We occupy approximately 2.6 million square feet of space at four principal United States operating centers in Chattanooga, Tennessee; Portland, Maine; Worcester, Massachusetts; and Columbia, South Carolina.
Further enhance financial flexibility through solid operating and investment performance, as well as a disciplined approach to capital management.
For 2010 we reported net income per share, assuming dilution, of $2.71 compared to $2.57 in 2009. After-tax operating income was $2.69 per share compared to $2.57 per share in 2009. Our operating revenue by segment increased 0.9 percent over 2009, with the current economic environment continuing to negatively impact our premium growth. Operating income by segment increased 2.0 percent over 2009, with solid performance in many of our product lines. See “Reconciliation of Non-GAAP Financial Measures” contained herein in Item 7.
Our Unum US segment reported an increase in segment operating income of 6.6 percent in 2010 compared to 2009, with the overall risk experience across our product lines remaining generally stable. The benefit ratio for the Unum US segment for 2010 was 79.3 percent compared to 79.1 percent in 2009, with year over year improvement in benefit ratios for group disability and voluntary benefits slightly offset by the higher benefit ratio in the individual disability - recently issued and long-term care product lines. Unum US premium income decreased slightly in 2010 compared to 2009. Similar to 2009, the ongoing high levels of unemployment and the competitive environment continued to pressure our sales and premium income growth. In particular, premium growth from existing customers continued to be unfavorably impacted by lower salary growth and lower growth in the number of employees covered under an existing policy. Partially offsetting this unfavorable impact on premium growth was higher persistency. Unum US sales, which were also negatively impacted by the economy and the competitive environment, decreased 5.7 percent in 2010 compared to 2009. Our group core market segment, which we define for Unum US as employee groups with fewer than 2,000 lives, reported a sales decline of 8.3 percent in 2010 relative to 2009. Sales in the group large case market segment in 2010 declined 19.8 percent compared to 2009. Sales of voluntary benefits increased 15.6 percent in 2010 compared to 2009. Persistency for all product lines remains high relative to historical levels.
Our Unum UK segment reported a decrease in segment operating income of 15.8 percent in 2010, as measured in Unum UK’s local currency, relative to last year. The decrease was driven by a decline in premium income as well as less favorable risk results. The decline in premium income resulted from lower premium growth from existing customers and pricing actions due to the competitive U.K. market. The benefit ratio for Unum UK was 67.0 percent in 2010 compared to 54.5 percent in 2009, driven primarily by lower premium income, the impact of higher inflation on claim reserves associated with group long-term disability policies containing an inflation-linked benefit increase feature, and unfavorable claim experience in group life. Overall sales in Unum UK were generally consistent with the prior year, with a decline of 0.9 percent in 2010, as measured in Unum UK’s local currency. Negatively affecting year over year comparisons is an increase in 2009 sales which resulted from the exit of another large insurance provider from the U.K. group risk market. Persistency generally improved over the levels of last year.
Index to Financial Statements Our Colonial Life segment reported a slight increase in segment operating income of 0.5 percent in 2010 relative to 2009, with premium growth of 6.0 percent relative to last year. Risk results were less favorable than last year, with a benefit ratio of 49.7 percent in 2010 compared to 47.3 percent in 2009, driven primarily by unfavorable experience in the accident, sickness, and disability product line. Colonial Life’s sales increased 4.4 percent relative to 2009. The number of new accounts and new agent contracts both increased relative to the prior year, while the average new case size declined. Persistency continues to remain strong and is slightly higher than the levels of 2009.
We believe our capital and financial positions are strong. At the end of 2010, the risk-based capital ratio for our traditional U.S. insurance subsidiaries, calculated on a weighted average basis using the NAIC Company Action Level formula, was approximately 398 percent, compared to 382 percent at the end of 2009. Our leverage ratio, when calculated using consolidated debt to total consolidated capital, was 25.9 percent at December 31, 2010 compared to 24.8 percent at December 31, 2009, reflecting the issuance of $400.0 million of senior notes during the third quarter of 2010. Our leverage ratio, when calculated excluding the non-recourse debt and associated capital of Tailwind Holdings, LLC (Tailwind Holdings) and Northwind Holdings, LLC (Northwind Holdings), was 22.8 percent at December 31, 2010 compared to 20.5 percent at the end of 2009. The cash and marketable securities at our holding companies equaled approximately $1.2 billion at the end 2010, compared to $915 million at the end of 2009. During 2010, we repurchased 16.4 million shares of Unum Group’s common stock under our $500.0 million share repurchase program, at a cost of approximately $356.0 million. In February 2011, our board of directors authorized the repurchase of up to $1.0 billion of Unum Group’s common stock over the next 18 months, in addition to the amount remaining to be repurchased under the $500.0 million program.
Despite the difficult economic environment, we continue to make steady and disciplined progress, executing on our business plans and strengthening our financial position. We remain cautious of the near-term outlook for employment levels and wages, both of which limit opportunities for premium growth, but we believe we are poised to profitably grow as employment trends improve.
Further discussion is included in “Segment Results,” “Investments,” and “Liquidity and Capital Resources” contained in this Item 7.
During 2011, our focus will remain on disciplined top-line growth and capital management. Objectives for the year include:
Leverage our capabilities, products, relationships, and reputation to deliver on our commitments as well as our bottom-line targets;
Our largest liabilities are reserves for claims that we estimate we will eventually pay to our policyholders. The two primary categories of reserves are policy reserves for claims not yet incurred and claim reserves for claims that have been incurred or are estimated to have been incurred but not yet reported to us. These reserves equaled $38.2 billion and $37.8 billion at December 31, 2010 and 2009, respectively, or approximately 78.9 percent and 82.3 percent of our total liabilities, respectively. Reserves ceded to reinsurers were $6.7 billion at both December 31, 2010 and 2009, and are reported as reinsurance recoverable in our consolidated balance sheets.
Policy reserves are established in the same period we issue a policy and equal the difference between projected future policy benefits and future premiums, allowing a margin for expenses and profit. These reserves relate primarily to our traditional non interest-sensitive products, including our individual disability, individual and group long-term care, and voluntary benefits products in our Unum US segment; individual disability products in our Unum UK segment; disability and cancer and critical illness policies in our Colonial Life segment; and, the Individual Disability - Closed Block segment products. The reserves are calculated based on assumptions that were appropriate at the date the policy was issued and are not subsequently modified unless the policy reserves become inadequate (i.e., loss recognition occurs).
Index to Financial Statements Policy reserves for Unum US, Unum UK, and Colonial Life products, which at December 31, 2010 represented approximately 40.0 percent, 0.2 percent, and 9.5 percent, respectively, of our total gross policy reserves, are determined using the net level premium method as prescribed by GAAP. In applying this method, we use, as applicable by product type, morbidity and mortality incidence rate assumptions, claim resolution rate assumptions, and policy persistency assumptions, among others, to determine our expected future claim payments and expected future premium income. We then apply an interest, or discount, rate to determine the present value of the expected future claims and claim expenses we will pay and the expected future premiums we will receive, with a provision for profit allowed.
Policy reserves for our Individual Disability - Closed Block segment, which at December 31, 2010 represented approximately 9.0 percent of our total gross policy reserves, are determined using the gross premium valuation method based on assumptions established as of January 1, 2004, the date of loss recognition. Key assumptions are policy persistency, claim incidence, claim resolution rates, commission rates, and maintenance expense rates. We then apply an interest, or discount, rate to determine the present value of the expected future claims, commissions, and expenses we will pay as well as the expected future premiums we will receive, with no provision for future profit. The interest rate is based on our expected net investment returns on the investment portfolio supporting the reserves for this segment. Under the gross premium valuation method, we do not include an embedded provision for the risk of adverse deviation from these assumptions. Gross premium valuation assumptions do not change after the date of loss recognition unless reserves are again determined to be deficient. We perform loss recognition tests on the policy reserves for this block of business quarterly.
Claim reserves supporting the Unum US group life and accidental death and dismemberment products represent approximately 3.8 percent of our total claim reserves at December 31, 2010. Claim reserves for these products are related primarily to death claims reported but not yet paid, IBNR death claims, and a liability for waiver of premium benefits. The death claim reserve is based on the actual face amount to be paid, the IBNR reserve is calculated using the count and severity method, and the waiver of premium benefits reserve is calculated using the tabular reserve methodology.
Claim reserves supporting our Unum UK segment represent approximately 9.0 percent of our total claim reserves at December 31, 2010, and are calculated using generally the same methodology that we use for Unum US disability and group life reserves. The assumptions used in calculating claim reserves for this line of business are based on standard United Kingdom industry experience, adjusted for Unum UK’s own experience.
The following table displays policy reserves, incurred claim reserves, and IBNR claim reserves by major product line, with the summation of the policy reserves and claim reserves shown both gross and net of the associated reinsurance recoverable. Incurred claim reserves represent reserves determined for each incurred claim and also include estimated amounts for litigation expenses and other expenses associated with the payment of the claims as well as provisions for claims which we estimate will be reopened for our long-term care products. IBNR claim reserves include provisions for incurred but not reported claims and a provision for reopened claims for our disability products. The IBNR and reopen claim reserves for our disability products are developed and maintained in aggregate based on historical monitoring that has only been on a combined basis.
1. The discount rate, which is used in calculating both policy reserves and incurred and IBNR claim reserves, is the interest rate that we use to discount future claim payments to determine the present value. A higher discount rate produces a lower reserve. If the discount rate is higher than our future investment returns, our invested assets will not earn enough investment income to support our future claim payments. In this case, the reserves may eventually be insufficient. We set our assumptions based on our current and expected future investment yield of the assets supporting the reserves, considering current and expected future market conditions. If the investment yield on new investments that are purchased is below or above the investment yield of the existing investment portfolio, it is likely that the discount rate assumption on claims will be established to reflect the effect of the new investment yield.
Because our actual experience regarding persistency and claim incidence has varied very little from our policy reserve and IBNR claim reserve assumptions, we have had minimal adjustments to our persistency assumptions and claim incidence assumptions during the years 2008 through 2010. Generally, we do not expect our mortality and morbidity claim incidence trends or our persistency trends to change significantly in the short-term, and to the extent that these trends do change, we expect those changes to be gradual over a longer period of time. However, we have historically experienced an increase in our group long-term disability morbidity claim incidence trends during and following a recessionary period, particularly in our Unum US operations. During 2010, claim incidence rates for Unum US group long-term disability were slightly elevated. Given the current economic conditions, it is possible that our claim incidence rates for this type of product may increase.
Claim resolution rates have a greater chance of significant variability in a shorter period of time than our other reserve assumptions. These rates are reviewed on a quarterly basis for the death and recovery components separately. Claim resolution rates in our Unum US segment group and individual long-term disability product lines and our Individual Disability - Closed Block segment have over the last several years exhibited some variability. Relative to the resolution rate we expect to experience over the life of the block of business, actual quarterly rates during 2009 and 2010 have varied by +3 and -4 percent in our Unum US group long-term disability line of business, between +10 and -12 percent in our Unum US individual disability - recently issued line of business, and between +5 and -3 percent in our Individual Disability - Closed Block segment.
Claim resolution rates are very sensitive to operational and environmental changes and can be volatile over short periods of time. Throughout the period 2008 to 2010, we had generally stable to improving claims management performance, and our claim resolution rates were fairly consistent with or slightly favorable to our long-term assumptions. Our claim resolution rate assumption used in determining reserves is our expectation of the resolution rate we will experience over the life of the block of business and will vary from actual experience in any one period, both favorably and unfavorably.
We monitor and test our reserves for adequacy relative to all of our assumptions in the aggregate. In our estimation, scenarios based on reasonably possible variations in each of our reserve assumptions, when modeled together in aggregate, could produce a potential result, either positive or negative, in our Unum US group disability line of business that would change our reserve balance by +/- 2.5 percent. Using our actual claim reserve balance at December 31, 2010, this variation would have resulted in an approximate change (either positive or negative) of $200 million to our claim reserves. Using the same sensitivity analysis approach for our Individual Disability - Closed Block segment, the claim reserve balance could potentially vary by +/- 2.6 percent of our reported balance, which at December 31, 2010, would have resulted in an approximate change (either positive or negative) of $260 million to our claim reserves. The major contributor to the variance for both the group long-term disability line of business and the Individual Disability - Closed Block segment is the claim resolution rate. We believe that these ranges provide a reasonable estimate of the possible changes in reserve balances for those product lines where we believe it is possible that variability in the assumptions, in the aggregate, could result in a material impact on our reserve levels, but we record our reserves based on our long-term best estimate. Because these product lines have long-term claim payout periods, there is a greater potential for significant variability in claim costs, either positive or negative.
We defer certain costs incurred in acquiring new business and amortize (expense) these costs over the life of the related policies. Deferred costs include certain commissions, other agency compensation, selection and policy issue expenses, and field expenses. Acquisition costs that do not vary with the production of new business, such as commissions on group products which are generally level throughout the life of the policy, are excluded from deferral.
1. The market approach uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities. Valuation techniques consistent with the market approach often use market multiples derived from a set of comparables or matrix pricing. Market multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering both quantitative and qualitative factors specific to the measurement. Matrix pricing is a mathematical technique used principally to value certain securities without relying exclusively on quoted prices for the specific securities but comparing the securities to benchmark or comparable securities.
We use valuation techniques that are appropriate in the circumstances and for which sufficient data are available that can be obtained without undue cost and effort. In some cases, a single valuation technique will be appropriate (for example, when valuing an asset or liability using quoted prices in an active market for identical assets or liabilities). In other cases, multiple valuation techniques will be appropriate. If we use multiple valuation techniques to measure fair value, we evaluate and weigh the results, as appropriate, considering the reasonableness of the range indicated by those results. A fair value measurement is the point within that range that is most representative of fair value in the circumstances.
Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources.
As of December 31, 2010, the key assumptions we generally used to estimate the fair value of these types of securities included those listed below. Where appropriate, we have noted the assumption used for the prior period as well as the reason for the change.
Increasing the 20 basis points added to the risk free rate for lack of liquidity by one basis point, increasing the five basis points added to the risk free rates for foreign investments by one basis point, and increasing the additional basis points added to each industry considered to be of greater risk by one basis point would have decreased the December 31, 2010 fair value of these types of securities by approximately $0.5 million. We believe this range of variability is appropriate, and historically the inputs noted have generally not deviated outside the range provided.
We regularly test the validity of the fair values determined by our valuation techniques by comparing the prices of assets sold to the fair values reported for the assets in the immediately preceding reporting period. Historically, our realized gains or losses on dispositions of investments have not varied significantly from amounts estimated under the valuation methodologies described above, which, combined with the results of our testing, indicates to us that our pricing methodologies are appropriate.
Approximately 69.7 percent of our fixed maturity securities were valued based on prices from pricing services that generally use observable inputs such as prices for securities or comparable securities in active markets in their valuation techniques. These assets were classified as Level 2. Level 2 assets or liabilities are those valued using inputs (other than prices included in Level 1) that are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
Whether we expect to recover the entire amortized cost basis of the security.
The time period during which there has been a significant decline in value.
Index to Financial Statements If we determine that the decline in value of an investment is other than temporary, the investment is written down to fair value, and an impairment loss is recognized in the current period, either in earnings or in both earnings and other comprehensive income, as applicable. For those fixed maturity securities with an unrealized loss for which we have not recognized an other-than-temporary impairment, we believe we will recover the entire amortized cost, we do not intend to sell the security, and we do not believe it is more likely than not we will be required to sell the security before recovery of its amortized cost. There have been no defaults in the repayment obligations of any securities for which we have not recorded an other-than-temporary impairment.
The assessment of a borrower’s ability to meet its contractual obligations will change.
Our net periodic benefit costs and the value of our benefit obligations for these plans are determined based on a set of economic and demographic assumptions that represent our best estimate of future expected experience. Major assumptions used in accounting for these plans include the expected discount (interest) rate and the long-term rate of return on plan assets. We also use, as applicable, expected increases in compensation levels and a weighted average annual rate of increase in the per capita cost of covered benefits, which reflects a health care cost trend rate, and the U.K. pension plan also uses expected cost of living increases to plan benefits.
The discount rate we used to determine our 2011 and 2010 net periodic benefit costs for our U.S. pension plans was 5.80 percent and 6.40 percent, respectively. The discount rate used for the net periodic benefit costs for 2011 and 2010 for our U.K. pension plan was 5.60 percent and 5.70 percent, respectively. The discount rate used in the net periodic benefit cost for our OPEB plan for 2011 and 2010 was 5.60 percent and 5.90 percent, respectively.
Increasing the discount rate assumption by 50 basis points would have resulted in a decrease in our 2010 pension expense of approximately $11.9 million, before tax, and a decrease in our benefit obligation of approximately $123.8 million as of December 31, 2010, resulting in an after-tax increase in stockholders’ equity of approximately $81.6 million as of December 31, 2010. A 50 basis point increase in the discount rate assumption would not change our annual OPEB costs.
The long-term rate of return assumption is the best estimate of the average annual assumed return that will be produced from the pension trust assets until current benefits are paid. The U.S. pension plans use a compound interest method in computing the rate of return on their pension plan assets. The investment portfolio for our U.S. pension plans contain a diversified blend of domestic and international large cap, mid cap, and small cap equity securities, U.S. government and agency and corporate fixed income securities, private equity funds of funds, and hedge funds of funds. Assets for our U.K. pension plan are invested in pooled funds, including a diversified growth fund, which invests in assets such as global equities, hedge funds, commodities, below-investment-grade fixed income securities, and currencies, as well as a fixed-interest U.K. corporate bond fund and an index-linked U.K.
Changing the expected long-term rate of return on the plan assets by +/-50 basis points would have changed our 2010 pension plan expense by approximately $5.8 million before tax, but our OPEB plan expense would not change. A lower rate of return on plan assets increases our expense.
During 2010, the fair value of our plan assets in our U.S. qualified defined benefit pension plan increased $291.1 million, or approximately 32.8 percent. The fair value of plan assets for our U.K. pension plan increased £13.2 million, or approximately 13.3 percent, during 2010. Although the effect of these increases had no impact on our 2010 net periodic pension costs, the favorable rate of return on plan assets in 2010 has a favorable impact on our net periodic pension costs for 2011. We expect that our 2011 pension costs will be generally consistent with the level of our pension costs in 2010, however, given the decrease in the discount rate. We believe our assumptions appropriately reflect the impact of the current economic environment.
The unrecognized gains or losses are amortized as a component of the net benefit cost. Our 2010, 2009, and 2008, pension and OPEB expense includes $29.1 million, $40.2 million, and $10.6 million, respectively, of amortization of the unrecognized net actuarial gain (loss) and prior service credit (cost). The lower amortization in 2010 resulted primarily from the decrease in the unrecognized net actuarial loss due to the favorable rate of return on plan assets for our U.S. pension plans. The unrecognized net actuarial loss for our pension plans, which is $513.8 million at December 31, 2010, will be amortized over the average future working life of pension plan participants, currently estimated at 11 years for U.S. participants and 15 years for U.K. participants, to the extent that it exceeds the 10 percent corridor, as described below. The unrecognized net actuarial gain of $1.4 million for our OPEB plan will be amortized over the average future working life of OPEB plan participants, currently estimated at 8 years, to the extent the loss is outside of a corridor established in accordance with GAAP. The corridor for the pension and OPEB plans is established based on the greater of 10 percent of the plan assets or 10 percent of the benefit obligation. At December 31, 2010, none of the actuarial gain was outside of the corridor for the OPEB plan.
Our expected return on plan assets and discount rate discussed above will not affect the cash contributions we are required to make to our U.S. pension and OPEB plans because we have met all minimum funding requirements set forth by ERISA. We had no regulatory contribution requirements for 2010 and 2009; however, we elected to make voluntary contributions of $167.0 million and $70.0 million, respectively, to our U.S. qualified defined benefit pension plan. We do not anticipate making any additional contributions during 2011.
The fair value of plan assets for our U.K. pension plan was £112.7 million at December 31, 2010, compared to £99.5 million at December 31, 2009. The U.K. pension plan has a surplus of £14.8 million at December 31, 2010, compared to a deficit of £7.8 million at December 31, 2009. We contribute to the plan in accordance with a schedule of contributions which requires that we contribute to the plan at the rate of at least 15.0 percent of total employee salaries (including employees who are not members of the defined benefit plan), less contributions to our defined contribution plan, sufficient to meet the minimum funding requirement under U.K. legislation. During 2010 and 2009, we made required contributions of £3.2 million and £3.5 million, respectively. We anticipate that we will make contributions during 2011 of approximately £3.2 million.
On a quarterly basis, we review relevant information with respect to litigation and contingencies to be reflected in our consolidated financial statements. An estimated loss is accrued when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. It is possible that our results of operations or cash flows in a particular period could be materially affected by an ultimate unfavorable outcome of pending litigation or regulatory matters depending, in part, on our results of operations or cash flows for the particular period. See Note 13 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further discussion.
Consolidated premium income for both 2010 and 2009 includes premium growth, relative to the preceding years, for our Unum US long-term care and voluntary benefits lines of business as well as for Colonial Life. Unum US group life and accidental death and dismemberment experienced premium growth in 2010 relative to 2009. Our Unum US group disability line of business experienced year over year declines in premium income during 2010 and 2009 relative to prior years due primarily to the ongoing high levels of unemployment and the competitive environment which impact sales growth and premium growth from existing customers. In particular, premium growth from existing customers continues to be unfavorably impacted by lower salary growth and lower growth in the number of employees covered under an existing policy. Premium income for Unum US individual disability - recently issued declined year over year primarily due to lower sales. Unum UK premium income, in local currency, decreased in both 2010 and 2009 relative to preceding years due primarily to lower premium growth from existing customers, similar to Unum US, and pricing actions due to the competitive U.K. market. Premium income in the Individual Disability - Closed Block segment, which is a closed block of business, continued its expected decline.
Net investment income was higher in 2010 relative to 2009 due primarily to continued growth in the level of invested assets and higher bond call premiums. We also received higher interest income during 2010 on bonds for
The benefit ratio was 85.5 percent in 2010 compared to 84.2 percent in 2009 and 85.1 percent in 2008, with generally consistent overall risk results in Unum US but higher benefit ratios in Unum UK and Colonial Life during 2010 relative to 2009. Risk results in 2009 improved in each of our business segments compared to 2008. Further discussion of our line of business risk results and claims management performance for each of our segments is included in “Segment Results” as follows.
Other expenses decreased in 2010 compared to 2009, primarily due to a decline in our pension costs. Other expenses, as reported, decreased slightly in 2009 relative to 2008. However, if the effect of the lower exchange rate for translating Unum UK’s expenses is excluded, other expenses increased in 2009 due primarily to an increase in our pension costs in 2009 relative to 2008.
In March 2010, legislation related to healthcare reform was signed into law. Among other things, the new legislation reduces the tax benefits available to an employer that receives a postretirement prescription drug coverage subsidy from the federal government under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Under the new legislation, to the extent our future postretirement prescription drug
Sales results shown in the preceding chart generally represent the annualized premium or annualized fee income on new sales which we expect to receive and report as premium income or fee income during the next 12 months following or beginning in the initial quarter in which the sale is reported, depending on the effective date of the new sale. Sales do not correspond to premium income or fee income reported as revenue in accordance with GAAP. This is because new annualized sales premiums reflect current sales performance and what we expect to recognize as premium or fee income over a 12 month period, while premium income and fee income reported in our financial statements are reported on an “as earned” basis rather than an annualized basis and also include renewals and persistency of in-force policies written in prior years as well as current new sales.
Premiums for fully insured products are reported as premium income. Fees for administrative services only (ASO) products are included in other income. Sales, persistency of the existing block of business, and the effectiveness of a renewal program are indicators of growth in premium and fee income. Trends in new sales, as well as existing market share, also indicate the potential for growth in our respective markets and the level of market acceptance of price changes and new product offerings. Sales results may fluctuate significantly due to case size and timing of sales submissions.
The non-GAAP financial measures of “operating revenue,” “operating income” or “operating loss,” and “after-tax operating income” differ from revenue, income (loss) before income tax, and net income as presented in our consolidated operating results and in income statements prepared in accordance with GAAP due to the exclusion of before-tax realized investment gains and losses and certain tax items. We measure performance excluding realized investment gains and losses and certain tax items because we believe that this performance measure is a better indicator of the ongoing businesses and the underlying trends in the businesses. Our investment focus is on investment income to support our insurance liabilities as opposed to the generation of realized investment gains and losses, and a long-term focus is necessary to maintain profitability over the life of the business. Realized investment gains and losses depend on market conditions and do not necessarily relate to decisions regarding the underlying business of our segments. However, income or loss excluding realized investment gains and losses and certain tax items does not replace net income or net loss as a measure of overall profitability. We may experience realized investment losses, which will affect future earnings levels since our underlying business is long-term in nature and we need to earn the assumed interest rates in our liabilities.
A reconciliation of operating revenue by segment to revenue, operating income by segment to net income, and after-tax operating income to net income is as follows:
Our reporting segments are comprised of the following: Unum US, Unum UK, Colonial Life, Individual Disability - Closed Block, and Corporate and Other. Financial information for each of the reporting segments is as follows.
Index to Financial Statements Sales of voluntary benefits increased 15.6 percent in 2010 relative to 2009, and the number of new accounts increased 13.3 percent. Sales in our individual disability line of business, which are primarily concentrated in the multi-life market, decreased 17.2 percent in 2010 compared to 2009. Sales of group long-term care increased 15.2 percent in 2010 compared to 2009.
We continue to believe that the group core market and voluntary benefits market, which combined together are approximately 70 percent of our Unum US sales, represent significant growth opportunities. We will also seek disciplined and opportunistic growth, generally at the market growth rate, in the group large case, group long-term care, and individual disability markets. While in the short-term we expect economic trends to continue to pressure sales growth, we believe we are well-positioned for economic recovery.
Sales of voluntary benefits increased by 2.1 percent, and the number of new accounts increased by 19.5 percent compared to 2008. Sales in our individual disability line of business decreased 10.9 percent compared to 2008, and sales of group long-term care decreased 30.4 percent. We discontinued selling individual long-term care during 2009.
Shown below are financial results and key performance indicators for Unum US group disability.
The benefit ratio was lower in 2010 compared to 2009 due primarily to a higher rate of claim recoveries for group long-term disability, offset partially by an increase in claim incidence rates for both group long-term and short-term disability.
Interest and debt expense related to the debt issued by Tailwind Holdings decreased in 2010 relative to 2009 due to lower rates of interest on the floating rate debt and a decrease in the amount of outstanding debt resulting from principal repayments.
Premium income for group disability declined in 2009 relative to 2008, a portion of which was expected and was attributable to our pricing, renewal, and risk selection strategy. Premium income for our Unum US group business, both disability and life, was also negatively impacted by lower premium growth from existing customers due to lower salary growth and lower growth in the number of employees covered under an existing policy. Premium persistency increased relative to 2008 for group short-term disability in both the core and large case segments. Premium persistency for group long-term disability increased relative to 2008 in the core market segment but decreased in the large case segment, resulting in an overall persistency decline for group long-term disability. Case persistency declined due to a higher number of terminated cases in the smaller size case market within the core segment. These terminations did not affect premium persistency negatively to the degree they affected case persistency due to a lower average premium per terminated case. Net investment income was consistent in 2009 relative to 2008, with an increase in the level of assets offset by lower interest rates on floating rate assets. Other income included ASO fees of $59.2 million and $64.8 million for 2009 and 2008, respectively.
Index to Financial Statements The other expense ratio increased in 2009 compared to 2008 due primarily to the decline in premium income and an increase in policy maintenance expenses associated with the change in the mix of in-force policies from the large case market to the core market segment. Included in 2008 other expenses was $4.4 million related to a 2008 broker compensation settlement agreement.
Index to Financial Statements The benefit ratio for 2010 was consistent with 2009. Commissions were higher due to an increase in supplemental payments. The deferral of acquisition costs increased in 2010 compared to 2009 due primarily to the increase in commission expense. The amortization of acquisition costs in 2010 was lower than 2009 due primarily to a decrease in amortization related to internal replacement transactions.
The other expense ratio decreased in 2010 in comparison to 2009 due to our continued focus on expense management.
The benefit ratio in 2009 was higher than 2008 as a result of a higher average paid claim size in group life which was only partially offset by a lower rate of paid claim incidence.
The deferral of acquisition costs increased in 2009 compared to 2008 due primarily to an increase in the level of deferrable expenses resulting from the increase in sales. Amortization of deferred acquisition costs was lower in 2009 relative to 2008 due to a decrease in amortization related to internal replacement transactions.
The other expense ratio increased in 2009 in comparison to 2008 due to the decline in premium income as well as an increase in policy acquisition-related costs associated with increased sales and an increase in policy maintenance expenses associated with the change in the mix of in-force policies from the large case market to the core market segment.
Premium income in total for these product lines increased in 2010 relative to 2009 due primarily to sales growth in the voluntary benefits product line and higher persistency for all of the product lines. Premium income declined in 2010 relative to 2009 for individual disability - recently issued due to lower sales. Net investment income increased in 2010 relative to 2009 due to growth in the level of assets supporting these lines of business, higher bond call premiums, and an increased level of prepayment income on mortgage-backed securities.
The deferral of acquisition costs in 2010 was consistent with 2009. The amortization of deferred acquisition costs was higher in 2010 relative to 2009 due to an acceleration of amortization resulting from lower persistency for certain issue years in certain of the product lines. The other expense ratio in 2010 was consistent with the level of 2009.
The individual disability - recently issued product line had goodwill of approximately $187.5 million at December 31, 2010, none of which is currently believed to be at risk for future impairment. The fair value of this product line is significantly in excess of its carrying value.
In late 2010, we began a process of filing requests with various state insurance departments for a rate increase on certain of our individual long-term care policies. The rate increase reflects current interest rates, higher expected future claims, persistency, experience, and other factors related to pricing individual long-term care coverage. In states for which a rate increase is submitted and approved, customers are also given options for coverage changes or other approaches that might fit their current financial and insurance needs. Higher premium income associated with the rate increase is expected to emerge during 2011.
Premium income increased in 2009 relative to 2008 due primarily to sales growth in the voluntary benefits product line, partially offset by a slight decline in premium persistency. Net investment income increased in 2009 relative to 2008 due to higher investment income related to growth in the level of assets supporting these lines of business, an increased level of prepayment income on mortgage-backed securities, and a higher yield on the portfolio due to the investment of new cash at higher yields than that of the existing portfolio.
The interest adjusted loss ratio for the individual disability - recently issued line of business declined in 2009 relative to 2008 due primarily to a more favorable claim recovery rate and a lower number of reopened claims, partially offset by an increase in the paid incidence rate. The interest adjusted loss ratio for long-term care increased in 2009 relative to 2008 due primarily to an increase in paid claim incidence rates. The benefit ratio for voluntary benefits decreased in 2009 as compared to 2008 due primarily an increase in premium income, partially offset by an increase in the paid claim incidence rate for the voluntary disability product line.
The deferral of acquisition costs decreased in 2009 as compared to 2008 due to the decrease in acquisition-related expenses resulting from lower overall sales. The amortization of acquisition costs was higher in 2009 as compared to 2008 due to an acceleration of amortization resulting from lower persistency in certain of the product lines. The other expense ratio in 2009 was consistent with 2008.
During 2010, we continued to experience an unfavorable impact on premium and sales growth, particularly growth in existing customer accounts, which we attribute to the current economic environment. Partially offsetting this unfavorable impact on premiums was higher than expected premium and case persistency in our group lines of business. We believe this is temporary in nature and that persistency may return to historical levels in 2011. Opportunities for premium and sales growth are expected to re-emerge as the economy improves and employment growth resumes. We expect some volatility in net investment income to continue during 2011 as a result of fluctuations in bond calls and other types of miscellaneous net investment income. We intend to continue to manage our expense levels relative to premium levels through operating effectiveness and performance management.
disability business. Components of claims experience, such as incidence and recovery rates, may be worse than we expect. Disability claim incidence and claim recovery rates may be influenced by, among other factors, the rate of unemployment and consumer confidence. Within the group disability market, pricing and renewal actions can be taken to react to higher claim rates, but these actions take time to implement, and there is a risk that the market will not sustain increased prices. In addition, changes in economic and external conditions may not manifest themselves in claims experience for an extended period of time. The current economic conditions may lead to a higher rate of claim incidence or lower levels of claim recoveries. We have previously taken steps to improve our risk profile, including reducing our exposure to volatile business segments through diversification by market size, product segment, and industry segment. We believe our claims management organization is positioned for stable and sustainable performance levels. The level of disability claims incidence in 2010 was generally consistent with what we experienced in the second half of 2009. We are uncertain as to whether the higher claim incidence is due to the normal volatility that occurs in our group disability business or is related to the economy. We continuously monitor key indicators to assess our risks and attempt to adjust our business plans accordingly.
We believe our Unum US growth strategy is sound and that we will be able to leverage the capabilities, products, and relationships and reputation we have built to deliver growth as the benefits market stabilizes. We continue to see future growth opportunity based on employee choice, defined employer funding, simple administration, and effective communication. We intend to maintain our discipline and will continue (i) directing the majority of our investments to capture opportunities emerging in our core group and voluntary markets to grow them at above-market rates, (ii) focusing on margins in large case group insurance, while leveraging core market, voluntary, and other shorter-term investments to grow at market rates, and (iii) seeking opportunities to improve margins and return in our supplemental lines of business.
Shown below are financial results and key performance indicators for the Unum UK segment. Certain reclassifications have been made to prior year amounts in order to conform to the current year presentation.
period. We report unrealized foreign currency translation gains and losses in accumulated other comprehensive income in our consolidated balance sheets.
Fluctuations in the pound to dollar exchange rate have an effect on Unum UK’s reported financial results and our consolidated financial results. In periods when the pound weakens relative to the preceding period or periods, as occurred in 2010 and 2009 relative to 2008, translating pounds into dollars decreases current periods’ results relative to the prior period. In periods when the pound strengthens relative to the preceding period, translating into dollars increases current periods’ results in relation to the prior periods.
Premium income decreased for 2010 relative to 2009 due primarily to lower premium growth from existing customers and pricing actions due to the competitive U.K. market, partially offset by higher persistency.
Net investment income increased in 2010 relative to 2009 due primarily to an increase in the level of assets supporting this business segment as well as an increase in inflation which increased the return on bonds for which interest income is linked to a U.K. inflation index. These index-linked bonds match the claim reserves associated with certain of our group policies that provide for inflation-linked increases in benefits. The increase in net investment income attributable to these index-linked bonds was generally offset by an increase in the reserves for future claims payments related to the inflation index-linked group policies.
Index to Financial Statements The deferral of acquisition costs in 2010 decreased slightly when compared to 2009 due primarily to a lower level of deferrable expenses resulting from lower levels of supplemental and voluntary sales. The decrease in amortization of deferred acquisition costs relative to 2009 is due primarily to a decrease in amortization related to internal replacement transactions.
Net investment income decreased in 2009 relative to 2008 due primarily to a reduction in inflation which reduced the return on bonds for which interest income is linked to a U.K. inflation index. The decrease in 2009 net investment income attributable to these bonds was generally offset by a comparable decrease in reserves, as previously noted.
The lower benefit ratio in 2009 in comparison to 2008 was primarily due to a decline in the level of claim incidence for group long-term disability as well as the impact of lower inflation on claim reserves associated with group long-term disability policies containing the inflation-linked benefit increase feature. Partially offsetting these items was an increase in claim incidence for the group life line of business. Claim recoveries for group long-term disability were generally consistent with the level of 2008.
Shown below are sales results in dollars and in pounds for the Unum UK segment.
Our current growth strategy focuses on generating organic growth and expanding our role as the leading provider of group disability insurance in the U.K. Our strategy for future growth combines optimizing the performance of our existing business while developing new market opportunities. We intend to optimize performance of the existing business by (i) increasing underwriting and pricing discipline, (ii) improving our claims management processes, and (iii) expanding our broker market capabilities and sales effectiveness. We intend to develop new market opportunities by raising awareness of the need for income protection and by offering a suite of employee paid workplace solutions using integrated products with simpler, defined choices and flexible funding options through a streamlined and efficient platform with online capabilities matched to broker and employer needs.
In the current competitive pricing market and economic environment, we continue to have a cautious outlook for premium growth in 2011 and anticipate negative earnings growth relative to 2010. We anticipate returning to more normalized levels of premium growth through continued favorable persistency and price increases, as well as increased sales to existing and new customers which we expect to occur commensurate with the timing of the U.K. economic recovery. We expect our overall benefit ratio to be generally consistent with that of 2010. We expect our profit margins to continue at a favorable level, although slightly below the level of 2010.
Index to Financial Statements Year Ended December 31, 2010 Compared with Year Ended December 31, 2009
Commissions and the deferral of acquisition costs both increased in 2010 compared to 2009 due primarily to increased sales. The amortization of deferred acquisition costs in 2010 was higher relative to 2009 due to the continued increase in the level of deferred acquisition costs, offset partially by the decrease in amortization related to certain of our interest-sensitive policies.
The overall benefit ratio for this segment remained stable in 2009 relative to 2008, with a lower benefit ratio in the life and cancer and critical illness lines of business partially offset by a slightly higher benefit ratio in the accident, sickness, and disability line of business. The life product line reported a lower benefit ratio in 2009 relative to 2008 due to a change in the mix of life business and the resulting lower change in the active life reserve. The cancer and critical illness product line reported a lower benefit ratio in 2009 relative to 2008 due primarily to a release of active life reserves, partially offset by an increase in disabled life reserves associated with the older cancer products. The increase in the benefit ratio in the accident, sickness and disability line of business resulted primarily from a slight increase in the claim incidence rates relative to the favorable experience of 2008.
Colonial Life’s sales in 2010 increased 4.4 percent relative to 2009. New account sales increased 4.2 percent, and existing account sales increased 4.4 percent in 2010 relative to 2009. Sales increased 8.1 percent in 2010 in the commercial market, driven primarily by sales growth of 9.3 percent in the core market segment, which we define as accounts with fewer than 1,000 lives. In the public sector market, sales declined 8.1 percent in 2010 compared to 2009. The number of new accounts in 2010 increased 13.6 percent relative to 2009, while the average new case size declined 8.2 percent.
During 2011, we expect premium growth to be modest relative to our long-term outlook. We believe that strong profit margins will continue, although we expect our overall benefit ratio to be slightly higher than the favorable risk experience of 2009 and the first half of 2010. We believe premium growth will reaccelerate as the economy improves and employment growth resumes.
The decrease in premium income for 2010 relative to 2009 is due to the expected run-off of this block of closed business driven by expected policy terminations and maturities. Net investment income for 2010 was slightly higher than 2009, with higher bond call premiums mostly offset by a lower level of assets supporting this closed block of business.
compared to 2009 due to lower rates of interest on our floating rate debt issued by Northwind Holdings and a decrease in the amount of outstanding debt resulting from principal repayments.
The other expense ratio increased slightly in 2009 when compared to 2008 due primarily to the decline in premium income. Included in 2008 other expenses is a $4.7 million litigation settlement.
Index to Financial Statements Other expenses were $40.1 million in 2010 compared to $56.2 million and $19.2 million in 2009 and 2008, respectively. The volatility in other expenses is due primarily to pension costs, which increased approximately $42.0 million in 2009 relative to 2008 and declined approximately $15.0 million in 2010 relative to 2009.
The maximum investment per issuer group is limited based on internal limits reviewed by the finance committee of Unum Group’s board of directors and approved by the boards of directors of our insurance subsidiaries and is more restrictive than the five percent limit generally allowed by the state insurance departments which regulate the type of investments our insurance subsidiaries are allowed to own. These internal limits are as follows:
We review these investment policies and guidelines annually, or more frequently if deemed necessary, and recommend adjustments, as appropriate. Any revisions are reviewed by the finance committee of Unum Group’s board of directors and must be approved by the boards of directors of our insurance subsidiaries.
The duration weighted book yield on the fixed income securities in our investment portfolio was 6.71 percent as of December 31, 2010, and the weighted average credit rating was A3. This compares to a yield of 6.74 percent as of December 31, 2009 and a weighted average credit rating of A3. We actively manage our asset and liability cash flow match and our asset and liability duration match to limit interest rate risk. Duration is a measure of the percentage change in the fair values of assets and liabilities for a given change in interest rates. Cash flows from the in-force asset and liability portfolios are projected at current interest rate levels and also at levels reflecting an increase and a decrease in interest rates to obtain a range of projected cash flows under the different interest rate scenarios. These results enable us to assess the impact of projected changes in cash flows and duration resulting from potential changes in interest rates.
During 2010, we recognized an other-than-temporary impairment loss of $10.2 million on securities issued by a Netherlands financial services company. The company recorded significant impairment losses in its securities and real estate portfolios during 2009 and 2008 and required a significant amount of government aid. At the time of the impairment loss, these securities had been in an unrealized loss position for a period of greater than three years
During 2009, we recognized an other-than-temporary impairment loss of $33.3 million on securities issued by a U.S. media conglomerate. The company reported mixed fourth quarter 2008 operating results as its outdoor advertising weakened significantly. During the first quarter of 2009, the company borrowed $1.6
During 2009, we recognized an other-than-temporary impairment loss of $17.5 million on securities issued by a U.K. financial institution. During 2008, a significant decrease in funding liquidity ultimately required the U.K. government to nationalize this institution. In this process, the government provided
During 2008, we recognized an other-than-temporary impairment loss of $32.0 million on securities issued by a U.S. based automobile manufacturer and its captive finance subsidiary. The company experienced a decline in profitability and cash flow due to the weak economic environment. Although at the time of the impairment loss the company had not yet received government bailout money, the probability of receiving some form of government financial aid had significantly increased. Other U.S. automakers that had received bailout money were expected to request their bondholders to accept a significant reduction in principal. In order for this company to stay competitive with other U.S. automakers, it was likely that it, too, would seek debt relief from its bondholders and that we would not recover our entire principal for these securities. At the time of the impairment loss, these securities had been in an unrealized loss position for a period of greater than three years.
During 2008, we recognized a loss of $16.2 million on the sale of securities issued by a large investment banking firm for which we had recorded an impairment loss in 2008, as previously discussed.
During 2008, we recognized a loss of $10.1 million on the disposition of the principal protected equity linked note, as previously discussed. The note’s substitution clause was triggered in the fourth quarter of 2008 due to the continued decline in the S&P 500 index. At the time of the triggering event, we made the decision to take ownership in the underlying Vanguard S&P 500 index mutual fund shares rather than accept the zero coupon bonds issued by the financial services company. At the time of disposition, this note had been continuously in an unrealized loss position for a period of less than ninety days.
view the effect of realized gains and losses recognized for this embedded derivative as a reporting requirement that will not result in a permanent change in assets or stockholders’ equity.
Index to Financial Statements Unrealized Loss on Below-Investment-Grade Fixed Maturity Securities
At December 31, 2010, our mortgage/asset-backed securities had an average life of 4.43 years, effective duration of 3.82 years, and a weighted average credit rating of AAA. The mortgage/asset-backed securities are valued on a monthly basis using valuations supplied by the brokerage firms that are dealers in these securities as well as independent pricing services. One of the risks involved in investing in mortgage/asset-backed securities is the uncertainty of the timing of cash flows from the underlying loans due to prepayment of principal with the possibility of reinvesting the funds in a lower interest rate environment. We use models which incorporate economic variables and possible future interest rate scenarios to predict future prepayment rates. The timing of prepayment cash flows may also cause volatility in our recognition of investment income. We recognize investment income on these securities using a constant effective yield based on projected prepayments of the underlying loans and the estimated economic life of the securities. Actual prepayment experience is reviewed periodically, and effective yields are recalculated when differences arise between prepayments originally projected and the actual prepayments received and currently projected. The effective yield is recalculated on a retrospective basis, and the adjustment is reflected in net investment income.
As of December 31, 2010, the amortized cost and fair value of our below-investment-grade fixed maturity securities was $2,668.9 million and $2,755.0 million, respectively. Below-investment-grade securities are inherently more risky than investment-grade securities 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, but we do not anticipate any liquidity problems resulting from our investments in below-investment-grade securities, nor do we expect these investments to adversely affect our ability to hold our other investments to maturity.
Our mortgage loan portfolio was $1,516.8 million and $1,404.0 million on an amortized cost basis at December 31, 2010 and 2009, respectively. Our mortgage loan portfolio is comprised entirely of commercial mortgage loans. We believe our mortgage loan portfolio is well diversified geographically and among property types. The incidence of problem mortgage loans and foreclosure activity continues to be low. Due to conservative underwriting, we expect the level of problem loans to remain low relative to the industry. At December 31, 2010, we held two mortgage loans which were considered impaired. The mortgage loans were carried at the estimated net realizable value of $22.9 million, net of a valuation allowance of $1.5 million. At December 31, 2009, we held one mortgage loan which was considered impaired. This loan was carried at the estimated net realizable value of $2.0 million, net of a valuation allowance of $3.2 million.
Our liquidity requirements are met primarily by cash flows provided from operations, principally in our insurance subsidiaries. Premium and investment income, as well as maturities and sales of invested assets, provide the primary sources of cash. Debt and/or securities offerings provide an additional source of liquidity. Cash is applied to the payment of policy benefits, costs of acquiring new business (principally commissions), operating expenses, and taxes, as well as purchases of new investments.
We have met all minimum pension funding requirements set forth by ERISA. We made voluntary contributions to our U.S. qualified defined benefit pension plan of $67.0 million and $100.0 million during the first and fourth quarters of 2010, respectively. The fourth quarter of 2010 contribution was made in lieu of our planned 2011 contribution, and we do not anticipate making any additional contributions during 2011. We have estimated our future funding requirements under the Pension Protection Act of 2006 and do not believe that the funding requirements will cause a material adverse effect on our liquidity.
In May 2010, our board of directors authorized an increase in the quarterly dividend paid on Unum Group’s common stock, from $0.0825 per common share to $0.0925 per common share, effective with our third quarter of 2010 dividend payment to stockholders.
Net cash provided by operating activities was $1,196.8 million for the year ended December 31, 2010, compared to $1,237.0 million and $1,326.1 million for 2009 and 2008, respectively. Operating cash flows are primarily attributable to the receipt of premium and investment income, offset by payments of claims, commissions, expenses, and income taxes. Premium income growth is dependent not only on new sales, but on renewals of existing business, renewal price increases, and persistency. Investment income growth is dependent on the growth in the underlying assets supporting our insurance reserves and on the earned yield. The level of commissions and operating expenses is attributable to the level of sales and the first year acquisition expenses associated with new business as well as the maintenance of existing business. The level of paid claims is affected partially by the growth and aging of the block of business and also by the general economy, as previously discussed in the operating results by segment. Operating cash flows for 2010, 2009, and 2008, include pension contributions of approximately $176.9 million, $79.7 million, and $140.9 million, respectively.
Proceeds from sales and maturities of other investments decreased in 2010 as compared to 2009 primarily due to a decrease in proceeds from terminations of derivative contracts within our cash flow hedging programs. Proceeds from maturities of commercial mortgage loans were higher in 2010 relative to 2009. Proceeds from sales and maturities of other investments increased in 2009 relative to 2008 primarily due to an increase in sales of other long-term investments and an increase in proceeds from terminations of derivatives within our cash flow hedging programs. This increase was partially offset by a decline in proceeds from commercial mortgage loan maturities and prepayments.
Purchases of other investments increased during 2010 relative to 2009 as a result of the purchase of tax credit partnerships, as well as a slight increase in the funding of mortgage loans. Purchases of other investments in 2009 primarily related to mortgage loans.
During 2010, we repurchased approximately 16.4 million shares of Unum Group’s common stock under our $500.0 million share repurchase program, at a cost of $356.0 million. During 2008, we completed a $700.0 million authorized share repurchase program by purchasing 29.9 million shares.
Index to Financial Statements For life insurance companies domiciled in the United States, that limitation generally equals, depending on the state of domicile, either ten percent of an insurer’s statutory surplus with respect to policyholders as of the preceding year end or the statutory net gain from operations, excluding realized investment gains and losses, of the preceding year. The payment of dividends to a parent company from its insurance subsidiaries is generally further limited to the amount of unassigned statutory surplus.
Northwind Holdings’ and Tailwind Holdings’ ability to meet their debt payment obligations is dependent upon the receipt of dividends from Northwind Re and Tailwind Re, respectively. The ability of Northwind Re and Tailwind Re to pay dividends to their respective parent companies will depend on their satisfaction of applicable regulatory requirements and on the performance of the business reinsured by Northwind Re and Tailwind Re.
The amount available during 2010 for the payment of ordinary dividends from Unum Group’s traditional U.S. insurance subsidiaries was $719.7 million, of which $410.8 million was declared and paid. The amount available during 2010 from Unum Limited was £198.5 million, of which £50.0 million was declared and paid. During 2010, Tailwind Re and Northwind Re paid dividends of $18.8 million and $58.9 million to Tailwind Holdings and Northwind Holdings, respectively.
Unum Group’s RBC ratio for its traditional U.S. insurance subsidiaries, calculated on a weighted average basis using the NAIC Company Action Level formula, was approximately 398 percent at the end of 2010, with the individual RBC ratios for Unum Group’s principal traditional U.S. insurance subsidiaries all in excess of 300 percent. The individual RBC ratios for Northwind Re and Tailwind Re are calculated using the NAIC Company Action Level formula and have target levels of 200 percent. The RBC ratios for Northwind Re and Tailwind Re each exceeded the 200 percent target level at the end of 2010. The individual RBC ratio for each of our insurance subsidiaries is above the range that would require state regulatory action.
The ability of Unum Group and certain of its intermediate holding company subsidiaries to continue to receive dividends from their insurance subsidiaries generally depends on the level of earnings of those insurance subsidiaries and additional factors such as RBC ratios and FSA capital adequacy requirements, funding growth objectives at an affiliate level, and maintaining appropriate capital adequacy ratios to support desired ratings. Insurance regulatory restrictions do not limit the amount of dividends available for distribution from non-insurance subsidiaries except where the non-insurance subsidiaries are held directly or indirectly by an insurance subsidiary and only indirectly by Unum Group. We intend to retain a level of capital in our traditional U.S. insurance subsidiaries such that we maintain a weighted average risk-based capital above capital adequacy requirements. We also expect Unum Limited to operate above FSA capital adequacy requirements and minimum solvency margins.
At December 31, 2010, we had long-term debt, including senior secured notes and junior subordinated debt securities, totaling $2,631.3 million and short-term debt of $225.1 million. Short-term debt consisted of the 7.625% senior notes due March 2011. Our leverage ratio, when calculated using consolidated debt to total consolidated capital, was 25.9 percent at December 31, 2010 compared to 24.8 percent at December 31, 2009, reflecting the issuance of $400.0 million of senior notes during the third quarter of 2010. Our leverage ratio, when calculated excluding the non-recourse debt and associated capital of Tailwind Holdings and Northwind Holdings, was 22.8 percent at December 31, 2010 compared to 20.5 percent at the end of 2009. Leverage is measured as total debt to total capital, which we define as total long-term and short-term debt plus stockholders’ equity, excluding the net unrealized gain or loss on securities and the net gain or loss on cash flow hedges. We believe that a leverage ratio which excludes the net unrealized gains and losses on securities and the net gain or loss on cash flow hedges, both of which tend to fluctuate depending on market conditions and general economic trends, and which also excludes the non-recourse debt and associated capital of Tailwind Holdings and Northwind Holdings is a better indicator of our ability to meet our financial obligations.
We monitor our compliance with our debt covenants. There are no significant financial covenants associated with any of our outstanding debt obligations. We remain in compliance with all debt covenants and have not observed any current trends that would cause a breach of any debt covenants.
In 2010, we purchased and retired $10.0 million of our 7.08% medium-term notes due 2024. In 2009, we purchased and retired the remaining $132.2 million of our 5.859% senior notes due May 2009, $1.2 million aggregate principal of our 7.19% medium-term notes due 2028, and $0.6 million aggregate principal of our 6.75% notes due 2028. We also repaid $58.3 million of reverse repurchase agreements outstanding at December 31, 2008. In 2008, we retired the remaining $175.0 million of our 5.997% senior notes due May 2008. We also purchased and retired $36.6 million of our 6.85% senior debentures due 2015 and $17.8 million of our 5.859% senior notes due May 2009.
In 2009, we issued $350.0 million of unsecured senior notes in a public offering. These notes, due in 2016, bear interest at a fixed rate of 7.125% and are payable semi-annually. The notes are callable at or above par and rank equally in right of payment with all of our other unsecured and unsubordinated debt.
In 2005, Unum Group repatriated $454.8 million in unremitted foreign earnings from its U.K. subsidiaries, and as part of its repatriation plan, UnumProvident Finance Company plc, a wholly-owned subsidiary of Unum Group, issued $400.0 million of 6.85% senior debentures, due 2015, in a private offering. The debentures are fully and unconditionally guaranteed by Unum Group. The aggregate principal amount outstanding was $296.9 million at December 31, 2010.
In 2002, Unum Group completed two long-term offerings, issuing $250.0 million of 7.375% senior debentures due 2032 and $150.0 million of 7.25% public income notes due 2032. The public income notes were called and retired in 2007. The 7.375% notes have an aggregate principal amount outstanding of $39.5 million at December 31, 2010.
In 2001, Unum Group issued $575.0 million of 7.625% senior notes due March 2011. The aggregate principal amount outstanding was $225.1 million at December 31, 2010.
In 1998, Unum Group completed public offerings of $200.0 million of 7.25% senior notes due 2028, $200.0 million of 7.0% senior notes due 2018, and $250.0 million of 6.75% senior notes due 2028. None of these amounts have been reduced other than the 6.75% notes, which have an aggregate principal amount outstanding of $165.8 million at December 31, 2010.
Interest paid on long-term and short-term debt and related securities during 2010, 2009, and 2008 was $140.7 million, $122.0 million, and $157.3 million, respectively.
Policyholder liability maturities and the related reinsurance recoverable represent the projected payout of the current in-force policyholder liabilities and the expected cash inflows from reinsurers for liabilities ceded and therefore incorporate uncertainties as to the timing and amount of claim payments. We utilize extensive liability modeling to project future cash flows from the in-force business. The primary assumptions used to project future cash flows are claim incidence rates for mortality and morbidity, claim resolution rates, persistency rates, and interest rates. These cash flows are discounted to determine the current value of the projected claim payments. The timing and amount of payments on policyholder liabilities may vary significantly from the projections above. See our previous
Purchase obligations include off-balance sheet commitments of $147.7 million to fund certain of our investments in private placement securities, commercial mortgage loans, and private equity partnerships. These are shown in the preceding table based on the expiration date of the commitments. The funds will be due upon satisfaction of contractual notice from the partnership trustee or issuer of the private placement securities. The amounts may or may not be funded. Also included are noncancelable obligations with outside parties for computer data processing services and related functions and software maintenance agreements. The aggregate obligation remaining under these agreements was $35.8 million at December 31, 2010.
Our derivatives counterparties have posted non-cash collateral in various segregated custody accounts to which we have a security interest in the event of counterparty default. This collateral, which is not reflected in the preceding table, had a market value of $17.3 million at December 31, 2010.
We account for all of our securities lending transactions and repurchase agreements as collateralized financings. We had no repurchase agreements outstanding at December 31, 2010. The average balance during 2010 was $39.4 million, and the maximum amount outstanding at any month end was $150.4 million. Our use of repurchase agreements can fluctuate during any given period, depending on our liquidity position, the availability of long-term investments that meet our purchasing criteria, and our general business needs.
We maintain an ongoing dialogue with the four rating agencies that evaluate us in order to inform them of progress we are making regarding our strategic objectives and financial plans, as well as other pertinent issues. A significant component of our communications involves our annual review meeting with each of the four agencies. We hold other meetings throughout the year regarding our business, including, but not limited to, quarterly updates.
On February 12, 2010, Fitch upgraded its ratings of Unum Group and its operating subsidiaries to BBB and A, respectively, and changed the outlook for the Company to “stable.” On March 8, 2010, AM Best affirmed its ratings of Unum Group and all of its operating subsidiaries, with the exception of Paul Revere Variable, and revised the outlook for the Company to “positive.” The rating of Paul Revere Variable was lowered to B++ due to the continued decline in this subsidiary’s closed block of business. On May 12, 2010, Moody’s upgraded the credit ratings of Unum Group’s senior debt to Baa3 from Ba1 and the financial strength ratings of each rated individual insurance subsidiary to A3 from Baa1. Moody’s maintained the outlook for the Company as “stable.” On January 26, 2011, AM Best upgraded its ratings of Unum Group and its operating subsidiaries to bbb and A, respectively, with the exception of Paul Revere Variable which retained its B++ rating, and revised the outlook for the Company and its subsidiaries to “stable.”
Basis of Presentation: The accompanying consolidated financial statements of Unum Group and its subsidiaries (the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). Such accounting principles differ from statutory accounting principles (see Note 14). Intercompany transactions have been eliminated. In connection with our preparation of the consolidated financial statements, we evaluated events that occurred subsequent to December 31, 2010, for recognition or disclosure in our financial statements and notes to our financial statements.
Fixed Maturity Securities: Fixed maturity securities include bonds and redeemable preferred stocks. Fixed maturity securities not bought and held for the purpose of selling in the near term but for which we do not have the positive intent and ability to hold to maturity are classified as available-for-sale and reported at fair value. Changes in the fair value of available-for-sale fixed maturity securities, except for amounts related to other-than-temporary impairment losses recognized in earnings, are reported as a component of other comprehensive income. These amounts are net of income tax and valuation adjustments to deferred acquisition costs and reserves for future policy and contract benefits which would have been recorded had the related unrealized gain or loss on these securities been realized.
Mortgage Loans: Mortgage loans are generally held for investment and are carried at amortized cost less an allowance for probable losses. Interest income is accrued on the principal amount of the loan based on the loan’s contractual interest rate. Prepayment penalties are recognized as investment income when received.
We use a comprehensive rating system to evaluate the investment and credit risk of our mortgage loans and to identify specific properties for further inspection, analysis, and reevaluation. For mortgage loans on which collection of investment income is uncertain, we discontinue the accrual of investment income and recognize investment income in the period when an interest payment is received. We typically do not resume the accrual of interest on mortgage loans on nonaccrual status until there are significant improvements in the underlying financial condition of the borrower. We consider a loan to be delinquent if full payment is not received in accordance with the contractual terms of the loan. Mortgage loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. We establish an allowance for probable losses on mortgage loans based on a review of individual loans and considering the underlying collateral, the value of which is periodically assessed. We do not purchase mortgage loans with existing credit impairments.
Policy Loans: Policy loans are presented at unpaid balances directly related to policyholders. Interest income is accrued on the principal amount of the loan based on the loan’s contractual interest rate. Included in policy loans are $2,790.5 million and $2,675.7 million of policy loans ceded to reinsurers at December 31, 2010 and 2009, respectively.
Tax credit partnerships in which we have invested were formed for the purpose of investing in the construction and rehabilitation of low-income housing. Because the partnerships are structured such that there is no return of principal, the primary sources of investment return from our tax credit partnerships are tax credits and tax benefits derived from passive losses on the investments, both of which may exhibit variability over the life of the investment. These partnerships are accounted for using either the equity or the effective yield method, depending primarily on whether the tax credits are guaranteed through a letter of credit, a tax indemnity agreement, or another similar arrangement. Tax credits received from these partnerships are reported in our consolidated statements of income as either a reduction of state premium tax, included in other expenses, or a reduction of income tax. For those partnerships accounted for under the equity method, the amortization of the principal amount invested in these partnerships is reported as a component of net investment income. For those partnerships accounted for under the effective yield method, amortization of the principal amount invested is reported as a component of income tax or other expenses.
depending on the level of ownership and the degree of influence over partnership operating and financial policies. For partnerships accounted for under the equity method, our portion of partnership earnings is reported as a component of net investment income in our consolidated statements of income. For those partnerships accounted for under the cost method, we record income received from partnership distributions as either a component of net investment income or of net realized investment gain or loss, in accordance with the source of the funds distributed from the partnership.
Short-term Investments: Short-term investments are carried at cost. Short-term investments include investments maturing within one year, such as corporate commercial paper and U.S. Treasury bills, bank term deposits, and other cash accounts and cash equivalents earning interest.
Fair value hedge. Changes in the fair value of the derivative, including amounts measured as ineffectiveness, and changes in the fair value of the hedged item attributable to the risk being hedged are recognized in current earnings as a component of net realized investment gain or loss during the period of change in fair value. The gain or loss on the termination of a fair value hedge is recognized in current earnings as a component of net realized investment gain or loss. When interest rate swaps are used in hedge accounting relationships, periodic settlements are recorded in the same income statement line as the related settlements of the hedged items.
Internal replacement transactions wherein the modification does not substantially change the policy are accounted for as continuations of the replaced contracts. Unamortized deferred acquisition costs from the original policy continue to be amortized over the expected life of the new policy, and the costs of replacing the policy are accounted for as policy maintenance costs and expensed as incurred. Internal replacement transactions, principally on group contracts, that result in a policy that is substantially changed are accounted for as an extinguishment of the original policy and the issuance of a new policy. Unamortized deferred acquisition costs on the original policy that was replaced are immediately expensed, and the costs of acquiring the new policy are capitalized and amortized in accordance with our accounting policies for deferred acquisition costs.
Property and Equipment: Property and equipment is reported at cost less accumulated depreciation, which is calculated on the straight-line method over the estimated useful life. The accumulated depreciation for property and equipment was $641.6 million and $619.7 million as of December 31, 2010 and 2009, respectively.
Value of Business Acquired: Value of business acquired represents the present value of future profits recorded in connection with the acquisition of a block of insurance policies. The asset is amortized based upon expected future premium income for traditional insurance policies and estimated future gross profits for interest-sensitive insurance policies. The value of business acquired, which is included in other assets in our consolidated balance sheets, was $37.6 million and $46.2 million at December 31, 2010 and 2009, respectively. The accumulated amortization for value of business acquired was $112.5 million and $108.2 million as of December 31, 2010 and 2009, respectively.
The amortization of value of business acquired, which is included in other expenses in the consolidated statements of income, was $7.4 million, $7.8 million, and $7.8 million for the years ended December 31, 2010, 2009, and 2008, respectively. We periodically review the carrying amount of value of business acquired using the same methods used to evaluate deferred acquisition costs.
Reinsurance activity is accounted for on a basis consistent with the terms of the reinsurance contracts and the accounting used for the original policies issued. Premium income and benefits and change in reserves for future benefits are presented in our consolidated statements of income net of reinsurance ceded. Ceded policy and contract benefits, ceded future policy and contract benefits, ceded unearned premiums, and ceded policy loans are reported on a gross basis in our consolidated balance sheets. Our reinsurance recoverable includes the balances due from
Where applicable, gains or losses on reinsurance transactions are deferred and amortized into earnings based upon expected future premium income for traditional insurance policies and estimated future gross profits for interest-sensitive insurance policies. The deferred gain on reinsurance included in other liabilities in our consolidated balance sheets at December 31, 2010 and 2009 was $100.2 million and $123.1 million, respectively.
In June 2009, the FASB established the FASB Accounting Standards Codification (Codification) as the source of authoritative accounting principles to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Securities and Exchange Commission (SEC) rules and interpretive releases, which may not be included in their entirety within the Codification, will remain as authoritative GAAP for SEC
In April 2009, the FASB issued a new accounting standard, now included in ASC 320, which amends the other-than-temporary impairment guidance for debt securities and expands and increases the frequency of previously existing disclosures for other-than-temporary impairments. The measure of impairment remains fair value. Under the standard, an other-than-temporary impairment must be recognized in earnings for a debt security in an unrealized loss position when an entity either (a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery.
In December 2008, the FASB issued a new accounting standard, now included in ASC 715, to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. We adopted this standard effective December 31, 2009. This standard expanded our disclosures but had no effect on our financial position or results of operations.
value when it is determined that there has been a significant decrease in the volume and level of activity or that the transaction is not orderly. We adopted this standard effective April 1, 2009. This standard expanded our disclosures but did not have a material effect on our financial position or results of operations.
In September 2009, the FASB issued an update to permit a reporting entity to measure the fair value of an investment on the basis of net asset value per share if the net asset value is calculated in a manner consistent with the measurement principles of U.S. GAAP for investment companies. This update also requires disclosures by major category of investments about the attributes of investments, such as the nature of any restrictions on the investor’s ability to redeem its investments, any unfunded commitments, and the investment strategies of the investees. We adopted this update effective December 31, 2009. The adoption of this update had no effect on our financial position or results of operations.
In April 2009, the FASB issued a new accounting standard, now included in ASC 825, which requires companies to disclose the fair value of certain financial instruments in interim financial statements. This standard also requires companies to disclose the method or methods and significant assumptions used to estimate the fair value of financial instruments and to discuss changes, if any, in those methods or assumptions during the period. We adopted this standard effective April 1, 2009. This standard expanded our disclosures but had no effect on our financial position or results of operations.
Presented as follows are the carrying amounts and fair values of financial instruments. The carrying values of financial instruments such as short-term investments, cash and bank deposits, accounts and premiums receivable, and accrued investment income approximate fair value due to the short-term nature of the instruments. As such, these financial instruments are not included in the following chart.
Policy Loans: Fair values for policy loans, net of reinsurance ceded, are estimated using discounted cash flow analyses and interest rates currently being offered to policyholders with similar policies. The carrying amounts of ceded policy loans of $2,790.5 million and $2,675.7 million as of December 31, 2010 and 2009, respectively, are reported on a gross basis in our consolidated balance sheets and approximate fair value.
The selection of the valuation method(s) to apply considers the definition of an exit price and depends on the nature of the asset or liability being valued. For assets and liabilities accounted for at fair value, we generally use valuation techniques consistent with the market approach, and to a lesser extent, the income approach. We believe the market approach valuation technique provides more observable data than the income approach, considering the type of investments we hold. Our fair value measurements could differ significantly based on the valuation technique and available inputs. When markets are less active, brokers may rely more on models with inputs based on the information available only to the broker. In weighing a broker quote as an input to fair value, we place less reliance on quotes that do not reflect the result of market transactions. We also consider the nature of the quote, particularly whether the quote is a binding offer. If prices in an inactive market do not reflect current prices for the same or similar assets, adjustments may be necessary to arrive at fair value. When relevant market data is unavailable, which may be the case during periods of market uncertainty, the income approach can, in suitable circumstances, provide a more appropriate fair value. During 2010, we have applied valuation techniques on a consistent basis to similar assets and liabilities and consistent with those techniques used at year end 2009.
Certain of our investments do not have readily determinable market prices and/or observable inputs or may at times be affected by the lack of market liquidity. For these securities, we use internally prepared valuations combining matrix pricing with vendor purchased software programs, including valuations based on estimates of future profitability, to estimate the fair value. Additionally, we may obtain prices from independent third-party brokers to aid in establishing valuations for certain of these securities. Key assumptions used by us to determine fair value for these securities include risk free interest rates, risk premiums, performance of underlying collateral (if any), and other factors involving significant assumptions which may or may not reflect those of an active market.
At December 31, 2010, approximately 13.5 percent of our fixed maturity securities were valued using active trades from TRACE pricing or broker market maker prices for which there was current market activity in that specific security (comparable to receiving one binding quote). The prices obtained were not adjusted, and the assets were classified as Level 1, the highest category of the three-level fair value hierarchy classification wherein inputs are unadjusted and represent quoted prices in active markets for identical assets or liabilities.
The remaining 86.5 percent of our fixed maturity securities were valued based on non-binding quotes or other observable or unobservable inputs, as discussed below.
Realized and unrealized investment gains and losses presented in the preceding tables represent gains and losses only for the time during which the applicable financial instruments were classified as Level 3. The transfers between levels resulted primarily from a change in observability of three inputs used to determine fair values of the securities transferred: (1) transactional data for new issuance and secondary trades, (2) broker/dealer quotes and pricing, primarily related to changes in the level of activity in the market and whether the market was considered orderly, and (3) comparable bond metrics from which to perform an analysis. For fair value measurements of financial instruments that were transferred either into or out of Level 3, we reflect the transfers using the fair value at the beginning of the period. Gains for the years ended December 31, 2010 and 2009 which are included in earnings and are attributable to the change in unrealized gains or losses relating to assets or liabilities valued using significant unobservable inputs and still held at each year end were $21.1 million and $243.1 million, respectively. These amounts relate entirely to the changes in fair value of an embedded derivative in a modified coinsurance arrangement which are reported as realized investment gains and losses.
At December 31, 2010, we had $29.9 million in commitments to fund certain private placement fixed maturity securities. These commitments are not legally binding and may or may not be funded.
Additionally, we recognize a liability for all legally binding unfunded commitments to these partnerships, with a corresponding recognition of an invested asset. Our liability for legally binding unfunded commitments to the tax credit partnerships was $169.9 million at December 31, 2010. Contractually, we are a limited partner in these investments, and our maximum exposure to loss is limited to the carrying value of our investment. We also had commitments of $73.0 million to fund certain of the private equity partnerships at December 31, 2010. These commitments are not legally binding and may or may not be funded during the life of the partnerships.
We previously were the sole beneficiary of a special purpose entity that was a securitized asset trust holding forward contracts to purchase unrelated equity securities. The trust also held a defeasance swap contract for highly rated bonds to provide principal protection for the investments. There were no restrictions on the assets held in this trust, and the trust was free to dispose of the assets at any time. Because we intended to sell the investment, we recognized an other-than-temporary impairment loss of $23.7 million during the third quarter of 2009 and subsequently sold the investment in the following quarter for a realized investment gain of $2.1 million.
Although all available and applicable factors are considered in our analysis, loan-to-value and debt service coverage ratios are the most critical factors in determining whether we will initially issue the loan and also in assigning values and determining impairment. We assign an overall rating to each loan using an internal rating scale of Aa (highest quality) to Ba (lowest quality). We review and adjust, as needed, our internal credit quality ratings on an annual basis. This review process is performed more frequently for mortgage loans deemed to have a higher risk of delinquency.
There was no valuation allowance for credit losses at December 31, 2008 and no activity in the allowance during 2008.
During 2010, no interest income was recognized on mortgage loans subsequent to impairment.
At December 31, 2010, we had $42.9 million in commitments to fund certain mortgage loans. These commitments are not legally binding and may or may not be funded.
Our investment policy also permits us to lend fixed maturity securities to unaffiliated financial institutions in short-term securities lending transactions. These transactions increase our investment income with minimal risk. Our securities lending policy requires that a minimum of 102 percent of the fair value of the securities loaned be
We are exposed to certain risks relating to our ongoing business operations. The primary risks managed by using derivative instruments are interest rate risk, risk related to matching duration for our assets and liabilities, and foreign currency risk. Historically, we have utilized current and forward interest rate swaps and options on forward interest rate swaps, current and forward currency swaps, forward treasury locks, currency forward contracts, and forward contracts on specific fixed income securities. Hedging transactions are primarily associated with our individual and group long-term care and individual and group disability products. All other product portfolios are periodically reviewed to determine if hedging strategies would be appropriate for risk management purposes.
To help limit the credit exposure of the derivatives, we enter into master netting agreements with our counterparties whereby contracts in a gain position can be offset against contracts in a loss position. We also typically enter into bilateral, cross-collateralization agreements with our counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a loss position to submit acceptable collateral with the other counterparty in the event the net loss position meets or exceeds an agreed upon amount. Our current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position less collateral held, was $14.8 million at December 31, 2010. We held cash collateral of $39.1 million and $24.9 million from our counterparties as of December 31, 2010 and 2009, respectively. This unrestricted cash collateral is included in short-term investments and the associated obligation to return the collateral to our counterparties is included in other liabilities in our consolidated balance sheets. We post either fixed maturity securities or cash as collateral to our counterparties. The carrying value of fixed maturity securities posted as collateral to our counterparties was $158.8 million and $123.1 million at December 31, 2010 and 2009, respectively. No cash was posted as collateral to our counterparties as of December 31, 2010 or 2009.
During 2010, we entered into $250.0 million notional amount of forward starting interest rate swaps used to hedge the interest rate risk associated with the anticipated issuance of long-term debt. The swaps were terminated in 2010 at the time the debt was issued. We recognized a loss of $18.5 million on the termination of these hedges. This loss was recognized in other comprehensive income and will be amortized into earnings as a component of interest and debt expense, which will have the effect of increasing the periodic interest expense on our debt issued in 2010.
For the year ended December 31, 2010, there was no material ineffectiveness related to our cash flow hedges. For the year ended December 31, 2009, we reclassified $12.3 million of net gains into earnings as a result of the discontinuance of cash flow hedges due to the improbability of the original forecasted transactions occurring during the time period originally anticipated. During 2010 and 2009, no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness.
As of December 31, 2010, we expect to amortize approximately $30.0 million of net deferred gains on derivative instruments during the next twelve months. This amount will be reclassified from accumulated other comprehensive income into earnings and reported on the same income statement line item as the hedged item. The income statement line items that will be affected by this amortization are net investment income and interest and debt expense. The estimated amortization includes the impact of certain derivative contracts that have not yet been terminated as of December 31, 2010. Fluctuations in fair values of these derivatives between December 31, 2010 and the date of termination will vary our projected amortization. Amounts that will be reclassified from accumulated other comprehensive income into earnings to offset the earnings impact of foreign currency translation of hedged items are not estimable.
As of December 31, 2010, we are hedging the variability of future cash flows associated with forecasted transactions through the year 2038.
During 2010, we entered into a $350.0 million notional amount receive fixed, pay variable interest rate swap to hedge the changes in the fair value of certain fixed rate long-term debt. This swap effectively converts the associated fixed rate long-term debt into floating rate debt and provides for a better matching of interest rates with our short-term investments, which have frequent interest rate resets similar to a floating rate security. For the year ended December 31, 2010, the change in fair value of the hedged fixed debt attributable to the hedged benchmark interest rate resulted in a gain $14.4 million, with an offsetting loss on the related interest rate swaps.
For the years ended December 31, 2010 and 2009, there was no material ineffectiveness related to our fair value hedges, and no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness. There were no instances wherein we discontinued fair value hedge accounting due to a hedged firm commitment no longer qualifying as a fair value hedge.
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 our average reserve discount rate used during 2010, 2009, and 2008.
Note 5 - Liability for Unpaid Claims and Claim Adjustment Expenses - Continued
“Incurred Related to Prior Years - All Other Incurred” declined in 2010 relative to the prior two years. The decrease relates primarily to an increased rate of claim recoveries for our group long-term disability and individual disability - recently issued lines of business in Unum US. Claim resolution rates are very sensitive to operational and environmental changes and can be volatile over short periods of time. Throughout the period 2008 to 2010, we had generally stable to improving claims management performance, and our claim resolution rates were fairly consistent with or slightly favorable to our long-term assumptions. Our claims management performance during 2010 for Unum US group long-term disability exceeded our long-term assumptions in regard to claim resolution rates. For the Unum US individual disability - recently issued line of business and the Individual Disability - Closed Block segment, the claims management performance in 2010 remained stable relative to 2009. Our claim resolution rate assumption used in determining reserves is our expectation of the resolution rate we will experience over the life of the block of business and will vary from actual experience in any one period, both favorably and unfavorably.
A reconciliation of the income tax expense (benefit) attributable to income from operations before income tax, computed at U.S. federal statutory tax rates, to the income tax expense (benefit) as included in our consolidated statements of income, is as follows:
We recognize interest expense and penalties, if applicable, related to unrecognized tax benefits in tax expense net of federal income tax. The total amounts of accrued interest and penalties in our consolidated balance sheets as of December 31, 2010, 2009, and 2008 are $25.4 million, $19.9 million, and $13.4 million, respectively. We recognized interest related to unrecognized tax expense in our consolidated statements of income of $5.5 million, $6.5 million, and $5.9 million during 2010, 2009, and 2008, respectively. There were no changes to our uncertain tax positions as a result of settlements or lapses in statutes of limitations during 2010, 2009, and 2008.
We file federal and state income tax returns in the United States and in foreign jurisdictions. We are under continuous examination by the Internal Revenue Service (IRS) with regard to our U.S. federal income tax returns. During 2010, the IRS completed its examination of tax years 2005 and 2006 and issued its revenue agent’s report (RAR) in December 2010. In January 2011, we filed a protest to the RAR with respect to all significant adverse proposed adjustments. During 2008, the IRS completed its examination of tax years 2002 through 2004 and issued its RAR. We filed a protest to the RAR in 2008 with respect to all significant adverse proposed adjustments.
During 2009, we had a conference with the IRS with respect to our appeal of IRS audit adjustments for the years 1999 to 2004. Although we have not yet reached a final settlement with the IRS for these years, it is reasonably possible that this appeal will be resolved in whole or in part within 12 months and that statutes of limitations may expire in multiple jurisdictions within the same period. As a result, it is reasonably possible that our liability for unrecognized tax benefits could decrease within 12 months by $0 to $40.0 million. We believe sufficient provision has been made for all uncertain tax positions and that any adjustments by tax authorities with respect to such positions would not have a material adverse effect on our financial position, liquidity, or results of operations.
Tailwind Holdings’ ability to meet its obligations to pay principal, interest, and other amounts due on the Tailwind notes will be dependent principally on its receipt of dividends from Tailwind Reinsurance Company (Tailwind Re), the sole subsidiary of Tailwind Holdings. Tailwind Re reinsured Unum America’s liability with respect to certain specified long-term disability claims incurred between January 1, 1999 and December 31, 2001 that were in payment status on January 1, 2006 pursuant to a reinsurance agreement between Tailwind Re and Unum America. The ability of Tailwind Re to pay dividends to Tailwind Holdings will depend on its satisfaction of applicable regulatory requirements and the performance of the reinsured claims.
In September 2010, we issued $400.0 million of unsecured senior notes in a public offering. In 2010, we purchased and retired $10.0 million of our 7.08% medium-term notes due 2024.
In 2008, $36.6 million of the 6.85% senior debentures due 2015 were redeemed. These debentures were issued by UnumProvident Finance Company plc, a wholly-owned subsidiary of Unum Group, and are fully and unconditionally guaranteed by Unum Group.
In 2009, we purchased and retired the remaining $132.2 million of our outstanding 5.859% notes and repaid $58.3 million of reverse repurchase agreements outstanding at December 31, 2008. In 2008, we purchased and retired $17.8 million of our outstanding 5.859% notes and $175.0 million of our 5.997% notes.
Assets for our U.S. pension plans include a diversified blend of domestic and international large cap, mid cap, and small cap equity securities, U.S. government and agencies, and corporate fixed income securities, private equity funds of funds, hedge funds of funds, and cash equivalents. The large cap and mid cap equity securities are comprised of equity index funds that are designed to track the Standard & Poor’s (S&P) 500 and S&P 400 Mid Cap indices, respectively. Small cap equity securities consist of individual equity securities as well as index funds that track the Russell 2000 index. International equity investments and emerging market equity investments consist of equity index funds that track the Morgan Stanley Capital International (MSCI) Europe Australasia Far East Index and the MSCI Emerging Markets Index, respectively. U.S. government and agency securities are comprised of treasury bonds and U.S. agency asset-backed securities. Corporate fixed income securities consist of investment-grade and below-investment-grade corporate bonds as well as certain asset-backed securities. Alternative investments, which include private equity funds of funds and hedge funds of funds, utilize proprietary strategies that tend to have a low correlation to the U.S. stock market. The target allocations for invested assets are 60 percent equity securities, 30 percent fixed income securities, and 10 percent alternative investments. Prohibited investments include, but are not limited to, unlisted securities, futures contracts, options, short sales, and investments in securities issued by the Company or its affiliates.
The categorization of fair value measurements by input level for the invested assets in our U.S. pension plans is as follows:
Level 1 equity and fixed income securities consist of individual holdings and funds that are valued based on unadjusted quoted prices from active markets for identical securities. Level 2 equity securities consist of funds that are valued based on the net asset value (NAV) of the underlying holdings. These investments have no unfunded commitments and no specific redemption restrictions. Level 2 fixed income securities are valued using observable inputs through market corroborated pricing.
The categorization of fair value measurements by input level for the assets in our OPEB plan is as follows:
A one percent increase or decrease in the assumed health care cost trend rate at December 31, 2010 would have increased (decreased) the service cost and interest cost by $0.3 million and $(0.2) million, respectively, and the postretirement benefit obligation by $3.4 million and $(2.7) million, respectively.
The unrecognized net actuarial loss, prior service credit, and transition asset included in accumulated other comprehensive income and expected to be amortized and included in net periodic pension cost during 2011 is $31.4 million before tax and $20.4 million after tax. The prior service credit expected to be amortized and included as a reduction to net periodic cost for our OPEB plan during 2011 is $2.6 million before tax and $1.7 million after tax.
The funding policy for our U.S. qualified defined benefit plan is to contribute annually an amount at least equal to the minimum annual contribution required under ERISA and other applicable laws, but generally not greater than the maximum amount that can be deducted for federal income tax purposes. We had no regulatory contribution requirements for 2010 and 2009; however, we elected to make voluntary contributions of $167.0 million and $70.0 million, respectively. We do not anticipate making any additional contributions to our U.S. plans during 2011. The funding policy for our U.S. non-qualified defined benefit pension plan is to contribute the amount of the benefit payments made during the year. Our expected return on plan assets and discount rate will not affect the cash contributions we are required to make to our U.S. pension and OPEB plans because we have met all minimum funding requirements required under ERISA.
Note 9 - Stockholders’ Equity and Earnings Per Common Share - Continued
We use the treasury stock method to account for the effect of outstanding stock options, nonvested stock awards, and performance restricted stock units on the computation of dilutive earnings per share. Under this method, these potential common shares will each have a dilutive effect, as individually measured, when the average market price of Unum Group common stock during the period exceeds the exercise price of the stock options, the grant price of the nonvested stock awards, and/or the threshold stock price of performance restricted stock units. For further discussion of stock-based awards see Note 10.
Under the broad-based stock plan of 2001, up to 2.00 million shares of common stock were available for stock option awards to our employees, officers, consultants, and brokers, excluding certain senior officers and directors. The plan was terminated in December 2007 for purposes of any further grants, other than reload grants, for which 20,000 shares were available at December 31, 2010. The stock options have a maximum term of ten years after the date of grant and generally vest after three years.
Under the stock plan of 1999, comprised of the Provident Companies, Inc. stock plan of 1999 and the UnumProvident Corporation stock plan of 1999, an aggregate of up to 17.50 million shares of common stock were available for awards to our employees, officers, brokers, and directors. Awards could be in the form of stock options, stock appreciation rights, stock awards, dividend equivalent awards, or any other right or interest relating to stock. The plan was terminated in May 2007 for purposes of any further grants, other than reload grants, for which 250,000 shares were available at December 31, 2010. Stock options have a maximum term of ten years after the date of grant and generally vest after three years.
Stock awards vest over a one to three year service period, beginning at the date of grant, and the compensation cost is recognized ratably during the vesting period. Compensation cost for stock awards subject to accelerated vesting upon retirement is recognized over the implicit service period. Forfeitable dividend equivalents on nonvested stock awards are accrued in the form of additional restricted stock units.
At December 31, 2010, we had $0.5 million of unrecognized compensation cost related to PRSUs that will be recognized over a weighted average period of 0.5 years. The PRSU expense and unrecognized compensation cost assume the performance goals are attained at 100 percent. Actual performance may result in zero to 100 percent of the units ultimately being earned. We use the accelerated method of amortization for recognizing compensation expense, which treats each of the three vesting tranches as a separate award over the expected life of the unit.
Risk free interest rate of 2.33 percent, 1.89 percent, and 2.93 percent, respectively, based on the yield of treasury bonds at the date of grant.
Cash received under all share-based payment arrangements for the years ended December 31, 2010, 2009, and 2008 was $10.0 million, $8.0 million, and $4.4 million, respectively.
We have three major business segments: Unum US, Unum UK, and Colonial Life. Our other segments are the Individual Disability - Closed Block segment and the Corporate and Other segment.
The Unum UK segment includes insurance for group long-term disability, group life, and supplemental and voluntary lines of business. The supplemental and voluntary lines of business are comprised of individual disability, group and individual critical illness, and voluntary benefits products. Unum UK’s products are sold primarily in the United Kingdom through field sales personnel and independent brokers and consultants.
Premium income by major line of business within each of our segments is presented as follows. Certain prior year amounts within Unum UK have been reclassified to conform to current year presentation.
In November 2009, we were contacted by Florida state insurance regulators to discuss a resolution of their investigation of our compliance with state and federal laws with respect to producer compensation, solicitation activities, policies sold to state or municipal entities, and information regarding compensation arrangements with brokers. This investigation commenced in 2005, and, until this most recent contact, we had received no communications from the regulators regarding this matter since December 2007.
We and certain of our subsidiaries, along with many other insurance brokers and insurers, have been named as defendants in a series of putative class actions that have been transferred to the U.S. District Court for the District of New Jersey for coordinated or consolidated pretrial proceedings as part of multidistrict litigation (MDL) No. 1663, In re Insurance Brokerage Antitrust Litigation. The plaintiffs in MDL No. 1663 filed a consolidated amended complaint in August 2005, which alleges, among other things, that the defendants violated federal and state antitrust laws, the Racketeer Influenced Corrupt Organizations Act (RICO), ERISA, and various state common law requirements by engaging in alleged bid rigging and customer allocation and by paying undisclosed compensation to insurance brokers to steer business to defendant insurers. Defendants filed a motion to dismiss the complaint on November 29, 2005. On April 5, 2007, defendants’ motion to dismiss was granted without prejudice as to all counts except the ERISA counts. Plaintiffs were granted a last opportunity to file an amended complaint, and they did so on May 22, 2007.
The following is a summary of our unaudited quarterly results of operations for 2010 and 2009: