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Unum Group 10-Q 2011 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One)
For the quarterly period ended March 31, 2011
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x 307,798,184 shares of the registrant’s common stock were outstanding as of April 28, 2011.
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. Certain information contained in this Quarterly Report on Form 10-Q (including certain statements in the consolidated financial statements and related notes and Management’s Discussion and Analysis), 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. We undertake no obligation to update these statements, even if made available on our website or otherwise. 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, a practice 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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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, 2010. 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.
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CONSOLIDATED BALANCE SHEETS Unum Group and Subsidiaries
See notes to consolidated financial statements. 3
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 INCOME (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 (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 March 31, 2011 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 GAAP 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, 2010. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of full year performance. In connection with our preparation of the consolidated financial statements, we evaluated events that occurred subsequent to March 31, 2011 for recognition or disclosure in our financial statements and notes to our financial statements. Note 2 - Accounting Developments Accounting Updates Adopted during the First Three Months of 2010: Accounting Standards Codification (ASC) 810 “Consolidation” In June 2009, the Financial Accounting Standards Board (FASB) issued an update to require a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity and require enhanced disclosures about an enterprise’s involvement with a variable interest entity. We adopted this update effective January 1, 2010. The adoption of this update had no effect on our financial position or results of operations. ASC 820 “Fair Value Measurements and Disclosures” In January 2010, the FASB issued an update to require a number of additional disclosures regarding fair value measurements. Specifically, the update requires a reporting entity to disclose the amounts of significant transfers between Level 1 and Level 2 of the three tier fair value hierarchy and the reasons for these transfers, as well as the reasons for any transfers in or out of Level 3, effective for annual and interim periods beginning after December 15, 2009. The update also requires information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances, and settlements on a gross basis, effective for annual and interim periods beginning after December 15, 2010. We adopted this update in its entirety, including early adoption of the additional Level 3 information, effective January 1, 2010. The adoption of this update expanded our disclosures but had no 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 March 31, 2011
Note 2 - Accounting Developments - Continued
ASC 860 “Transfers and Servicing” In June 2009, the FASB issued an update to eliminate the exceptions for qualifying special-purpose entities from the consolidation guidance and eliminate the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, this update clarifies certain requirements for financial assets that are eligible for sale accounting and requires enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. We adopted this update effective January 1, 2010. The adoption of this update had no effect on our financial position or results of operations. Accounting Updates Outstanding: ASC 310 “Receivables” In January and April 2011, the FASB deferred the effective date of disclosures about troubled debt restructurings and issued updates providing additional clarification to help creditors in determining whether a creditor has granted a concession as well as whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. These updates will be effective for interim and annual reporting periods beginning on or after June 15, 2011. The adoption of these updates may require additional disclosures but will have no effect on our financial position or results of operations. ASC 944 “Financial Services - Insurance” In October 2010, the FASB issued an update which is intended to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify as deferred acquisition costs. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, and permit retrospective application. The guidance in this update will result in a decrease in the opening balance of our retained earnings if we choose retrospective application on adoption and will result in a decrease in the level of costs we defer subsequent to adoption. Given that application guidance is still evolving, we have not yet finalized the expected impact 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 March 31, 2011
Note 3 - Fair Values of Financial Instruments Presented as follows are the carrying amounts and fair values of financial instruments. The carrying values of financial instruments such as short-term investments, cash and bank deposits, accounts and premiums receivable, and accrued investment income approximate fair value due to the short-term nature of the instruments. As such, these financial instruments are not included in the following chart.
The methods and assumptions used to estimate fair values of financial instruments are discussed as follows.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
Fair Value Measurements for Financial Instruments Not Carried at Fair Value Mortgage Loans: Fair values are estimated using discounted cash flow analyses and interest rates currently being offered for similar loans to borrowers with similar credit ratings and maturities. Loans with similar characteristics are aggregated for purposes of the calculations. Policy Loans: Fair values for policy loans, net of reinsurance ceded, are estimated using discounted cash flow analyses and interest rates currently being offered to policyholders with similar policies. The carrying amounts of ceded policy loans of $2,771.1 million and $2,790.5 million as of March 31, 2011 and December 31, 2010, respectively, are reported on a gross basis in our consolidated balance sheets and approximate fair value. Miscellaneous Long-term Investments: Carrying amounts approximate fair value. Policyholders’ Funds: Policyholders’ funds are comprised primarily of deferred annuity products and supplementary contracts without life contingencies. The carrying amounts approximate fair value. Fair values for insurance contracts other than investment contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in our overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts. Short-term and Long-term Debt: Fair values are obtained from independent pricing services or discounted cash flow analyses based on current incremental borrowing rates for similar types of borrowing arrangements. Unfunded Commitments to Investment Partnerships: Unfunded equity commitments represent legally binding amounts that we have committed to certain investment partnerships, subject to the partnerships meeting specified conditions. When these conditions are met, we are obligated to invest these amounts in the partnerships. Carrying amounts approximate fair value. Fair Value Measurements for Financial Instruments Carried at Fair Value We report fixed maturity securities, derivative financial instruments, and equity securities at fair value in our consolidated balance sheets. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices in active markets generally have more pricing observability and less judgment utilized in measuring fair value. An active market for a financial instrument is a market in which transactions for an asset or a similar asset occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and should be used to measure fair value whenever available. Conversely, financial instruments rarely traded or not quoted have less observability and are measured at fair value using valuation techniques that require more judgment. Pricing observability is generally impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction, and overall market conditions. Valuation techniques used for assets and liabilities accounted for at fair value are generally categorized into three types. The market approach uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities. The income approach converts future amounts, such as cash flows or earnings, to
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
a single present amount, or a discounted amount. The cost approach is based upon the amount that currently would be required to replace the service capacity of an asset, or the current replacement cost. We use valuation techniques that are appropriate in the circumstances and for which sufficient data are available that can be obtained without undue cost and effort. In some cases, a single valuation technique will be appropriate (for example, when valuing an asset or liability using quoted prices in an active market for identical assets or liabilities). In other cases, multiple valuation techniques will be appropriate. If we use multiple valuation techniques to measure fair value, we evaluate and weigh the results, as appropriate, considering the reasonableness of the range indicated by those results. A fair value measurement is the point within that range that is most representative of fair value in the circumstances. The selection of the valuation method(s) to apply considers the definition of an exit price and depends on the nature of the asset or liability being valued. For assets and liabilities accounted for at fair value, we generally use valuation techniques consistent with the market approach, and to a lesser extent, the income approach. We believe the market approach valuation technique provides more observable data than the income approach, considering the type of investments we hold. Our fair value measurements could differ significantly based on the valuation technique and available inputs. When markets are less active, brokers may rely more on models with inputs based on the information available only to the broker. In weighing a broker quote as an input to fair value, we place less reliance on quotes that do not reflect the result of market transactions. We also consider the nature of the quote, particularly whether the quote is a binding offer. If prices in an inactive market do not reflect current prices for the same or similar assets, adjustments may be necessary to arrive at fair value. When relevant market data is unavailable, which may be the case during periods of market uncertainty, the income approach can, in suitable circumstances, provide a more appropriate fair value. During 2011, we have applied valuation techniques on a consistent basis to similar assets and liabilities and consistent with those techniques used at year end 2010. We use observable and unobservable inputs in measuring the fair value of our financial instruments. Inputs that may be used include the following:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
We review all prices obtained to ensure they are consistent with a variety of observable market inputs and to verify the validity of a security’s price. The overall valuation process for determining fair values may include adjustments to valuations obtained from our pricing sources when they do not represent a valid exit price. These adjustments may be made when, in our judgment and considering our knowledge of the financial conditions and industry in which the issuer operates, certain features of the financial instrument require that an adjustment be made to the value originally obtained from our pricing sources. These features may include the complexity of the financial instrument, the market in which the financial instrument is traded, counterparty credit risk, credit structure, concentration, or liquidity. Additionally, an adjustment to the price derived from a model typically reflects our judgment of the inputs that other participants in the market for the financial instrument being measured at fair value would consider in pricing that same financial instrument. The parameters and inputs used to validate a price on a security may be adjusted for assumptions about risk and current market conditions on a quarter to quarter basis, as certain features may be more significant drivers of valuation at the time of pricing. Changes to inputs in valuations are not changes to valuation methodologies; rather, the inputs are modified to reflect direct or indirect impacts on asset classes from changes in market conditions. Fair values for derivatives other than embedded derivatives in modified coinsurance arrangements are based on market quotes or pricing models and represent the net amount of cash we would have paid or received if the contracts had been settled or closed as of the last day of the period. We analyze credit default swap spreads relative to the average credit spread embedded within the London Interbank Offered Rate (LIBOR) setting syndicate in determining the effect of credit risk on our derivatives’ fair values. If counterparty credit risk for a derivative asset is determined to be material and is not adequately reflected in the LIBOR-based fair value obtained from our pricing sources, we adjust the valuations obtained from our pricing sources. In regard to our own credit risk component, we adjust the valuation of derivative liabilities wherein the counterparty is exposed to our credit risk when the LIBOR-based valuation of our derivatives obtained from pricing sources does not effectively include an adequate credit component for our own credit risk. Fair values for our embedded derivative in a modified coinsurance arrangement are estimated using internal pricing models and represent the hypothetical value of the duration mismatch of assets and liabilities, interest rate risk, and third party credit risk embedded in the modified coinsurance arrangement. Certain of our investments do not have readily determinable market prices and/or observable inputs or may at times be affected by the lack of market liquidity. For these securities, we use internally prepared valuations combining matrix pricing with vendor purchased software programs, including valuations based on estimates of future profitability, to estimate the fair value. Additionally, we may obtain prices from independent third-party brokers to aid in establishing valuations for certain of these securities. Key assumptions used by us to determine fair value for these securities include risk free interest rates, risk premiums, performance of underlying collateral (if any), and other factors involving significant assumptions which may or may not reflect those of an active market. At March 31, 2011, approximately 18.3 percent of our fixed maturity securities were valued using active trades from TRACE pricing or broker market maker prices for which there was current market activity in that specific security (comparable to receiving one binding quote). The prices obtained were not adjusted, and the assets were classified as Level 1, the highest category of the three-level fair value hierarchy classification wherein inputs are unadjusted and represent quoted prices in active markets for identical assets or liabilities.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
The remaining 81.7 percent of our fixed maturity securities were valued based on non-binding quotes or other observable or unobservable inputs, as discussed below.
We consider transactions in inactive or disorderly markets to be less representative of fair value. We use all available observable inputs when measuring fair value, but when significant other unobservable inputs and adjustments are necessary, we classify these assets or liabilities as Level 3.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
The categorization of fair value measurements by input level is as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
Transfers of assets between Level 1 and Level 2 are as follows:
Transfers between Level 1 and Level 2 occurred due to the change in availability of either a TRACE or broker market maker price. Depending on current market conditions, the availability of these Level 1 prices can vary from period to period. For fair value measurements of financial instruments that were transferred either into or out of Level 1 or 2, we reflect the transfers using the fair value at the beginning of the period.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
Changes in assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) are as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 3 - Fair Values of Financial Instruments - Continued
Realized and unrealized investment gains and losses presented in the preceding tables represent gains and losses only for the time during which the applicable financial instruments were classified as Level 3. The transfers between levels resulted primarily from a change in observability of three inputs used to determine fair values of the securities transferred: (1) transactional data for new issuance and secondary trades, (2) broker/dealer quotes and pricing, primarily related to changes in the level of activity in the market and whether the market was considered orderly, and (3) comparable bond metrics from which to perform an analysis. For fair value measurements of financial instruments that were transferred either into or out of Level 3, we reflect the transfers using the fair value at the beginning of the period. Gains for the three months ended March 31, 2011 and 2010 which are included in earnings and are attributable to the change in unrealized gains or losses relating to assets or liabilities valued using significant unobservable inputs and still held at March 31 were $14.1 million and $18.3 million, respectively. These amounts relate entirely to the changes in fair value of an embedded derivative in a modified coinsurance arrangement which are reported as realized investment gains and losses. Note 4 - Investments Fixed Maturity Securities At March 31, 2011 and December 31, 2010, all fixed maturity securities were classified as available-for-sale. The amortized cost and fair values of securities by security type are shown as follows.
There were no other-than-temporary impairments recognized in accumulated other comprehensive income as of March 31, 2011.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
The following charts indicate the length of time our fixed maturity securities had been in a gross unrealized loss position.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
The following is a distribution of the maturity dates for fixed maturity securities. The maturity dates have not been adjusted for possible calls or prepayments.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
At March 31, 2011, the fair value of investment-grade fixed maturity securities was $37,440.6 million, with a gross unrealized gain of $3,398.7 million and a gross unrealized loss of $176.9 million. The gross unrealized loss on investment-grade fixed maturity securities was 81.1 percent of the total gross unrealized loss on fixed maturity securities. Unrealized losses on investment-grade fixed maturity securities principally relate to changes in interest rates or changes in market or sector credit spreads which occurred subsequent to the acquisition of the securities. At March 31, 2011, the fair value of below-investment-grade fixed maturity securities was $2,874.5 million, with a gross unrealized gain of $165.4 million and a gross unrealized loss of $41.2 million. The gross unrealized loss on below-investment-grade fixed maturity securities was 18.9 percent of the total gross unrealized loss on fixed maturity securities. Generally, below-investment-grade fixed maturity securities are more likely to develop credit concerns than investment-grade securities. At March 31, 2011, the unrealized losses in our below-investment-grade fixed maturity securities were generally due to credit spreads in certain industries or sectors and, to a lesser extent, credit concerns related to specific securities. For each specific security in an unrealized loss position, we believe that there are positive factors which mitigate credit concerns and that the securities for which we have not recorded an other-than-temporary impairment will recover in value. As of March 31, 2011, we held 227 individual investment-grade fixed maturity securities and 39 individual below-investment-grade fixed maturity securities that were in an unrealized loss position, of which 51 investment-grade fixed maturity securities and 28 below-investment-grade fixed maturity securities had been in an unrealized loss position continuously for over one year. In determining when a decline in fair value below amortized cost of a fixed maturity security is other than temporary, we evaluate the following factors:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
We evaluate available information, including the factors noted above, both positive and negative, in reaching our conclusions. In particular, we also consider the strength of the issuer’s balance sheet, its debt obligations and near term funding requirements, cash flow and liquidity, the profitability of its core businesses, the availability of marketable assets which could be sold to increase liquidity, its industry fundamentals and regulatory environment, and its access to capital markets. Although all available and applicable factors are considered in our analysis, our expectation of recovering the entire amortized cost basis of the security, whether we intend to sell the security, whether it is more likely than not we will be required to sell the security before recovery of its amortized cost, and whether the security is current on principal and interest payments are the most critical factors in determining whether impairments are other than temporary. The significance of the decline in value and the length of time during which there has been a significant decline are also important factors, but we generally do not record an impairment loss based solely on these two factors, since often other more relevant factors will impact our evaluation of a security. While determining other-than-temporary impairments is a judgmental area, we utilize a formal, well-defined, and disciplined process to monitor and evaluate our fixed income investment portfolio, supported by issuer specific research and documentation as of the end of each period. The process results in a thorough evaluation of problem investments and the recording of losses on a timely basis for investments determined to have an other-than-temporary impairment. If we determine that the decline in value of an investment is other than temporary, the investment is written down to fair value, and an impairment loss is recognized in the current period, either in earnings or in both earnings and other comprehensive income, as applicable. For those fixed maturity securities with an unrealized loss for which we have not recognized an other-than-temporary impairment, we believe we will recover the entire amortized cost, we do not intend to sell the security, and we do not believe it is more likely than not we will be required to sell the security before recovery of its amortized cost. There have been no defaults in the repayment obligations of any securities for which we have not recorded an other-than-temporary impairment. Other-than-temporary impairment losses on fixed maturity securities which we intend to sell or more likely than not will be required to sell before recovery in value are recognized in earnings and equal the entire difference between the security’s amortized cost basis and its fair value. For securities which we do not intend to sell and it is not more likely than not that we will be required to sell before recovery in value, other-than-temporary impairment losses recognized in earnings generally represent the difference between the amortized cost of the security and the present value of our best estimate of cash flows expected to be collected, discounted using the effective interest rate implicit in the security at the date of acquisition. The determination of cash flows is inherently subjective, and methodologies may vary depending on the circumstances specific to the security. The timing and amount of our cash flow estimates are developed using historical and forecast financial information from the issuer, including its current and projected liquidity position. We also consider industry analyst reports and forecasts, sector credit
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
ratings, future business prospects and earnings trends, issuer refinancing capabilities, actual and/or potential asset sales by the issuer, and other data relevant to the collectibility of the contractual cash flows of the security. We take into account the probability of default, expected recoveries, third party guarantees, quality of collateral, and where our debt security ranks in terms of subordination. We may use the estimated fair value of collateral as a proxy for the present value of cash flows if we believe the security is dependent on the liquidation of collateral for recovery of our investment. For fixed maturity securities for which we have recognized an other-than-temporary impairment loss through earnings, if through subsequent evaluation there is a significant increase in expected cash flows, the difference between the new amortized cost basis and the cash flows expected to be collected is accreted as net investment income. The following table presents the before-tax credit-related portion of other-than-temporary impairments on fixed maturity securities still held as of the dates shown for which a portion of the other-than-temporary impairment was recognized in other comprehensive income.
At March 31, 2011, we had non-binding commitments of $129.5 million to fund certain private placement fixed maturity securities. Variable Interest Entities We invest in variable interests issued by variable interest entities. These investments include tax credit partnerships, private equity partnerships, and special purpose entities. For those variable interests that are not consolidated in our financial statements, we are not the primary beneficiary because we have neither the power to direct the activities that are most significant to economic performance nor the responsibility to absorb a majority of the expected losses. The determination of whether we are the primary beneficiary is performed at the time of our initial investment and at the date of each subsequent reporting period. As of March 31, 2011, the carrying amount of our variable interest entity investments that are not consolidated under the provisions of GAAP was $385.4 million, comprised of $287.6 million of tax credit partnerships and $97.8 million of private equity partnerships. These variable interest entity investments are reported as other long-term investments in our consolidated balance sheets.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
Additionally, we recognize a liability for all legally binding unfunded commitments to these partnerships, with a corresponding recognition of an invested asset. Our liability for legally binding unfunded commitments to the tax credit partnerships was $168.1 million at March 31, 2011. Contractually, we are a limited partner in these investments, and our maximum exposure to loss is limited to the carrying value of our investment. We also had non-binding commitments of $65.8 million to fund certain of the private equity partnerships at March 31, 2011. We are the sole beneficiary of a special purpose entity which is consolidated under the provisions of GAAP. This entity is a securitized asset trust containing a highly rated bond for principal protection, nonredeemable preferred stock, and several partnership equity investments. We contributed the bond and partnership investments into the trust at the time it was established. The trust supports our investment objectives and allows us to maintain our investment in the partnerships while at the same time protecting the principal of the investment. There are no restrictions on the assets held in this trust, and the trust is free to dispose of the assets at any time. Because the assets in the trust are not liquid investments, we periodically provide funding to the underlying partnerships in the trust upon satisfaction of contractual notice from the partnerships. The fair values of the bond, nonredeemable preferred stock, and partnerships were $109.1 million, $0.1 million, and $11.9 million, respectively, as of March 31, 2011. The bonds are reported as fixed maturity securities, and the nonredeemable preferred stock and partnerships are reported as other long-term investments in our consolidated balance sheets. At March 31, 2011, we had non-binding commitments to fund approximately $1.9 million to the underlying partnerships. The amount of funding provided to the partnerships during the three months ended March 31, 2011 and 2010 was de minimis. Mortgage Loans Our mortgage loan portfolio is well diversified by both geographic region and property type to reduce risk of concentration. All of our mortgage loans are collateralized by commercial real estate. When issuing a new loan, our general policy is not to exceed a loan-to-value ratio, or the ratio of the loan balance to the estimated fair value of the underlying collateral, of 75 percent. We update the loan-to-value ratios at least every three years for each loan, and properties undergo a general inspection at least every two years. Our general policy for newly issued loans is to have a debt service coverage ratio greater than 1.25 times on a normalized 25 year amortization period. We update our debt service coverage ratios annually.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
Mortgage loans by property type and geographic region are as follows:
We evaluate each of our mortgage loans individually for impairment and assign an internal credit quality rating based on a comprehensive rating system used to evaluate the credit risk of the loan. The factors we use to derive our internal credit ratings may include the following:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
Although all available and applicable factors are considered in our analysis, loan-to-value and debt service coverage ratios are the most critical factors in determining whether we will initially issue the loan and also in assigning values and determining impairment. We assign an overall rating to each loan using an internal rating scale of Aa (highest quality) to B (lowest quality). We review and adjust, as needed, our internal credit quality ratings on an annual basis. This review process is performed more frequently for mortgage loans deemed to have a higher risk of delinquency. Mortgage loans, sorted by the applicable credit quality indicators, are as follows:
Based on an analysis of the above risk factors, as well as other current information, if we determine that it is probable we will be unable to collect all amounts due under the contractual terms of the mortgage loan, we establish an allowance for credit loss. If we expect to foreclose on the property, the amount of the allowance typically equals the excess carrying value of the mortgage loan over the fair value of the underlying collateral. If we expect to retain the mortgage loan until payoff, the allowance equals the excess carrying value of the mortgage loan over the expected future cash flows of the loan. The projection of future cash flows or a determination that the borrower can make the contractual payments is inherently subjective, and methodologies may vary depending on the circumstances specific to the loan. Additions and reductions to our allowance for credit losses on mortgage loans are reported as a component of net realized investment gains and losses. There have been no changes to our accounting policies or methodology from the prior period regarding estimating the allowance for credit losses on our mortgage loans.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
The activity in the allowance for credit losses is as follows:
Impaired mortgage loans are as follows:
During the three months ended March 31, 2011, $0.3 million of interest income was recognized on mortgage loans subsequent to impairment. During the three months ended March 31, 2011, we foreclosed on a previously impaired mortgage loan with a book value of $9.8 million and transferred it into other long-term investments in our consolidated balance sheets. No realized loss was recognized on the foreclosure. As of March 31, 2011 and December 31, 2010, none of our commercial mortgage loans were past due regarding principal and interest payments and none were on nonaccrual status. At March 31, 2011, we had no commitments to fund mortgage loans.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 4 - Investments - Continued
Transfers of Financial Assets To manage our cash position more efficiently, we enter into repurchase agreements with unaffiliated financial institutions. We generally use repurchase agreements as a means to finance the purchase of invested assets or for short-term general business purposes until projected cash flows become available from our operations or existing investments. Our repurchase agreements are typically outstanding for less than 30 days. We post collateral through our repurchase agreement transactions whereby the counterparty commits to purchase securities with the agreement to resell them to us at a later, specified date. The fair value of collateral posted is generally 102 percent of the cash received. Our investment policy also permits us to lend fixed maturity securities to unaffiliated financial institutions in short-term securities lending transactions. These transactions increase our investment income with minimal risk. Our securities lending policy requires that a minimum of 102 percent of the fair value of the securities loaned be maintained as collateral. Generally, cash is received as collateral under these agreements. In the event that securities are received as collateral, we are not permitted to sell or re-post them. We account for all of our securities lending transactions and repurchase agreements as collateralized financings. We had no securities lending transactions or repurchase agreements outstanding at March 31, 2011. Realized Investment Gain and Loss Realized investment gains and losses reported in our consolidated statements of income are as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 5 - Derivative Financial Instruments Purpose of Derivatives We are exposed to certain risks relating to our ongoing business operations. The primary risks managed by using derivative instruments are interest rate risk, risk related to matching duration for our assets and liabilities, and foreign currency risk. Historically, we have utilized current and forward interest rate swaps and options on forward interest rate swaps, current and forward currency swaps, forward treasury locks, currency forward contracts, and forward contracts on specific fixed income securities. Hedging transactions are primarily associated with our individual and group long-term care and individual and group disability products. All other product portfolios are periodically reviewed to determine if hedging strategies would be appropriate for risk management purposes. Our cash flow hedging programs are as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 5 - Derivative Financial Instruments - Continued
Our fair value hedging programs are as follows:
Derivative Risks The basic types of risks associated with derivatives are market risk (that the value of the derivative will be adversely impacted by changes in the market, primarily the change in interest and exchange rates) and credit risk (that the counterparty will not perform according to the terms of the contract). The market risk of the derivatives should generally offset the market risk associated with the hedged financial instrument or liability. To help limit the credit exposure of the derivatives, we enter into master netting agreements with our counterparties whereby contracts in a gain position can be offset against contracts in a loss position. We also typically enter into bilateral, cross-collateralization agreements with our counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a loss position to submit acceptable collateral with the other counterparty in the event the net loss position meets or exceeds an agreed upon amount. Our current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position less collateral held, was $2.5 million at March 31, 2011. We held no cash collateral from our counterparties as of March 31, 2011. We held cash collateral of $39.1 million from our counterparties as of December 31, 2010. This unrestricted cash collateral is included in short-term investments and the associated obligation to return the collateral to our counterparties is included in other liabilities in our consolidated balance sheets. We post either fixed maturity securities or cash as collateral to our counterparties. The carrying value of fixed maturity securities posted as collateral to our counterparties was $164.8 million and $158.8 million at March 31, 2011 and December 31, 2010, respectively. No cash was posted as collateral to our counterparties as of March 31, 2011 and December 31, 2010. The majority of our derivative instruments contain provisions that require us to maintain specified issuer credit ratings and financial strength ratings. Should our ratings fall below these specified levels, we would be in violation of the provisions, and our derivatives counterparties could terminate our contracts and request immediate payment. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a liability position was $206.8 million and $199.6 million at March 31, 2011 and December 31, 2010, respectively.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 5 - Derivative Financial Instruments - Continued
Hedging Activity The table below summarizes by notional amounts the activity for each category of derivatives.
The following table summarizes the timing of anticipated settlements of interest rate swaps outstanding under our cash flow hedging programs at March 31, 2011, whereby we receive a fixed rate and pay a variable rate. The weighted average variable interest rates assume current market conditions.
Cash Flow Hedges As of March 31, 2011 and December 31, 2010, we had $485.0 million and $540.0 million, respectively, notional amount of forward starting interest rate swaps to hedge the anticipated purchase of fixed maturity securities. As of March, 31 2011 and December 31, 2010, we had $606.9 million and $617.9 million, respectively, notional amount of open current and forward foreign currency swaps to hedge fixed income foreign dollar-denominated securities. During the first three months ended March 31, 2011, we entered into $19.9 million notional amount of forward treasury locks used to minimize interest rate risk associated with the anticipated disposal of certain fixed maturity securities. The treasury locks were terminated at the time the securities were called and/or sold, and we recognized a gain of $0.1 million on the termination of these hedges during the three months ended March 31, 2011. The gain was recognized in other comprehensive income and amortized into net investment income. For the three months ended March 31, 2011 and 2010, there was no material ineffectiveness related to our cash flow hedges, and no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 5 - Derivative Financial Instruments - Continued
As of March 31, 2011, we expect to amortize approximately $31.1 million of net deferred gains on derivative instruments during the next twelve months. This amount will be reclassified from accumulated other comprehensive income into earnings and reported on the same income statement line item as the hedged item. The income statement line items that will be affected by this amortization are net investment income and interest and debt expense. The estimated amortization includes the impact of certain derivative contracts that have not yet been terminated as of March 31, 2011. Fluctuations in fair values of these derivatives between March 31, 2011 and the date of termination will vary our projected amortization. Amounts that will be reclassified from accumulated other comprehensive income into earnings to offset the earnings impact of foreign currency translation of hedged items are not estimable. As of March 31, 2011, we are hedging the variability of future cash flows associated with forecasted transactions through the year 2038. Fair Value Hedges As of March 31, 2011 and December 31, 2010, we had $174.0 million notional amount of receive variable, pay fixed interest rate swaps to hedge the changes in fair value of certain fixed rate securities held. These swaps effectively convert the associated fixed rate securities into floating rate securities, which are used to fund our floating rate long-term debt. Changes in the fair value of the derivative and changes in the fair value of the hedged item attributable to the risk being hedged are recognized in current earnings as a component of net realized investment gain or loss during the period of change in fair value. For the three months ended March 31, 2011 and 2010, the change in fair value of the hedged fixed maturity securities attributable to the hedged benchmark interest rate resulted in a loss of $2.6 million and $2.3 million, respectively, with offsetting gains on the related interest rate swaps. As of March 31, 2011 and December 31, 2010, we had a $350.0 million notional amount receive fixed, pay variable interest rate swap to hedge the changes in the fair value of certain fixed rate long-term debt. This swap effectively converts the associated fixed rate long-term debt into floating rate debt and provides for a better matching of interest rates with our short-term investments, which have frequent interest rate resets similar to a floating rate security. For the three months ended March 31, 2011, the change in fair value of the hedged fixed debt attributable to the hedged benchmark interest rate resulted in a gain of $2.1 million, with an offsetting loss on the related interest rate swaps.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 5 - Derivative Financial Instruments - Continued
For the three months ended March 31, 2011 and 2010, there was no material ineffectiveness related to our fair value hedges, and no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness. There were no instances wherein we discontinued fair value hedge accounting due to a hedged firm commitment no longer qualifying as a fair value hedge. Derivatives Not Designated as Hedging Instruments We have an embedded derivative in a modified coinsurance arrangement for which we include in our realized investment gains and losses a calculation intended to estimate the value of the option of our reinsurance counterparty to cancel the reinsurance contract with us. However, neither party can unilaterally terminate the reinsurance agreement except in extreme circumstances resulting from regulatory supervision, delinquency proceedings, or other direct regulatory action. Cash settlements or collateral related to this embedded derivative are not required at any time during the reinsurance contract or at termination of the reinsurance contract. There are no credit-related counterparty triggers, and any accumulated embedded derivative gain or loss reduces to zero over time as the reinsured business winds down. Locations and Amounts of Derivative Financial Instruments The following tables summarize the location and fair values of derivative financial instruments, as reported in our consolidated balance sheets.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 5 - Derivative Financial Instruments - Continued
The following tables summarize the location of and gains and losses on derivative financial instruments designated as cash flow hedging instruments, as reported in our consolidated statements of income and consolidated statements of comprehensive income.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 5 - Derivative Financial Instruments - Continued
The following table summarizes the location of and gain on our embedded derivative in a modified coinsurance arrangement, as reported in our consolidated statements of income.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 6 - Segment Information Our reporting segments are comprised of the following: Unum US, Unum UK, Colonial Life, Individual Disability - Closed Block, and Corporate and Other. Premium income by major line of business within each of our segments is presented as follows. Certain prior year amounts within Unum UK have been reclassified to conform to current year presentation.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 6 - 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 March 31, 2011
Note 6 - Segment Information - Continued
A reconciliation of total operating revenue and operating income by segment to revenue and net income as reported in our consolidated statements of income follows:
Assets by segment are as follows:
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 7 - Pensions and Other Postretirement Benefits The components of net periodic benefit cost related to the Company sponsored defined benefit pension and other postretirement benefit plans (OPEB) for our employees are as follows:
We have no regulatory contribution requirements for our U.S. qualified defined benefit plan in 2011. For our U.K. operation, which maintains a separate defined benefit plan, we made required contributions totaling $1.3 million, or approximately £0.8 million, during the three months ended March 31, 2011.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 8 - Stockholders’ Equity and Earnings Per Common Share Net income per common share is determined as follows:
We use the treasury stock method to account for the effect of outstanding stock options, nonvested stock awards, and performance restricted stock units 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 common stock during the period exceeds the exercise price of the stock options, the grant price of the nonvested stock awards, and/or the threshold stock price of performance restricted stock units. The outstanding stock options have exercise prices ranging from $11.37 to $32.08, the nonvested stock awards have grant prices ranging from $10.59 to $26.29, and the performance restricted stock units have a threshold stock price of $26.00. 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 not included in the computation of dilutive earnings per share because their impact would be antidilutive, based on current market prices, approximated 1.9 million and 3.7 million shares of common stock for the three month periods ended March 31, 2011 and 2010, respectively. In May 2010, our board of directors authorized the repurchase of up to $500.0 million of Unum Group’s common stock. During 2010, we repurchased 16.4 million shares, at a cost of $356.0 million, including commissions of $0.3 million, under this share repurchase program. On February 2, 2011, our board of directors authorized the repurchase of up to $1.0 billion of Unum Group’s common stock, in addition to the amount remaining to be repurchased under the $500.0 authorization. The $1.0 billion share repurchase program has an expiration date of August 2012.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued Unum Group and Subsidiaries March 31, 2011
Note 8 - Stockholders’ Equity and Earnings Per Common Share - Continued
On February 4, 2011, we repurchased 7.1 million shares, at a cost of $200.0 million, using an accelerated repurchase agreement with a financial counterparty. As part of this transaction, we simultaneously entered into a forward contract indexed to the price of Unum Group common stock, which subjected the transaction to a future price adjustment. Under the terms of the repurchase agreement, we were to receive, or be required to pay, a price adjustment based on the volume weighted average price of Unum Group common stock during the term of the agreement, less a discount. Any price adjustment payable to us was to be settled in shares of Unum Group common stock. Any price adjustment we would have been required to pay would have been settled in either cash or common stock. The final price adjustment settlement occurred on March 18, 2011 resulting in the delivery to us of 0.6 million additional shares. In total, we repurchased 7.7 million shares pursuant to the accelerated repurchase agreement, which completed the $500.0 million repurchase authorization and initiated the $1.0 billion repurchase program. In addition to these repurchases, we repurchased an additional 0.9 million shares on the open market at a cost of $23.6 million, for a total repurchase of 8.6 million shares at a cost of $223.6 million during the three months ended March 31, 2011. The dollar value of shares remaining under the $1.0 billion repurchase program at March 31, 2011 is $920.7 million. Pursuant to these repurchase programs, we retired 7.7 million shares during the first three months of 2011. All other repurchased shares have been classified as treasury stock and accounted for using the cost method. 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. Note 9 - Commitments and Contingent Liabilities | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||