at a floating rate equal to the three month London Interbank Offered Rate (LIBOR) plus 0.78%. Recourse for the payment of principal, interest, and other amounts due on the notes will be dependent principally on the receipt of dividends from Northwind Re, the sole subsidiary of Northwind Holdings. The ability of Northwind Re to pay dividends to Northwind Holdings will depend on its satisfaction of applicable
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Table of Contentsregulatory requirements and on the performance of the business of Paul Revere Life, Provident, and Unum America (collectively, the ceding insurers) reinsured by Northwind Re. None of Unum Group, the ceding insurers, Northwind Re, or any other affiliate of Northwind Holdings is an obligor or guarantor on the notes. See “Liquidity and Capital Resources” contained herein in Item 2 and Notes 6 and 10 of the “Notes to Consolidated Financial Statements” contained in Item 1 for additional information. Dispositions During the first quarter of 2007, we completed the sale of our wholly-owned subsidiary, GENEX Services, Inc. (GENEX), a leading workers’ compensation and medical cost containment services provider. Our growth strategy is focused on the development of our primary markets, and GENEX’s specialty role in case management and medical cost containment related to the workers’ compensation market was no longer consistent with our overall strategic direction. We recognized an after-tax gain on the transaction of approximately $6.2 million. See Note 3 of the “Notes to Consolidated Financial Statements” contained herein in Item 1 for additional information. Income Tax The income tax rate in the U.K. will be reduced from 30 percent to 28 percent in April 2008. In accordance with U.S. generally accepted accounting principles (GAAP), we are required to adjust deferred tax assets and liabilities through income on the date of enactment of a rate change, which occurred during the third quarter of 2007. Therefore, we recorded a reduction of $1.7 million to our income tax expense in the third quarter of 2007 to reflect the impact of the rate change on our net deferred tax liability related to our U.K. operations. Accounting Pronouncements Effective January 1, 2007, we adopted the provisions of Statement of Position 05-1 (SOP 05-1), Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs (DAC) on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The cumulative effect of applying the provisions of SOP 05-1 decreased our 2007 opening balance of retained earnings $445.2 million. Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109 (SFAS 109). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. Unlike SFAS 109, FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The cumulative effect of applying the provisions of FIN 48 increased our 2007 opening balance of retained earnings $22.7 million. Effective January 1, 2007, we adopted the provisions of Statement of Financial Accounting Standards No. 155 (SFAS 155), Accounting for Certain Hybrid Financial Instruments, an amendment of Statement of Financial Accounting Standards Nos. 133 (SFAS 133) and 140 (SFAS 140). SFAS 155: (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (c) establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and, (e) eliminates restrictions on a qualifying special-purpose entity’s ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. The adoption of SFAS 155 did not have a material effect on our financial position or results of operations.
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Table of ContentsFirst Nine Months 2006 Significant Transactions and Events Revised Claim Reassessment Reserve Estimate In the first quarter of 2006, we completed an analysis of our assumptions related to the reserves we established for the claim reassessment process. Our analysis was based on preliminary data as of the end of the first quarter of 2006, when actual results to date were considered credible enough to enable us to update our initial expectations of costs related to the reassessment process. We concluded that a change in our initial assumptions, primarily related to the number of claimants for whom payments will continue because the claimant remains eligible for disability payments, was warranted. We based our conclusion and our revised estimate on the information that existed at that time, which was the actual cost related to approximately 20 percent of the projected ultimate total number of claims expected to be reassessed. The characteristics, profile, and cost of those initial 20 percent of claims were more statistically credible than the information on which we based the initial charges in 2004 and 2005. Based on our analysis, in the first quarter of 2006 we recorded a charge of $86.0 million before tax, or $55.9 million after tax, to reflect our then current estimate of future obligations for benefit costs for claims reopened in the reassessment. The first quarter charge decreased 2006 before-tax operating results for our Unum US group income protection line of business $72.8 million and our Individual Income Protection – Closed Block segment $13.2 million. In the third quarter of 2006, we increased our provision for the cost of the reassessment process $325.4 million before tax and $211.5 million after tax based on changes in our emerging experience for the number of decisions being overturned by the reassessment process and the average cost per reassessed claim. The revised third quarter estimate was based on the cost of approximately 55 percent of the projected ultimate total number of claims expected to be reassessed. The third quarter charge was comprised of $310.4 million to reflect our revised estimate of future obligations for benefit costs for claims reopened in the reassessment and $15.0 million for additional incremental direct claim reassessment operating expenses because of the additional time then estimated to complete the process. Our best estimate of $310.4 million for the reopened claims assumed that the nature and characteristics of the approximately 45 percent remaining claims estimated to be reassessed at that time would be similar to the average profile of the 55 percent already reviewed at that time. The third quarter charge decreased before-tax operating results for our Unum US group income protection line of business $291.4 million and our Individual Income Protection – Closed Block segment $34.0 million. Financing The scheduled remarketing of the senior note element of our 2003 units occurred in February 2006, as stipulated by the terms of the original offering, and we reset the interest rate on $575.0 million of senior notes due May 15, 2008 to 5.997%. We purchased $400.0 million of the senior notes in the remarketing which were subsequently retired. The associated write-off of deferred debt costs decreased 2006 income by $5.3 million before tax, or $3.4 million after tax. In May 2006, we settled the purchase contract element of the 2003 units by issuing 43.3 million shares of common stock. We received proceeds of approximately $575.0 million from the transaction. In June 2006, we purchased $50.0 million of our outstanding 7.405% capital securities due 2038 and $250.0 million aggregate principal amount of our outstanding 7.625% notes due 2011. The cost of the cash tender offer decreased our second quarter of 2006 income approximately $17.8 million before tax, or $11.6 million after tax. In November 2006, Tailwind Holdings issued $130.0 million of senior, secured notes in a private offering. The payment of principal, interest, and other amounts due on the notes will be dependent principally on the receipt of dividends from Tailwind Reinsurance Company (Tailwind Re), the sole subsidiary of Tailwind Holdings. The ability of Tailwind Re to pay dividends to Tailwind Holdings will depend on its satisfaction of applicable regulatory requirements and on the performance of the reinsured claims of Unum America reinsured by Tailwind Re. None of Unum Group, Unum America, Tailwind Re, or any other affiliate of Tailwind Holdings is an obligor or guarantor on the notes. See “Liquidity and Capital Resources” contained herein in Item 2 and Note 6 of the “Notes to Consolidated Financial Statements” contained in Item 1 for additional information.
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Table of ContentsAccounting Pronouncements Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (SFAS 123(R)), Share-Based Payment, which is a revision to Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee service in exchange for share-based payments. Under SFAS 123(R), share-based awards that do not require future service (i.e., vesting awards) are expensed immediately. Share-based employee awards that require future service are amortized over the relevant service period. We adopted SFAS 123(R) using the modified prospective transition method. Under this method, the provisions are generally applied only to share-based awards granted after adoption. The adoption of SFAS 123(R) did not have a material effect on our financial position or results of operations. Critical Accounting Estimates We prepare our financial statements in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in our financial statements and accompanying notes. Estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed in our financial statements. The accounting estimates deemed to be most critical to our results of operations and financial condition are those related to reserves for policy and contract benefits, DAC, valuation of fixed maturity investment securities, and income taxes. There have been no significant changes in our critical accounting estimates during the first nine months of 2007, other than those resulting from the January 1, 2007 adoption of SOP 05-1 and FIN 48, which were disclosed in our “Critical Accounting Estimates” in our 2006 Form 10-K and are also discussed in Notes 2 and 8 of the “Notes to Consolidated Financial Statements” included herein in Item 1. For additional information concerning our accounting policies and critical accounting estimates, see Note 1 of the “Notes to Consolidated Financial Statements” in Part II, Item 8 and “Critical Accounting Estimates” in Part II, Item 7 of our annual report on Form 10-K for the year ended December 31, 2006.
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Table of ContentsConsolidated Operating Results
N.M. = not a meaningful percentage In describing our results, we may at times note certain items and exclude the impact of these items on financial ratios and metrics to enhance the understanding and comparability of our Company’s performance and the underlying fundamentals in our operations, but this exclusion is not an indication that similar items may not recur. The second quarter of 2007 and first and third quarter of 2006 revisions to our estimate of benefit costs and associated operating expenses for claims reopened in our claim reassessment process affect the comparability of the financial results reported herein and, only where noted, are excluded from certain of our financial ratios and metrics. Consolidated premium income was slightly higher in the third quarter of 2007 relative to the third quarter of 2006, but was marginally lower in the first nine months of 2007 relative to the same prior year period. We reported increases in premium income for the third quarter and first nine months of 2007 relative to the comparable prior year periods for Unum US supplemental and voluntary lines of business, Unum UK, and Colonial. Unum US group income protection and group life and accidental death and dismemberment lines of business experienced declines in premium income, as expected, due primarily to our continued pricing discipline for our Unum US group business and our strategy of developing a more balanced business mix. Premium income in the Individual Income Protection – Closed Block segment decreased in the third quarter and first nine months of 2007 relative to the same prior year periods due primarily to the expected decline in this block of closed business.
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Table of ContentsNet investment income was higher in the third quarter and first nine months of 2007 than the third quarter and first nine months of 2006 due primarily to the growth in invested assets and an increase in bond call premiums, offset by a lower yield due to the investment of new cash at lower rates than that of our overall portfolio yield and a decline in the level of prepayment income on mortgage-backed securities. We expect that our portfolio yield will continue to gradually decline until the market rates on new purchases increase above the level of the overall yield in our portfolio, but our investment income is expected to increase due to the continued growth in invested assets. Although the fair value at which we report our fixed maturity securities in our consolidated balance sheets increased only $190.9 million during the first nine months of 2007, due primarily to the impact of the increase in interest rates on fair values, our amortized cost of fixed maturity securities increased over $1.2 billion during the first nine months of the 2007, reflecting new purchase activity. For the third quarter and first nine months, we reported net realized investment losses of $46.1 million and $39.4 million in 2007 compared to gains of $4.8 million and $1.5 million for the comparable periods of 2006. Included in those amounts are changes in the fair value of the embedded derivatives in certain reinsurance contracts, which resulted in net realized losses of $27.7 million and $21.4 million in the third quarter and first nine months of 2007 compared to a net realized gain of $3.0 million and a loss of $4.5 million for the prior year periods. Also, in the third quarter of 2007, we recognized losses of $18.4 million related to the decline in fair value below amortized cost for certain securities for which it was determined during the third quarter of 2007 that we no longer had the intent to hold to recovery or maturity due to anticipated changes in our capital requirements resulting from the reinsurance transactions involving our Individual Income Protection – Closed Block segment business and the related issuance of $800.0 million of senior, secured notes in a private offering, as previously discussed herein, as well as our capital redeployment plans. We actively manage our credit risk and expect our gains and losses for the fourth quarter of 2007 to be relatively consistent with the first two quarters of 2007. See “Investments” contained herein in Item 2 for further discussion. The reported ratio of benefits and change in reserves for future benefits to premium income was 86.9 percent and 89.1 percent for the third quarter and first nine months of 2007 compared to 106.1 percent and 97.3 percent for the same periods of 2006. Our reported benefits and change in reserves for future benefits include charges of $65.8 million for the first nine months of 2007 and $310.4 million and $396.4 million for the third quarter and the first nine months of 2006, respectively, related to revisions to our estimate of benefit costs for claims reopened in our claim reassessment process. Excluding these charges, the ratio of benefits and change in reserves for future benefits to premium income was 88.0 percent for the first nine months of 2007 and 90.3 percent and 90.6 percent, respectively, for the third quarter and first nine months of 2006. See “Segment Results” as follows for discussions of line of business risk results and claims management performance in each of our segments. Interest and debt expense is lower relative to the third quarter and first nine months of 2006 due to the reduction in our outstanding debt. The reported ratio of compensation and other expenses to premium income declined in the third quarter and first nine months of 2007 relative to the prior year periods. Those expenses include increases (decreases) in the claim reassessment related incremental direct operating expense estimates of $(12.8) million in the first nine months of 2007 and $15.0 million in the third quarter and first nine months of 2006, as well as the charge of $18.5 million for the broker compensation settlements in the third quarter and first nine months of 2006. Excluding those items, our expense ratios increased in comparison to the third quarter and first nine months of 2006. The increase was due primarily to the decrease in premium income, as well as the second quarter of 2007 litigation settlement expense and additional expenses associated with the development of new product offerings in our core lines of business. We intend to aggressively manage our expenses while continuing to increase the effectiveness of our operating processes. As previously noted, during the third quarter of 2007, we recorded a reduction of $1.7 million to our income tax expense to reflect the impact of the enactment of the U.K. tax rate change on our net deferred tax liability related to our U.K. operations.
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Table of ContentsConsolidated Sales
Sales results shown in the preceding chart generally represent the annualized premium or annualized fee income on new sales which we expect to receive and report as premium income or fee income during the next 12 months following or beginning in the initial quarter in which the sale is reported, depending on the effective date of the new sale. Sales do not correspond to premium income or fee income reported as revenue in accordance with GAAP. This is because new annualized sales premiums reflect current sales performance and what we expect to recognize as premium or fee income over a 12 month period, while premium income and fee income reported in our financial statements are reported on an “as earned” basis rather than an annualized basis and also include renewals and persistency of in force policies written in prior years as well as current new sales. Premiums for fully insured products are reported as premium income. Fees for ASO products (those where the risk and responsibility for funding claim payments remain with the customer and we only provide services) are included in other income. Sales, persistency of the existing block of business, and the effectiveness of the renewal program are indicators of growth in our premium and fee income. Trends in new sales, as well as existing market share, also indicate our potential for growth in our respective markets and the level of market acceptance of price changes and new product offerings. Sales results may fluctuate significantly due to case size and timing of sales submissions. We intend to continue with our disciplined approach to pricing and also with our strategy of developing a more balanced business mix. This strategy is expected to result in a lower premium persistency or market share, particularly in the large case Unum US group market, but historically the profitability of business that terminates has generally been lower than the profitability of retained business. We do not anticipate a decline in the number of cases, or case persistency, for our Unum US group market on an aggregate basis. See “Segment Results” as follows for additional discussion of sales by segment. Segment Results Our reporting segments are comprised of the following: Unum US, Unum UK, Colonial, Individual Income Protection – Closed Block, Other, and Corporate. In the following segment financial data and discussions of segment results, “operating revenue” excludes net realized investment gains and losses. “Operating income” or “operating loss” excludes net realized investment gains and losses and income tax. These are considered non-GAAP financial measures. A non-GAAP financial measure is a numerical measure of a company’s performance, financial position, or cash flows that excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP.
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Table of ContentsThese non-GAAP financial measures of “operating revenue” and “operating income” or “operating loss” differ from revenue and income (loss) from continuing operations before income tax as presented in our consolidated operating results and in income statements prepared in accordance with GAAP due to the exclusion of before tax realized investment gains and losses. We measure segment performance for purposes of Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, excluding realized investment gains and losses because we believe that this performance measure is a better indicator of the ongoing businesses and the underlying trends in the businesses. Our investment focus is on investment income to support our insurance liabilities as opposed to the generation of realized investment gains and losses, and a long-term focus is necessary to maintain profitability over the life of the business. Realized investment gains and losses depend on market conditions and do not necessarily relate to decisions regarding the underlying business of our segments. However, income or loss excluding realized investment gains and losses does not replace net income or net loss as a measure of overall profitability. We may experience realized investment losses, which will affect future earnings levels since our underlying business is long-term in nature and we need to earn the assumed interest rates in our liabilities. A reconciliation of total operating revenue by segment to total consolidated revenue and total operating income by segment to consolidated net income is as follows:
As previously noted, included in operating income (loss) by segment are before-tax charges of $53.0 million in the first nine months of 2007 and $325.4 million and $411.4 million in the third quarter and the first nine months of 2006, respectively, related to revisions to our regulatory claim reassessment reserve estimates. These charges lowered net income $34.5 million in 2007 and $211.5 million and $267.4 million in 2006 for the applicable periods.
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Table of ContentsUnum US Segment The Unum US segment includes group long-term and short-term income protection insurance, group life and accidental death and dismemberment products, and supplemental and voluntary lines of business. The supplemental and voluntary lines of business are comprised of recently issued individual income protection insurance, group and individual long-term care insurance, and voluntary workplace benefits products. Unum US Operating Results Shown below are financial results for Unum US. In the sections following, financial results and key ratios are also presented for the major lines of business within the segment.
As previously discussed, included in operating income (loss) for Unum US are before-tax charges of $66.2 million in the first nine months of 2007 and $291.4 million and $364.2 million in the third quarter and first nine months of 2006, respectively, related to revisions to our regulatory claim reassessment reserve estimates.
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Table of ContentsUnum US Sales
Sales for Unum US in the third quarter of 2007 were higher than that of the prior year period, but on a year-to-date basis, declined from the level of 2006. We maintained our disciplined pricing and our overall sales mix was generally in line with our target mix. In the third quarter of 2007, we had a sales mix in our group product lines of approximately 69 percent core market and 31 percent large case market. In the first nine months of 2007, we had a sales mix of approximately 57 percent core market and 43 percent large case market, generally in line with our targeted 60 percent core/40 percent large case market distribution mix. Although sales on an annualized premium basis declined year over year in our group core market segment, the number of new accounts in this segment increased over the prior year first nine months. Sales for our individual income protection line of business increased over the prior year third quarter and first nine months. We continue to focus on the multi-life individual income protection business, with approximately 94.0 percent and 93.4 percent of total third quarter and first nine months of 2007 sales for this line of business occurring in the multi-life market. Long-term care sales were generally in line with our strategy for this product line, with growth in the group product and a decline in sales for individual long-term care. Our voluntary workplace benefits sales increased in the third quarter and first nine months of 2007 relative to the same prior year periods, consistent with our focus on sales growth in our voluntary product lines. We anticipate that sales for our group core market segment and our supplemental lines will increase during the remainder of 2007 relative to the prior year. Because our focus for our 2007 renewal program is aimed primarily at improving the profitability of our large case group business, sales and persistency for the large case market segment have declined during 2007, as expected. As previously noted, during the third quarter of 2007, we introduced Simply Unum, a new product offering and administrative platform designed to better meet the needs of our group core market segment and our voluntary market. The full roll out to all sales offices is expected to occur during the first quarter of 2008.
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Table of ContentsUnum US Persistency and Renewal of Existing Business A continuing part of our strategy for Unum US group business involves executing our renewal programs and managing persistency in our existing blocks of business. Our renewal programs have generally been successful in retaining business that is relatively more profitable than business that terminated. While we expect that the additional premium and related profits associated with renewal activity will continue to emerge, we intend to balance the renewal program with the need to maximize persistency and retain broker relationships. As previously discussed, we expected persistency, measured in both premium dollars and in number of cases, for the large case group market segment to decline during 2007 relative to the prior year because of our 2007 strategy for this market. We do not expect premium and case persistency to decline for our core group market segment. As previously discussed, we adopted the provisions of SOP 05-1 effective January 1, 2007, and recorded a cumulative effect adjustment which decreased our 2007 opening balance of Unum US DAC $589.8 million. SOP 05-1 provides guidance on accounting for DAC on internal replacements and effectively shortens the amortization period for DAC for many of our group products. Despite the shorter amortization period, we do not believe that the adoption of SOP 05-1 will have a material effect on amortization expense for Unum US as a result of the decrease in DAC from the cumulative effect adjustment. We will continue to monitor the persistency of the existing business and reflect changes relative to our amortization assumptions, as appropriate, in the current period’s amortization of DAC. In January of 2006, we began a process of filing a request with various state insurance departments for rate adjustments on one older series of individual long-term care policies. The rate adjustment brings the rates for this policy series closer to today’s market, better reflecting current interest rates, higher expected future claims, persistency, experience, and other factors related to pricing individual long-term care coverage. In states for which a rate increase is submitted and approved, customers are also given options for coverage changes or other approaches that might fit their current financial and insurance needs. Higher premium income associated with the rate increases has begun to emerge and is expected to continue to do so during the remainder of 2007.
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Table of ContentsUnum US Group Income Protection Operating Results Shown below are financial results and key performance indicators for Unum US group income protection.
Included in this ratio are the third quarter of 2006 $276.4 million and first quarter of 2006 $72.8 million increases in our claim reassessment reserve estimate. Excluding these revisions, the benefit ratio for the three and nine month periods ended September 30, 2006 would have been 94.5% and 95.0%, respectively.
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Table of ContentsIncluded in this ratio is the third quarter of 2006 $15.0 million increase in our claim reassessment incremental direct operating expense estimate. Excluding this revision, the other expense ratio for the three and nine month periods ended September 30, 2006 would have been 22.6% and 23.1%, respectively.
Included in this ratio are the third quarter of 2006 $291.4 million and first quarter of 2006 $72.8 million increases in our claim reassessment cost estimate. Excluding these revisions, the before-tax operating income ratio for the three and nine month periods ended September 30, 2006 would have been 2.7% and 1.5%, respectively. Premium income for group income protection decreased in the third quarter and first nine months of 2007 relative to the prior year, as expected, due primarily to our more disciplined approach to pricing, renewals, and risk selection. Premium persistency and case persistency are both consistent with our expectations given our business mix strategy. Net investment income increased in the third quarter and first nine months of 2007 in comparison to the same prior year periods due to the growth in the level of assets supporting these lines of business and an increase in bond call premiums, partially offset by the impact of the lower yield resulting from the lower interest rate environment. Other income includes ASO fees of $16.7 million and $48.4 million for the third quarter and first nine months of 2007, respectively, and $14.8 million and $46.0 million for the third quarter and first nine months of 2006. Excluding the revisions to our estimate for claim reassessment costs, the benefit ratios for the third quarter and first nine months of 2007 were lower than the benefit ratios for the comparable periods of 2006 due primarily to lower paid claims in both group long-term and short-term income protection and a higher rate of claim recoveries relative to the third quarter and first nine months of 2006. Our claim operational effectiveness continues to improve as a result of our organizational and process changes. While additional performance improvement is expected to occur during the remainder of 2007, the operational improvement we have projected may occur at a slower rate, and we may incur higher than anticipated claim costs. The net decrease in the amortization of DAC is due primarily to the decrease in the level of DAC for these lines of business resulting from the adoption of the new accounting policy related to DAC on internal replacements, offset somewhat by higher amortization resulting from the shorter amortization period for DAC. The other expense ratio, excluding the adjustments to our claim reassessment incremental operating expense estimate, increased slightly in the third quarter and first nine months of 2007 compared to the same prior year periods due to the decline in premium income. We continue to aggressively manage expenses against this expected revenue decline. As discussed under “Cautionary Statement Regarding Forward-Looking Statements,” certain risks and uncertainties are inherent in our group income protection business. Components of claims experience, including, but not limited to, incidence and recovery rates, may be worse than we expect. Both economic and societal factors can affect claim incidence. Adjustments to reserve amounts may be required if there are changes in assumptions regarding the incidence of claims or the rate of recovery, as well as persistency, mortality, and interest rates used in calculating the reserve amounts.
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Table of ContentsUnum US Group Life and Accidental Death and Dismemberment Operating Results Shown below are financial results and key performance indicators for Unum US group life and accidental death and dismemberment.
As expected, premium income in group life decreased in the third quarter and first nine months of 2007 relative to the same prior year periods due primarily to our more disciplined approach to pricing, renewals, and risk selection. Premium persistency and case persistency are both consistent with our expectations. The decrease in net investment income relative to the prior year third quarter and first nine months resulted primarily from a decline in the level of assets supporting these lines of business. The benefit ratio decreased in the third quarter and first nine months of 2007 due primarily to a lower submitted and paid claim incidence rate for group life, offset partially by higher paid claim incidence rates for the accidental death and dismemberment line of business.
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Table of ContentsSimilar to our group income protection products, amortization of DAC is lower this year relative to last year due to the adoption of SOP 05-1. Other expenses decreased in the third quarter and first nine months of 2007 relative to the same prior year periods, enabling the other expense ratio to remain stable against the expected decline in premium income.
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Table of ContentsUnum US Supplemental and Voluntary Operating Results Shown below are financial results and key performance indicators for Unum US supplemental and voluntary product lines.
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Table of ContentsThe increase in premium income for the third quarter and first nine months of 2007 relative to the prior year third quarter and first nine months is due to sales growth and overall stable persistency, although premium persistency for certain of the product lines declined compared to the prior year. Net investment income increased relative to the prior year third quarter and first nine months primarily from growth in the level of assets supporting these lines of business. The interest adjusted loss ratio for the individual income protection – recently issued business decreased slightly in the third quarter and first nine months of 2007 relative to the same prior year periods due primarily to a decrease in the submitted claim incidence rate as well as an increase in the claim recovery rate. The interest adjusted loss ratio for long-term care was higher in the third quarter and first nine months of 2007 than in the same prior year periods due primarily to an increase in the submitted claim incidence rate and a decrease in the claim recovery and mortality rates. The benefit ratio for voluntary workplace benefits decreased in comparison to the third quarter and first nine months of 2006 due primarily to a lower rate of paid claim incidence. The amortization of deferred acquisition costs increased in the third quarter and first nine months of 2007 relative to the same prior year periods due to the acceleration of amortization for certain of the product lines with lower than anticipated persistency. Other expenses for the third quarter of 2007 and the first nine months of 2007 increased in comparison to the third quarter and first nine months of 2006, driven primarily by growth in the long-term care and voluntary workplace benefits lines of business. The other expense ratio for the supplemental and voluntary lines of business increased slightly in comparison to the third quarter of 2006 but decreased relative to the first nine months of 2006 due to the growth in premium income. Segment Outlook Our primary focus for the remainder of 2007 is continued improvement of our claims management performance in our group income protection line of business, with an expected overall benefit ratio for group income protection in the 90 to 92 percent range by the end of 2007, excluding the second quarter of 2007 impact from the revision to our claim reassessment reserve. We also continue to focus on improved profitability in certain of our supplemental products and the maintenance of current performance levels in our other lines. We intend to continue to invest in technology and new product solutions to meet the changing needs and opportunities in our markets. Our Simply Unum product offering and administrative platform, designed to better meet the needs of our group core market segment and our voluntary market, was introduced in selected sales offices during the third quarter of 2007, and we are pleased with the market reception. Simply Unum is a long-term strategy and will continue to adapt to the needs of our marketplace in multiple phases over the next several years. We continue to shift our mix of business to the group core market and the supplemental and voluntary product lines and to maintain our disciplined approach to pricing, renewals, and risk selection, with a continued effort to balance growth and profitability. This strategy has, as expected, caused a lower premium persistency or market share, particularly in the large case market. As expected, we have not experienced a decline in the number of cases, or case persistency, for our Unum US group core market segment or for the Unum US group market on an aggregate basis.
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Table of ContentsUnum UK Segment Unum UK includes insurance for group long-term income protection, group life, and individual income protection products sold primarily in the United Kingdom through field sales personnel and independent brokers and consultants. Operating Results Shown below are financial results and key performance indicators for the Unum UK segment.
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