普登 (UNM) 2004 Q4 法說會逐字稿

Good day and welcome to the UnumProvident Corporation's Fourth Quarter 2004 Earnings Results Conference Call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Head of Investor Relations, Mr. Tom White. Please go ahead, sir.

Thank you, and good morning everyone. Welcome to your fourth quarter analyst and investor conference call. Before we get started let me read the Safe Harbor statement.

The Safe Harbor is provided for forward-looking statements under the Private Securities Litigation Reform Act of 1995. Statements in this conference call regarding the business of UnumProvident Corporation, which are not historical facts, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. These forward-looking statements are made based upon management's current expectations and beliefs as of the date of this conference call, but there can be no assurance that future developments affecting the company will be those anticipated by management. For a discussion of the risks and uncertainties that could affect actual results, see the sections entitled Cautionary Statement Regarding Forward-Looking Statements and Risk Factors in the company's Form 10-K for the fiscal year ended December 31, 2003 and our subsequently filed Form 10-Qs. The company expressly disclaims any duty to update any forward-looking statements.

Our discussion this morning will include non-GAAP financial measures, therefore a reconciliation to GAAP will be available on our website at www.unumprovident.com.

With that now I'd like to turn the call over to UnumProvident's President and Chief Executive Officer, Tom Watjen.

Thank you, Tom, and good morning. Joining me this morning with Dean Copeland, our general counsel, Bob Greving, our CFO, Kevin McCarthy, our Chief Underwriter, Roger Edgren, our head of sales, Peter Madeja who runs our GENEX operations and has responsibility for your benefits organization, and Joe Foley, our Head of Product Management, as well as a couple of others.

As we know we reported our fourth quarter and full year 2004 earnings yesterday, and I'm generally pleased with the overall results. Our operating trends were generally positive with a strong year over year increase in our GAAP operating earnings as well as strong statutory net income, despite the impact of the previously announced multi-state resolution, which was a pretax charge of $127 million in the quarter. Our US brokerage operation continued to show positive momentum, while our primary subsidiaries UnumLimited, Colonial, and GENEX continued to make strong contributions to the company overall performance. I'm particularly pleased with the performance in three important areas we have discussed on prior conference calls: successful execution of our renewal program, improved investment performance and credit quality, and better operating expense efficiently. I'll cover our results in a couple of these areas in more detail later.

Now, I view the highlights of the quarter as follows.

First as I said earlier, after tax operating income, excluding a number of special items that Tom White will detail in a moment, increased 21 percent to $129.8 million in the fourth quarter with solid contributions from all of our primary lines of business.

Second, our statutory earnings were very strong this quarter. In fact, statutory net income this quarter was $140.1 million and $607.6 million for the full year including, the charge taken for the multi-state, market conduct exams settlement. This strong performance helped us reach a record level of combined statutory capital and surplus, including AVR of $4.5 billion at the end of 2004, compared to $4 billion at the end of 2003. Our preliminary estimate of our weighted average risk based capital ratio for year-end 2004 is 298 percent, the highest level in our company's history and a sharp improvement from the 247 percent at year-end 2003.

Thirdly, our investment results continue to show improvement with net realized investment losses, excluding the impact of DIG-B 36, at relatively low levels compared to prior quarters. Credit quality overall has been improving steadily since 2002 with our high yield bond exposure to 6.4 percent of investment's assets, and our non-current investments declined to 91.5 million from over 250 million earlier this morning.

The fourth point I would like to make is that with submitted incidence trends were generally positive this quarter with both our group and individual income protection lines showing improvement. In the group long-term income protection line, submitted incidents in all case sizes declined, as did incidents in our economically sensitive manufacturing and wholesale retail segments. Claim recovery experience was lower this quarter, not surprising given the attention focused on implementing the claim process enhancements associated with the multi-state settlement.

Fifth, we continue to see favorable trends in the number of quality measures in business, including lower claim litigation and lower complaints, and a strong and improving service levels. These all indicate to me that our people are continuing to maintain relationships and serving customers well and in doing so, we have done a good job of protecting or franchise in the challenging period.

Finally I'm encouraged by the early results we're seeing with our January 1st renewals with persistency in line with our expectations. This along with our disciplined pricing should continue to help us to continue to allow to improve continued profitability.

Now as always, there is there are challenges ahead, and I'd point to three in particular. Our sales are below our long-term expectations in our US brokerage and Colonial operations. While I think the broader industry issues and the focus on renewals and persistency were a distraction, we recognize the importance of profitably growing sales, and this is an area of focus for us in 2005. While we expect to continue to face a competitive market, especially in our US brokerage business, we do not expect that we will begin to -- we do expect that we will begin to see a more favorable sales pattern later in 2005.

This is also obviously a critical period for our benefits organization. We must successfully implement the changes outlined in the multi-state agreement while continuing to maintain service levels and operating effectiveness. This organization is under great pressure to meet these challenges, but I'm confident that our management team is focused on the right issues.

Finally the interest rate environment continues to present a challenge for us, and the industry as well, as new money rates continue at lower than desired levels, which may have an impact on the future discount rates, used for new claim referrals. We made no adjustment to the new claim discount rates this quarter. In fact our margins widened somewhat, due to the downward adjustments we've made in the past and hedging activities in prior periods. However we will monitor this area obviously closely as we move through 2005.

Let me turn the call over to Tom White to review our segment operating results, and then I'll provide more color on our business trends later. Thank you. Tom?

Thank you.

As you can see from reviewing our earnings release, there are several items included in the fourth quarter results that merit separate discussion in order to provide a clearer view of our segment operating performance. Also keep in mind that since the Canadian operation was sold earlier this year, the historical results are reported as discontinued operations and are excluded from 2003 results.

The company reported net income of $134.5 million or $.45 per diluted common share in the fourth quarter of 2004, compared to a loss of $347 million or $1.18 per diluted share in the fourth quarter of 2003. There are five items in the quarter, which I want to discuss briefly.

First, net realized investment gains for the fourth quarter of '04, which totaled $16.8 million on an after tax basis or $.06 per diluted common share, include a gain of $25.5 million after taxes to reflect the increase in the fair value of DIG- B 36 derivatives. Excluding this provision, the after tax net realized investment loss in the quarter was 8.7 million.

Second, the fourth quarter included the loss related to the settlement of the multi-state market conduct examination. Consistent with our announcement of November 18th, the loss reported was $127 million before tax, or $87.8 million after tax, which is $.29 per share. This loss is included in three of our lines of business, 116.7 million in the group income protection line, 1.7 million in the recently issued individual income protection line, and 8.6 million in the closed block individual income protection line.

Third, the fourth quarter of 2004 includes the impact of settlements with the Internal Revenue Service on certain tax issues affecting the company's federal income tax liability related to years 1996 through 1998, and a favorable judgment in refund litigation for tax year 1984. This is recorded as interest income on the refunds of $14 million in the corporate segment. The after-tax benefit is $51.1 million or $.17 per diluted common share, which includes the tax refund and the after-tax benefit from the interest on the refund.

Fourth, during the quarter we reduced our ownership position in our Argentinean operation to 40 percent and reported a before-tax loss of $4.7 million in the other segment. The after tax impact is an after tax gain of $2.7 million or $.01 per diluted common share as the company also recognized a tax benefit of $7.4 million from this transaction.

Fifth, net investment income in the fourth quarter includes $33.7 million before tax, or $21.9 million after tax, which is $.07 per diluted common share related to the periodic retrospective adjustment of the amortization of the purchase discount on the company's mortgage-backed securities. This adjustment is the result of actual prepayments on the mortgage-backed securities being significantly higher than the prepayments assumed when the securities were purchased. The adjustment is reflected in net investment income primarily in the closed block Individual Income Protection segment, which was 13.3 million, the Income Protection segment which was 12.7 million, and in the Life and Accident segment, which was 4.9 million.

To provide some background, our CMOs, all of which are AAA rated, are a sub segment of the mortgage-backed holdings and represent approximately 10 percent of invested assets. We do not invest in interest only or principal only securities and the majority of our CMOs are the long, deep traunches. The CMOs are purchased at a discount to par, and in accordance with FAS 91 we amortized this discount over income-estimated life of the securities.

In a low interest rate environment, when the CMO prepay, they pay off at par which results in accelerated recognition of the discount and a higher yield that provides some protection to us from falling interest rates. In a rising interest rate environment, the duration of the securities extends and provides the match for our long duration liabilities. Interest rate changes and the associated change in mortgage refinancing will necessitate periodic adjustments to the prepayment assumptions. The lower interest rate environment of 2004 required an acceleration of amortization, which is being recognized this quarter. There was no FAS 91 adjustment in 2003 because a significant number of the affected CMOs traunches completely paid off. This occurred as a result of the sharp drop in interest rates. The discount was fully recognized and included in our net investment income when the payoff proceeds were received.

Now I'd like to briefly review the segment operating results.

First, the Income Protection Segment reported an operating loss of $8.9 million in the fourth quarter compared to a loss of 377.9 million in the fourth quarter 2003. This quarter's results include a loss of $118.4 million related to the settlement of the multi-state market conduct examination. Also, net investment income in this segment for the fourth quarter of 2004 included $12.7 million for the periodic adjustment of the purchase discount on mortgage backed securities. The fourth quarter of 2003 loss includes the reserve strengthening of $440 million for the Group Income Protection. Excluding these items, operating income totaled $96.8 million in the fourth quarter, which is a 56 percent increase from the year ago quarter. Included in the Income Protection segment is our Group Income Protection line, which reported operating earnings, this would be excluding the multi-state and the mortgage backed securities, of $59.7 million in the fourth quarter of 2004, compared to 11 million in the fourth quarter of 2003, which excludes the reserve strengthening last year.

A few highlights. First, persistency declined due to our efforts this year to reprice the more poorly performing business with our US Group Income Protection persistency declined to 84.8 percent in 2004 from 87.2 percent for full year 2003. The benefit ratio in the quarter, adjusted for the multi-state settlement charge, was 88.0 percent an improvement from the 92.9 percent in the year ago quarter, again adjusted for the reserves charge then, and as well as the 88.1 percent experienced in the third quarter of 2004. The key factors that impacted the improve benefit ratio in the fourth quarter were the risk metrics in our U.S. group long-term income protection line showed an improvement in submitted claims in the fourth quarter relative to the prior quarter and the year ago quarter. This was offset somewhat by claim recovery experience which was lower than the experience of the third quarter and the year ago quarter. Secondly, our U.K. group long-term income protection business continued its strong performance trend with strong growth in premium income and stable risk management trends.

Finally, the discount rate on new claims remained level with the prior quarter. The interest reserve margin on US Group long-term income protection reserves widened to 69 basis points at the end of the fourth quarter from 66 basis points the prior quarter and is comfortably above our target range of 50 to 60 basis points.

Next I'll review the individual income protection recently issued by the business. In this line we had operating income in the fourth quarter of $22.3 million compared to $31.3 million in the 2003 fourth quarter. This quarter's results include a loss of $1.7 million related to the settlement of the multi-state market conduct examination. Specifically in this line premium income grew by 9.8 percent, sales were down 18 percent in the fourth quarter compared to the year ago, and the multi-life sales mix was approximately 84 percent of the activity in this line. You'll see that the interest adjusted benefit ratio for the line increased in the fourth quarter compared to the year ago quarter, reflecting relatively flat incidents trends and slightly lower claim recovery experience compared to the year ago quarter. Also the interest rate margin is 63 basis points in this line, which is in line with our long-term target range again of 50 to 60 basis points. No adjustment was made to the discount rate on new claim incurrals during the fourth quarter.

Also, within the income protection segment, our long-term care earnings were $11.9 million in the fourth quarter compared to 15.6 million a year ago.

Finally the disability management services line produced income of $4 million in the quarter compared to $4.2 million in the year ago quarter.

Now, I'd like to move to the Life and Accident segment, which included our group life, AD&D, voluntarily, life and other products. This segment reported income of $75.3 million in the fourth quarter compared of '04 to $72.6 million one year ago. Net investment income in the fourth quarter of '04 included $4.9 million for the periodic adjustment of amortization of mortgage-backed securities. Within this segment, group life results were down from year ago levels, reflecting the impact of the update of capitalization of acquisition costs which we implemented in the first quarter of 2004 and a slight increase in the benefit ratio as new claims for group life were lower than a year ago while the average claim size was higher in this quarter. Results in our voluntary and our AD&D line were improved from the year ago results.

Colonial continued to make a solid contribution to overall corporate results with operating income of $40 million in the fourth quarter compared to 37.6 million in the fourth quarter of '03. Sales growth at Colonial continued below or long-range expectations with a decline of 5.9 percent in the fourth quarter and a decline of 2.3 percent for full year 2004. As we have discussed in previous conference calls, we've been making adjustments to the sales organization, primarily around regional sales leadership, people development, and recruiting. We believe there is great potential for stronger more consistent growth in sales and are optimistic about the future of Colonial. Also Colonial's benefit ratio improved to 54.6 percent in the fourth quarter in '04 compared to 58.5 percent in the fourth quarter of 2003, reflecting lower claim incidence and improved performance in the income protection product lines.

Next, the individual income protection closed block segments produced operating income in the fourth quarter of $37.8 million, which is up from 22.2 million in the fourth quarter last year. Included in these results is a loss of $8.6 million related to the settlement of the multi-state market conduct exam and net investment income of $13.3 million from the periodic -- or adjustment of amortization on mortgage-backed securities. New claim incidence remains relatively stable with prior periods while claims resolution experience was lower than prior quarters.

The other segment reported income of $4.3 million in the fourth quarter. This compares to a loss of 2.3 million in the fourth quarter of 2003. Again, the before tax loss of $4.7 million from the restructuring of the company's ownership of the business in Argentina is included in the operating segment. The prior year fourth quarter includes a before tax loss of $13.5 million related to the write down for this operation.

Finally the corporate segment reported a loss of $31.5 million in the fourth quarter compared to a loss of 46.6 million in the year ago quarter. Keep in mind operating income in this quarter included interest income of $14 million related to the settlements with the IRS.

Tom indicated statutory earnings were very strong this quarter. Net income on a statutory basis totaled $140.1 million in the fourth quarter compared to $23.7 million in the year ago quarter. For the full year, statutory net income improved from $22.7 million in 2003 to $607.6 million in 2004. Obviously this improvement significantly helps our statutory capital and surplus position and as Tom indicated our estimate of year-end risk based capital is 298 percent which is an improvement of 51 points over 2003 and is essentially in line with our long-term target of a 300 percent ratio.

You'll notice that our tax rate this quarter is somewhat higher than in the past. This is primarily driven by our U.K. operation, where group relief benefits are served to lower or overall effective tax rate in prior years. The losses in the U.K. on which group release benefits were being recognized in the past with fully used, so together with the strong performance of our U.K. operation in recent years, we expect our tax rate going forward to approximate the statutory rate of 35 percent.

Finally, the weighed average number of shares assuming dilution in the fourth quarter was 302.2 million compared to 294.8 million in last year's fourth quarter and the notes to our statistical supplement provide a description of how to calculate our weighted average shares under various stock price scenarios.

With that review of the quarter let me turn things back to Tom.

Thank you Tom. I'll focus my final comments before we go to the question and answer session to just providing a further update around some of the business trends, an update on the multi-state resolutions and related matters and close as I do on previous calls with a little bit of outlook for 2005.

As we've discussed with you throughout the year, a significant focus of ours in 2004 has been to improve the profitability of our US group income protection business. Our actions have been focused in three areas: implementing targeted rate increases to specific cases and market segments which were not performing or meeting our profit expectations, adjusting our business plan to improve the balance in our sales mix by case size, and increasing the focus on the profitability of the new sales we're making. While not yet satisfied with the profitable of our US group income protection business, overall I'm very pleased with the progress we've made in he these three areas in 2004 and I'm encouraged with our potential for future improvement in the future. Our persistency remains stable in the fourth quarter with U.S. group long-term protection at 84.8 percent for the full year 2004, US Group short-term protection at 80.6 percent and group life at 84 percent.

Regarding the group long-term income protection, persistency I'm encouraged by two things, the persistency in our small and mid-sized business actually improved slightly in 2004 compared to 2003, which means the terminations were more heavily concentrated in the lower margin, large case business, which is a good thing for us, and the profitability of the business that terminated was significantly worse than the block that we have retained.

We took strong rate actions in our 2004 renewal program with average rate increases of 13 percent for our group business overall and actually above that in our group income protection line. For 2005, our renewal program will be smaller in size, but is still an important element in our plan to improve profitability. We have for some time anticipated lower persistency in 2005 with group long-term income protection persistency in the range of 80 to 82 percent while our short term income protection line is expected to remain constant with 2004. We do, however, continue expect group life persistency to drop off from our 2004 level of 84 percent to the mid 70 percent level in 2005, reflecting the significant pricing actions we have taken in our large case group life block.

Now, regarding sales. The environment continues to present some challenges. Our total sales from continuing operations, including Colonial and the U.K. were off 27 percent in the fourth quarter and 19 percent for the full year. Our US brokerage operation experienced a sales decline of 34 percent and 30 percent for the year while Colonial is off 6 percent for the quarter and 2 percent for the year. Clearly these results are unacceptable over the long-term but are to be expected in the short term given the changes we've undergone in our business. At Colonial we've made a number of changes this past year to strengthen sales management teams, and I expect with these changes, Colonial will begin to year over year improvement early in 2005.

While not making excuses, as I mentioned earlier, there are a number of things impacting US brokerage sales results, including our pricing discipline, our focus on renewals, and frankly some of the general broker distraction with some of the events towards the last half of last year. I would expect sales momentum to reemerge in our U.S. brokerage business by the middle of 2005. I'm encouraged by our sales and quote levels in our target markets, especially in supplemental product lines.

Many of you ask about the status of our sales force. Sales rep staffing is generally where it should be to support our projected business volumes and turnover is generally in line with past experience. Our overall sales rep quality is very, very high and we continue to attract very good new people to this organization.

As Tom mentioned in his comments, committed claim trends were encouraging this quarter, and we have begun to see some improvement in the more economically sensitive parts of our business. I'm cautious about drawing longer-term conclusions from this quarter, but incidence levels did benefit our results this quarter, and I'm cautiously optimistic that this will carry over into 2005. The improved incidence levels were offset somewhat by lower claim recoveries this quarter, again not a surprise given the emphasis we placed on implementing many of the claim management enhancements from the multi-state resolution.

As I mentioned earlier, we must both successfully implement the changes while maintaining service levels and operating effectiveness. Obviously a sensitive balance, but one I believe we can successfully accomplish.

I'm also very encouraged with the improving trends we are seeing in claim litigation and complaints. The level of claim related complaints are down 26 percent relative to last year and the number of new lawsuits involving individual and group policies in 2004 declined 31 percent and 24 percent respectively over the past year. This continues a trend we have seen now for several quarters.

Now, there are also some further signs that the investment environment is improving with Fed tightening and improving credit quality. Credit quality, which had a concern a couple of years ago, is much less of an issue today. The improving investment portfolio quality has led to improved statutory net income, which helps to drive the improvement in our RBC ratios.

On the negative side, we are challenged by generally low interest rates and the limited supply of investments that meet our quality, yield, and duration parameters. Our hedging decision in prior periods, and our lower discount rates on new claim incurrals, have helped us to generate wider net interest margins this quarter. This is still not an attractive interest environment, and we will obviously therefore be continuing to watch market conditions. We are committed to maintaining our interest margin of approximate 60 basis points and will lower our discount rate on new claim incurrals if we feel it is not sustainable. Our hedging strategy has positioned us well for this year as we have almost half of our expected 2005 cash flows of $2 billion hedged at rates that exceed our desired margins. As a reminder, the cost of a 25 basis point move in our discount rate on new claim incurrals is approximately $5 million per quarter for the group long-term income protection line, $5 million on the closed box, and $1 million for the recently issued individual income protection block.

Now, let me provide a brief update on a few regulatory matters. As you know we previously announced that the settlement agreement relating to the multi-state market conduct examination on disability claims handling became effective on December 20, 2004, when 48 states and the District of Colombia joined the agreement. This will well above the two-thirds required and we are very pleased all but two states are parties to the settlement agreement. The implementation of this agreement is well underway. Two states, California and Montana, chose not to join the multi-state agreement, but the position we have taken is residents of all states will participate in the claim reassessment process if they are eligible under the terms of the multi-state agreement. We are currently in discussions with the California Department of Insurance seeking to resolve issued raised in its examination, some of which are specific to California. Predicting when we have reach closure on something like this is always difficult, but I believe all parties are working to resolve any outstanding issues as quickly as possible.

On another regulatory topic, we and many others in our industry continue to respond to various is investigations from either state insurance departments or State Attorneys General, relating to broker compensation and bidding practices. As we announced last October, as a matter of policy, our company is highly supportive of full disclosure to the customer of all compensation paid to a broker. Unfortunately, it appears there will not be any uniform, regulatory, or statutory guidance available in the near future on what constitutes appropriate disclosure of fees being paid by the customer. We are developing guidelines for our brokers, who we believe are in the best positive position to provide this information. We will also be responsive to direct requests from customers seeking information about broker compensation. With the relevant information in hand, customers can determine whether and how compensation arrangements affect their buying decision. As we learn more about the issues of interest to regulators, I'm sure we will find things to do differently, and we will continue to make adjustments in our business practices as we go along.

As you know, there have been several lawsuits and regulatory investigations launched on broker compensation and related business practices, and we will provide further updated information in the 10-K annual report to be filed in early March. In addition, we continue to provide status updates in our quarterly filings with the SEC, or earlier if appropriate.

Now, before we go to our questions, I'd like to close with a few comments on our outlook for 2005. I'm optimistic that we will continue to build on the successes of 2004. Our outlook is unchanged as we expect operating earnings for 2005 will continue to be flat or up slightly from the current base of earnings. Companywide sales will likely run slightly behind prior year's results in early 2005 but are expected to improve as we move through the year. Our primary focus will remain on improving our level of profitability, but we also look to restore profitable growth if appropriate. Our renewal program will be smaller in scale in 2005, but we anticipate these actions will continue to lead to improving our margins in our group income protection business. Persistency will be lower for the group long-term income protection and group life business, but we do not foresee the group income protection persistence dropping below 80 percent. In fact, I'm optimistic we can be closer to the higher end of our estimated range of 80 to 82 percent. Given our strong statutory earnings, the improved risk based capital level, and holding company caps position of $270 million, we expect to reduce our leverage somewhat in 2005 by paying of the $227 million of debt coming due this year. Dividend capacity at our insurance -- at the insurance subsidiary level will be very strong this year at over $660 million, and total sources of holding company cash flows will exceed $760 million. The combination of reduced leverage and strong dividend capacity will result in significantly improved coverage ratios in 2005.

In short, I'll proud of the progress we've made over this past year and the efforts of our employees to produce these results. I believe we have turned the corner and are building momentum. We continue to face challenges to restore profitable sales growth, manage through the slow interest environment, and successfully execute our business plan, but there are far fewer challenges today than we had last year at this time. I'm convinced we're moving in the right direction and that as we continue to deliver improved results, we will gradually strengthen the confidence of all of our constituents. This completes our prepared comments, and we'd like to go to the question and answer session.

Thank you, if you would like to ask a question please do so by pressing the star key followed by the digit 1 in our touch-tone telephone. If you're using a speaker phone, make sure your mute is turned off to allow your signal to reach our equipment. We'll go first to David Lewis with SunTrust Robinson Humphrey.

Good morning. Thank you. Can you talk a little bit about the improvement in the claims incidence? Do you think it more of the re-underwriting of the book of the business, or do you think you're starting to see some economic benefits? Secondly, where do you think maybe over the next two to three to four years, you can actually before bring the group benefit ratio down and can you get more normalized range in kind of the 83 to 85 percent as you see the benefits from the pricing and maybe some further economic benefits?

Thank you, David. I'll start first and ask others to fill in for me. But I do think that actually our results reflect probably a little bit of both. It's both the improvement in the economy as we said earlier, but it is also the fact that the renewal programs we put in place are certainly purging the company of business which had very high incidence experience. With that, maybe I'd ask Kevin McCarthy who is our Chief Underwriter just to say a little bit with the renewal actions and frankly what our underwriters are seeing in terms of the business that leaving the company because I do think it's business that that tends to have much higher incidence levels than the rest of the book of business.

Thanks, Tom. Good morning, David. I think two quick points on the incidence. One, I think our movement toward target markets and industries that have typically lower levels of incidence and better consistency around profit margins and persistency and renewal placement probably is beginning to reflect itself in our incidence patterns. And secondly assist we renewed and had experienced some terminations and losers, particularly in our larger cases in the business it tend to be in sort of wholesale or retail or manufacturing, those tend to have higher incidence levels, and as those move you see a dampening effect on our overall incidence, reported incidence levels.

Kevin, did you adjust for the shift in sectors that you focus on? Are you actually seeing improvement, if you kept, you know, the retail overall or manufacturing or anything on that end?

I think, Dave, two things happen. One is, as we shift mix of business away from such a high concentration in large case wholesale, retail, manufacturing, toward smaller and mid-market professional services, education, health care we're going to get that dampening effect just in the reported result. In addition to that, we do see some marginal improvement in the economy. Manufacturing and wholesale both experienced improvements in incidence during the fourth quarter.

Great. Thanks very much.

With respect to to the benefits ratio, Tom White, maybe could you just provide a little perspective on the guidance on the benefit ratio.

David, as you know we haven't provided specific guidance, but I think the general outlook you're talking about is one we're comfortable with, given the things that are going on with Kevin that he referred to. We think we can show nice improvement in that benefit ratio and get it to the kind of levels you're talking about over the next two to three years.

Thank you.

We'll go necessary to Vanessa Wilson with Deutsche Bank.

Thank you, good morning. I have two questions, the first is on capital, the second is on LTD top line growth. On the capital position, you articulated you're going to pay down some debt this year. You're already at a 298 percent RBC ratio year end '04. If you fast forward to year end '05, what kind of excess capital do you think you would have generated during '05 going into '06?

You're right. We're in a somewhat unique position to start even talking about excess capital. As you know, the priority has been very much to build liquidity to build financial flexibility and build the RBC close to 300 percent and fortunately we exceeded our expectations at the end of the year with that. But, Bob Greving, maybe just as it relates as we look forward to 2005 and 2006, maybe just respond to vanessa's question. The other thing I would say -- I should have added to my comments is that we do have a debt maturity coming due as I said this year of 227 million. Our next debt maturity is not actually until 2011. So there's quite a gap which I think even makes this discussion of capital even more germane.

Not mis-speaking about the debt maturities, those are self-funded debt maturities, the mandatory convertibles basically self-fund. Getting back to your question, Vanessa, we have about $270 million of cash. The holding company now will be using about $227 million to pay down that debt. We do have significant dividend capacity, particularly in our a couple of companies that generated risk based capital increases this year. And the rating agencies have given us some guidance that they would like to see us hold at the holding company something in the $150 to $160 million level of cash at the holding company. We will move this year toward doing that, so we will actually be able to pay down the debt and probably have a little bit of that excess capital, like I say held as cash liquidity at the parent company by year-end and still maintain somewhat in excess of the 300 percent risk based capital that is our ultimate target.

I guess if you could refine that a little bit more. You're going to generate 4 to 500 million of statutory earnings this year. That's what you can theoretically dividend up and keep the 298 percent RBC and you're going to pay your common dividends, pay your interest experience? It sounds like you're already covered for the debt maturity. How much is excess, or left, at the end of '05?

I would say by the time we get done with the debt paydown, we'll have $50 million left at the parent company. We need 150 to 170 million just to pay the experiences at the parent company level, and we'll leave some of this -- as you know, we never take full dividend capacity at the insurance companies, so we will be leaving capital at the insurance companies and we will be increasing that risk-based capital in that area. so I think we will generating an excess of probably between $100, $150 million. We'll hold a portion of that at the parent company to increase the cash at the parent company to satisfy the rating agencies, and we'll probably leave the remainder of it at the insurance companies to build capital there.

I think beyond the amount we would keep at the holding company just to satisfy the rating agency requirements, I'd say, Bob, there's probably a couple hundred million dollars of additional capital beyond the 300 percent RBC that's our target. And I think, as you can imagine, that grows more dramatically as you go to '06 and '07.

But as you get to '06 and the first convert? How think about that? You're going to be sitting here with excess capital and then the convert's going to convert. Can you get us to that point?

I think the converts, what she's speaking of in the 575 million, which is the first mandatory convertible I believe will actually convert in 2006, and that will generate excess cash in the organization, which we will have to put into play into the organization and obviously we'll take a look at other uses of that cash other than basically holding them for the two years to pay down the debt. So I think we need to be efficient about how we utilize that, because as you are aware we will be generating excess cash in the organization at that point. I think we have some plans on where that's going, but I think that's all part of our longer term capital plan at this point, and I'm not sure those have been finalized or approved by our Board at this point.

And I think what Bob's alluding to is that we are cautious as we look beyond '05 with respect to capital. We are generating significant excess capital, especially when you take into account the securities you're referring to. I think we want to move through this a little more before we begin to think about how to put that capital to work. I think, Bob, the easiest way to think about it is we simply know we will be overcapitalized for a period as we look to '08 and '07. We haven't made any decisions about what to do in that kind of situation. We have to think about it very carefully and work in concert with a lot of our constituents as we think about an answer. We know it sort of hangs out as a potential drag on growth and a potential drag on return on equity. I think at this point our horizon from a capital point of view is limited to 2005 and early 2006 and we've not made any determination what we would do with that excess capital at this point because it's too new a phenomena for us.

To move on to the top line. If I look at the level of sales you're generating right now, assuming they're flat in '05 so no growth, that would basically top up your premium basis by something like 1o to 12 percent. You've identified a lapse rate something on the order of 18 percent for the LTD business. So we have a difference here of 6 to 8 percent to make up with a combination of rate increases and the natural growth of payroll inflation, et cetera. Should we be prepared to see a 1 to 3 percent premium growth decline in '05, or do you think premiums are going to be flat?

Vanessa, I think you're hitting it the right way. It'll be down a little bit. The way we look at it is we have four pieces in there. We have our U.K. business which will show some nice group, the U.S. LTD will be off slightly and it's obviously the biggest component, but it's probably down a couple of percent. STD in the U.S. is probably down a couple of percent, and when you pull out the Canadian premiums, that's going to add a little bit to the decline. So we're probably looking at maybe a 2 percent decline in overall premiums, a little more in the U.S., it's going to be offset by the growth we're seeing in the U.K. But probably about a 2 percent is the decline in premiums, again this is for the group income protection line for 2005.

How much flexibility do you have on the margin side such as the experience ratio?

We're continuing, as you know, Vanessa to work on expenses. We've brought it down over the last 18 months by about 150 basis points. It continues to be a big priority so that, again, it does put a little pressure on that because you don't see any top line growth, but I think we're committed to being sure we don't see big increases and if anything try to maintain a flat expense ratio in a declining premium environment, that's what we face.

Thanks, so much.

We'll go next to Colin Devine with Smith Barney.

Good morning, gentlemen. I have a couple of questions. First off, if we can focus on the reported figures for the LTD line, could we get backed out of that what is coming from the U.K. and what's coming from the U.S. so we can get some sense of what the growth is in each of those divisions and what percentage each of is accounting for? That's one.

Second with respect to the Zs in the investment portfolio -- which you guys probably have more than anybody I've ever seen, how much are they adding to investment income in the fourth quarter or four 2004, and how do you replace that this year if you're not getting basically bought out of par on the refinance cleanup calls?

Then, lastly on the capital situation, I noticed you were very careful to see you haven't figured out what you will do beyond early 2006. Is really what it comes down to is what it going to take to get the ratings back and how you deploy the capital basically depends on where the rating agencies are at that point?

Tom, you want to pick up on the first question on LTD?

Again, on LTD for this year, the U.K. operation generates about $500 million of the little over $3 billion we have in the group income protection. U.K. is also in group life and also in the individual disability. In total, the U.K. business produces about $650 million in premiums, which is about 8 percent of the total company premiums. No doubt its margins are better. It's been a very nice contributor to, particularly the LTD, but it also shows up in the group life and in the individual income protection. The U.K. GAAP equity is a little over $700 million, so it's a substantial business. As I said, it's one that has performed quite well.

Can we get the earnings numbers please?

We don't split it out the earnings separately there.

I think in the future this will something we need to look at, in terms of whether we adjust the reportings slightly to provide a little more transparency on that business. I think we'll continue to look at that.

All right just maybe to get some clarification, in looking at earnings in '03 versus '04, what's going on in? How much of the change is coming from the U.K., and what's going on in the domestic U.S. business? Is it getting better or worse, because right now I can't tell.

The domestic U.S. business for LTD is up very nicely. 2004 over 2003, there's a significant percentage increase. No question it is not performing at the levels we want it to be.

It's doing better. It's showing quarter-to-quarter improvement throughout 2004, but there's still a lot of leverage in those earnings as we look out over the next three to four years to get it back to the level of profitability that we think it should be. There's no question that the U.K. operation, you know, has done very well and it's helped these numbers, but again, the momentum is building back very nicely in the U.S. business.

Let me reiterate what Tom said. We obviously as you know are very aggressively working the U.S. block to restore that profitability. That's where the renewal actions have been so critical, that's where the pricing actions have been so critical, and those really have been leading to as Tom alluded to some improved results in our U.S. brokerage business. There's no doubt, again, the U.K. has been a very strong contributor, but I would think the trends have been quite good in the progression we've made in U.S. brokerage. It's not where it needs to be. That's why I said earlier, '05 is an important time for us as we deliver renewals and continue to work on pricing, but I'm very encouraged by the progress in the U.S. LTD business.

Colin, at the risk of over-answering the question, if you just look from third quarter to fourth quarter, most of the improvement we had was in the U.S. LTD. The benefit ratio when we get real granular with it in the U.K. operation was off slightly. The STD was off very slightly, so the improvement was driven by what is going on in the U.S. LTD side.

Shifting to the Zs, we have a slightly larger position in the others in the Zs as an asset class and it works very well for the long duration nature of our liabilities. Tom and Bob, I think the question around the contribution to the investment income and the expectations in the future, either one of you want to take that one?

Again, it's about 10 percent of the investor income. The yield on it isn't any higher than the other securities, so it's kind of the normal contribution is coming through. This quarter we did have the FAS 91 adjustments that we booked. It did add $33.7 million, and it spread throughout all of the segments.

As Tom said, it's an asset claim that gives us good quality. We buy the Zs at a discount, so that if we do have a lower interest rate environment, we have the benefit of that discount that we're going to amortize into income, and therefore it helps the yield. It gives up some downside protection if we buy it at a discount, and the benefit we get if rates go up is these will extend. We are always look for duration, we have long duration liabilities. If the duration of these things extends, that's going to fit very nicely for us as well. They're AAA rated, so the risk with them is more when we get our cash in as opposed to if. So to some extent it's a nice balance with the 6 percent or so that we have in high yield, but it's a very liquid market. The structures that we're buying fit very nicely with our liabilities, which I think are -- they're a little unique in the industry. Not every typical life or annuity company would have the same investment strategy as we would because our liabilities are different.

Just to clarify because you do take the prepayment gains into investment income, the component here can swing quite a bit. The amount of investment income you're recognizing off these bonds can be significantly higher in a declining rate environment than it may be in a rising one. Isn't that going to be the case?

Colin, this is Bob. It certainly is enhanced in a declining interest rate environment because you're amortizing that discount over a shorter period of time. If that reverses, obviously, it would be extended out. That's where the adjustment in the fourth quarter actually comes from, is actually recognizing, and under accounting rules we have to recognize it as if that acceleration occurred since we actually purchased the investment. Many of these Zs we've actually owned for a while, and so that's what gives rise to that larger adjustment. You're absolutely right. In a declining interest rate environment, you're accelerating that discount amortization, and in a rising interest rate environment, you're extending it out.

With respect to to capital Colin, you're on the right point, I didn't mean to be so evasive in Vanessa's question around capital. I think the ultimate deployment decision how we manage capital in '06 and '07 as we inventory greater amounts of excess capital, that's something we have to think about and work in close concert with the rating agencies to be sure that whatever we choose to do is consistent with some of their expectations. Again, the good news is we see an environment where we've come close if not met our RBC target. We have the excess liquidity at the holdings company. We have strong statutories and dividend capacity, so we're moving now into an environment of truly excess capital, but cautious as to how we think about deploying until we've had a chance to have those kinds of discussions.

Thank you.

We'll go next to Jason Zucker with Fox-Pitt.

Thank you. Good morning. I had three questions all around to some sensitivity in different areas. The first one, Bob, was I was hoping you could tell us on the group life persistency, is there a certain level that we should think about that might trigger DAC acceleration? Then the second question which is hopefully a follow-up from the last, let me ask this way: What would the interest margin have been in we excluded the one time net investment income and mortgage prepays in this quarter? Then the third question is: Could you tell us what your RBC would be if we excluded some of the large finite deals? I guess just in conjunction of that, is that a relevant question? Is there a possibility that either a something like the [Santa Ria] or the Berkshire deal could unwind?

Let's go with me just first to your sensitivity question, Bob on the group life and the related DAC question.

On the group life, we're anticipating that will drop down to the mid 70s. We don't anticipate it will stay there. One of the things you have to think about is the entire life of a block of business, not just what occurs in one year. We would not anticipate it would drop to mid 70s and stay there. Obviously it's a result of some acute actions that we're taking to restructure that block of business and to get the rate increases in there. We do anticipate a bit higher amortization in 2005 in the $3 to $6 million range. That's built into our plan, that's what we have anticipated in our plan. It's also built into our guidance. That's about where we are anticipating for the 2005 change over 2004 as a result of that change.

Bob is that 3 to 6 million a quarter?

$3 to $6 million in the year.

Jason on your second question on the interest margin, the prepaid debt is less than a basis point, so it would probably round to zero.

Does that include also the net investment income that we would call sort of the one time?

Yes.

Okay.

I think on the RBC, that's about a 14-page calculation, and I haven't run it without the one timers, but just to give you kind of a feel, a basis point of risk-based capital is about $14 million. So as we build capital, you can kind of use that $14 to $15 million depends on what company it's in and there's a lot of different factors in play. In that $14 to $15 million range for a basis point or a 1 percent of risk based capital on a consolidated basis. If you want to back some of those out, I guess you can kind of sort through them and divide it by 15,but I haven't actually done that exercise, Jason.

I don't think we have any finite agreements in place that are of the type that a lot of people have been raising questions about that. The Berkshire traction was associated with the IBI business, it's a very traditional kind of reinsurance agreement. I don't think these are the kind of agreements that are being brought into questions. The Santa Ria agreement affected an older block of individual disability business, again not the kind that are being raised into question. Those, I don't think, Bob, we're done for the purpose of raising substantial capital. Even something remote were to happen, that wouldn't really change some of our outlook in terms of capital adequacy.

They both qualify for risk transfer in statutory accounting, so there's not an issue those were constructed for something other than risk transfer. Neither one of them actually served to smooth or mask or delay any of our earnings on a period by period basis for GAAP purposes. Those are the really the finite reinsurance agreements that are really being targeted, those designed to somehow smooth out or spread out losses on GAAP reporting, and neither of those were those types of arrangements

Great. . Thanks everyone.

I think at we'll take one more question. I'm sensitive to the time that's approaching here. So if we could just limit it to one additional question. We're around the rest of the day for questions out the call.

We'll take our final question from Nigel Dalley from Morgan Stanley.

A question on interest rates. I know your overall interest margin is in pretty good shape, 60 basis points. Can you also let us know what the margin is between new money rates and your discount rates for new claims. Second, if rates don't increase when would you see having to reduce your discount rates for all those new plans? And third, can you also discuss whether you need to take any sort of charge to increase existing reserves if overall interest rates don't move higher during the course of the year.

Tom, do you want to --

Let me try and get those for you Nigel. The margin right now -- the spread between the new money investment and the discount rate is a little better than 50 basis points, so it's a little below where we want to be at 60 basis pounds. Keep in mind at LTD our margin right now is 69 basis points. We have about half of our 2005 cash flows are already hedged, and they are hedged at better the 60 basis point margin. We have benefit there. We would lose slightly on the new money rates, but again, with 50 percent of it hedged already, we really don't see an issue falling below the 60 basis point level and therefore having to increase the discount rate on new claim incurrals. It's something we have to watch closely. If interest rates stay at this level or decline, we have to take a look at it. But the way we have things hedged and the way cash flows look and the way we have the discount rate right now, we don't see an issue with that.

Let me clarify one thing I said on Jason's answer. The interest margin impact on the prepaid is less than one basis points and not percentage point. I mis-spoke, but less than one basis point.

Nigel, the last part of your question is the way we run the business, Tom, if we were to adjust the discount rate it doesn't necessitate a charge. It's actually dealing with new claim incurrals. So because we built such a strong margin to begin with, we're obviously keeping the discipline of maintaining that margin. If we saw rates coming down and we thought they were down on a sustainable basis you could make the discount rate adjustment on new incurrals, which as I said earlier, 25 basis point drop on the discount rate on new incurrals does put some earnings pressure on a couple lines of business, but it's not something that necessitates a charge.

I think what Nigel's really getting at is the matching -- or the cash flow management we have on our's sets versus our liabilities and on those existing claims they're very well matched up, so we do not anticipate, even in the extension of the current interest rate environment that would result in interest rate charge on our existing rates portfolio.

Thanks great, thank you.

Thank you all for taking the time to participate in this morning's call. We're all around for any follow-up questions and that will complete our call this morning.

Thank you. That does conclude today's conference, and you may disconnect at this time.