普登 (UNM) 2009 Q3 法說會逐字稿

Good day and welcome to the Unum Group 2009 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, Clayton. Good morning everyone, and welcome to the third quarter 2009 analyst and investor conference call for Unum.

I'd like to remind you that our remarks this morning will include forward-looking statements, which are statements that are not of current or historical fact. As a result, actual results might differ materially from results suggested by these forward-looking statements. Information concerning factors that could cause results to differ appears in our filings with the Securities and Exchange Commission, and are also located in the section entitled "Cautionary statement regarding forward-looking statements and risk factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, as well as on subsequently filed Form 10-Q's. Our SEC filings can be found in the investor section of our web site at www.Unum.com. Please take note that the statements in today's call speak only as of the date they are made, and we undertake no obligation to publicly update or revise any forward-looking statements.

A presentation of the most directly comparable GAAP measures and reconciliations of any non-GAAP financial measures included in today's presentation can be found on the website, also in the investor section.

Participating in this morning's conference call are Rick McKenney, Executive Vice President and CFO, as well as the Heads of our three core operating segments, Kevin McCarthy, Randy Horn and Susan Ring.

Now I would like to turn the call over to Unum's President and CEO, Tom Watjen. Tom?

Thank you, Tom, and good morning.

I'd like to begin this morning's comments -- call with a few observations on the third quarter before I turn it over to Tom White for a review of our operating results, and then to Rick McKenney for his comments on the quarter and a review of our capital management and investment portfolio results.

The third quarter was another good one for our Company, with a continuation of many of the business trends that have been evident over the past several quarters. Let me touch on a few highlights. First, excluding net realized after tax investment gains, we reported $0.64 per share in operating income for the third quarter, in line with last year's third quarter. Operating results in Unum US were especially strong, with earnings increasing 15%, which was driven by a continued profit improvement in our group disability line of business. While the soft economy and continued high levels of unemployment continue to put pressure on our ability to grow the top line, as it does with all of our businesses, Unum US's profitability continues to improve.

Colonial Life's third quarter results were also solid, with operating earnings growing 6%, with just over a 3% premium growth and generally stable risk experience. Finally, our Unum UK results were below our expectations, with operating earnings on a local currency basis declining by 27% relative to a year ago. The decline is primarily attributable to lower premium income, which will be discussed further in a few moments.

Second, despite the difficult economy, I'm encouraged by our sales results in our target markets. Specifically, we saw an 11% increase in Unum US's core market sales, a 3.4% growth in sales at Colonial Life, and a nice rebound in Unum UK's sales. In addition, case count growth continues to be a strong -- continues to be strong across all of our businesses, especially in the smaller end of the market. As I mentioned earlier, we continue though to see some premium pressure, as employers are not generally adding new benefits in this environment, and in many cases the level of employment with our existing customers is down. We are likely to continue to face these headwinds into 2010 as well.

The third point is the Investment portfolio continues to perform extremely well, and the quality remains very high. As a result of the significant change in the interest rate environment, including rates and spreads, the value of our fixed maturity securities portfolio now stands at a net unrealized gain of $2.2 billion, compared to a net unrealized loss of $2.5 billion just six months ago.

Finally, we continue to build financial flexibility, with continued strong statutory earnings and the opportunistic debt financing we did late in the third quarter, further strengthening our capital position. Rick McKenney will provide greater detail on our capital position, but you can expect that we will comfortably exceed the 2009 targets for holding company liquidity and risk-based capital.

In summary, I feel very good about our third quarter results, and our position as we move ahead. Our core operating segments continue to perform well, and are generally meeting our expectation. Our solid risk results today reflect the plans we implemented over the past few years that included disciplined pricing, underwriting and risk selection. Sales momentum in our target markets remains generally positive, with solid growth in our core group market. Our strong value proposition and broad array of product choices, supported by our commitment to service, is serving us well in the marketplace.

While the economic conditions may continue to adversely affect premium growth, I can assure you we will remain disciplined and will not be tempted to stretch for growth. Our investment portfolio has continue to perform very well in this environment; and certainly last but not least, our financial position is excellent, and we continue to build financial flexibility. Our excess capital remains a valuable asset, especially in this uncertain economic environment.

Now I will turn the call over to Tom White, who will provide more detail on the operating results in the third quarter. Tom?

Great, thanks Tom.

Net income for the third quarter was $221.1 million or $0.66 per diluted common share, compared to net income of $108 million or $0.32 per diluted common share last year. Included in the results for the third quarter 2009 are net realized after tax investment gains of $9.5 million or $0.02 per diluted common share, compared to losses of $108.9 million or $0.32 per diluted common share a year ago. These amounts include the impact of the embedded derivative and a modified coinsurance arrangement, which resulted in a third quarter 2009 realized after tax investment gain of $28.9 million, compared to a $44.1 million after tax loss a year ago. Net realized after tax investment losses related to sales and writedowns of investments were $19.4 million in the third quarter of '09, compared to losses of $64.8 million in the year ago quarter. So excluding the items, after tax operating income was $211.6 million for this quarter, or $0.64 per diluted common share, compared to $216.9 million or $0.64 per diluted common share a year ago quarter.

Looking at operating results for our operating segments, in total Unum US's operating income increased by 14.9% to $197.1 million in the third quarter. Within Unum US, the group disability line reported another strong quarter, with income up 37% to $75 million. We continue to see improvement in the benefit ratio, which declined to 85.3% in the third quarter, compared to 87% in the second quarter of this year and 89.3% in the year ago quarter. A number of factors continue to drive this improvement, including the ongoing shift in our block of business to more core market business and less large case business, as well as the shift to more stable industries and away from traditionally economically sensitive industries; a generally consistent rate of claim recoveries and net favorable claims experienced; and also the ongoing adherence to pricing discipline, particularly in the large case business.

Paid claim incidence rates in our group long-term disability line were slightly higher this quarter relative to the third third of '08 and the second of '09 experience, but the average size of the new claims was lower, and therefore the financial impact of these claim was minimal. The higher claims were largely from traditionally non-economically sensitive sectors of the economy, so we believe it's normal quarterly volatility rather than a trend related to the economic environment. Also our STD, or short-term disability, claims experience was also somewhat higher this quarter than in the second quarter of '09.

Moving to the group life and AD&D line, operating income declined slightly to $50 million in the third quarter, compared to $50.9 million in the year ago quarter, primarily driven by lower premium income, which declined by 2%, and a stable benefit ratio of 70.3% in the third quarter of this year compared to 70.4% in the year ago quarter. The supplemental and voluntary line third income -- third quarter income grew 9% to $72.1 million. The recently issued individual disability line and long-term care line both reported improved earnings over a year ago, while the operating results in the voluntary benefit lines were marginally lower.

Reported sales for Unum US declined by 7.1% in aggregate. Core market sales for our group lines, which include LTD, STD and Group Life, showed continued positive momentum, increasing 11% for the third quarter and 15.6% for the first nine months of 2009. Sales in the large case market for these lines declined 3.3% in the third quarter. The mix of our core market and large case sales thus far in 2009 is 66% core market and 34% large case, which is a very positive trend. The supplemental and voluntary lines struggled this quarter, with a combined sales decline of 21.9%. Voluntary benefits had a sales decline of 17.8%. Case count growth remains positive in the voluntary benefits line, which increased 24% relative to last year, which reflects a continuation of a good level of activity in the under 500 life market.

Moving to our UK results, before tax operating earnings in this segment declined from $92.5 million in the year ago quarter to $58.7 million in the third quarter this year. The decline in the value of the British pound relative to the dollar, which came from $1.89 in the third quarter last year to $1.64 in the third quarter this year, continued to negatively impact translated results for the Unum UK segment. The underlying operating performance was also weaker, with before tax operating earnings in local currency declining 27% to GBP35.8 million from GBP49 million a year ago. The primary driver of the lower operating earnings was the decline in premium income, which was GBP103.4 million this quarter, compared to GBP118.6 million in the year ago quarter and GBP111.6 million in the second quarter 2009.

Basically the same factors that we see in the US are impacting the premium income in Unum UK. That is, higher than expected levels of lapses, somewhat in the large case block. Secondly, a reduction in the existing block due to companies downsizing, reductions in salaries and lower sales to existing accounts. And then third, the lower level of sales and lower persistency that we experienced during 2008, which reduced the size of the [in-force] block relative to the prior year. Also impacting the earnings in this segment this quarter was a return to what we would call a more normal level of claim incidence from the extraordinarily favorable trends we experienced in the first half of 2009.

The benefit ratio in Unum UK declined to 50.2% in the third quarter, compared to 52.4% a year ago and 54.4% in the second quarter. This is largely driven by the impact of lower inflation on claim reserves associated with group LTD policies containing an inflation-linked benefit increase feature. The offset is reported in the net investment income line, where lower net investment income results from a reduction in inflation, which reduced the return on bonds for which the interest income is linked to UK inflation. The impact this quarter was approximately GBP9 million for both lower net investment income and reserves, which would result in a benefit ratio of approximately 59% if you adjust for this.

Third quarter sales for UK were quite strong, you will see increasing 63% in local currency. We continue to benefit from the exit of a competitor in the UK group risk market, and the movement of some of that business to us. We also expect to see strong fourth quarter sales as we gain this business in the open market.

Moving to Colonial Life and including our core operations, Colonial Life's operating results remain strong, with operating income of $70.4 million, a 6% increase over the third quarter last year. Premium income in this segment grew by 3.4%, while the benefit ratio of 48.2% this quarter was slightly higher than the year ago result, reflecting a higher level of paid cancer claims. The third quarter margin remains quite favorable at 27.8%, again for the third quarter 2009. Despite the difficult sales environment, sales at Colonial Life increased 3.4% in the third quarter. Many of the same trends we've discussed in recent quarters continued this quarter, with favorable new account growth -- our new accounts increased 16.7% over a year ago, and new account sales increased by 10.9% -- while sales to existing accounts remain challenging, with a decline this quarter of [0.9%]. This level of sales to existing accounts, while it's lower year-over-year, does mark an improvement from the trend of first half of the year. We also saw favorable sales growth of 19% in the public sector market, which is a very important market for Colonial Life, which produces about 23% of total sales again for Colonial.

Recruiting continues to remain strong, with growth in new rep contracts up 45% this quarter and 31% on a year-to-date basis. And the average weekly producers increased 7.6% in the third quarter. The individual disability closed block pretax earnings improved to $7.2 million from $2.5 million a year ago. The interest adjusted loss ratio was stable at 81.6% this quarter, while premium income declined 6.7% and net investment income declined slightly by 2.6%.

Finally, the corporate and other segment recorded an operating loss of $13.7 million, compared to $7.2 million in the year ago quarter. Expenses are higher in this segment, reflecting approximately $10 million of incremental quarterly pension costs. Interest expense was reduced to $24.1 million in the third quarter of '09, compared to $28.2 million in the third quarter last year.

So with that review of our operating results, I will turn the call over to Rick McKenney.

Thank you, Tom.

As you heard in the overview of our operating results, the trends we experienced in our businesses this quarter remain consistent with those of the past several quarters. you can see that consistency playing out in multiple areas of our business and across each of our segments. Let me break it down into the key drivers of profit. First, we saw a generally steady risk experience across the business. We did see a slightly higher level of volatility in this quarter's claims in the US disability business. It is something we will continue to monitor closely, but not something we see as a trend at this point, and the benefit ratio continued to improve. Risk results in the UK, in terms of claim incidence and recovery trends, were generally in line with expectations. I would note that although this quarter's results were not as favorable as the very positive trends and margins we experienced in the first half of this year, they are strong and improved from a year ago. Then when you take Colonial Life's steady results, the overall picture continues to be favorable.

Second, we have not been immune to the environment on the top line. We have had good sales, but we have seen premiums decline in the third quarter on a year-over-year basis by 3% after adjusting for currency. The environment is causing some clear global headwinds for the growth of the benefits business. In the quarter this is most pronounced in our UK business, which is feeling the effects of earlier lower sales and persistency, and challenges from the economy such as downsizing and salary reductions. These elements are true to some degree across each of our businesses, and will persist until we see improvement in the economy.

Third, underlying our consistency has been the performance of our investment portfolio. This was strong again this quarter, reflecting the ongoing rally in the fixed income markets and the rapid tightening of corporate bond trends across the rating spectrum. Corporate bonds compose the majority of our investments. For reference, the spread of the Lehman -- the Barclays US investment grade credit index has tightened back to 198 basis points at September 30, compared to 275 basis points at June 30, and all the way from 493 basis points at year end 2008. With this tightening, the net unrealized position of our fixed maturities securities portfolio has now swung to a net unrealized gain of $2.2 billion, compared to net unrealized loss of $2.3 billion at year end.

With the rebound in the credit markets, the Company's book value per share likewise rebounded. Book value per share was $24.86 at September 30th, a sequential increase of 10% from June 30th and 23% from a year ago. Excluding accumulated other comprehensive income, book value per share was $24.06 as of September 30th.

With the continued tightening of credit spreads in the third quarter, it's not surprising that our new money yields declined somewhat from the levels of late 2008 and the first half of 2009. Our new money yield adjusted for hedges in the third quarter was 6.75%, compared to 6.82% in the second quarter and 7.46% in the first quarter. The overall portfolio yield has remained relatively stable throughout the year, and the net interest rate reserve margins for Unum US group disability continued to widen.

Finally, in the third quarter our reported net realized investment losses, excluding the embedded derivative gain of $29 million after tax, totaled $19.4 million after tax. The $19.4 million realized loss this quarter compares to $40 million in the second quarter and $57 million in the first quarter, and clearly continued the trend of declining realized losses. As we look forward, some level of realized losses is likely to persist, though the amount we believe will be manageable relative to the size of our investment portfolio and our capital position.

Moving to capital management, in addition to the strong GAAP earnings this quarter, our statutory earnings in our traditional US life insurance companies were also solid, with third quarter 2009 after tax operating earnings of $137 million, which brings 9-month after tax operating earnings to almost $500 million. This level of statutory earnings continues to drive very positive momentum in our capital measurement metrics and overall financial strength and flexibility. Additionally, a highlight of the third quarter was the issuance of $350 million of senior debt in the last week of the quarter. Over the past 24 months we have significantly reduced our leverage, which was 18.5% at the end of the second quarter. We have expected debt issuance as part of our capital management strategy, and with the rally in the credit market over the past several months, we launched an offering late September. We are pleased with the execution and demand for the 7-year note, which fits well in our debt stack, and priced at just over 7%. With this financing the Company's level ratio, excluding the securitization-related debt and equity, is around 21%, where we are comfortable, and we don't have any debt maturing until 2011.

When you take this debt issue and the continuation of strong statutory earnings, we are revising expectations for our year end 2009 capital position. We now believe that risk-based capital for our traditional US insurance companies will be approximately 360% at year end, surpassing our expectations of 330% to 335%, and our estimated third quarter RBC ratio of 340%. Holding company liquidity is expected to be at around $900 million, well ahead of our expectations of $750 million, and ahead of our current level of $864 million. Finally, leverage will be around 21%, in line with our prior expectations.

We still believe today's economic environment dictates a strong financial position, and we believe that we are in excellent shape. I hope you will join us at our investor briefing next week, when we will take you through our plans for 2010. To sum up, all in all it was a good quarter for the Company. Despite the difficult business and economic conditions, we continue to perform well and build on our strong financial platform.

Now I will turn the call back to Tom for his closing comments.

Thanks, Rick.

While this continues to be a difficult business and economic environment, I'm pleased with our results and extremely proud of the work our people continue to do in serving our customers and delivering on our plans. As you have heard from our comments, the recession is having an impact on our ability to grow our top line. Both here in the US and in the UK, the rise in unemployment over the past several quarters has impacted the natural growth rate of our business. Importantly, though, we see little evidence that employers are eliminating plans, and are encouraged by our account growth and healthy case persistency. These position us well for future top line growth when the employment picture improves. While the economy has had its greatest impact on our premium growth, we are also closely watching for any other factors which could impact our profitability, such as low interest rates, expense trends and claim incidence trends. Since I know you will ask, we have not seen any meaningful increase in claims incidence, but we are seeing some volatility in claim incidence in some parts of our business, and we will certainly be keeping a close watch on this.

As we said many times in these calls, we are not immune to the effects of the recession, but with our diversified business mix, focus on profitable growth, and solid balance sheet and capital position, we are very well positioned. While we have a great deal of confidence in our position and ability to execute our plans, we are still very cautious on the general environment, which impacts our approach to business planning and capital strategy for 2010; again, as Rick said, something we will discuss in further detail at our annual investor meeting to be held in New York next Monday, the 9th of November. Finally with respect to guidance, we continue to expect operating earnings per share for 2009 to fall within our previous guidance range of $2.50 to $2.60 per share. However, with the top line pressures we are seeing, the lower half of that range is more likely than the upper half of that range.

Operator, this completes our formal comments, so let's move to the question-and-answer session.

(Operator Instructions)

First question comes from Bob Glasspeigel with Langen-McAlenney.

Good morning, Tom. I'm probably over-analyzing the exact words you used, but in your concluding remarks I think you said the economy is beginning to -- or the recession is beginning to have an impact on the Company. It's sort of ironic that this would be in a quarter where GDP was up 3.5%, so I suspect you're in a cynical camp on that number. But specifically, the question is how much do you think you are going to lag the economic recovery? It sounds like to just begin to have an impact on the economy in this quarter suggests that there is a lag, because the economy has been weak for a while.

Yes, I think -- Bob it's a good question. I think when we look at the impact the economy has on the Company, I want to clarify, I think -- we think it's mostly around the employment picture. I think that's where, as you look at unemployment rates continuing to move up, you look at -- certainly we've seen some slowing in the deterioration of the employment picture, but still I think the outlook that most economists have for 2010 continues to call for relatively slow recovery in the employment picture. I think that's what you hear reflected in management's comments today.

Again, that's something we have been watching all year. I think if you look back to the comments we made in the last couple of quarters, I think we have talked about the premium pressure, and really the premium pressure is really coming just because of the employment picture. So again, I like you see some great signs that the general economy is improving, whether it is economic growth or some of the trade things, but on the other hand I think our business is most focused around the employment picture.

Thank you. My follow-up is if you execute your plan, and it seems like you've surpassed your capital goals for -- at the holding company, when is the soonest you think you can consider another buy back, recognizing the rating agencies are a huge wild card?

We will talk more about this next week, Bob, but I think just at this point I think, again, I want to clarify, we feel confident in our Company's business plan and strategy, our ability to execute that planned strategy. I think any hesitancy we have about sort of putting any capital to work on a share buyback comes more about the concerns about the general economic outlook. So I don't want to put a time out there, except to say that we were very fortunate to have the capital position we have, as Rick gave some of the guidance for year end, we're expecting to even be in a stronger position than we expected to be. Our operations continue to perform very well, but again I think it's our view at this particular point that this is a time to continue to accumulate capital, and accumulate capital until you begin to sense the things that are important to our business, like the employment picture, begins to show some improvement. That's the mindset I think we're going to bringing to this as we move into 2010.

Thanks. I'll follow up with you next week on this, thanks.

Thanks, Bob.

Next question comes from Colin Devine with Citigroup.

Good morning. A couple of questions. First following up on the capital, Tom, with the cash building up pretty rapidly, and obviously you generate a fair amount of cash flow on your own annually, you talked about I guess being careful, conservative; is there some thought maybe being given to strengthening the capital position of the insurance businesses even further? Obviously, you want your ratings back, and there would seem to be something like a 400% ratio might make that statement?

Second question, I think we would appreciate just an update from Kevin and probably Susan on how the sort of renewal season is going, and pricing trends, and I guess we'll get more next week. I didn't want to leave Randy out. Colonial's sales I thought were just extremely strong, certainly in very stark contrast of the disappointment we saw at [AFLAC], in the same sector. I guess what are you guys doing right, because clearly your biggest competitor is struggling mightily?

Three important points, Colin. Let's get started on the capital, and I will ask Rick to pick up on your questions.

Thanks, Colin. I think it's important to go back to what you mentioned, which is the strong free cash flow that is generated out of our statutory earnings. That gives us a lot of flexibility to channel those earnings in the direction we want. Over the past year, that's been building up holding company levels, and we've done that. I think we'll probably slow that down, and you will see it building up in the insurance companies on natural basis. That would be reflected in the year end forecast of around 360. So you will see those RBC levels build up. We don't really need more cash at the holding company at this point, and the strength of our insurance companies will be the focus as well.

Let me just shift then to market conditions in both the Unum US and the Unum UK business. Kevin, do you want to pick up on the question around renewals and the market conditions?

Thanks, Tom. Good morning, Colin. The renewal program for 2010 will be about the same size, slightly larger, than it was in 2009. The large majority of those renewals, particularly in the larger case sector, have been offered already. The average increase is quite small, sort of in the 1% to 2% range, and I think that reflects the fact that we have gotten through sort of everything that we needed to get through in terms of rebalancing the portfolio over the last three or four years. The renewal program is really more about just being disciplined with the way in which we continue to manage that in-force block. So far, persistency remains solid. Nothing out there that indicates that we are going to have anything that is going to shake us up on the persistency side.

Thanks, Kevin. Susan, do you want to pick up on the market environment that you are facing in the UK?

Thanks, Tom, thanks, Colin. Yes, I mean it remains a very competitive environment here in the UK, but we believe that we are very strongly positioned, and still remain the recognized market leader, and all the metrics indicate that we're staying there. So we are focused and very disciplined, and certainly very focused on renewing our existing block.

In terms of our renewal program, we are certainly still seeing that there is pressure on existing clients with regard to salaries or lack of salary inflation, and also membership pressure. So we are seeing shrinkage of some of the schemes that we hold. In particular, as you are aware, the financial services sector, the financial sector as a whole, actually, has been under some pressure, so that is in particular where we've seen it come through. But we are maintaining pricing discipline, and ensuring that we keep our margins healthy and high.

I'm sure -- I know I can relate to salary inflation pressure. With respect to the strong sales you were talking about for the fourth quarter, how much can that buffer the earnings impact of the slower premium growth over the next year?

Do you want me to take that, Colin?

Please, Susan, go ahead.

Sure. We still expect -- obviously, we had a strong sales quarter in the third quarter, and as you can see from the metrics we were sort of up 63% versus the same quarter last year, and showing growth on the second quarter this year. We still expect sales to be strong in the fourth quarter, and that's certainly going to help improve our payment position and help offset some of the erosion that we seen in our existing block.

Moving on last but not least, Randy, just the success you've had at Colonial.

Yes, thanks Tom, good morning, Colin. Yes, as a backdrop, the entire industry has seen pressure on existing case sales, due to the economy. We have been no exception to that. But we did see nice improvement in the third quarter, that -- the existing sales tend to be somewhere around 65% of our total sales. So that's a very important issue for us. We've instituted a lot of programs to help our agents get out and visit existing customers, and talk to them about our various offerings, and again seen very good improvement there. Our new account activity, as Tom White and Tom Watjen referred to earlier, continues to be very strong, good double-digit growth there.

I think overall, Colin, we just continue to see a nice growth rate in our entire agency system. As you know, we've been very focused on new rep recruiting and district manager recruiting over the last several years, starting to see that pay off at this point. I think a good indicator is that of those strong new account sales that we had in the quarter, over a third of those were from reps recruited in the last couple of years. So again, good growth in the system, good focus, and we are seeing pretty good results at this point.

Thank you very much.

Next question comes from Mark Hughes with SunTrust.

Thank you very much. I'm not sure if you have this level of detail but I was curious, you mentioned how employment levels have been something of a headwind. Have you been able to perceive any difference in the core versus the large case customers?

Maybe I'll ask Kevin, any reaction to Mark's question?

I can't think of anything that pops out at me in terms of looking at metrics, Mark, that would indicate that kind of difference. The only thing I would say is that the large case market is basically fully penetrated, so the pressure -- excuse me, the pressure in terms of premiums comes from those large customers having declining employment levels, which is pressuring our top line, our premium natural growth, if you will, in the fact that they may be deferring decisions about what we call MBOC or upgrades in benefits. So we see that in the larger case sector.

In the smaller case sector, on the other hand, you know it is not fully penetrated. We continue to see really, really solid new account growth. Core premium was up 11%. I think small voluntary cases were up 24%. Case count for the year is up overall. So we are not seeing sort of the same dynamic.

Thanks for the color. Then the benefit associated with lower inflation, is that all captured in 3Q, if we look at Q4, assuming no change in the underlying inflation? Is there any continuing effect in the fourth quarter or any benefit from that, or is that all captured in 3Q?

I think that is captured in 3Q. When you look at, our processes reflect that in the reserves, so we would have reflected what we saw in the inflation movement, the corresponding reduction in benefits as well as in the investments. It's a matched-up asset to liability type thing. It would be reflected in third quarter if it stays flat; fourth quarter inflation, you wouldn't expect carry through on that element.

Thank you.

Next question comes from Mark Finkelstein with FPK.

Good morning. Three, I think, quick questions. One is back to Colin's renewals question, Kevin, I'm just curious, are you seeing anything different in the buying habits of employers of group products, whether it's in the extent of coverage, et cetera?

I think there is pressure on employers in terms of their employee benefits budget. That's coming from the economy, and it's also coming from some of the healthcare side of the equation. That of course is what drove us to invest in our [Simply Unum] platform and continue to invest in our voluntary products portfolio. As we've introduced that Simply Unum initiative during the course of the last 12 months, we continue to see an increase in the number of purchasers of group benefits who also buy a voluntary coverage along with it, particularly in the smaller end of the market. So in that sense, I think there is a slow but gradual shift towards maybe packaging of benefits and sharing costs between employers and employees within the benefits program, and that is consistent with the strategy that we have been invested in.

Okay. I guess back to the claim activity, I guess I understand comments around incidence being a slight uptick, which you are characterizing as kind of random fluctuation; but the other side of that is recoveries looked better, offsets looked better. Would you characterize that as normal volatility as well, or is there anything different you are doing in, whether it's reserving or what have you, that's part of that answer?

On the recovery side we are not doing anything different, and it is not really anything reflective of anything we are doing on the reserving side. I think we are seeing just continued good, solid performance in our benefits operations area.

I think on the offset side the same thing is true, although there is also maybe a positive affect showing up from Social Security maybe approving more claims in recent days, and also there was a cost of living adjustment during the course of this year in Social Security as well, so that probably benefits us to some small degree on the offset side. But no, I think it's just diligent performance.

Okay. And then back to the capital management question. I guess I understand the comments and understand the rational of wanting to be patient. We are still in a -- somewhat of a volatile market. But I guess the one thing I struggle a little bit with is, you know, why not take a little bit of where we are at and top up the pension plan before year end? I guess what I am thinking about is it looks theoretically you've got, call it, $1.2 billion of capital margin today. Topping up the pension plan before year end is obviously rating agency friendly; cosmetically it shows a better position. I guess, why not take a little bit of that, I think it was said around $200 million on a prior quarter call, why not do that before year end?

Rick?

So as we look at the pension in terms of how it's come down and the funding status in the course of the year, we had funded part of that earlier in the year, we are looking at a potential addition by the end of the year, but we don't have a need to fund up completely right away. We do see some of those investments that we have will come back over time, and we like to take a little bit longer-term view to it, but not to say that we wouldn't put some more money in the pension before year end and adjust our plans over the next couple of years, but we don't have a need to completely fund that up today, watch it continue to accrete and have that capital then, effectively, be within the pension and unable to access it.

Okay. Thank you.

Next question comes from Tom Gallagher with Credit Suisse.

Thanks guys, it's Mike [Johnson] filling in for Tom, actually. Two questions. So spread tightening's been great for book value, obviously. Some competitors have talked about lower new money yields pressuring margins, though. I believe in your prepared remarks you talked about your reserve margin widening, which seemed a little bit counter-intuitive, so if you can give us some color on that issue?

Tom, you want to take that one?

Sure. Michael, I think what we are seeing, first of all to put numbers around it, we saw the this is for Unum US LTD block of business, that net interest margin widened from 87 basis points in the second quarter to about 91 basis points here in the third quarter. You are exactly right, you know, new money yields have come down, but I think what we are benefiting is that fact that late last year, the early part of this year, those new money investments were so wide that it's just given us some nice momentum that will probably continue here for a couple of more quarters.

So if you think about it, we've got a very large investment portfolio, $6 billion, $7 billion, and we are investing for that particular block of business in real round numbers maybe $100 million a quarter or something like that. So any one quarter's new money yields aren't going to have a significant impact. You really kind of need to think of it more kind of on a rolling four-quarter basis. Again, we are still benefiting from some of the nice high yields.

Now what we look at is, we project all this forward, and we were -- given where we are with the discount rate on new claim [incurrals] being quite a bit lower than the aggregate that we use, we are in good shape. We are -- the 91 basis points I referenced. We target somewhere in the 50 to 60 basis point range, so there is quite a bit of cushion there that we could potentially eat into over many, many quarters before we would be in a position to need to make any adjustments to new claim incurrals.

With that -- I guess this gets into my next question, I guess the cushion between you're saying 50 is your target, you've got 91 bips, if I look on -- I don't know if that has anything that correlates with -- on a statutory basis, prior year reserve development still continues to look great, I think it was positive $69 million this quarter. I believe it was likely a net number. I don't know if there were any particularly big positives or negatives in there on a statutory basis or if this cushion --

There really weren't any unusual items in the statutory earnings. I think it's just a good, solid quarter, and as Kevin referenced when he was talking about operations, a good, solid operating performance on the claims side, and that leads into nice solid profitability.

Okay. Thank you, guys.

Thank you, Michael.

Next question comes from the Randy Binner with FBR Capital Markets.

Thanks. Just back to the incidence thing, you made comments at one of the investor conferences in September that overall incidence and other claims trends for DI were not where they usually are relative to macro trends, most notably unemployment. So I hear the comments that you have made that its more a volatility issue rather than any kind of trend, but maybe just at a higher level it would be nice to hear a view of kind of where you potentially saw this kind of volatility relative to past cycles, in particular as it relates to the unemployment rate?

Kevin, you want to take that? Maybe a good place to start is reminding everyone about the mix shift that we have been through. Because I think in the past, certainly we saw greater volatility in incidence amongst our large case block of business, and obviously we've been through fairly substantial change in strategy there.

That's exactly right, Tom. I think -- as you remember last year at investor day, we modeled out sort of the idea that we might have a 5% or so uptick in incidents during the course of this year, and we haven't really seen that. We saw a little bit of volatility during the third quarter, although most of that was actually in July. As I look at incidence as it emerged through the rest of the third quarter and into the beginning of the fourth quarter, it seems to have come right back down and stabilized again.

I think the big difference for us as a company compared to prior recessions is really two things; we are much more focused on mix of business by size, as Tom said, I think Tom White mentioned that two-thirds of our sales were in the core during the third quarter, and that's been a pretty consistent pattern over the last six, seven, eight quarters.

Also we often talk about our diligence about industry mix as well, and shifting our mix of business away from transportation, wholesale, retail, more recession-sensitive industries, and towards health care, education, professional services, where at least in health care employment has been fairly stable in comparison to other industries. So I think our management of mix of business has been the most critical factor in keeping that incidence line stable.

Maybe this is a teaser for investor day, I think you will go into that in more depth by industry type, actually, this upcoming Monday.

Yes.

Okay, that's helpful. Maybe on the new money yields, obviously it trended across the industry that new money yields are lower, and so we are already seeing that investment income lines. Just some color on if there is any sort of shift in how you are looking at different asset classes on a new money basis, and where you maybe see the best opportunity?

Yes, Randy, really no changes there, we are basically a corporate bond investor. The BBB, single A range is kind of the sweet spot for us. I'd say we are probably seeing maybe incrementally a little bit more opportunity in some commercial mortgage loans, but that's really the area. One of the things we benefit on, I probably should have mentioned it in my other answer, was we've done fair amount of hedging over the years, and that -- we get benefits from that. Part of the reason for the program is because when we get into environments like this, where treasuries are low, spreads come in, having that little incremental pick up from hedges certainly helps that new money yield, and probably adds 20, 25 basis points to a quarter's new money yield.

Okay. Great, thank you.

Next question comes from the John Nadel with Sterne Agee.

Good morning, everybody. So I wanted to go back to the capital management issue, and I assume that next week there will be some more time spent on this, so I don't want to steal any of your thunder. But I'm thinking about the $900 million target for cash and liquidity at the holding company; if you're at a 360 RBC, maybe the RBC ratio needs to be higher sustainably going forward than it's been historically. But you could still sort of argue $5 million to 700 million of capital cushion at the life company is under that scenario.

You are sitting on a lot. The business overall appears to be trending down, in terms of the size, just given macro conditions, so capital needed to support growth seems to be lower than historical. I'm just wondering if you could give us maybe a little bit better sense of understanding the caution on the outlook -- macro outlook, how long would you expect to sort of maintain those extra -- that extra cushion?

Rick, you want to pick up on that?

Sure. We will talk about it in a fair amount of detail next week as well, but not to delay to that, there isn't really a timeframe. We are evaluating on a daily basis what the economy is looking like. This is a cautious stance, and with a fair amount of capital, so wouldn't want to put a timeframe on it, or anything we are going to do.

We do have options, and this flexibility does give us options about where we put that capital. We will talk about -- more about what the options are. But I think your numbers are right. We have a fair amount of capital cushion both at our insurance companies as well as at the holding company, and we will have to choose what to do with that over the course of the next 12 to 18 months. What we have said is just now is not that time.

Okay. Somewhat relatedly, is there anything, are there any real opportunities out there from an M&A perspective?

John, I'll pick up on that one. I think -- we have always said our first focus is just taking our existing three businesses, investing heavily in them, especially now when maybe some others don't have ability to do so, just to continue to build off of our strengths in the marketplace. So I just want to emphasize, our first priority is just taking the three operations we have and continue to make them better.

Having said that, we are going to certainly keep our eye open for acquisitions that may supplement the things we are doing in our three businesses. We obviously have the financial and capital wherewithal to so, but we are awfully disciplined. It would have to fit very nicely with the things we're doing, the risk would have to be incredibly manageable. So I would say at this particular point in time there is not much out there. We're looking, we continue to network to be sure that we have a chance to look at things that might work. But it's very slim pickings in terms of things that would be fitting the criteria that I admit are very high, but the criteria we have set for an acquisition.

Fair enough, thank you.

(Operator Instructions)

Next question comes from Steven Schwartz with Raymond James and Associates.

Good morning. Just a couple of quickies here, going back to renewals on the group DI business, any change really in the trends vis-a-vis rate guarantee periods?

Kevin?

Good morning, Steven. Not from our end, at least, in terms of rate guarantee period. I think we are watching the economy, we are happy with persistency, the improving persistency that we have on the block. We think the block is stable, which is why our rate increases and our stance is pretty flat. We have seen some activity, more on the sales side in the marketplace, where larger, longer rate guarantees have been offered by some competitors but not by us. We are not moving on that.

Okay, very good. Just on the question of ratings migration as a corporate bond buyer, my assumption just sitting here looking at my screen day-in, day-out, would be that that have slowed down considerably?

Actually, we have not seen a lot of ratings migration across our book of business in general, and certainly that would have slowed down as of late, but it is important to note that we did not see that much in the quality of our booking from where we were over the course of time.

Steven, it's Tom White. One thing that we will have on the investor day materials, we will break out that BBB exposure, and what you will see there is the low end of the BBB, you know, we have much less exposure, so I think there is a bit less risk of seeing downgrades, because we tend to migrate to the upper end of that BBB range.

Okay, very good. See you all Monday.

There are no other questions in queue, so I will turn it back over for closing remarks.

Thank you, Operator. Thank you all for joining us this morning. We look forward to seeing as many of you as possible next Monday for our investor day meeting. This concludes our third quarter earnings call.

This concludes today's conference call. You may now disconnect.