普登 (UNM) 2005 Q4 法說會逐字稿

Good day and welcome to the UnumProvident Corporation fourth quarter 2005 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 the Head of Investor Relations, Mr. Tom White. Please go ahead, sir.

Thank you, Jennifer. And good morning, everyone. And welcome to our fourth quarter analyst and investor conference call. Before we get started let me read the Safe Harbor statement. A 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 belief 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, 2004, and our subsequently filed 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, reconciliations to the corresponding GAAP measures will be available on our website at www.unumprovident.com under the "Investors and Shareholders" section. Representing the Company on this morning's call will be Tom Watjen, President and Chief Executive Officer; Joe Zubretsky, Senior Executive Vice President of Finance, Investments and Corporate Development; and Bob Greving, our Chief Financial Officer. We also have representatives from our U.S. Brokerage, Colonial and Unum Limited operation on the call for the question-and-answer session. And now I would like to turn the call over to Tom Watjen.

Thank you, Tom, and good morning. As you know yesterday we reported fourth quarter net income of $0.43 per diluted common share. Although, these results are slightly below our expectations and the consensus earnings estimate of $0.45 per share, there were many positive developments in the quarter in all of our businesses; U.S. Brokerage, Colonial, and the U.K. Those positive results were unfortunately offset by lower-than-expected results in our U.S. Brokerage Group Income Protection line of business, and I will share a few comments in each of these trends and themes. First, aside from the profitability of our Group Income Protection business we had a generally strong performance in all of the U.S. Brokerage segment lines in the quarter and throughout the year. The strong earnings in our Group Life recently issued individual income protection, and supplemental and voluntary lines were consistent with our expectations. In addition, we saw improvement in the earnings from our Individual Income Closed Block segment.

I continue to also be encouraged by our sales trends. While total corporate sales were down 5.6 for the fourth quarter of 2005, we are seeing growth in most of the areas we have targeted for growth. Our U.S. Brokerage core market group sales or sales to employers with less than 2,000 employees increased by 30% in the group long-term income protection line, 47% in the group short-term income protection line and 18% in the group life line of business. For full year 2005, these core market results showed a combined increase of 12%. Sales to the large employer markets are lower than last year as we continue to maintain strong pricing discipline in this marketplace. We have made good progress toward our goal of a more balanced mix of business between core market and large case sales which has positive implications for our future profitability. Growth in our voluntary worksite benefits line slowed to 4% in the fourth quarter, but increased 14% for the full year and has a solid activity pipeline entering into 2006. We have also continued to see positive results from our renewal and persistency management programs in 2005. Rate increases in our group long-term income protection line averaged over 9% for the year and persistency for this line ended the year at 84.8%. Stable with 2004 and well-ahead of our expectations, this demonstrates to me that our customer loyalty remains strong and our franchise is intact. Group life persistency of 78.3% was lower than the 84% posted in 2004, primarily driven by the aggressive large case repricing actions which adversely impacted first quarter persistency. Persistency for this product line continued to improve though during the year. Looking ahead to 2006 we expect stable to slightly higher persistency in our primary lines of business within U.S. Brokerage reflecting a less aggressive renewal actions needed on our enforced block of business.

The second thing I would point to is our subsidiary performance continues to remain very strong. Unum Limited had another solid quarter and a record year in 2005 with pretax operating income of $180 million, an increase of 20% over 2004. Our U.K. management team has done an excellent job over the past few years of strengthening our position in this market and this business is becoming a much more significant contributor to the Company's overall results. Looking ahead, the rate of growth -- the rate of topline growth will certainly slow as the acquisition-related growth of the past few years subsides, but I fully expect them to continue to produce strong margins and returns on equity. Colonial also reported another solid quarter when results were adjusted for charges related to certain litigation costs. For the full year operating income increased 8%, its best performance in several years. I'm also encouraged by the sales trends this quarter. The 5.3% increase in sales was the highest growth rate in the past two years. Perhaps even more important is that the Company generated a 10% sales growth in the small business marketplace, an attractive market and one targeted for growth by Colonial's management. While the primary focus has been on restoring sales momentum the risk management and expense trends in this business continue to be very, very favorable.

And thirdly, we continue to generate very strong capital and cash flow in 2005 and closed the year in our strongest position in many years. Our statutory net gain from operations of $650 million for the year will drive a strong level of dividend capacity and holding company cash flow for 2006. We closed the year with an RBC ratio of 308%, well above our planned expectations and with the completion of the U.K. repatriation transaction we are well-positioned to further deleverage our balance sheet in 2006. Now, as I mentioned earlier, though, these positive trends were more than offset by lower-than-expected results in our U.S. group -- U.S. Brokerage Group Income Protection line of business. Improved submitted claims incidents, higher premium for life and strong performance in our group short-term income protection line were not enough to offset the lower-than-expected claim performance.

I'm obviously very disappointed that we lost some of the recent momentum that had resulted in an improving benefit ratio. I spent a great deal of time this past quarter in the benefits area of our Company to better understand the issues impacting our results. We have made a number of organizational and process changes, which I am confident will improve our long-term performance. Through these changes we have effectively reorganized this area under two proven leaders who many of you know, Kevin McCarthy and Bob Best. Kevin has assumed the role of Executive Vice President of Risk Operations, which will now include the Benefit Center Operations in addition to his prior underwriting and product development responsibilities. Bob has assumed the role of Executive Vice President of Service Operations and has added the service elements of the claims operations to its current responsibilities of customer service and information technology. Kevin and Bob have proven their ability to manage large complex organizations and I am confident in their ability to lead this important part of our business in this period of change. While it will take time for these changes to impact results, we are maintaining the long-term targets of before tax margins of approximately 9.5% and a benefit ratio in the 87 to 88% range for this line of business, which we provided you at the October Analyst Meeting.

As I close my opening comments, I believe we had a -- we've made great progress this past year in many areas of the Company and entered 2006 with a much stronger operating and financial platform. The one exception is our U.S. Brokerage Group Income Protection results, but I remain -- I again believe through the steps that we've taken over the past several weeks we will gradually -- we will see gradually improving results in this area. Now, let me turn the call over to Tom White to review our segment operating results and then Joseph Zubretsky will provide more detail on certain business trends before I make some closing comments. Tom?

Thanks, Tom. The Company reported net income of $137.5 million, which is $0.43 per diluted common share in the fourth quarter of 2005. This is compared to 134.5 million or $0.45 per diluted common share in the fourth quarter of 2004. Included in these results are net realized aftertax investment gains of $1.5 million in the fourth quarter of 2005, compared to net realized aftertax investment gains of 16.8 million or $0.06 per diluted share in the fourth quarter of 2004.

Before I quickly review our segment results, I want to cover three items in the quarter separately in order to put our operating results into better perspective for you. First, we recorded an expense of $9.1 million before tax or $5.9 million aftertax, which is $0.02 per common diluted share to recognize a termination fee to exit an existing contract with an information technology provider. We have entered into an agreement with a new provider which is expected to result in a significantly less costly infrastructure. This expense is reflected primarily in the U.S. Brokerage and Colonial segments. Second, we recorded charges related to litigation costs in the Colonial segment totaling $6.8 million before tax or $4.4 million aftertax, which is $0.01 per common diluted share. And third, we recorded two tax benefits in the quarter, first a tax benefit related to the U.K. repatriation of $3.3 million or $0.01 per diluted common share, and second, a tax benefit for U.K. group tax relief of $5.5 million or $0.02 per diluted common share. Adjusting for these items, and there are others which we will highlight in the segment discussion, particularly in the corporate segment, this produces an operating view of the fourth quarter of $207.4 million of before tax income, $137.5 million of aftertax income, which is still $0.43 per diluted common share.

Now I'll briefly review the segment results which reflect the new reporting format we adopted last quarter. Of these comparisons -- the comparisons I will make to the fourth quarter of 2004 for each segment and line of business will exclude the impact of the charges related to the multi-state market conduct examination settlement, which totaled $127 million before tax and the FAS 91 adjustment, which increased net investment income by $33.7 million before tax. So first the U.S. Brokerage segment reported operating income of $103.9 million in the fourth quarter, compared to 116.5 million in the fourth quarter of 2004. Within this segment, the Group Income Protection line of business reported operating income of $13.6 million, compared to $18.2 million in the fourth quarter 2004. Tom described the underlying positive trends which were countered by the lower-than-expected claim recovery performance, which negatively impacted the quarterly results, and Joe will cover these results in more detail momentarily. The U.S. Brokerage Group Life and AD&D line reported a decline in operating income to $43.5 million in the fourth quarter of '05, compared to 57.7 million in the 2004 fourth quarter. The year-over-year decline in earnings primarily reflects the lower premium levels as risk trends were consistent. Overall, we were pleased with the level of profitability of this line and will continue to manage towards preserving the profit margin in what we feel is a highly competitive marketplace. Also within the U.S. Brokerage segment are the supplemental and voluntary lines of business, which reported fourth quarter 2005 operating income of $46.8 million, compared to 40.6 million the fourth quarter 2004. The improved earnings are driven by premium growth of 6.6% in the quarter and a slight improvement in the benefit ratio which primarily reflects positive claim experience in the Individual Income Protection recently issued line of business.

Moving to the Unum Limited segment, the Unum Limited segment reported a very strong quarter with income of $49.3 million, compared to 46.7 million in the year-ago quarter. The increased operating income reflects strong premium growth of 12%, a slight improvement in the benefit ratio reflecting favorable claims experience and a lower expense ratio. Sales in this segment declined by 35% in the quarter, compared to a year-ago due primarily to higher sales during 2004 that resulted from the exit of a major insurer in the U.K. market. Group Life sales were also negatively impacted due to the competitive environment in the U.K. and Unum Limited's decision to maintain pricing discipline. Colonial had another solid quarter with operating income of $38.7 million in the fourth quarter, compared to 38.3 in the fourth quarter of 2004. The 2005 results include $6.8 million in benefit and expense charges related to litigation costs. Adjusting for these charges the benefit ratio was 54.9% in the fourth quarter of 2005, compared to 54.6% in the year-ago quarter and the expense ratio is 18.6%, compared to 19.2%. Sales increased 5.3% in the fourth quarter, which reflects strong growth in our core markets despite the effects on the fourth quarter sales from hurricanes in the Gulf Coast and Florida. We continue to be encouraged by the leading indicators of sales activity with new rep contracts of 5.1% on a year-to-date basis. Our tier-one producers, and these are producers that are achieving certain stated sales goals, were up 12.7% on a year-to-date basis. And our district managers, and these are the people who are responsible for recruiting and developing agents at the local level is up 15.3% on a year-over-year basis.

The Individual Income Protection-Closed Block segment reported operating income of 33.7 million in the fourth quarter of 2005, this compares to operating income of $33.1 million in the year-ago quarter. And the interest adjusted benefit ratio was flat with the year-ago quarter at 89%. The "Other" segment, which includes the results of the Disability Management Services along with the former "other" segment lines of business reported income of $8.9 million in the fourth quarter 2005, compared to 7.3 million in the year-ago quarter. Remember, that the year-ago results included before tax loss of $4.7 million resulting from the Company's reduction of our ownership position in the Argentinean subsidiary. Finally, the Corporate segment reported a loss of $43 million in the fourth quarter, compared to a loss of $31.6 million in the year-ago quarter. This quarter's results include a 6.1 million -- include $6.1 million of expenses and additional interest costs related to the U.K. repatriation and the write-off of an investment management fee receivable. And, again, the year-ago results include income of $14 million before tax which is attributable to the interest portion of settlements with the Internal Revenue Service which entitled the Company to a refund of tax plus interest. And now I will turn the call over to Joe Zubretsky for some additional detail on the results this quarter.

Thank you, Tom. I want to focus my comments on four topics this morning. First, the impact of the claims management performance in the fourth quarter, what's driving the underperformance, and what we were doing to improve performance in 2006. Second, a summary of investment performance and management of our discount rates and interest reserve margins in this low interest rate environment. Third, an update on the claim reassessment process through year-end and lastly an update on our capital initiatives.

Our reported benefit ratio for the Group Income Protection line for the fourth quarter of 2005 was 93.9% which compares to 92.4% in the third quarter of 2005, adjusted for the charge related to the settlement of the California market conduct exam. This 150 basis point increase in the benefit ratio was largely driven by lower recovery rates and our group long-term income protection line, which negated the positive impact of lower submitted claims incidents, the positive effects of our pricing and renewal efforts and very strong results in the group short-term income protection line of business due to pricing improvements over the last several quarters. While it is disappointing that the benefit center performance deteriorated in the quarter after continually improving throughout most of 2005, what is important is our long-term outlook, which is that our long-term performance goals will be achieved consistent with our pricing targets. We continue to see inconsistency in our recovery performance as recent additional changes to our claims management process and organization lengthened our decision making cycles.

Specific to this quarter we can trace some of the performance to the lack of productivity that can occur as employees anticipate organizational changes. Since these management changes were announced internally, we have evidence that our claims professionals have responded well, embraced the new organizational structure and are being managed back to optimum performance. As we outlined in our October investor meeting, our business plan for returning to our long range performance levels centers on improving inventory management, better aligning our resources with recovery opportunity areas throughout the benefit center, and minimizing the process content while emphasizing decision making with our disability benefits specialists. We continue to see the positive trend in some of the other key metrics in the claims management organization which drive financial performance. The trends and appeal rates, new claim litigation rates, and complaint rates improved in the fourth quarter relative to the year-ago quarter and suggests we are living up to our promises to our customers.

Second, I will comment on our interest reserve margins. Despite this continued low interest rate environment and flat yield curve all of the reserve interest margins and our primary business lines remained above our target range of 60 basis points at year-end 2005. The overall portfolio yield of 6.85% declined by only 1 basis point in the quarter as a significant amount of our cash flows had been previously hedged and is testimony to our interest rate risk management processes. With the hedges we have in place for 2006, which cover 50% of our expected cash flow, and our expectations for normal levels of interest rate volatility, we do not foresee any changes to our discount rate on new claim incurals for 2006. We have a dynamic process in place to manage interest rate risk and continue to be comfortable with our current position.

Third, I would like to provide an update on the claim reassessment process through year end. The number of notices mailed is 249,000 with an opt in rate of 27.9% on these mailings. For those individuals who have opted in we are now mailing claim reassessment information forms. Approximately 35,000 reassessment forms have been mailed. Of these mailed reassessment forms, 21% have been completed and returned to us for review. This rate of completion will likely increase over time as individuals have a 60-day time period in which to complete the forms and return them for review, and for many this time period has not expired. The claim reassessment unit is now at full capacity and has started to resolve and pay claims as appropriate. The results of the next few quarters will give us a much better view of the financial outcome relative to our initial expectations. But at this point we believe that the total reserves for our reassessment processes are adequate.

Finally, we made great progress in building financial flexibility this year. We were able to obtain a risk-based capital ratio of 308%. We reduced debt by $227 million prior to the repatriation. We reduced our inner company loan balance to zero. We recaptured the center reagreement and we absorbed the cost of the California settlement, as well as the earnings impact of the benefit center underperformance. In the fourth quarter, we also completed our U.K. repatriation initiative. This involved a successful November offering of $400 million of 10-year notes by our U.K. operations at the attractive rate of 6.85%, fully guaranteed by the parent which helped to fund the repatriation of approximately $455 million of dividends under the Homeland Investment Act of 2004. I am very pleased with the execution of this initiative and the credit markets validation of our financial strength, which has enabled us to utilize the strong cash flows from our U.K. operations to service corporate debt on a tax sufficient basis. Keep in mind that the cash from the repatriated dividend is currently being held at the holding company and you will, therefore, see a higher cash position and leverage calculation on our year-end balance sheet. This impact is expected to be only temporary as we anticipate that approximately $400 million will be used to participate in the remarketing of the debt component of our ASIS Securities in February and we will then return to a normalized leverage ratio.

As we outlined at our "Investor Day" presentation, we see a very strong capital management story emerging in 2006, 2007 and beyond. Our plans are to continue to deleverage our balance sheet in 2006 by retiring an additional $300 million of outstanding debt in order to bring our debt-to-total capital ratio to 25% at the end of 2006. Additionally, we estimate that by the end of 2007, we will accumulate over $1 billion of holding company liquidity which we believe will give us great opportunities to engage in both credit and shareholder friendly initiatives. We also are actively engaged in a variety of other initiatives to better allocate capital based on economic drivers. These initiatives are in the early planning stages and we will provide a more specific update to you at the end of the first quarter. Now, I would like to turn the call back to Tom Watjen who will make some brief closing comments before we go to Q&A. Tom?

Thank you, Joe. As I mentioned earlier, we continue to be confident in the two to three year financial objectives that we discussed at our October investor meeting. These include double-digit pretax earnings growth over the next three years primarily driven by improved margins in the Group Income Protection line. stable performance in our other major lines, and ROE expansion from this year's level of 8.9% to a range of 10 to 12% over the next three years. In October, we also mentioned that claims performance was the largest risk factor in improving Group Income Protection margins. That certainly played itself out in the fourth quarter and while we are not changing our long-term guidance in light of our fourth quarter performance, we are now -- we now believe that the speed of recovery in this line of business has been slowed. We are, therefore, more comfortable with earnings estimates for 2006 being in the range of $1.75 to $1.80 per share.

Looking back on the quarter and full year results I'm generally pleased though. The back-to-basics approach we have taken has served us well. The obvious focus is on building on the momentum established in many areas of the Company and working to improve the claims performance in our Group Income Protection line of business. We closed the year with most businesses and product lines meeting our objectives with a strong financial position and improved financial flexibility, with a generally lower risk business plan, and growing confidence that the momentum we are building can be carried into 2006. Operator, this completes our prepared comments. We will now go to the question-and-answer session.

Thank you. [OPERATOR INSTRUCTIONS]. We will go first to Vanessa Wilson, Deutsche Bank.

Thank you. Good morning.

Good morning.

Tom Watjen, could you talk a little bit about the management changes in the claims operations and just to think back over what has been going on with this Company for actually a number of years. There has been management change after management change in these operations and it's been kind of a constant cycle of change. What is there to give us confidence that now that -- we all know Kevin McCarthy and Bob Best very well, but now this strategy will be put in place and left in place for a long enough period of time that we can actually let it work?

Vanessa, it's a great question and appreciate it. It's a good lead in to what I think some follow-on questions. I guess I would start with if you think back to the last three years we've worked very hard. We had a long list of probably a dozen or 15 items that, frankly, we as a company had to work our way through. And I think over that last two or three years I hope we've sort of proven that when we put our resources behind fixing something and addressing something that we have a successful track record in doing so. So, again, I guess I'd start there with just a little bit of context because the things that we've done either strategically, financially or operationally we've set out to do, we have done, this obviously is an area of disappointment.

And let me give you a little bit of the background. Really I think it was in the fall that I was -- as I sort of, as a CEO, looked at performance, looked at some of the goals we set for our Company, was frankly, concerned that this area of the Company, which as you know has gone through a substantial amount of change. We still hadn't developed the consistency that, frankly, we need to have in this part of the business, and that's consistency by location, that's consistency by month-to-month or quarter-to-quarter. And, frankly, concerned too that maybe the plans weren't necessarily in place to improve that consistency. So in the fall I actually personally got much more engaged in this part of the business. Actually, had all the claims operations reporting directly to me, that obviously was not a permanent solution, but it was a way for me to get very quickly an assessment of what the issues were that, frankly, were affecting our ability to achieve the objectives I just talked about. So it came very quickly by just immersing myself in the business. And I think what came out of it, obviously, is the plan that I talked about earlier. And when you think about the plan, there was a piece of this which related to sort of breaking that business really into two pieces. The part of it that has a substantial judgment piece, which is obviously the part we talked about with respect to LTD, and the part of it which has less judgment, which is more of a service business. And as I said, we actually put those -- broke the business into two pieces. We put it under two executives who have a lot of experience in managing those two different aspects of our business. So I guess I would start there.

The second piece, obviously, is what are we going to do specifically in the part that's more judgmental, which is the parts that is affecting the LTD results, and that we talked, obviously, extensively about that. And the thrust of the plan really is around, again, trying to improve the consistency of performance across all parts of the business. Being sure that we have gotten more resources in place to support those parts of our business. So I think the plan we put in place is really, frankly, a different one than we had in the past. It has got, actually greater resources being applied. More management resources being applied. Bringing all of our people closer to the business where our managers can work more directly with our claims paying professionals to help them with the tough judgments and improve their confidence in making a timely decision.

The other thing that we have done that I think has been a pattern of our success is in other parts of the Company is, we also drafted some other executives from other parts of our business, in addition to Kevin and his head underwriter who has now took over the claims operation, Jack McGarry. We drafted some other executives to come over to that part of the business. These are all people who have proven track records of managing complex situations. Working very effectively and moving through swiftly to a good business plan that, frankly, will produce the kind of consistent results that I've talked about.

And the other part of it is we've eliminated distractions. Again, we've purified these roles so that there is limited opportunities for people to be distracted on other things. So I could go on, but I think those are the sorts of things, Vanessa, that went through my mind. It came out of get -- as I said, getting very close to the business in the fall to see what was behind some of the things that I guess I saw where I was concerned that we weren't really making as quick a progress perhaps as we should and moving towards consistent performance. As I said, we know that this organization had to go through a lot of change, but we had to move more quick at a consistent performance. And I'm confident that the changes we made people-wise, organizational-wise and others are going to be successful.

So, Tom, I guess the real issue for the shareholders at this point is there is some concern here maybe that your recovery rates have been permanently changed by this settlement. That somehow the process is so much more complex that it adds, I don't know another 30 days to every decision. How can we get some comfort that there isn't a permanent change in recovery rates here or that your forecast and assumptions about the business have incorporated that already?

Again, I very much appreciate that. That's an important question. I actually think that there is -- that we really haven't changed materially the profile, the recovery pattern in the business. My issue was more with execution. And, again, I felt that the plan we put in place wasn't as crisp to deal with execution and to implement change and wasn't as rigorous as it should have been. So at this point I really don't believe that there has been a material shift in the recovery pattern in the business as a result of some of the things we've entered into. But, again, what we have to do is put, I think, the right team and the right organization in place to be sure that we're driving that change and we're committed to making those changes quickly to be sure that that, in fact, is not the case. But there is no evidence of that right now. And what I might just ask, too, is that even though he has only been in the role formally for a couple weeks, he has certainly been helping me for much longer on this, maybe ask Kevin McCarthy just to offer his insights and perspectives on that as well.

Thanks, Tom. Good morning, Vanessa.

Hi, Kevin.

Let me try to reiterate a couple of things and then drive down from there. The first thing I would say here is that as Tom said, everything that we've set out to do over the last several years we've then gone and executed, and a lot of that has to do with Tom taking at first, the personal involvement and that’s the same approach here. He took a personal involvement, identified what he thought we needed to do, and then we moved on it.

As Tom said, we are implementing smaller business operating units. Let me harken back to three years ago when we had a series of issues in the underwriting organization. We had inconsistent performance with regard to pricing. What we did is we brought additional management in from different disciplines to address the issue. We aligned the organization around smaller operating units. We built across organizational quality assurance program with measurements of quality and then focused on continually improving processes and practices and monitoring. And in the process of doing that we built bench strength in our management leadership in the underwriting organization. And I think we've had very consistent and continuously improving underwriting results over that two or three-year time period.

We are applying that same discipline now to the claims organization. We are going to smaller business units bringing experienced management closer to the floor; trying to through that experience management on the floor; give greater confidence level to the decision makings -- decisions being made on the floor by claims professionals. Bringing additional management in to help instill discipline as we apply those processes. Making sure that our claims people are closer to the customer in the sense that we think it's easier to focus on making the right decision in claim management and service if there is a stronger relationship between the claim professional, and the employer and employee. And we are building an enhanced quality assurance program to focus on processes and practices, improve training where we need to, change processes where we need to, and to understand and control the causes of volatility and inconsistency in the organization. And I think as we look at that, if you look back over the last several years we have had basically reasonably good claim management performance except for in quarters where we didn't exercise enough discipline around the way in which we were implementing change. And so the whole focus here is on implementing change as close to the floor as possible.

Thank you.

Thanks, Vanessa.

Our next question comes from Bob Glasspiegel, Langen McAlenney.

Good morning.

Good morning, Bob.

I was wondering if we could focus on where we are in the sort of re-underwriting process in the group protection line? And, in particular, have we gone through the cleansing of the large case, small/medium case mix shift where we can start to see some sales growth in '06 in total? Is there anything in this sort of claims backward step that makes you have to adjust pricing on the margin? So where are we and what is your sales outlook for group protection in '06?

That's a good question, Bob, and I guess I would start with the fact that as you are rightly doing, we sort of separated that business into two businesses. One is our core market sales, which as I mentioned in my comments we actually had a very, very strong year last year. And actually we're pretty pleased with the fact that we've gotten our business rebalanced. As you know historically we -- there is a period of time in history where we got ourselves, I think, much more heavily weighted toward large case business and away from the small marketplace. The small marketplace is very profitable, has good persistency and good consistency trends. And we really put a lot of effort to refocus our energies there and as I mentioned in the sales statistics that has proven out to be very successful and we feel very good about that.

We want to continue though to be careful in the large case marketplace. We want to grow it. I would say more of the issue with the large cases isn't so much what our in-force block of business looks like. And I will ask Kevin for -- in a minute just to talk about where we are with the repricing of the in-force block. The issue is the competitive dynamics. We simply aren't going to give ourselves back in the position where we just go out and buy large business. And there still is some challenging competitive dynamics out there where some of our competitors are actually pricing business at less than claim cost. And so that's where we want to stay very disciplined and not be drawn back into that marketplace just for the sales. But, again, we are very, very encouraged with the developments we've seen in the core market side of the business. But as it relates to the in-force block, Kevin, maybe just an update on where we are with repricing the in-force large case block.

Thanks, Tom. Good morning, Bob. We have been through now three years of fairly extensive renewal programs and we've consistently managed out the underperforming part of that business, and for the most part we’re through that. There will always be a part of our business that doesn't -- there is always a low side and a high side in the interest of the performance business. But I think generally we are through the mix of business problem on the in-force book that we had several years ago. Our pricing adjustments have graded down over the years from 15% to 10% now to the 6 to 10% range or so and are expected in 2006. And I think that most of that is fairly predictable at this point. Our mix of business on new sales, as Tom mentioned, is graded down from over 60% large case business in '03 to 40% or so in '05. Our core sales are tracking up where as our large case sales have graded down and are now at fairly flat levels.

Our target market mix of business, that's the business industries that we think have better claim patterns, better incidents patterns, a more consistent profitability in real patterns, that mix of business has continued to grade up and our pricing is focused on that. That's about 60 to 70% of our business. And I think, in general, we are going to continue to see growth, particularly in our core and supplemental lines of business as opposed to our large case business, which I think will stay fairly flat. I don't believe to answer your other question that the claim performance that we saw in the fourth quarter is reflective of a long-term trend that, therefore, requires us to implement renewal pricing increases greater than we are currently executing on. But we will keep monitoring that.

So when we sum this all up, I mean are we looking for group protection sales to be up in '06 in single-digit, double-digit or is that just not a focus area that we should be looking at as a sign of confidence that you've turned the corner?

Group income protection sales ought to be up, particularly in the core significantly. In overall, sort of in the low double-digit kind of range.

But again, Bob, it's Tom White, again, the focus is really on the mix and making sure that we got the right mix; that we are seeing growth in the core market and just not pushing for sales activity in the large case.

And, Bob, that's a consistent theme across all three of our businesses. U.S. Brokerage, obviously we've talked about it, is very focused on being, should we get the right mix that we're not drawn into large case just for the sake of writing a case. The same is very true with Colonial. As I mentioned in my comments about Colonial. The growth rate that actually we are seeing there from the small, mid sized market is much higher. So, again, the focus there is very much staying the course of the bread and butter of the small and mid sized marketplace, and the same is very true in the U.K. We want to continue to keep pricing discipline. We are seeing some pretty aggressive pricing actions in the U.K. across both the group income protection and the group life business.

So, again, if we are being a little hesitant on a growth rate, it's only because we want to be sure that we maintain that discipline that I think we recognize is very important to be sure we don't create some of the same issues we had to work our way out of three or four years ago. I would say though from the point of being encouraged, we do have strong grip in the marketplace. Whether it's looking at the core market sales here in the U.S. Whether it's looking at some of the service scores that we are getting from some of our very frequent customer research. I think people really view the Company as having turned the corner. It's -- I think some of the most recent research indicates strongly the commitment of our producers and our customers to renew and do more business with us. That's very recent research by the way within the last week or two. So we're going to have to be sure that we sort of try as we explain our results to somehow be able to differentiate between things that are related to being just hopefully good financial keepers of the capital in terms of being sure we don't write bad business. At the same time also give you the glimmers of what's really happening in the marketplace in terms of our market [inaudible], which, frankly, is very good.

Thank you very much.

Thanks, Bob.

Our next question comes from Jason Zucker Fox-Pitt Kelton.

Good morning. Thanks I had a few questions.

Good morning. Sure.

If -- I'm thinking about the multi-state and if I go back at the time this all started to take place, I think you guys were talking about seeing the loss ratio go down about half a point a quarter. And, again, if your initial reserve estimates were in part based on the estimate of the claim recoveries, my question is I guess how is it that you have confidence that your initial reserves are then adequate?

Tom or Joe.

Sure, Jason. Basically the disruption that you've seen throughout the year when we've sort of talked about disruption and the fact that we hit earnings for the amount of disruption, we've basically been expensing it. And so I don't know what you call exactly "reserve action" but we have been expensing the disruption. The disruptive effects of the claim operation as we've gone along here as we just did in the fourth quarter.

So our reserves are -- look at the long-term view. They assume that we're going to have a certain level of performance in the future. We're confident in that. There is a plan in place to obtain that performance. And as you can tell we are monitoring it very, very closely. But I think the answer is we have been expensing it as we have gone along here, which is exactly the right thing to do. If a claim doesn't get settled that your reserves contemplate to get settled then the reserve goes up and you book an expense. And heck we've had, what now? $70 million, $75 million plus of quote-unquote disruption costs here in a year. So it's already in earnings.

Okay. And I wanted to follow-up, Tom, just following up on Vanessa's management-related questions. And it just -- it seems like there is a theme now where a lot of the top execs are now wearing a lot of different hats. So Kevin has got now underwriting, and I think products and now claims. Have you guys thought about perhaps bringing some people in from the outside as well to maybe take a fresh look to see what's going on.

And then I guess a related question -- and just correct me if I'm wrong about this -- but I think Bob is listed as both CFO and Chief Actuary. And I was wondering whether or not that's something that over time is something where he should hold dual roles. It just seems to me that there could be a conflict of interest. And the question is I guess whether or not Joe would move into the CFO role or somebody would move into the Chief Actuary role?

Jason, all good questions. And I will take the first one and then ask Joe Zubretsky to take the second piece of your question. But you are absolutely right, to think about the burdens and the expanse of control of our people. And I actually -- believe or not I actually spent quite a bit of time on leadership development, building bench strength and succession planning as I should, in fact, we will be trying do more of that in 2006. I think as Kevin shared some of his comments we are actually blessed as we thought about some of these changes, but with actually having built some pretty good depth in different parts of our Company, which we drew upon as we thought about the solution here. So I'm very sensitive to being sure that we don't overweight any of our people with too much in the way of responsibilities that obviously was something I thought about very, very carefully, sort of the back-end of last year as we put together this plan for what we wanted to do to attack these issues.

But, again, I feel pretty strongly that both Kevin and Bob have the capacity to do that. But that comes because they have good people under them and we've drafted some good people under this part of the organization to be sure that we actually continue to -- be sure that there is good underpinnings there. As Kevin said, keep people close to the business and be able to do the kind of things that we think we can do. So we're going to keep an eye on this all. Because, again, you're right we are -- we don't want to stretch any of our resources too far. But I feel pretty good about that. I think though as you step back one of the other things that I think you probably have seen is we haven't been bashful about going outside to continue to supplement internal talent with outside talent. And I think -- I'm just going to do the numbers off the top of my head, I think we probably have four new executives that report to me that two years ago weren't at the Company. So we've continued to bring in some additional resources.

I think we have got a pretty good read on the issues in the claims department. Again, as I said in my comments, not that I'm a claims expert but I am somebody who can kind of get to the nub of an issue relatively quickly. And I spent a lot of time in the fall with a lot of people and a lot of employee meetings to understand some of the issues. So I think we have a pretty good read on that. We worked very hard at the back-end of last year, a few of us developing the plant that we rolled out at the beginning of this year. So I think we feel pretty good about that. But please don't ever think that we don't look outside the Company for resources that can supplement the talent we have here. It's all part of building depth at the Company and being sure none of our leadership group is overburden with things that may stretch their capacity. But, Joe, on the other point?

Sure, Jason, on the second question, that's an astute observation. Because as you know, purely from a governance perspective a lot of companies have been sort of bifurcating the roll of chief actuary & CFO. But I think it's important as you analyze the question is to look at our line of business operations and our subsidiary operations. We have clearly moved to a holding company line of business model. Each one of our businesses has a fully functioning CFO and a fully functioning chief actuary: Colonial, U.S. Brokerage, and our U.K. Limited operation. And we have very, very strong dotted lines to Bob and Bob is wearing both hats as Chief Actuary of the Corporation & CFO of the Corporation. So I have confidence in the model as does Tom on our Board clearly because we have done a lot of work in the past year to create fully functioning CFO and chief actuaries of all of our businesses and we have a lot of confidence in that talent.

And, Joe, while I have you just a quick numbers question. The IDI numbers jump around a lot quarter-to-quarter. And I was wondering is there any correlation or should there be any correlation to the change we see in the reinsurance recoveral on the balance sheet? And then just a specific numbers question. Could you guys have the number for the current GAAP carrying value of the National Indemnity Reinsurance receivables?

I don't think we have the reinsurance information with us. Are you talking about the closed block? Jason?

Yes.

The closed block. Most of the volatility in the closed block, two things, one, net of benefit income jumps around a little bit due to what we call "variable income" or "miscellaneous income." And second, I think it's important to understand that in a individual claim operation the recovery rates tend to be more volatile quarter-to-quarter and given the operating leverage of the balance sheet versus the income statement it shows up in earnings in a more dramatic fashion, yet it's really nothing to worry about. So I think the key point there is the operating leverage any sort of noise in the recovery rates creates period-to-period volatility and we've had some noise in what we call the "miscellaneous income" line in net investment income for that line of business as well.

Okay. So in a sense then I shouldn't be looking at that reinsurance recoveral to try to find a correlation?

No, this is our long-term view. And, again, you have to account for the way you have to account for things. This is a $30 million contributor to before tax operating income per quarter over time. Obviously, that will grade down in the out years because it's a closed block and it's getting smaller.

Okay. Thank you.

Thank you, Jason.

Our next question comes from Jimmy Bhullar, JPMorgan.

Hi, I just have a couple of questions. First, if you could just talk about competitive conditions in your various segments? I think you mentioned that some of the competitors being irrational pricing business [inaudible] claims. The other question is on just your claims recovery experience. It's significantly worst than that for most of their competitors. So how much of a disadvantage is it in your ability to price competitively and your ability to sort of turn the corner on your market share?

Good let me just -- there's two questions there. Actually with respect to the competitive dynamics, maybe I will ask Kevin McCarthy just to speak a little bit to what is happening from a competitive standpoint in the U.S. marketplace. And then Susan Ring who I think as everyone knows runs our U.K. operation. Just ask Susan to speak briefly to the competitive dynamics over there. But, Kevin?

Good morning, Jimmy. Well, as Tom mentioned earlier the competitive marketplace I think needs to be evaluated a little bit by size, if you will, of business. The large case marketplace continues to be extremely aggressive both because the buyers have a lot of purchasing power and because there are competitors that are willing to pursue market share -- to pursue their own market share by grabbing those large cases and the ones that basically we're willing to walk away from. And so the large case market place is incredibly price pressured and we expect it to remain so and that's why we have significantly reduced our emphasis on that versus our core business.

In terms of the core business, I would say while it's a very competitive business because there are a lot of players there we do see some signs of renewal actions by other competitors that we hadn't seen in the past. And we see that the premium for life and the industry gradually working its way up. And we feel fairly confident regarding both our pricing level and our ability to compete given both our momentum in core sales in 2005. And the customer satisfaction ratings regarding service and value and quality and intent to place business with us that Tom mentioned earlier.

Thank you, Kevin. Susan maybe just a brief update on just the U.K. market dynamics.

Yes, well, actually we're seeing some of the similar dynamics to what Kevin mentioned in the U.S. market, in particular, with the very aggressive pricing in group life, but also in large case business. And in addition to that we're seeing competitive really particularly trying to hang onto their existing business. So very aggressively pricing at rates we passed and trying to keep that business whether it's by a low rate or even maintaining their existing rate. So those are probably the three main areas where we are seeing very aggressive competitive pricing actions.

Thank you, Susan. And Jimmy, just on respect to claim recoveries, I think we recognize that claim recoveries are one of the pieces to the pricing formula. Obviously, the others include things like expenses and investment results, and plan design and incidents, and things like that. And we obviously want to be sure all of the components of our pricing are ones that were competitive and recognize that that's one of the reasons we need to improve performance in the claim recovery area. But Kevin, anything you would add to that in terms of just how you are reacting to this in the current state of just business today?

Thanks, Tom. Well, we are pricing for our current claim recovery levels, so that's built into our pricing. We do have some slightly improving incidents built into our pricing as well and our mix of business, of course, reflects our desire to price business and seek business where we can be more competitive and more profitable. So at the moment at least we were monitoring it carefully, but don't see a significant disadvantage to where we are. Although, certainly improving benefit performance will improve our pricing power over time.

Okay. And just to follow-up, you mentioned earlier on the call on use of excess capital as you build up some more capital for shareholders and then I think you mentioned interest-friendly initiatives. Could you elaborate on that a little bit?

Sure, let me pass it to Joe Zubretsky.

Sure, due to the conversion of the ASIS Securities and projected it very -- if we hit our plan very, very good statutory earnings, and therefore, holding company cash flow capacity we expect, as we said on October 17th, to build a war chest of about a billion to 1.4 billion of excess capital. Obviously, we've also stated very publicly that our number one capital initiative is to retain our investment grade ratings. And so as we think about deploying that capital we're going to have to work with our constituencies, the rating agencies. We're going to have to -- certainly it's going to matter how well we're performing against our other benchmarks. And we're going to deploy that capital, as I said, in a combination of credit-friendly and shareholder-friendly actions.

We think that if we can deleverage the Company back down to 25% debt-to-total cap by the end of 2006, there might be more we deploy to deleveraging the Company if, in fact, it helps us regain our investment grade rating. So we really can't sort of put a hardline or draw a hardline, a bright line across that. But we're going to work with our constituencies and make sure that we deploy that capital as we said, and initiatives that are both credit and shareholder friendly.

But buybacks are probably unlikely until you get the ratings? Is that a fair assessment?

I think most of the ratings -- as you know, the rating agency very publicly stated, no share buybacks until we are sort of through that. So I think that's a realistic statement to make that as we move forward here we will apply to every first dollar toward deleveraging the Company until such time we've got the gate open to get money back to our shareholders. So I think that's a realistic statement, yes.

Okay. Thank you.

You're welcome.

Our next question comes from Saul Martinez, Bear Stearns.

Hi, good morning.

Good morning, Saul.

Two questions. I guess I am still struggling with why the worsening in the fourth quarter from the implementation of the multi-state after three quarters of seeming progress. And I guess my question is why would the anticipation of management changes impact the timing of the quality of change decisions? I'm still unclear about that.

And secondly, Tom, you mentioned you did get more involved in the claims operations in the fourth quarter and I think specifically you said you seen some inconsistencies in geography in month-by-month performance. Can you elaborate on that a little bit? Give some examples of what those inconsistencies are? And I guess specifically also on what it is, what some examples are that are driving the lengthening in the claims decision process?

Yes, Saul, I will start and then I will ask sort of Kevin to supplement my comments a little bit. Again, I think it, frankly, it's -- I think it's probably no more complicated than human nature as to why I think people tend to hold back on decisions when there is an impending sort of management change. And even though, again, as you can imagine over the course of the falls I spent time with groups and tried to better understand some of the issues that were preventing our people perhaps from doing the things that they are trained to do. The other part of my sentence always would include the fact that while we go through this discovery process please focus on the things you can focus on and continue to serve your customers well. But I think, again, human nature being what it is when I think people see an impending change it's naturally going to cause people to pause a little bit. Especially amongst the leadership and management group because that's obviously the one that I think wonder and worry about how some of these things might unfold. So, again, I would like to think that in some cases those are manageable where you sort of -- again, you can communicate effectively enough with the leadership group that people are focused on the business at hand. But I think, again, we saw a degree of that in the fourth quarter where I think people were distracted.

Now, as it relates to specifics on consistency, I really don't -- I would rather not get into sort of locations and things. I think I would rather just stay at a high level and just say as I said, as I spend time in the business and, frankly, looking at some of the trends that we have seen even going back beyond just this 2005. It goes back probably a couple of years that there was a little more erratic behavior -- reset of results by location. And that's -- we define results as everything from recovery rates to return-to-work to themes around quality and service. And so, again, virtually every measure that we would look at in terms of just the overall set of results I think we saw that there was some inconsistencies by location, but then also inconsistencies by one month to the next. And I think what we are trying to do around the whole Company, as you know, is to create a much more predictable business plan where virtually everything that we do is predictable and consistent.

And Kevin used the analogy in underwriting, that's very much what we do in the underwriting part of our business a couple of years ago and I think the net results is what you saw with this quarter, which is very, very predictable persistency pricing and things like that. Those are the same things I think we are trying to introduce into the benefit side of the organization. I have to say they have a very, very tough job. It's not an easy position to be in. Certainly with all the change that we've had to go through and react to some of the things that we have had to react to in the marketplace that's added even a greater level of pressure in that part of the organization. So I just think there's some tools that we can put in place that -- and have put in place already to improve the resources there to help our people make effective decisions. But, Kevin, anything you would add to that?

That was a pretty good summary, Tom. I do think that I agree with you that it's human nature. Some people react to change more differently than others. Some are more hesitant. We have had inconsistencies by operating unit in a wide range of execution of changes in process. That seems to indicate to me the need to do two things that I've already mentioned. The need to get management closer to the floor both a deeper level of management and closer to the floor to aide the decision-making process and the confidence with which claim professionals make those decisions. And we also are going to implement, as I said, an enhanced quality assurance process which is designed to make sure that we have greater consistencies, sharing of best practices and, frankly, a better understanding of the decision cycle that affect our business and how to be as productive as possible.

Operator, we have got time for one more question, please.

Thank you. We will go next to Eric Berg with Lehman Brothers.

Thanks very much and good morning.

Good morning, Eric.

My question is a variation on Saul's in the sense that I, too, don't fully understand the chronology here and allow me to explain it. I will be genuinely super brief. My sense is that things were going great. You had an initial problem in implementing the multi-state accord. You had an -- then you sort of fixed the problem -- not fixed it, but you showed improvement in the June quarter and then in the September quarter. And then there was this reversal before the math -- and I'm thinking that you would not have made this management change personally becoming involved unless there were a reversal.

My question, which I hope you will understand to be different from the previous one is, why did this reversal happen even -- it must have happened I'm thinking to myself even before you became involved. Because after all, that's presumably what prompted you to get deeper involved. You got somehow derailed. What caused this reversal in the first place?

It's a good question, Eric, and I appreciate the challenge that you and others have to sort of see what we went through. But let me see if I can take another little stab at this, too. Because I think -- I wouldn't use the word reversal. I would actually use the theme around, do we have a business plan in place that not only sort of gets us through, but frankly, is sustainable over the long-term. And I guess that's probably one of the key judgments that I had to make in the fall was as we've seen some inconsistent performance by location or as we've seen some of the challenges implementing change and knowing that still change is going to be a part of this part of the business, the real test for me really is as I look at the results is, am I confident that we have the underpinnings and the foundation in place that we may have to go through further change, but that it's sustainable over the long-term.

And the plans are in place to ensure the things that we put in place are sustainable over the long-term. And I think that's the part Eric where I wasn't obviously quite confident of that. And that's where I felt that maybe we needed to look at a somewhat different structure and a somewhat different business model to be sure that we had the resources and pieces in place to be sure that what we put in place was sustainable. So we don't come back some time down the road and have to use the word "disruption" with anybody. I find that word, frankly, a little bit distasteful. I think what we really want to do is as you know throughout the Company is focus on consistent operating performance in virtually everything we do. And the only way you do that is being sure that you have got a very solid foundation and business plan in place with the right people and the right resources in place to execute upon that. And I think as I looked at this -- and, again, it's a judgment call. I didn't feel that was the case and that's why I think we stepped back a little bit. And, again, the model I've used around the Company over the last three years, is when I see something like that I jump head first into it myself personally, but then quickly assess it and decide what then is the remedy for that. So it really comes down to I think feeling as though that the plan we are planning, we could maybe bootstrap our way along a little bit, but was it really a more permanent sustainable change that we were looking for and I think that's what necessitated the change.

That's additional helpful perspective. Thank you.

Good. Thank you, Eric. Well, thank you again all for taking the time and at this point this will complete our fourth quarter call. As usual Tom and Lenny are available for follow-on questions, but again, thank you very much.

Once again, ladies and gentlemen, that does conclude today's conference. You may now disconnect.