In 2005, the Company disposed of its remaining 40 percent ownership position in its Argentinean operation and recognized an after tax gain of approximately $0.4 million.
Assets transferred to the buyer included available-for-sale fixed maturity securities with a fair value of $1,099.4 million (book value of $957.7 million) and cash of $31.7 million. Liabilities transferred included reserves of $1,254.8 million. The Company retained a portion of the Canadian branch fixed maturity bond portfolio according to the terms of the transaction. At the close of the transaction, the bonds retained had a fair value of $732.9 million and a yield of 7.14 percent, which added approximately four basis points to the investment portfolio yield rate in the Company’s continuing operations. These investments were subsequently redeployed to the Company’s other lines of business. Financial results for the Canadian branch are reported as discontinued operations in the consolidated financial statements. Accordingly, the discussion of results by segment as follows does not include amounts related to those operations. See “Discontinued Operations” contained herein in Item 7 and Note 2 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further discussion of the Company’s discontinued operations.
(3) Certain items for the Unum Limited segment have been reclassified between IBNR and All Other to conform to current reporting.
Current Baa corporate bond spreads ranging from 0.78 percent to 1.75 percent plus an additional 30 basis points were added to the risk free rate to reflect the lack of liquidity.
Included in the results for 2005 is an after tax charge of $51.6 million related to the Company’s settlement of a market conduct examination with the California DOI and related matters. Included in the results for 2004 are after tax charges of $701.0 million related to the restructuring of the individual income protection - closed block business and $87.8 million related to the Company’s settlement of the multistate market conduct examination. Included in the results for 2003 is an after tax charge of $581.1 million related to U.S. Brokerage group income protection reserve strengthening. The losses from discontinued operations are related to the sale of the Company’s Canadian branch, which closed effective April 30, 2004. See preceding discussions concerning significant transactions and events and “Discontinued Operations” contained herein in Item 7 and the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further details.
Shown below are financial results and key performance indicators for U.S. Brokerage supplemental and voluntary product lines.
As of December 31, 2005, the Company’s exposure to below-investment-grade fixed maturity securities was $2,180.7 million, approximately 6.0 percent of the fair value of invested assets excluding ceded policy loans, compared to 6.4 percent at the end of 2004. Below-investment-grade bonds are inherently more risky than investment-grade bonds since the risk of default by the issuer, by definition and as exhibited by bond rating, is higher. Also, the secondary market for certain below-investment-grade issues can be highly illiquid. Additional downgrades may occur during 2006, but the Company does not anticipate any liquidity problem caused by its investments in below-investment-grade securities, nor does it expect these investments to adversely affect its ability to hold its other investments to maturity.
During 2005, the Company initiated a derivatives strategy to hedge the foreign currency risk associated with the U.S. dollar denominated debt issued by one of its U.K. subsidiaries. As of December 31, 2005, the Company had $400.0 million notional amount of currency swaps and $216.3 million notional amount of forward currency contracts outstanding under this program.
During 2003, the Company had cash inflows of $110.0 million related to the acquisition of Sun Life. The Company also received fixed maturity securities of approximately $118.4 million and other miscellaneous assets and liabilities of approximately $20.3 million and assumed reserves of approximately $285.9 million relative to the Sun Life acquisition, for a net purchase price of $37.2 million. During 2003, the Company had $152.5 million of cash outflows related to the disposition, through reinsurance ceded, of a block of policies previously sold through trade associations.
In May 2004, S&P downgraded the Company’s counterparty credit rating and senior debt rating to BB+ from BBB- while at the same time lowering the counterparty credit and financial strength ratings on the Company’s insurance company subsidiaries to BBB+ from A-, all with a “stable” outlook, citing concerns about the consistency of risk controls and valuation practices, which S&P believes have led to reserve charges and asset impairments in the past several quarters and have also contributed to marginal operating performance in the Company’s U.S. group income protection business. The outlook reflects the effects of strengthened capital adequacy, improved investment risk, and corrective measures taken by the Company to limit the downside on the closed block of individual income protection business and to improve profitability on its U.S. group income protection insurance. The change in the senior debt rating to BB+ represents a below-investment-grade rating. In October 2005, S&P reaffirmed all of the ratings of the Company following the announcement of the settlement agreement with the California DOI. In November 2005, S&P assigned a BB+ rating to the $400.0 million 6.85% senior debentures.
Policy Loans are presented at unpaid balances directly related to policyholders. Included in policy loans are $3,005.4 million and $2,881.2 million of policy loans ceded to reinsurers at December 31, 2005 and 2004, respectively.
Foreign currency exposure hedge. To the extent it is effective, changes in the fair value of the derivative are reported in other comprehensive income as part of the foreign currency translation adjustment and reclassified into earnings in the same period or periods during which remeasurement of the hedged foreign currency asset affects earnings. The ineffective portion of the hedge, if any, is recognized in current earnings during the period of change in fair value. The gain or loss on the termination of an effective foreign currency exposure hedge is reported in other comprehensive income as part of the foreign currency translation adjustment and reclassified into earnings in the same period or periods during which remeasurement of the hedged foreign currency asset affects earnings.
Derivatives: Fair values are based on market quotes or pricing models and represent the net amount of cash the Company would have received or paid if the contracts had been settled or closed as of the last day of the year.
The majority of the net balances are related to disability claims with long-tail payouts on which interest earned on assets backing liabilities is an integral part of pricing and reserving. Interest accrued on prior year reserves has been calculated on the opening reserve balance less one-half year’s cash payments at the average reserve discount rate used by the Company during 2005, 2004, and 2003.
A reconciliation of the income tax expense (benefit) attributable to income (loss) from continuing operations before income tax and cumulative effect of accounting principle change, computed at U.S. federal statutory tax rates to the income tax expense (benefit) as included in the consolidated statements of operations, is as follows.
Interest paid on short-term and long-term debt and related securities during 2005, 2004, and 2003 was $210.7 million, $205.2 million, and $182.2 million, respectively.
During 2005, the large cap equity manager of the U.S. qualified defined benefit plan elected to sell the Company’s common stock that was previously held in this plan. The investment managers serve as plan fiduciaries and have authority to execute investments based on the plan’s investment policy statement. At December 31, 2004, equity securities in this plan included $8.1 million of holdings in the Company’s common stock. Dividends paid to the plan during 2005 and 2004 were immaterial.
Effective July 1, 2005, the Company modified its reporting segments to separate its United States business from that of its United Kingdom subsidiary, Unum Limited, due to the continued growth in that subsidiary and to recent organizational changes within the Company which established a separate management team to focus solely on the U.S. Brokerage lines of business. The Company’s new reporting segments are comprised of the following: U.S. Brokerage, Unum Limited, Colonial, Individual Income Protection - Closed Block, Other, and Corporate.
The Company experienced increased market conduct examinations by state insurance departments during 2002 and 2003 focused specifically on its disability claims handling policies and practices. On March 19, 2003, the Company consented to the entry of an order by the Georgia Insurance Commissioner that, among other things, ordered four of the Company’s insurance subsidiaries to each pay a monetary penalty of $250,000 and to adhere to certain claims handling practices. The order also placed these four companies on regulatory probation for two years. The Georgia order did not cite any violations of Georgia law or regulations.