The Company leases and occupies approximately 89,000 square feet of office space in Glendale, California. Additionally, the Company leases other office space, for periods principally from five to ten years, for use by its affiliates and sales forces.
The Company believes its properties and facilities are suitable and adequate for current operations.
(6) In 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51. The Company adopted the provisions of FIN 46 in 2003 and subsequently adopted FIN 46(R) (revised December 2003) effective March 15, 2004, resulting in the elimination of the company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely junior subordinated debt securities of the company and an increase of $300.0 million in long-term debt.
The following management assessment of the Company’s financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto contained herein in Item 8.
Segment operating performance improved during 2005 relative to the prior year, with the Unum Limited segment, the Colonial segment, and many of the lines of business in the U.S. Brokerage segment reporting stable or improving operating performance. The Company believes that its U.S. Brokerage segment group income protection business continues to exhibit long-term improvement with respect to underwriting, pricing, and expense management due to the actions taken over the past several quarters to increase the profitability in this business. Claims management results for U.S. Brokerage group long-term income protection during 2005 were below the Company’s long-term expectations for this business.
Producing improvements in financial and operating performance which meet or exceed the expectations of the rating agencies, thereby increasing the opportunity for improved debt and financial strength ratings over time; and
Maintaining a strong balance sheet and capital position, including reducing the Company’s leverage.
The Company’s Unum Limited and Colonial segments produced favorable operating results in 2005 relative to 2004, with segment operating income increasing $36.4 million, or 24.1 percent, for Unum Limited and $12.5 million, or 8.0 percent, for Colonial. Sales for Colonial increased marginally compared to 2004, but gained growth momentum in the fourth quarter of 2005. Sales for Unum Limited decreased relative to the prior year due primarily to higher sales during 2004 that resulted from the exit of a major insurer from the U.K. market, but group life sales were also negatively impacted due to the competitive environment in the U.K. for group life products and the Company’s decision to maintain its pricing discipline.
Operating improvement, particularly in its U.S. Brokerage group income protection line of business;
As part of the settlement with the California DOI, the Company paid a civil penalty of $8.0 million and agreed to change certain practices and policy provisions related to its California business. The settlement also incorporates claims handling practices previously covered by the multistate settlement agreements and includes certain additional claim handling changes. In entering the settlement, the Company did not agree with the allegations and characterization of the Company’s past claims handling practices made by the California DOI. During the past two years, the Company has undertaken broad changes designed to improve the quality of claims decisions and its service levels to policyholders, including changes made as a result of the multistate settlement agreements. Because of this, the Company does not believe that the California DOI’s allegations or its market conduct examination report provide an accurate portrayal of the Company’s claim practices today.
The Company amended the multistate settlement agreements to include mailing a notice of eligibility to participate in the claim reassessment process to approximately 29,500 individuals whose claims were denied or terminated between January 1, 1997, and December 31, 1999. Under the original multistate settlement agreements, claimants during this period could request participation in the reassessment process, but they were not sent a notice. Those claimants who are eligible to participate but do not receive notice pursuant to the amendment remain eligible to request participation until June 30, 2006.
In connection with the settlement agreements related to the multistate market conduct examination and the California DOI market conduct examination and investigation, as of mid-February 2006, the Company had completed the mailing of approximately 90 percent of the total required claim reassessment notices. Those individuals who want their claims reviewed have the opportunity to request a claim reassessment information form and have 60 days to complete the form once it is received. Through mid-February 2006, approximately 29 percent of the recipients of the reassessment notice have requested claim reassessment information forms. The rate of response for reassessment is likely to increase over time as many of the individuals have unexpired time remaining to request and complete the necessary information forms. The Company believes that total reserves for the reassessment process are adequate based on the reassessment results to date; however, actual results of the reassessment process may differ from the Company’s initial expectations.
The subpoenas and information requests sought information regarding, among other things, quoting processes, producer compensation, solicitation activities, policies sold to state or municipal entities, and information regarding compensation arrangements with brokers, particularly with regard to Universal Life Resources, Inc. The Company is cooperating fully with these investigations.
The Company has been reviewing its compensation policies and procedures for compliance with applicable legal requirements. In accordance with its announced support for disclosure of compensation paid to producers, including both brokers and agents, the Company has implemented policies to facilitate customers obtaining information regarding producer compensation from the producers. Additionally, the Company provides appropriate notices to customers stating its policy surrounding disclosure and provides information on its website about its producer compensation programs. Under these policies, any customer who wants specific producer compensation related information can obtain this information by contacting the Company’s Producer Compensation Services toll-free number. Other changes include requiring customer approval of compensation paid by the Company to the producer when the customer is also paying a fee to the producer and strengthening certain policies and procedures associated with new business and quoting activities. The Company is still monitoring developments relating to “contingent commissions” and will consider alternative arrangements when there is more clarity on the issue as a component of producer compensation.
In February 2006, the Company received from the Financial Services Authority (FSA) in the U.K. the results of the FSA’s recent risk assessment review of Unum Limited. In the normal course of regulatory review, the FSA focuses on the identification and assessment of risks within U.K. regulated businesses. The Company is in the process of responding to the report.
During 2005, the Company’s wholly-owned subsidiary GENEX acquired Independent Review Services, Inc., a provider of medical diagnostic networks and independent medical examinations, at a price of $3.5 million. This acquisition will broaden GENEX’s product offerings through the addition of medical diagnostic services.
In 2005, Unum Limited completed the sale of its Netherlands branch. The gain on the sale was approximately $4.0 million after tax.
The amount of the policyholders’ surplus accounts of the Company’s U.S. insurance subsidiaries at December 31, 2004, was approximately $228.8 million. Distributions made during 2005 by these life insurance subsidiaries, including dividend distributions, were deemed to occur first from the policyholders’ surplus accounts. As a result, the Company’s U.S. life insurance subsidiaries distributed as dividends the remaining balance of their policyholders’ surplus accounts to the holding company during 2005. This resulted in the elimination of a future potential tax of approximately $80.1 million which had not previously been provided for in current or deferred taxes because management considered the conditions under which such a tax would be paid to be remote. This will also allow the Company to engage in transactions in the future without concern for triggering a tax liability related to distributions from the policyholders’ surplus accounts.
During the fourth quarter of 2005, the Company repatriated $454.8 million in unremitted foreign earnings from its U.K. subsidiaries under the Homeland Investment Act of 2004. In connection with the repatriation, the Company recorded current taxes payable on such previously unremitted foreign earnings of approximately $15.3 million and recorded a tax benefit of approximately $18.6 million as a result of the reversal of the deferred tax liability related to unremitted earnings of its foreign subsidiaries, both of which are included in the results reported for 2005.
On a statutory basis of reporting, the recapture increased statutory surplus $57.5 million in Unum America. The recapture does not have a material impact on the Company’s targeted risk-based capital objectives for its U.S. insurance subsidiaries.
During 2005, several hurricanes struck the United States gulf coast region in close proximity and timing. The Company has client companies and sales offices that were impacted by the storms. Some individual policyholders who resided in the area have moved, taken other jobs, or lost their jobs as a result of the storms. In addition, some of the Company’s group policyholders may be unable to continue business as a result of the storms.
The Company has extended its grace period for premium payments due from its policyholders in counties and parishes proclaimed disaster areas by the Federal Emergency Management Agency (FEMA) due to these hurricanes. The Company is unable to estimate a range of reasonably possible losses on policies that may ultimately lapse, but the Company will likely experience some persistency and premium collection reductions during 2006 as a result of the storms. It is also expected that sales in the affected region will be lower for some period of time until recovery is achieved.
A principal feature of the settlement agreements is a reassessment process. Under the agreements, the Company is offering to reassess any individual or group long-term disability claim that was denied or closed since January 1, 2000, except for specific categories of closures such as settlement, death, or payment of maximum benefits. The potential pool of claims decided over the nearly five year period that are eligible for reassessment if the claimant elects to participate is approximately 215,000 claims. However, almost half of these claims are subject to a preliminary determination as to whether the claimant seeking reassessment “returned to work” under the policy, in which case the claim is not eligible for further reassessment. The Company will also accept requests for reassessment from other individuals whose claims were closed after January 1, 1997, and through December 31, 1999, subject to the same closure exceptions as the group receiving notice, and from claimants who dispute the category for closure if it affects their eligibility for reassessment. There will be ongoing oversight by the Company and lead state regulators of the reassessment process. The DOL may also participate in this monitoring of the reassessment process. See previous discussion under “California Settlement Agreement and Amendment of the Multistate Market Conduct Examination Settlement Agreements” contained herein pertaining to subsequent amendments to the multistate settlement agreements’ reassessment process.
The Company also agreed to enhance certain aspects of its claim operations, including making changes to its organization and procedures to improve the consistency of and the support for each claim decision and create an easier process for claimants. First, the Company increased the number of experienced claims professionals involved in making claim decisions, as well as more heavily involved higher levels of management in signing off on adverse claim decisions. Doing so not only put more experienced people into closer contact with claim decisions, but it should also improve turnaround times and clarify accountability for claims decisions. Second, to improve the support for the initial claim decisions, the Company modified its policies regarding medical information, including guidelines for the use of independent medical evaluations and the process for handling claimants with multiple medical conditions. Third, to make it easier for a claimant to understand and proceed through the claim process, the Company added a number of service components, including referring certain claims to field personnel who will meet with the claimant in an effort to make the process less burdensome. Also, there is an additional telephone hotline available to claimants who seek additional assistance. Finally, to further assure consistency in the initial claim decision, the Company added a position of quality compliance consultant to assess the totality of the claim decision and to focus on issues of compliance and documentation.
requirements, as well as general claims handling compliance. The committee is composed of five independent directors, including two directors with significant insurance industry or insurance regulatory experience.
The agreements will remain in place until the later of January 1, 2007, or the completion of an examination of claims handling practices and an examination of the reassessment process, both of which will be conducted by the lead state regulators. In addition to the fine of $15.0 million, the insurance subsidiaries that are parties to the settlement agreements are subject as a group to potential fines for non-compliance with the settlement agreements, including contingent fines of $100,000 per day if certain implementation deadlines are not met and a contingent fine of $145.0 million for failure to satisfactorily meet the performance standards in the settlement agreements relating to the examinations referred to above, which will be conducted in approximately two years. This latter contingent fine relating to examination of the claims handling practices or the reassessment process is limited to a maximum of $145.0 million for both examinations should the performance standards not be met. The performance standard is based on compliance with a maximum tolerance standard for claims procedures based on review of a statistically credible random sample of individual or group claims. The Company believes that the changes it has made to its claims operations and to enhance its oversight functions will substantially reduce the likelihood that the Company would fail to meet the performance standards in the agreements when these examinations are concluded.
In conjunction with the restructuring of the individual income protection - closed block business, effective January 1, 2004, the Company modified its reporting segments to include a separate segment for this business. The reporting, monitoring, and management of the closed block of individual income protection business as a discrete segment is consistent with the Company’s financial restructuring and separation of this business from the lines of business which actively market new products. In the past, this business had been reported in combination with the individual income protection - recently issued line of business. Prior to 2004, detailed separate financial metrics and models were unavailable to appropriately manage this block of business separately from the recently issued individual income protection block of business.
As part of the restructuring, in May 2004, the Company issued 12.0 million 8.25% adjustable conversion-rate equity security units (units) in a private offering for $300.0 million. The Company subsequently registered the privately placed securities for resale by the private investors. Proceeds from the offering were used to restore the Company’s insurance subsidiaries’ risk-based capital to the approximate overall level that existed prior to the individual income protection - closed block reinsurance transaction and to provide additional liquidity at the holding company level.
During 2004, the Company recognized tax benefits as a result of settlements with the IRS of certain tax issues (primarily related to insurance tax reserves and investment losses) affecting the Company’s federal income tax liability related to its 1996 through 1998 tax years. During the fourth quarter of 2004, the Company obtained a judgment in refund litigation for federal income tax paid for tax year 1984, plus interest, and as a result will be entitled to a refund of tax plus interest for all tax years subsequent to tax year 1984 in which the IRS took inconsistent positions on the deductibility of insurance tax reserves that were the subject of the litigation and for which the Company paid tax based on the IRS’ inconsistent positions. Included in 2004 operating results is income of $14.0 million before tax and approximately $59.3 million after tax attributable to these prior year tax items.
In January 2004, the Company completed its annual review of claim reserves to ensure that its claim reserves make adequate and reasonable provision for future benefits and expenses. Based upon this review, as of December 31, 2003, the Company increased its U.S. Brokerage group long-term income protection claim reserves by $421.0 million and its U.S. Brokerage group short-term income protection claim reserves by $19.0 million, for a total
The Company had two reinsurance contracts for which DIG Issue B36 was applicable. Transition to the provisions of DIG Issue B36 required the Company to value the credit risk provisions in these contracts as derivatives and report them in the consolidated statements of financial condition at their current fair values, with the change in fair value since inception of the reinsurance contracts up to the date of adoption reported as a 2003 cumulative effect of accounting principle change. The Company included in miscellaneous assets a deposit asset for one of the applicable reinsurance contracts. The deposit asset previously included unrealized gains or losses on the marketable securities held in the trust. Under the provisions of DIG Issue B36, any net unrealized gain was attributed to the value of the embedded derivative and was reported as such in fixed maturity securities. Any net unrealized loss was attributed to the marketable securities held in the trust and reported as an adjustment to the deposit asset, with the related effects on claim reserves reflected in the reinsurance receivable for claim reserves.
Since policies may receive claim payments for a number of years, it is unlikely that the chosen discount rate assumption will prove to be accurate for any one policy; rather, the discount rate is chosen to apply to many claims with various characteristics of length and severity. The Company uses its experience and analysis of its existing claims and investment performance to determine the appropriate discount rate assumption. Actual claim reserves incurred in the calendar quarter are sensitive to the choice of discount rate. For example, a 25 basis point increase or decrease in the U.S. Brokerage group long-term income protection claim discount rate for current year claims would change a quarter’s incurred claim cost in 2005 by approximately $4.0 million.
one percent increase or decrease in the U.S. Brokerage group long-term income protection claim resolution rate would change a quarter’s incurred claim cost in 2005 by approximately $3.0 million.
The Company has liability for claims that have been incurred but not reported to the Company and must establish a liability for these claims equal to the present value of the expected benefit payments. In addition to the discount rate and claim resolution rate, the incidence rate is also a primary assumption in the IBNR reserve. The incidence rate is the rate at which new claims per thousand insured lives are submitted to the Company. The incidence rate is affected by many factors including the age of the insured, the insured’s occupation or industry, the benefit plan design, and certain external factors such as consumer confidence and levels of unemployment. The Company establishes the incidence assumption using a historical review of actual incidence results along with an outlook of future incidence expectations. As the actual claims are reported and claim reserves are established, the accuracy of the IBNR emerges. While the Company expects its IBNR reserve to be appropriate over the long term, it will not always equal, in a particular reporting period, the actual reserve established for a reported claim. For example, a 10 basis point deviation in the actual incidence rate from that assumed in the U.S. Brokerage IBNR reserve would result in an increase or decrease of approximately $10.0 million in claim reserves established during a quarter in 2005, relative to the IBNR reserve previously established to cover those claims.
(1) IBNR for income protection includes “reopen reserves.” These two categories of reserves are developed and maintained in aggregate based on historical monitoring that has only been on a combined basis.
(2) Equals the sum of “Policy and Contract Benefits,” “Reserves for Future Policy and Contract Benefits,” “Unearned Premiums,” and “Other Policyholder Funds” as reported in the consolidated statements of financial condition.
The Company uses its own historical experience and expectation of the future performance of its business in determining the expected life of the policies. Over 90 percent of the Company’s deferred policy acquisition costs relate to traditional non interest-sensitive products, for which the costs are amortized in proportion to the estimated premium income to be received over the life of the policies in accordance with the provisions of Statement of Financial Accounting Standards No. 60, Accounting and Reporting by Insurance Enterprises. The estimated premium income in the early years of the amortization period is higher than in the later years due to higher anticipated policy persistency in the early years, which results in a greater proportion of the costs being amortized in the early years of the life of the policy. Amortization of deferred costs on traditional products is adjusted to reflect the actual policy persistency as compared to the anticipated experience. The Company will experience accelerated amortization if policies terminate earlier than projected.
Deferred costs for Unum Limited group and individual income protection and group life products are generally amortized over a fifteen-year period, with approximately 80 percent of the original deferred costs expected to be amortized by year ten. Deferred costs for products issued by the Colonial segment are generally amortized over a seventeen-year period, on average, with approximately 80 percent and 90 percent of the original deferred costs expected to be amortized by years ten and fifteen, respectively.
Private placement fixed maturity securities had a fair value of approximately $3.9 billion, or 11.1 percent of total fixed maturity securities, at December 31, 2005. Private placement fixed maturity securities do not have readily determinable market prices. For these securities, the Company uses 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, the Company obtains prices from independent third-party brokers to establish valuations for certain of these securities. The Company’s ability to liquidate its positions in some of these securities could be impacted to a significant degree by the lack of an actively traded market, and the Company may not be able to dispose of these investments in a timely manner. Although the Company believes its estimates reasonably reflect the fair value of those securities, the key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral (if any), and other factors involve significant assumptions and may not reflect those of an active market. The Company believes that generally these private placement securities carry a credit quality comparable to companies rated Baa or BBB by major credit rating organizations.
As of December 31, 2005, the key assumptions used to estimate the fair value of private placement fixed maturity securities included the following:
Additional basis points were added as deemed appropriate for certain industries and for individual securities in certain industries that are considered to be of greater risk.
Goodwill is the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. Goodwill is not amortized, but the Company reviews on an annual basis the carrying amount of goodwill for indications of impairment, with consideration given to financial performance and other relevant factors. In accordance with accounting guidance, the Company tests for impairment at either the operating segment level or one level below. In addition, certain events including, but not limited to, a significant adverse change in legal
The decline in premium income in 2005 relative to the prior year is generally in line with the Company’s expectations as premium income has declined in the Company’s U.S. Brokerage group income protection and group life and accidental death and dismemberment lines of business due to the Company’s pricing strategy for its group business. The Unum Limited segment, Colonial segment, and remaining U.S. Brokerage segment lines of business reported growth in premium income. In addition, premium income in the Individual Income Protection - Closed Block segment increased in 2005 due to the recapture of a ceded block of business effective August 8, 2005. Premium income increased in 2004 relative to 2003 due to increases in the U.S. Brokerage supplemental and voluntary lines and the Unum Limited and Colonial segments. This growth was partially offset by a decline in premium income in the U.S. Brokerage group income protection and group life and accidental death and dismemberment lines of business. See the operating results by segment contained herein for further discussions of premium income variances between years.
Net investment income increased slightly in 2005 relative to the prior year. Included in net investment income for 2005 is approximately $35.0 million related to the $1.6 billion of bonds transferred to the Company in conjunction with the 2005 recapture of a ceded closed block of individual income protection business. Excluding that, net investment income was consistent year over year, with the increase from the growth in invested assets and higher bond call premiums offset by the investment of new cash at lower rates and a decline in the level of prepayments on mortgage-backed securities relative to the prior year. Net investment income in 2004 was level with 2003, with the growth in invested assets offset by lower income on new cash invested in the lower interest rate environment and by a decline in the level of prepayments on mortgage-backed securities. See “Investments” contained herein in Item 7 for further discussion.
The results of the disability management services business are now reported in the Other segment, which has been redefined to include the disability management services business as well as results from U.S. Brokerage insured products not actively marketed (with the exception of the individual income protection products in the Individual Income Protection - Closed Block segment). There were no changes to the Colonial, Individual Income Protection - Closed Block, or Corporate segments. Segment information for prior periods has been reclassified to conform to the current reporting segments.
These non-GAAP financial measures of “operating revenue” and “operating income” or “operating loss” differ from revenue and income (loss) from continuing operations before income tax as presented in the Company’s consolidated operating results reported herein and in income statements prepared in accordance with GAAP due to the exclusion of before tax realized investment gains and losses. The Company measures segment performance for purposes of Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, excluding realized investment gains and losses because management believes that this performance measure is a better indicator of the ongoing businesses and the underlying trends in the businesses. The Company’s investment focus is on investment income to support its 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 are dependent on market conditions and not necessarily related to decisions regarding the underlying business of the Company’s segments. However, income or loss excluding realized investment gains and losses does not replace net income or net loss as a measure of the Company’s overall profitability. The Company may experience realized investment losses, which will affect future earnings levels as the underlying business is long-term in nature and requires that the Company be able to earn the assumed interest rates in its liabilities.
Included in the 2005 before-tax operating income by segment of $716.3 million is a before-tax charge of $75.0 million related to the settlement of the market conduct examination with the California DOI and related matters. Included in the 2004 before-tax operating loss by segment of $288.7 million is a before-tax charge of $127.0 million related to the settlement of the multistate market conduct examination and a before-tax charge of $967.0 million related to the first quarter of 2004 restructuring of the individual income protection - closed block of business. Included in the 2003 before-tax operating loss by segment of $261.4 million is a before-tax charge of $894.0 million related to U.S. Brokerage group income protection reserve strengthening.
The U.S. Brokerage segment includes group long-term and short-term income protection insurance, group life and accidental death and dismemberment products, and supplemental and voluntary lines of business. The supplemental and voluntary lines of business are comprised of recently issued individual income protection insurance, group and individual long-term care insurance, and voluntary workplace benefits products. Shown below are financial results for the U.S. Brokerage segment. In the sections following, financial results and key ratios are also presented for the major lines of business within the segment.
Sales for the U.S. Brokerage segment during 2005 were generally consistent with Company expectations. The Company anticipated relatively weaker sales for the first half of 2005 relative to the comparable period of 2004 for both group and individual income protection products primarily as a result of the competitive pricing environment. The Company began to restore sales momentum during the latter half of the year, particularly in the small and mid-employer core markets, while maintaining its commitment to a disciplined pricing approach for new business. The Company intends to continue to emphasize profitable premium growth through a balance of new sales, renewal programs, and persistency of existing profitable blocks of business.
Voluntary workplace benefits sales increased in comparison to the prior year due to both growth in existing products along with the introduction of new products.
The portion of the individual income protection sales attributable to multi-life business was approximately 81 percent for 2004 sales and 77 percent for 2003 sales, although both multi-life and non multi-life sales declined in 2004 relative to the prior year. Voluntary workplace benefits sales increased in 2004 relative to 2003 and were generally in line with the Company’s expectations.
For the years 2002 and subsequent, the Company lowered its premium persistency assumptions for group income protection, group life, and group accidental death and dismemberment policy acquisition costs deferred in those years to reflect its current estimate of persistency. This accelerated the amortization of acquisition costs deferred in those years into the early life of the policy by using lower premium persistency assumptions to determine the “scheduled” or expected amortization. Although persistency in the future may be lower than historical levels, particularly in certain issue years due to the Company’s increased emphasis on retaining profitable business, the acceleration of “scheduled” amortization may eliminate the need for additional amortization related to the decline in actual persistency relative to “scheduled” or expected persistency. The Company does not anticipate that the persistency levels for 2006 will result in increased amortization.
A continuing part of the Company’s strategy for U.S. Brokerage group business involves executing its renewal programs and managing persistency in its existing blocks of business. Persistency for the primary lines of business within the U.S. Brokerage segment is expected to remain stable or slightly improve during 2006, which reflects the need for less aggressive renewal actions needed on the in-force business and a smaller 2006 renewal program than those of 2004 and 2005. Included in the Company’s 2006 renewal program is a focus on group income protection products sold in the State of California. As a result of the Company’s settlement agreement with the California DOI and the resulting revisions in group income protection product requirements for policies issued in California, the Company’s 2006 renewal program includes a focus on new sales and renewal of existing business in the California market.
(2) Included in these ratios are the 2005 before-tax charge of $10.1 million related to the settlement agreement with the California Department of Insurance and related matters and the 2004 before-tax charge of $36.5 million related to the settlement of the multistate market conduct examination. Excluding these charges, the operating expense ratios for 2005 and 2004 would have been 22.6% and 22.0%, respectively.
(3) Included in these ratios are the 2005 before-tax charge of $37.4 million related to the settlement agreement with the California Department of Insurance and related matters; the 2004 before-tax charge of $116.7 million related to the settlement of the multistate market conduct examination; and the 2003 before-tax reserve strengthening of $894.0 million. Excluding these charges, the before-tax operating income ratios for 2005, 2004, and 2003 would have been 2.7%, 2.2%, and 0.9%, respectively.
Operating revenue for group income protection decreased in 2005 relative to the prior year due to the expected decline in premium income. Net investment income increased due to the growth in the level of assets supporting these lines of business, offsetting the impact of the declining yield which results from investing new cash in the lower interest rate environment. Other income, which increased in 2005 relative to the prior year, includes ASO fees of $59.0 million and $56.1 million for 2005 and 2004, respectively.
The benefit ratio for group long-term income protection increased in 2005 relative to the prior year, excluding the charges taken in 2005 and 2004 related to the settlement agreement with the California DOI and related matters and the settlement agreements related to the multistate market conduct examination, due primarily to claims management performance, particularly reduced operational effectiveness in the timing of claim decisions and claim recoveries. For group short-term income protection, the 2005 benefit ratio was lower than 2004 due primarily to increased premiums per insured life and a decrease in the paid claim incidence rate.
Premium income for group income protection decreased slightly in 2004 relative to 2003, primarily due to the expected decrease in persistency for group short-term income protection. Net investment income decreased in 2004 compared with 2003 due primarily to lower investment portfolio yields resulting from the decline in market interest rates and from less prepayment income on fixed maturity securities, offset somewhat by a year over year increase in the retrospective adjustment of the amortization of the purchase discount on mortgage-backed securities. Included in other income are ASO fees of $56.1 million for 2004 and $46.5 million for 2003.
U.S. Brokerage Group Life and Accidental Death and Dismemberment Operating Results
The group life line of business reported a decrease in the benefit ratio for 2005 relative to the prior year. Submitted claim incidence was slightly lower in 2005 relative to the prior year, but the average paid claim size and submitted waiver incidence increased relative to the prior year. The accidental death and dismemberment line of business reported a slightly increased benefit ratio for 2005 compared to the prior year due to slightly higher levels of paid claim incidence offset partially by a decreased average paid claim size.
Commissions and the deferral of policy acquisition costs decreased in 2005 compared to the prior year due primarily to the decrease in sales in comparison to the prior year, partially offset by a 2005 buy-out of a block of business from a commissioned sales agency. Operating expenses have remained relatively stable in 2005 relative to the prior year, but the operating expense ratio increased due to the decline in premium income. Although aggressively managing expenses, the Company anticipates continuing pressure on its operating expense ratios for group life and accidental death and dismemberment.
Premium income decreased in 2004 relative to 2003 due primarily to lower sales. The group life line of business benefit ratio decreased slightly in 2004 relative to 2003 due to an increase in premiums per life partially offset by higher submitted and paid claim incidence rates in 2004 relative to 2003 as well as an increase in the average paid claim size.
Acquisition costs capitalized during 2004 were lower than in 2003 due primarily to an updated analysis of costs associated with the acquisition of new business and due to the decrease in sales.
Net investment income increased relative to the prior year due primarily to growth in the level of assets supporting these lines of business, partially offset by the inclusion in 2004 of a portion of the investment income attributable to the bonds retained from the sale of the Canadian branch that were subsequently redeployed to other lines of business and also due to a decline in the yield on the portfolio from investing new cash in the lower interest rate environment.
The growth in premium income for individual income protection - recently issued resulted from prior year sales growth and stable persistency of the existing block of business. Premium income for long-term care increased during 2004 compared to 2003 primarily due to new sales growth in previous periods. Changes in the product offering during 2003 decreased the 2004 growth in individual long-term care sales relative to historical trends. Persistency in the long-term care line of business remained high and stable. The growth in premium income for voluntary workplace benefits was due primarily to sales growth.
The Company’s primary focus during 2006 will be continued improvement of its claims management results and profitability enhancement in its group income protection line of business, along with an emphasis on continued growth in the small and mid-employer core markets and the supplemental and voluntary product lines. The Company intends to continue its disciplined approach to pricing, renewals, and risk selection, with a more conscious effort to balance growth and profitability. Although this strategy may cause a somewhat lower persistency or market share, historically the profitability of business that terminates has generally been less than the profitability of retained business.
The Company believes that its U.S. Brokerage results will benefit if there is an improvement in overall economic conditions and a higher interest rate environment, although the improvement in results may lag behind the improvements in the economy and interest rate environment.
Sales decreased in 2005 relative to the prior year due in part to higher sales in 2004 related to the exit of a major insurer from the U.K. market during 2004. Sales for group life products were also unfavorably impacted in 2005 relative to the prior year due to the competitive environment in the U.K. for group life products and the Company maintaining pricing discipline.
While underlying claims experience was favorable, the benefit ratio for the group long-term income protection line of business increased in comparison to 2004 due to the inclusion in the prior year of extremely favorable claim resolution experience on an acquired block of group long-term income protection business. The benefit ratio for the group life line of business decreased in comparison to 2004 due to favorable claim experience in 2005 and recent renewal activity which resulted in terminations during 2005 of less profitable business.
The Company believes that this segment will continue to produce growth in operating income, although the rate of growth will decline as the acquisition-related growth of the last several years subsides.
The Colonial segment includes insurance for income protection products, life products, and cancer and critical illness products issued by the Company’s subsidiary Colonial Life & Accident Insurance Company and marketed to employees at the workplace through an agency sales force and brokers. Shown below are financial results and key performance indicators for the Colonial segment.
Sales in 2005 increased for all lines of business as compared to 2004 driven primarily by growth in the core markets, which are comprised of employee groups with less than 2,000 lives, partially offset by a decline in sales in the large case market. Sales were also unfavorably impacted by the hurricanes in the Gulf Coast and Florida.
Premium income growth in 2004 relative to the prior year was attributable primarily to favorable persistency. The 2004 benefit ratio for this segment was lower than in 2003 due primarily to a lower benefit ratio for the income protection line of business. Individual short-term income protection claim incidence decreased for 2004 compared with the prior year while the average claim duration for closed claims was higher in 2004 relative to 2003. The average indemnity for individual short-term income protection was higher in 2004 relative to 2003. For accident and sickness products, the claim incidence rate decreased in 2004 relative to the prior year, but the average claim payment increased over that reported in 2003. The life line of business reported an increase in the number of paid claims relative to 2003 and an increase in the average claim payment.
Sales results in recent years have not grown at the rate the Company believes it can competitively and profitably achieve. In 2006, the Company will continue to emphasize consistent, profitable sales growth by focusing on the recruitment and productivity of agents, improved business tools, and enhanced marketing research and development.
Shown below are financial results and key performance indicators for the Individual Income Protection - Closed Block segment.
(2) Included in these ratios are the 2005 before-tax charge of $1.0 million related to the settlement agreement with the California Department of Insurance and related matters and the 2004 before-tax charge of $1.1 million related to the settlement of the multistate market conduct examination. Excluding these charges, the operating expense ratios for 2005 and 2004 would have been 21.0% and 20.9%, respectively.
(3) Included in these ratios are the 2005 before-tax charge of $3.3 million related to the settlement agreement with the California Department of Insurance and related matters and the 2004 before-tax charge of $1.7 million related to the settlement of the multistate market conduct examination. Excluding these charges, the before-tax operating income ratios for 2005 and 2004 would have been 13.8% and 15.8%, respectively.
As previously discussed, effective August 8, 2005, the Company recaptured the closed block individual income protection business originally ceded to Centre Life Reinsurance Ltd. in 1996. The underlying operating results of the reinsurance contract, prior to recapture, were reflected in other income. The recapture did not have a material impact on operating income for the segment.
Premium income increased in 2005 compared to the prior year due to the recapture of the previously discussed block of business, which added approximately $70.0 million of premium income to this segment and on an annual basis, is expected to add approximately $185.0 million of premium income. Other than premiums on the recaptured block of business, premium income declined in 2005 relative to the prior year, as expected in this closed block of business. Net investment income decreased in 2005 relative to the prior year due to a decline in the portfolio yield rate and a decrease in income from prepayments on mortgage-backed securities. These declines were offset somewhat by approximately $35.0 million of investment income related to the $1.6 billion of bonds transferred to the Company in conjunction with the reinsurance recapture. Other income includes the underlying results of certain blocks of reinsured business, including the results of the aforementioned block of business prior to the recapture date.
Total revenue, subsequent to a full year’s inclusion of premium and net investment income related to the recaptured block of business, is expected to decline very slowly over time as the Company believes that persistency will remain in the mid-90 percent range. The Company believes that the interest adjusted loss ratio will be relatively flat over the long-term, but the segment may experience quarterly volatility. The expense ratio throughout 2006 is expected to be consistent with or lower than that reported for 2005.
The Other operating segment includes results from disability management services and U.S. Brokerage insured products not actively marketed (with the exception of certain individual income protection products in the Individual Income Protection - Closed Block segment), including individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities. It is expected that operating revenue and income in this segment resulting from the products that are not actively marketed will decline over time as these business lines wind down, and management expects to reinvest the capital supporting these lines of business in the future growth of the U.S. Brokerage, Unum Limited, and Colonial segments.
Operating revenue from disability management services, which includes the Company’s wholly-owned subsidiaries GENEX and Options and Choices, Inc., totaled $177.9 million in 2005, compared to $177.1 million in 2004 and $173.0 million in 2003. Operating income totaled $15.7 million in 2005, compared to $16.2 million in 2004 and $17.2 million in 2003.
During 2000, the Company reinsured substantially all of the individual life and corporate-owned life insurance blocks of business. The Company ceded approximately $3.3 billion of reserves to the reinsurer. The $388.2 million before-tax gain on these transactions was deferred and is being amortized into income based upon expected future premium income on the traditional insurance policies ceded and estimated future gross profits on the interest-sensitive insurance policies ceded.
Total operating revenue for individual life and corporate-owned life insurance was $41.0 million, $40.0 million, and $39.9 million in 2005, 2004, and 2003, respectively. Operating income for the same periods was $38.8 million, $38.2 million, and $33.5 million.
Group pension, health insurance, individual annuities, and other closed lines of business had operating revenue of $110.4 million, $144.6 million, and $150.4 million in 2005, 2004, and 2003, respectively, and operating income (losses) of $2.2 million, $(1.5) million, and $(1.5) million. Decreases in operating revenue and income are expected to continue as these lines of business wind down.
Included in these amounts were the Company’s operating results for its previously owned operation in Argentina, which produced operating revenue of $27.7 million and $18.1 million in 2004 and 2003, respectively, and operating losses of $6.2 million and $13.4 million in 2004 and 2003, respectively. As previously disclosed, in the fourth quarter of 2005 the Company disposed of its remaining 40 percent ownership position in its Argentinean operation. The Argentinean operation had been restructured during 2004 wherein at that time the Company reduced its ownership position to 40 percent and reported a before-tax loss of $4.7 million. During 2003, the Company recognized an impairment loss of $13.5 million related to this operation.
Operating revenue in the Corporate segment was $61.2 million in 2005, compared to $66.0 million in 2004 and $31.6 million in 2003. As previously discussed, during the fourth quarter of 2004 the Company obtained a judgment in refund litigation for federal income tax paid for tax year 1984, plus interest, and as such, recognized $14.0 million of operating revenue in the Corporate segment related to the interest portion of the anticipated refund. Also contributing to the decline in revenue during 2005 relative to 2004 was a $9.4 million curtailment gain recognized in 2004 related to changes in the Company’s retiree medical plan. See Note 7 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further discussion of the curtailment gain.
Losses from discontinued operations were $60.8 million and $161.7 million, net of tax, in 2004 and 2003, respectively. Excluding the 2004 and 2003 losses on the sale and the write-downs, income from discontinued operations was $10.5 million and $35.2 million in 2004 and 2003, respectively.
Investment activities are an integral part of the Company’s business, and profitability is significantly affected by investment results. Invested assets are segmented into portfolios that support the various product lines. Generally, the investment strategy for the portfolios is to match the effective asset cash flows and durations with related expected liability cash flows and durations to consistently meet the liability funding requirements of the Company’s business. The Company seeks to maximize investment income and total return and to assume credit risk in a prudent and selective manner, subject to constraints of quality, liquidity, diversification, and regulatory considerations. The Company’s overall investment philosophy is to invest in a portfolio of high quality assets that provide investment returns consistent with that assumed in the pricing of its insurance products. Assets are invested predominately in fixed maturity securities, and the portfolio is matched with liabilities so as to eliminate as much as possible the Company’s exposure to changes in the overall level of interest rates. Changes in interest rates affect the amount and timing of cash flows.
The Company actively manages its asset and liability cash flow match as well as its asset and liability duration match in order to minimize interest rate risk. The Company may redistribute its investments within its different lines of business, when necessary, to adjust the cash flow and/or duration of the asset portfolios to better match the cash flow and duration of the liability portfolios. Asset and liability portfolio modeling is updated on a quarterly basis and is used as part of the overall interest rate risk management strategy. Cash flows from the inforce 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 the Company to assess the impact of projected changes in cash flows and duration resulting from potential changes in interest rates. Testing the asset and liability portfolios under various interest rate scenarios enables the Company to choose the most appropriate investment strategy as well as to minimize the risk of disadvantageous outcomes. This analysis is a precursor to the Company’s activities in derivative financial instruments, which are used to hedge interest rate risk and to manage duration match. At December 31, 2005, the weighted average duration of the Company’s policyholder liability portfolio was approximately 8.09 years, and the weighted average duration of the Company’s investment portfolio supporting those policyholder liabilities was approximately 7.71 years.
Below is a summary of the Company’s formal investment policy, including the overall quality and diversification objectives.
The majority of investments are in high quality publicly traded securities to ensure the desired liquidity and preserve the capital value of the Company’s portfolios.
The long-term nature of the Company’s insurance liabilities also allows it to invest in less liquid investments to obtain superior returns. A maximum of 10 percent of the total investment portfolio may be invested in below-investment-grade securities, 2 percent in equity type instruments, up to 35 percent in private placements, and 5 percent in commercial mortgage loans. The remaining assets can be held in publicly traded investment-grade corporate securities, mortgage-backed securities, asset-backed securities, and U.S. government agencies and municipal securities.
The Company intends to manage the risk of losses due to changes in interest rates by matching asset duration with liabilities to within a range of +/- three years.
Derivative instruments may be used to hedge interest rate risk and foreign currency risk and match liability duration and cash flows consistent with the plan approved by the board of directors.
other than temporarily declined during the applicable reporting period, as well as the result of further declines in the values of fixed maturity and equity securities that had initially been written down in a prior period.
Approximately 58 percent of the 2004 other than temporary impairment losses in continuing operations occurred in the financial institutions and transportation industries. Circumstances surrounding larger other than temporary impairment losses are as follows:
$20.5 million loss on securities issued by a large domestic based airline. The company continues to be plagued by a high cost structure and faces liquidity problems if costs are not substantially reduced in the short-term. The securities were investment-grade at the time of purchase but were downgraded to below-investment grade in the third quarter of 2001. At the time of the impairment loss, these securities had been in an unrealized loss position for a period of greater than three years. The circumstances of this impaired investment have no impact on other investments.
$12.0 million loss on senior notes issued by a United Kingdom based engineering and manufacturing company engaged in the bus and automotive industry. The company experienced a rapid deterioration in business prospects at its main operating unit in late 2003 and early 2004, followed by the discovery of bookkeeping fraud at one of its business units. Both of these issues were discovered and disclosed to the company’s banks and note holders by outside financial consultants during the first quarter of 2004. The company filed for U.K. administration on March 31, 2004. The securities were investment-grade at the time of purchase but were downgraded to below-investment-grade in the third quarter of 2003. At the time of the impairment loss, these securities had been in an unrealized loss position for a period of greater than 180 days but less than 270 days. The circumstances of this impaired investment have no impact on other investments.
$8.9 million loss on private equity securities issued by a U.S. based insurance services company. The Company initially recognized an impairment loss on these securities in the first quarter of 2002 due to the negative revenue impact resulting from the company’s loss of a single large client. The Company closely monitored the financial performance of the company during 2002 and 2003. In the first quarter of 2004, following a review of the company’s capital condition, its revenue and earnings performance, and discussions with company management, it was determined that the investment was further impaired. In the third quarter of 2004, the company was recapitalized at a market price that indicated an additional impairment loss had occurred. The investment was originally purchased as part of the Company’s private equity investment program. There had been no unrealized gain or loss subsequent to the initial impairment loss in 2002. The circumstances of this impaired investment have no impact on other investments.
Approximately 46 percent of the 2003 impairments in continuing operations occurred in the energy and utilities industries. Circumstances surrounding larger other than temporary impairment losses are as follows:
$26.4 million loss on securities issued by a related entity of a U.S. based energy company. The securities were issued by a utility company that services an industrial site in England and whose 98 percent parent filed for insolvency in December 2001. This issuer was excluded from the parent’s insolvency filing due to the financial separation from the parent and was operating as a going concern during 2002. Despite the financial separation, the issuer’s securities were downgraded to below-investment-grade in the fourth quarter of 2001. The Company initially recognized an impairment loss on these securities at the time of the parent’s insolvency filing in 2001. These bonds were secured by a second lien on the real estate holdings of the company. The Company closely monitored this security and the value of the collateral during 2002. Following extensive negotiations during 2002 and the first quarter of 2003 with the company’s two other lenders, financial advisors, and counsel, it was determined that the investment was further impaired. Prior to its impairment loss in 2003, the investment had been in an unrealized loss position for a period of greater than 270 days but less than one year. The circumstances of this impaired investment have no impact on other investments.
$11.0 million loss on securities issued by a travel services company located in the United Kingdom. The impairment loss was taken following discussions between the issuer and its creditors regarding difficulties in the issuer’s businesses due to geopolitical unrest and persistent weakness in demand for leisure travel and requests for certain waivers and consents of debt covenants. These securities were investment-grade at the time of purchase but were downgraded to below-investment-grade in the first quarter of 2003. At the time of the impairment loss, these securities had been continuously in an unrealized loss position for a period of greater than 270 days but less than one year. The circumstances of this impaired investment have no impact on other investments.
Realized Investment Losses during 2005 from Sale of Fixed Maturity Securities
$14.6 million loss on securities issued by a major U.S. based automotive parts supplier. The company has experienced declining sales and production levels, along with higher steel prices and growing employee health care and retirement costs. The company filed for bankruptcy in the third quarter of 2005. These securities were investment-grade at the time of purchase but were downgraded to below-investment-grade in the first quarter of 2005. At the time of sale, these securities had been continuously in an unrealized loss position for a period of greater than 90 days but less than 180 days. The circumstances of this investment have no impact on other investments.
$12.6 million loss on securities issued by a major U.S. based automotive manufacturer. The company has experienced declining sales due to competition and the increase in gasoline prices, along with higher raw materials costs and growing employee health care and retirement costs. These securities were investment-grade at the time of purchase but were downgraded to below-investment-grade in the third quarter of 2005. At the time of sale, these securities had been continuously in an unrealized loss position for a period of less than 90 days. The circumstances of this investment have no impact on other investments.
Realized Investment Losses during 2004 from Sale of Fixed Maturity Securities
$5.8 million loss on securities issued by a leading builder of power plants and a provider of electricity generation in the U.S., Canada, and the United Kingdom. The company had suffered from an over supply of power generation in most of the markets in which it operates. In addition, the company had experienced weak cash flow and high debt ratios as a result of weak industry and economic fundamentals. These securities were originally purchased as part of the Company’s below-investment-grade strategy. At the time of sale, these securities had been continuously in an unrealized loss position for a period of greater than two years but less than three years. The circumstances of this investment have no impact on other investments.
For the year ended December 31, 2003, the Company realized a loss of $143.6 million on the sale of fixed maturity securities in its continuing operations. The securities sold during the year had a book value of $821.0 million and a fair value of $677.4 million at the time of sale and represented 94 different issuers, of which approximately 59 percent were a part of the Company’s 2003 program to reduce its below-investment-grade fixed maturity securities holdings to comply with its investment policy regarding diversification and to better position the investment portfolio in the then current environment and reduce exposure to potential credit-related losses. Circumstances surrounding larger realized investment losses from sale of securities are as follows:
$25.2 million loss on securities guaranteed by an Italian dairy company. The loss was incurred after it was revealed that the guarantor had engaged in massive fraud, ultimately leading to the company’s bankruptcy. The guarantor had been rated investment-grade until December 2003. At the time of sale, the investment had been in an unrealized loss position for a period of less than 90 days. The Company also owns $22.5 million of fixed maturity securities of a wholly-owned Canadian subsidiary of the parent company. Although the financial and operating profiles of the subsidiary are separate from the parent and no other than temporary impairment was deemed to exist, in conjunction with the classification of the Canadian branch as an asset held for sale, the Company recognized a loss of $4.0 million to write down the value of these securities, which were held in the Canadian branch investment portfolio, to market value. This loss is included in the loss from discontinued operations.
The following table is a distribution of the maturity dates for fixed maturity bonds in an unrealized loss position at December 31, 2005.
The following table shows the length of time the Company’s below-investment-grade fixed maturity bonds had been in a gross unrealized loss position as of December 31, 2005. The fair value and gross unrealized losses are categorized by the relationship of the current fair value to amortized cost for those securities on December 31, 2005. The fair value to amortized cost relationships are not necessarily indicative of the fair value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of the relationships subsequent to December 31, 2005.
As of December 31, 2005, the Company held two securities with a gross unrealized loss of $10.0 million or greater, as shown in the chart below.
Unrealized losses on investment-grade fixed maturity securities principally relate to changes in interest rates or changes in market or sector credit spreads which occurred subsequent to the acquisition of the securities. These changes are generally temporary and are not recognized as realized investment losses unless the securities are sold, it becomes unlikely that the Company will hold the securities until recovery based on relevant facts and circumstances, or the securities become other than temporarily impaired. Generally, below-investment-grade fixed maturity securities are more likely to develop credit concerns. As previously discussed under “Critical Accounting Policies” contained herein, in determining whether a decline in fair value below amortized cost of a fixed maturity security is other than temporary, the Company utilizes a formal, well-defined, and disciplined process to monitor and evaluate its fixed income investment portfolio. The process results in a thorough evaluation of problem investments and the recording of realized losses on a timely basis for investments determined to have an other than temporary impairment.
The principal protected equity linked note is a zero coupon bond, issued by a large, well capitalized Fortune 500 financial services company, the return of which is linked to a Vanguard S&P 500 index mutual fund. This bond matures on August 24, 2020 and carried the AA rating of the issuer, as determined by S&P as of December 31, 2005. This note has an embedded derivative contract and substitutes highly rated bonds in place of the underlying S&P 500 index mutual fund to provide principal protection in the event of a significant decline in the equities market. The note derives its value from the underlying S&P 500 index mutual fund. The reduction in the market value of this note was the result of the decline in the S&P 500 index subsequent to the purchase date of the note. Based on historical long-term returns of the S&P 500 index, the Company believes that the value of the underlying S&P 500 index mutual fund will equate to or exceed the par value of the security at maturity. The Company therefore believes that the decline in fair value of the note is temporary. The Company has the ability to hold this security to the earlier of recovery or maturity.
The Company has a significant interest in, but is not the primary beneficiary of, a special purpose entity which is a collateralized bond obligation asset trust in which the Company holds interests in several of the tranches and for which the Company acts as investment manager of the underlying securities. The Company’s investment in this entity is reported at fair value with fixed maturity securities in the consolidated statements of financial condition. The fair value of this investment was derived from the fair value of the underlying assets. The fair value and amortized cost of this investment were $21.5 million and $21.0 million, respectively, at December 31, 2005, and $25.6 million and $24.8 million, respectively, at December 31, 2004.
The Company uses derivative financial instruments to manage reinvestment risk, duration, and currency risk. Historically, the Company has utilized interest rate futures contracts, current and forward interest rate swaps and options on forward interest rate swaps, current and forward currency swaps, interest rate forward contracts, forward treasury locks, currency forward contracts, and forward contracts on specific fixed income securities. All of these freestanding derivative transactions are hedging in nature and not speculative. Positions under the Company’s hedging programs for derivative activity that were open during 2005 involved current and forward interest rate swaps, current and forward currency swaps, forward treasury locks, currency forward contracts, and options on forward interest rate swaps.
During the years ended December 31, 2005, 2004, and 2003, the Company recognized net gains of $120.7 million, $29.1 million, and $79.6 million, respectively, on the termination of cash flow hedges and reported $121.0 million, $29.2 million and $79.1 million, respectively, in other comprehensive income and $(0.3) million, $(0.1) million, and $0.5 million as a component of realized investment gains and losses. The Company amortized $21.8 million, $20.7 million, and $17.3 million of net deferred gains into net investment income in 2005, 2004, and 2003, respectively.
As of December 31, 2005 and 2004, the Company had $684.5 million and $707.3 million, respectively, notional amount of open current and forward foreign currency swaps to hedge fixed income Canadian dollar denominated securities the Company retained after the sale of the Canadian branch.
As of December 31, 2005 and 2004, the Company had $348.0 million and $785.0 million, respectively, notional amount of open options on forward interest rate swaps under the hedging program used to lock in a reinvestment rate floor for the reinvestment of cash flows from renewals on policies with a one to two year minimum premium rate guarantee.
The Company also has embedded derivatives in modified coinsurance contracts recognized under DIG Issue B36. The derivatives recognized under DIG Issue B36 are not designated as hedging instruments, and the change in fair value is reported as a realized investment gain or loss during the period of change. Due to the change in fair value of these embedded derivatives, the Company recognized $7.9 million of net realized investment losses during 2005 and $88.6 million, and $0.8 million of net realized investment gains during 2004 and 2003, respectively.
The Company’s liquidity requirements are met primarily by cash flows provided from operations, principally in its 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. The Company has established an investment strategy that management believes will provide for adequate cash flows from operations.
The Company’s cash flows from discontinued operations for the years ended December 31, 2004 and 2003 are combined with cash flows from continuing operations within each cash flow statement category in the consolidated statements of cash flows. The absence of cash flows from discontinued operations in 2005 did not materially affect liquidity and capital resources nor is it expected to do so in the future.
Net cash provided by operating activities was $1,503.6 million for the year ended December 31, 2005, compared to $747.0 million and $1,345.2 million for the comparable periods of 2004 and 2003. Included in the operating cash flows for 2004 is a cash disbursement of $707.4 million made in conjunction with the reinsurance of the Company’s individual income protection - closed block of business. During 2003, by mutual consent the Company amended existing reinsurance contracts with one of its reinsurers to transform the contracts from coinsurance to modified coinsurance arrangements. Under the terms of those amendments, the Company, as the assuming reinsurer, transferred to the ceding reinsurer cash equal to the statutory disabled life reserves of approximately $286.2 million and established a corresponding receivable. The ceding reinsurer will retain the assets backing the statutory disabled life reserves and will credit interest at a 7.00 percent effective annual rate to the Company. This 2003 cash disbursement is included in cash flows from operations.
The income tax adjustment to reconcile net income (loss) to net cash provided by operating activities increased $231.3 million in 2005 compared to 2004 primarily as a result of the utilization of net operating loss carryforwards during 2005 compared to an income tax benefit in 2004 related to the previously mentioned first quarter of 2004 restructuring charges associated with the individual income protection - closed block segment.
During 2004, the Company had cash inflows of $18.8 million in conjunction with the sale of its Japanese operations. In conjunction with the 2004 disposition of the Canadian branch, the Company transferred fixed maturity securities with a fair value and book value of approximately $1,099.4 million and $957.7 million, respectively, and cash of $31.7 million. While no cash was exchanged in the previously discussed 2004 Swiss Life transaction, the Company assumed reserves of approximately $279.6 million and received fixed maturity securities of approximately $259.0 million and other miscellaneous assets of approximately $5.2 million, for a net purchase price of $15.4 million. In 2004, the Company had cash outflows of $0.7 million to acquire Integrated Benefits Management.
During 2005, the Company repaid $227.0 million of maturing debt. Also in 2005, the Company received proceeds of $399.6 million from issuance of 6.85% senior debentures less underwriting discounts of $4.0 million. During 2004, the Company received proceeds of $300.0 million from the issuance of adjustable conversion-rate equity security units.
The Company is dependent upon payments from its subsidiaries to pay dividends to its stockholders, to pay its debt obligations, and to pay its expenses. These payments by the Company’s insurance and non-insurance subsidiaries may take the form of interest payments on amounts loaned to such subsidiaries by the Company, operating and investment management fees, and/or dividends. At December 31, 2005, the Company had outstanding from its insurance subsidiaries a $150.0 million surplus debenture due in 2006 with a weighted average interest rate during 2005 of 8.56 percent and a $100.0 million surplus debenture due in 2027 with a weighted average interest rate during 2005 of 8.25 percent. Semi-annual interest payments are conditional upon the approval by the insurance department of the applicable state of domicile.
The amount available during 2005 for the payment of ordinary dividends from the Company’s U.S. insurance subsidiaries was $663.3 million, of which $280.0 million was utilized. The amount available during 2005 from Unum Limited was $152.5 million, of which $69.6 million was utilized and repatriated under the Homeland Investment Act of 2004. The remaining dividend of $385.2 million of unremitted foreign earnings repatriated in 2005 under the Homeland Investment Act of 2004 was from the Company’s non-insurance U.K. subsidiaries.
During the fourth quarter of 2005, the Company repatriated $454.8 million in unremitted foreign earnings from its U.K. subsidiaries, and as part of its repatriation plan, issued $400.0 million of 6.85% senior debentures due November 15, 2015 in a private offering.
Company issued $575.0 million of 5.997% senior notes due May 15, 2008. The Company participated in the remarketing of the units and purchased $400.0 million of the senior notes which were subsequently retired.
The maintenance of a Best Capital Adequacy Ratio (BCAR) of at least 150 percent on a consolidated basis, as well as for the primary operating companies.
The debt-to-capital ratio cannot exceed its present level, and this ratio should trend downward with future equity growth through retained earnings and the 2005 debt pay-down.
Cash at the holding company will be maintained to cover approximately six months of after-tax debt interest service and stockholder dividends. While the agency stated that a portion of the current cash position is intended for the pay-down of debt in 2005, it expects that the Company will build to a six-month cash position over a reasonable period of time.
Persistency of the Company’s core group long-term income protection business will not drop below 80 percent. AM Best will also be taking into consideration the quality of business lapsing and the resulting impact on the Company’s loss ratios.
Settlement expectations shall not exceed 120 percent of expected response rates, amount of claims reopened, size of claims payments and expenses associated with the payout.
The Company believes that its results for the year ended December 31, 2005 are in compliance with each of these measures, as follows:
The Company repaid $227.0 million of maturing debt in 2005 but, as part of its repatriation plan, issued $400.0 million of ten-year senior notes. In order to maintain its current debt leverage ratio, the Company reduced its outstanding debt $400.0 million during the first quarter of 2006 by participating in the remarketing of the senior note element of the Company’s adjustable conversion-rate equity security units in February 2006.
While the reassessment is still in the early stages, the Company believes that total reserves for the reassessment process are adequate based on the results to date; however, actual results of the reassessment process may differ from the Company’s initial expectations.
In June 2005 and again in October 2005, AM Best reaffirmed the existing financial strength rating of the Company and maintained a negative outlook. AM Best anticipates that the negative outlook will remain in effect until there is more clarity with regards to the ultimate cost of the multistate market conduct regulatory settlement agreements and the California settlement agreement and further improvement is exhibited in the financial flexibility of the parent company. In November 2005, AM Best assigned a bbb- rating to the $400.0 million 6.85% senior debentures and reaffirmed all of the Company’s remaining debt and financial strength ratings.
In the first quarter of 2004, the ratings from Fitch were placed under review for a possible downgrade due to concerns expressed about the Company’s fourth quarter of 2003 reserve strengthening for group income protection and the profitability for this line of business. In May 2004 and again in November 2004, Fitch reaffirmed all of the Company’s ratings but kept the ratings under review pending Fitch’s completion of an analysis of the Company’s reserves. In February 2005, Fitch completed its analysis, citing the material progress the Company has made in strengthening risk based capital levels, resolving the multi-state market conduct examination, and improving GAAP and statutory earnings. Fitch reaffirmed all of the Company’s ratings and revised the outlook to stable. In October 2005, Fitch again reaffirmed all of the ratings of the Company following the announcement of the settlement agreement with the California DOI. In November 2005, Fitch assigned a BBB- rating to the $400.0 million 6.85% senior debentures and reaffirmed its ratings on all outstanding debt of the Company.
In May 2004, Moody’s downgraded the Company’s senior debt credit ratings to Ba1 from Baa3 and the financial strength ratings on the Company’s insurance company subsidiaries to Baa1 from A3. The ratings outlook is “negative”. This action concluded the ratings review Moody’s initiated in February 2004. Moody’s indicated that the primary driver in the rating action was concern about the execution risk associated with the Company’s strategic plans to restore profitability to its core U.S. group long-term income protection business. Moody’s also noted that the Company had made considerable progress in improving its capital position throughout 2003. The change in the senior debt rating to Ba1 represents a below-investment-grade rating. In November 2004, Moody’s placed the Company’s senior debt credit ratings and the financial strength ratings of the Company’s insurance company subsidiaries on review for possible downgrade due to the heightened event risk associated with the issues concerning broker compensation in the employee benefit market. In April 2005, Moody’s confirmed the Company’s senior debt credit ratings and the financial strength ratings of the Company’s insurance subsidiaries while maintaining a
The discount rate is an interest assumption used to convert the benefit payment stream to a present value. The Company sets the discount rate assumption at the measurement date for each of its retirement related benefit plans to reflect the yield of a portfolio of high quality fixed income debt instruments matched against the timing and amounts of projected future benefits. The discount rate used for the net periodic benefit costs for the U.S. pension plans was 5.80 percent and 6.05 percent in 2006 and 2005, respectively. Using a similar methodology applied to the postretirement plan cash flows, the discount rate used in the net periodic benefit cost for 2006 and 2005 was 5.50 percent and 5.70 percent, respectively.
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 Company uses a compound interest method in computing the rate of return on pension plan assets. The long-term rate of return on assets used in the net periodic pension costs for the U.S. qualified defined benefit pension plan for 2006 and 2005 was 8.00 percent and 8.50 percent, respectively. Lowering the expected long-term rate of return on the plan assets by 50 basis points would have increased the 2005 pension expense by approximately $2.4 million. For 2006, lowering the assumption by 50 basis points would be expected to increase pension expense by approximately $2.6 million.
The Company reported U.S. pension expense of $54.8 million, $43.6 million, and $41.8 million in 2005, 2004 and 2003, respectively.
The Company’s U.K. operation maintains a separate defined benefit plan for its eligible employees. The U.K. defined benefit pension plan (Scheme) was closed to new entrants on December 31, 2002.
The Company elected to set the discount rate assumption at the measurement date for the Scheme to reflect the yield of a portfolio of high quality fixed income debt instruments matched against the timing and amounts of projected future benefits. The discount rate assumptions were 4.80 percent and 5.30 percent as of December 31, 2005 and 2004, respectively.
Pension expense was $11.7 million, $11.6 million, and $8.8 million in 2005, 2004, and 2003, respectively.
The fair value of plan assets in the Scheme was $92.1 million at December 31, 2005, compared to $80.5 million at year end 2004. The Scheme has a deficit of $45.2 million at December 31, 2005, compared to $50.2 million at December 31, 2004. The Company contributes to the Scheme in accordance with a schedule of contributions which requires the Company to contribute to the Scheme at the rate of at least 18.20 percent of eligible salaries, sufficient to meet the minimum funding requirement under U.K. legislation. The Company contribution rate of 20.25 percent of eligible salaries is currently being reviewed. The Company made a $44.2 million contribution into the Scheme in January 2006 to reduce the deficit. The Company anticipates it will make additional contributions during 2006 into the Scheme of approximately $9.1 million.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and concluded that, as of December 31, 2005, the Company maintained effective internal control over financial reporting.
The effectiveness of the Company’s internal control over financial reporting and management’s assessment of that effectiveness, as of December 31, 2005, have been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which follows.
In our opinion, management’s assessment that UnumProvident Corporation and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, UnumProvident Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of UnumProvident and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005, and our report dated February 28, 2006 expressed an unqualified opinion thereon.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of UnumProvident Corporation and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of UnumProvident Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2006 expressed an unqualified opinion thereon.
Basis of Presentation: The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). Such accounting principles differ from statutory accounting principles (see Note 16). The consolidated financial statements include the accounts of UnumProvident Corporation and its subsidiaries (the Company). Material intercompany transactions have been eliminated. Certain prior year amounts have been reclassified to conform to current year presentation.
Fixed maturity securities include bonds and redeemable preferred stocks. Equity securities include common stocks and nonredeemable preferred stocks. Fixed maturity and equity securities not bought and held for the purpose of selling in the near term but for which the Company does not have the positive intent and ability to hold to maturity are classified as available-for-sale.
Changes in the fair value of available-for-sale fixed maturity securities and equity securities are reported as a component of other comprehensive income. These amounts are net of income tax and valuation adjustments to reserves for future policy and contract benefits which would have been recorded had the related unrealized gain or loss on these securities been realized.
The accounting for changes in the fair value (i.e., gain or loss) of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship, and further, on the type of hedging relationship. To qualify as a hedging instrument, a derivative must pass prescribed effectiveness tests, performed quarterly using both qualitative and quantitative methods. For those derivatives that are designated and qualify as hedging instruments, the derivative is designated, based upon the exposure being hedged, as one of the following:
Fair value hedge. Changes in the fair value of the derivative as well as the offsetting change in fair value on the hedged item attributable to the risk being hedged are recognized in current earnings during the period of change in fair value. The gain or loss on the termination of an effective fair value hedge is recognized in current earnings.
Deferred Policy Acquisition Costs: Certain costs of acquiring new business that vary with and are primarily related to the production of new business have been deferred. Such costs include commissions, other agency compensation, certain selection and policy issue expenses, and certain 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. Deferred policy acquisition costs are subject to recoverability testing at the time of policy issue and loss recognition testing subsequent to the year of issue.
Revenue Recognition: Traditional life and accident and health products are long duration contracts, and premium income is recognized as revenue when due from policyholders. If the contracts are experience rated, the estimated ultimate premium is recognized as revenue over the period of the contract. The estimated ultimate premium, which is revised to reflect current experience, is based on estimated claim costs, expenses, and profit margins.
Policy and Contract Benefits Liabilities: Active life reserves for future policy and contract benefits on traditional life and accident and health products have been provided on the net level premium method. The reserves are calculated based upon assumptions as to interest, withdrawal, morbidity, and mortality that were appropriate at the date of issue. Interest assumptions for active life reserves may be graded downward over a period of years. Withdrawal assumptions are based on actual Company experience. Morbidity and mortality assumptions are based upon industry standards adjusted as appropriate to reflect actual Company experience. The assumptions vary by plan, year of issue, and policy duration and include a provision for adverse deviation.
Deferred Gain or Loss on Reinsurance: The Company is a party to various reinsurance agreements. Where applicable, gains or losses on these 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 the consolidated statements of financial condition at December 31, 2005 and 2004 was $204.2 million and $236.4 million, respectively.
Separate Accounts: The separate account amounts shown in the accompanying consolidated financial statements represent contributions by contract holders to variable-benefits and fixed-benefits pension plans. The contract purchase payments and the assets of the separate accounts are segregated from other Company funds for both investment and administrative purposes. Contract purchase payments received under variable annuity contracts are subject to deductions for sales and administrative fees. Also, the sponsoring companies of the separate accounts receive management fees based on the net asset values of the separate accounts.
Translation of Foreign Currency: Revenues and expenses of the Company’s continuing and discontinued foreign operations are translated at average exchange rates. Assets and liabilities are translated at the rate of exchange on the balance sheet date. The translation gain or loss is generally reported in accumulated other comprehensive income, net of deferred tax.
Accounting for Participating Individual Life Insurance: Participating policies issued by one of the Company’s subsidiaries prior to its 1986 conversion from a mutual to a stock life insurance company will remain participating as long as the policies remain in force. A Participation Fund Account (PFA) was established for the benefit of all such individual participating life and annuity policies and contracts. The assets of the PFA provide for the benefit, dividend, and certain expense obligations of the participating individual life insurance policies and annuity contracts. The PFA was $353.1 million and $353.0 million at December 31, 2005 and 2004, respectively, and represented approximately 0.7 percent of consolidated assets and 0.7 and 0.8 percent of consolidated liabilities at December 31, 2005 and 2004, respectively.
The adoption of DIG Issue B36 resulted in a $39.9 million cumulative effect of accounting principle change ($0.14 per common share, basic and assuming dilution), net of $21.4 million in tax. The adoption of DIG Issue B36 requires the change in the fair value of the embedded derivatives to be reported as a realized investment gain or loss during the period of change.
Statement of Position 05-1 (SOP 05-1), Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts, was issued by the Accounting Standards Executive Committee in September 2005. SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards No. 97 (SFAS 97), Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. The Company has not yet determined the effect of the adoption of SOP 05-1 on its financial position or results of operations.
Of the $431.3 million in gross unrealized losses on fixed maturity bonds and the derivatives that hedge these bonds at December 31, 2005, $343.5 million, or 79.6 percent, are related to investment-grade fixed maturity bonds. Unrealized losses on investment-grade fixed maturity securities principally relate to changes in interest rates or changes in market or sector credit spreads which occurred subsequent to the acquisition of the securities.
The following chart indicates the length of time the Company’s investment-grade and below-investment-grade fixed maturity bonds had been in a gross unrealized loss position as of December 31, 2005. The fair value and gross unrealized losses are categorized by the relationship of the current fair value to amortized cost for those securities on December 31, 2005. The fair value to amortized cost relationships are not necessarily indicative of the fair value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of the relationships subsequent to December 31, 2005.
As of December 31, 2005, the Company held two securities with a gross unrealized loss of $10.0 million or greater, as follows:
In determining when a decline in fair value below amortized cost of a fixed maturity security is other than temporary, the Company evaluates the following factors:
The amortized cost and fair values of fixed maturity securities by maturity date are shown as follows. The maturity dates have not been adjusted for possible calls or prepayments.
At December 31, 2005, the total investment in below-investment-grade fixed maturity securities was $2,180.7 million or 6.0 percent of the fair value of invested assets excluding ceded policy loans. The amortized cost of these securities was $2,157.2 million.
At December 31, 2005, the Company had capital commitments of approximately $13.1 million to fund certain of its private placement fixed maturity securities. The funds are due upon satisfaction of contractual notice from the issuer. These amounts may or may not be funded during the term of the security.
The components of the change in the net unrealized gain on securities and the change in the net gain on cash flow hedges included in other comprehensive income (loss) are as follows.
To help limit the credit exposure of the derivatives, the Company has entered into master netting agreements with its counterparties whereby contracts in a gain position can be offset against contracts in a loss position. The Company also typically enters into bilateral, cross-collateralization agreements with its 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. The Company’s current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position, was $63.4 million at December 31, 2005.
The Company has executed a series of cash flow hedges in the group income protection, individual income protection - recently issued, group and individual long-term care, and individual income protection - closed block portfolios using forward starting interest rate swaps. The purpose of these hedges is to lock in the reinvestment rates on future anticipated cash flows through the year 2013 and protect the Company from the potential adverse impact of declining interest rates on the associated policy reserves. The Company plans on terminating these forward interest rate swaps at the time the projected cash flows are used to purchase fixed income securities.
The settlement dates of the forward contracts correspond to the settlement dates of the previously mentioned forward interest rate swap agreements. This combination of derivative instruments allows the Company to lock in the interest rate component and the credit spread component of yields on future bond purchases. The Company did not have any of these derivative contracts outstanding at December 31, 2005.
During 2005, the Company entered into several foreign currency interest rate swaps and a foreign currency forward contract in order to hedge the currency risk of U.S. dollar denominated debt which will be serviced by dividends in British pound sterling from one of the Company’s U.K. subsidiaries. Under the terms of the foreign currency interest rate swaps, the Company receives a fixed rate of interest denominated in U.S. dollars and pays a fixed rate of interest denominated in British pound sterling. Certain of these swaps require an exchange of principal and interest during their term, and certain of them require an exchange of interest only. The foreign currency forward contract requires the Company to receive a fixed amount of U.S. dollars and pay a fixed amount of British pound sterling. This currency forward is scheduled to mature at the same time the hedged debt matures. The purpose of these derivatives is to eliminate the variability of functional currency cash flows associated with the debt payments serviced by British pound sterling dividends.
During 2005 and 2004, the Company purchased options on forward interest rate swaps in order to hedge the interest rate risk on certain insurance liabilities with minimum interest rate guarantees. By purchasing options on the interest rate swaps, the Company is able to lock in the minimum investment yields needed to meet the required interest rate guarantee on these insurance liabilities. If interest rates rise above the option’s strike rate, the Company will not exercise the option, but will instead invest at the higher rates. If interest rates fall below the option’s strike rate, the Company will exercise the option to enter a receive fixed/pay floating forward interest rate swap. In the event the options are exercised, the Company intends to settle for cash the forward interest rate swap agreements prior to commencement of the exchange of interest payments. These cash flows are hedged through the year 2006.
eliminate the variability of functional currency cash flows associated with the proceeds from the sale of the Canadian branch. The Company terminated these currency forwards, for cash, at the time of the closing of the sale of the branch and recognized a gain of $2.4 million which was reported as a component of the loss from discontinued operations.
During 2004, the Company acquired Integrated Benefits Management, a provider of case management services, at a price of $0.7 million.
During 2004, the Company recognized an impairment of $367.1 million for the remaining balance of the individual income protection - closed block value of business acquired. The impairment related to the restructuring of this business and the resulting modification of the Company’s reporting segments. See Note 14 for further discussion.
The estimated net amortization of value of business acquired for each of the next five years is $7.7 million in each of the years 2006, 2007, and 2008, $8.6 million in 2009, and $8.8 million in 2010.
During 2004, the Company completed the sale of its Canadian branch. See Note 2 for further discussion.
In April 2004, the Company completed an analysis of the assumptions related to its individual income protection - closed block claim reserves. The analysis was initiated based on the restructuring effective January 1, 2004, which reflected the individual income protection - closed block as a stand-alone segment. Previously these reserves were analyzed for the individual income protection line of business on a combined basis. Included in the analysis was a review of morbidity assumptions, primarily claim resolution rates, and claim reserve discount rate assumptions. Based upon this analysis, the Company lowered the claim reserve discount rate to reflect the segmentation of the investment portfolio between the individual income protection - recently issued business and the individual income protection - closed block business, the duration of the assets and the related policy liabilities. Based on the April 2004 analysis, in the first quarter of 2004 the Company increased its individual income protection - closed block claim reserves by $110.6 million before tax, or $71.9 million after tax, to reflect its current estimate of future benefit obligations. The first quarter 2004 change represented a 1.2 percent increase in total net Individual Income Protection - Closed Block segment reserves as of March 31, 2004, which equaled $9.530 billion prior to this increase. In conjunction with this restructuring of the individual income protection - closed block business and the subsequent reserve strengthening, reinsurance, and other related adjustments, the net increase in the reserve liability reported in the preceding table for 2004 for total incurred claims was $237.9 million, $0.5 million of which was related to current year incurred claims and $237.4 million to prior year incurred claims.
In January 2004, the Company completed its annual review of claim reserves to ensure that its claim reserves make adequate and reasonable provision for future benefits and expenses. Based upon this review, the Company increased its U.S. Brokerage group income protection claim reserves as of December 31, 2003 by $440.0 million before tax, or $286.0 million after tax. Approximately $300.0 million of the reserve strengthening reflected implementation of a lower discount rate for the Company’s group income protection claim reserves. The discount rate was lowered to reflect the Company’s actual change in investment portfolio yield rates during 2003, the expectation of future investment portfolio yield rates, and the Company’s new discount rate management approach of maintaining a wider spread between its group income protection portfolio investment yield rate and its average discount rate. The Company’s new discount rate management approach is intended to better reflect the current investment environment and position the Company to be more responsive with discount rates on new incurred claims as changes to the investment environment emerge. Approximately $140.0 million of the reserve increase related to a strengthening of the morbidity assumptions to reflect the impact of the Company’s view of a continuing jobless economic recovery on claim incidence and severity. Of this amount, approximately $64.0 million was established to reflect higher claim incidence expectations. Claim incidence in the second half of 2003 was 8.4 percent higher than the first half of the year and 5.8 percent above the second half of 2002. Claim incidence was expected to continue at an elevated level for several quarters as the Company believed that early indications of a recovering economy were not yet reflected in improved consumer confidence or job creation. Also included in the $140.0 million strengthening was approximately $76.0 million to reflect higher severity expectations driven primarily by a lengthening of claim duration expectations in those claims that had been open 36 months or longer. The $440.0 million reserve increase represented a 6.6 percent increase in total net U.S. Brokerage group income protection reserves as of December 31, 2003, which totaled $6.674 billion prior to this increase.
of time since the disability initially occurred, and claim diagnosis. The claim resolution rates for group long-term income protection during the first quarter of 2003 were below levels anticipated for reserves and were lower than those experienced in the full years 2002, 2001, and 2000. The analysis indicated not only a decrease in overall claim resolution rates, but also a change in claim resolution rates by claim duration. The analysis of emerging claim resolution rates and the reasons driving the changes resulted in a reduction in the Company’s long-term expectations with respect to claim resolution rates. The Company’s long-term expectations applied to all claims incurred regardless of the date of incurral. In addition, the Company reviewed the reserve discount rate, which is the interest rate at which future cash flows for benefits and expenses to be paid are discounted to determine the current value of those cash flows. The Company concluded at that time that a change in its discount rate assumptions was not warranted. Based on the April 2003 analysis, in the first quarter of 2003 the Company increased its U.S. Brokerage group long-term income protection claim reserves by $454.0 million before tax, or $295.1 million after tax, to reflect its current estimate of future benefit obligations. The active claim reserve for claims already reported to the Company and still in open claim status was increased by $516.0 million, the IBNR reserve was decreased by $23.0 million, and the reopen reserve was decreased by $39.0 million before tax. The first quarter 2003 change represented a 7.8 percent increase in total net U.S. Brokerage group income protection reserves as of March 31, 2003, which equaled $5.828 billion prior to this increase.
Under the Life Insurance Company Tax Act of 1959, U.S. stock life insurance companies were required to maintain a policyholders’ surplus account containing the accumulated portion of income which had not been subjected to income tax in the year earned. The Deficit Reduction Act of 1984 required that no future amounts be added after 1983 to the policyholders’ surplus account and that any future distributions to shareholders from the account would become subject to federal income tax at the general corporate federal income tax rate then in effect. During 2004, the Homeland Investment Act of 2004 was enacted. The Homeland Investment Act of 2004 provides, in part, that distributions from policyholders’ surplus accounts during 2005 and 2006 will not be taxed.
The Homeland Investment Act of 2004 provides a deduction of 85 percent of certain foreign earnings that were repatriated during 2005, up to a maximum of $500.0 million. For the portion of unremitted foreign earnings of its non-U.S. operations that had been considered to be permanently reinvested, the Company had not previously provided U.S. income taxes. During the fourth quarter of 2005, the Company repatriated $454.8 million in unremitted foreign earnings from its U.K. subsidiary. The Company recorded current taxes payable on those previously unremitted foreign earnings of approximately $15.3 million and recorded a tax benefit of approximately $18.6 million as a result of the reversal of the deferred tax liability related to such unremitted earnings. Remaining amounts of unremitted earnings are considered permanently invested in the foreign subsidiaries, and no taxes have therefore been provided on those amounts.
The Company’s consolidated statements of operations include the following amounts of income subject to foreign taxation, including the results of the Canadian branch discontinued operations, and the related foreign income tax expense (benefit):
During 2004, the Company obtained a judgment in refund litigation for tax year 1984, and as a result was entitled to a refund of tax plus interest for 1984 and for tax years subsequent to 1984 in which the IRS took inconsistent positions on the deductibility of the insurance tax reserves that were the subject of the litigation and for which the Company paid tax based on the IRS’ positions. As a result of the judgment, interest income before taxes was increased by $14.0 million and results from operations were increased by $26.2 million, after taxes.
Also during 2004, the Company recognized tax benefits from settlements of IRS examinations of tax years 1996 through 1998. Under the settlements, the Company resolved issues raised by the IRS pertaining to calculation of insurance tax reserves and the deductibility of losses on notional principal contracts. Tax benefits of $33.1 million are included in 2004 results from operations attributable to the effect of prior year tax settlements.
As of December 31, 2005, the Company’s subsidiaries had net operating loss carryforwards in the U.S. of approximately $144.9 million, and capital loss carryforwards of $7.7 million. The majority of the net operating loss carryforwards will expire in 2019. Capital loss carryforwards of $7.7 million will expire in 2008. As of December 31, 2005, the Company’s foreign subsidiaries had net operating loss carryforwards of $6.0 million for which a full valuation allowance has been established because in management’s judgment, the Company will most likely not realize a tax benefit for these losses.
Total income taxes paid (refunded) during 2005, 2004, and 2003 were $93.4 million, $91.5 million, and $(3.9) million, respectively.
The scheduled remarketing of the senior note element of the units issued in May 2003 occurred in February 2006, as stipulated by the terms of the original offering, and the Company issued $575.0 million of 5.997% senior notes due May 15, 2008. The Company participated in the remarketing of the units and purchased $400.0 million of the senior notes which were subsequently retired.
The weighted average assumptions used in the measurement of the Company’s benefit obligations as of December 31 are as follows:
For measurement purposes at December 31, 2005, the annual rate of increase in the per capita cost of covered health care benefits assumed for 2006 was 9.00 percent for benefits payable to retirees prior to Medicare eligibility and 9.80 percent for benefits payable to Medicare eligible retirees. The rate range was assumed to change gradually to a rate of 5.00 percent for 2010 and remain at that level thereafter. For measurement purposes at December 31, 2004, the annual rate of increase in the per capita cost of covered health care benefits assumed for 2005 was 8.75 percent for
benefits payable to retirees prior to Medicare eligibility and 11.00 percent for benefits payable to Medicare eligible retirees. The rate range was assumed to change gradually to a rate of 5.00 percent for 2008 and remain at that level thereafter.
The medical and dental premium used to determine the per retiree employer subsidy are capped. If the cap is not reached by the year 2015, the caps are then set equal to the year 2015 premium. Certain of the current retirees and all future retirees are subject to the cap.
To determine the net periodic pension cost for the U.S. qualified defined benefit pension plan for the year 2005, an 8.5 percent long-term expected rate of return assumption was used. The long-term rate of return assumption is an estimate, based on statistical analysis, of the average annual assumed return that will be produced from the pension trust assets until current benefits are paid. The investment portfolio contained a diversified blend of large cap, mid cap, small cap equity securities, convertible securities, as well as both investment-grade and below-investment-grade fixed income securities in 2005. The Company’s expectations for the future investment returns of these asset categories were based on a combination of historical market performance and the Company’s evaluations of investment forecasts prepared by external consultants and economists. The methodology underlying the return assumption examined the various elements of the expected return for each asset class including: long-term rates of return, volatility of returns and the correlation of returns between various asset classes. The expected return for the total portfolio was calculated based on the plan’s strategic asset allocation. Investment risk is measured and monitored on an ongoing basis through annual liability measurements, periodic asset/liability studies, and quarterly investment portfolio reviews. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The plan prohibits the use of derivative instruments. During the fourth quarter of 2005, the Company performed a review of the portfolio and elected to add an international equity allocation. Based on the plan’s new asset allocation and changes in capital market assumptions, the Company lowered the expected long-term rate of return assumption to 8.0 percent, which will be used to determine the 2006 net periodic pension cost.
The Company’s U.K. operation maintains a separate defined benefit plan (Scheme) for eligible employees. The Scheme assets are invested in pooled funds, with a 64 percent global equity securities allocation. The remainder of the assets is predominantly invested in fixed interest bonds and index linked bonds. The long-term rate of return
assumption is the best estimate of the average annual assumed return that will be produced from the Scheme assets until current benefits are paid. The Company contributes to the Scheme in accordance with a schedule of contributions which requires the Company to contribute to the Scheme at the rate of at least 20.25 percent of eligible salaries less Company input into a separate defined contribution arrangement, sufficient to meet the minimum funding requirement under U.K. legislation. The Company made contributions of $8.8 million and $8.6 million in 2005 and 2004, respectively. The Company made a $44.2 million contribution into the Scheme in January 2006 and expects to make additional contributions of approximately $9.1 million during 2006.
In 2003, the Company issued 52,877,000 shares of common stock, par value $0.10 per share, in a public offering and received approximately $547.7 million in proceeds after deducting underwriting discounts. Dividends paid per common share were $0.30, $0.30, and $0.3725 for the years ended December 31, 2005, 2004, and 2003, respectively.
The Company has 25,000,000 shares of preferred stock authorized with a par value of $0.10 per share. No preferred stock has been issued to date.
Note 11 - Stockholders’ Equity and Earnings Per Share - Continued
Options to purchase approximately 12.1 million, 14.4 million, and 16.4 million shares of common stock for the years ended December 31, 2005, 2004, and 2003, respectively, were outstanding but were not included in the computation of earnings per share, assuming dilution, because the exercise prices of the options were greater than the average market price of the Company’s common stock. The purchase contract elements of the units issued in 2004 were also excluded from the computation for the year ended December 31, 2004 because the threshold appreciation price was greater than the average market price of the Company’s common stock.
Under the stock plan of 1999, the Company has available up to 17,500,000 shares of common stock for awards to its employees, officers, producers, and directors. Awards may be in the form of stock options, stock appreciation rights, restricted stock awards, dividend equivalent awards, or any other right or interest relating to stock. Stock options have a maximum term of ten years after the date of grant and generally vest after three years. The number of shares available to be issued as restricted stock or unrestricted stock awards under the stock plan of 1999 is limited to 6,125,000 shares. The Company granted 1,192,526 shares, 78,594 shares, and 1,347,874 shares of restricted stock during 2005, 2004, and 2003, respectively, to certain employees and directors with a weighted average grant date value of $17.43, $15.14, and $10.64, respectively, per common share. Compensation cost recognized in the consolidated statements of operations for restricted stock awards is $12.7 million, $4.9 million, and $4.3 million for 2005, 2004, and 2003, respectively. These amounts are not included in the pro forma adjustments presented in Note 1. At December 31, 2005, 7,205,842 shares were available for future grants under the stock plan of 1999.
Note 12 - Incentive Compensation and Stock Purchase Plans - Continued
Substantially all of the Company’s employees are eligible to participate in an ESPP. Under the plan, up to 3,460,000 shares of the Company’s common stock are authorized for issuance. Stock may be purchased at the end of each financial quarter at a purchase price of 85 percent of the lower of its beginning or end of quarter market prices. The Company sold 154,395 shares, 205,172 shares, and 318,499 shares to employees with a weighted average exercise price of $15.38, $12.88, and $9.73 during the years 2005, 2004, and 2003, respectively.
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 the consolidated statements of operations net of reinsurance ceded.
During 2005, the Company recaptured its individual income protection - closed block business originally ceded to Centre Life Reinsurance Ltd. in 1996. The recaptured business included approximately $1.6 billion in invested assets and $185.0 million of annual premium. The effective date of the recapture was August 8, 2005. The underlying operating results of the reinsurance contract, prior to recapture, were reflected in other income. The recapture therefore did not have a material impact on operating income for the Individual Income Protection - Closed Block segment.
The Unum Limited segment includes group long-term income protection, group life, and individual income protection products sold primarily in the United Kingdom through field sales personnel and independent brokers and consultants.
The Individual Income Protection - Closed Block segment generally consists of those individual income protection policies that were designed to be distributed to individuals in a non-workplace setting and which were primarily in force prior to the Company’s substantial changes in product offerings, pricing, distribution, and underwriting which generally occurred during the period 1994 through 1998. A minimal amount of new business continued to be sold subsequent to these changes, but the Company ceased selling new policies in this segment at the beginning of 2004 other than update features contractually allowable on existing policies.
In conjunction with the restructuring of the individual income protection - closed block business during 2004, as discussed in Note 13, the Company at that time modified its reporting segments to include a separate segment for this business. The reporting, monitoring, and management of the closed block of individual income protection business as a discrete segment is consistent with the Company’s financial restructuring and separation of this business from the lines of business which still actively market new products. In the past, this business had been reported in combination with the individual income protection - recently issued line of business. Prior to 2004,
The separation of the closed block business into a separate reporting segment required the Company to perform, separately for the individual income protection - closed block business and individual income protection - recently issued business, impairment testing for goodwill and loss recognition testing for the recoverability of deferred policy acquisition costs and value of business acquired. As required under GAAP, prior to the change in reporting segments, these tests were performed for the individual income protection line of business on a combined basis. The testing indicated impairment of the individual income protection - closed block deferred policy acquisition costs, value of business acquired, and goodwill balances of $282.2 million, $367.1 million, and $207.1 million, respectively. Also as part of the restructuring, the Company increased its claim reserves for the closed block of individual income protection business $110.6 million before tax. The impairment charges and reserve strengthening, which total $967.0 million before tax, are reported in the Individual Income Protection - Closed Block segment. The after-tax charge of $701.0 million is included in the net loss reported for the year ended December 31, 2004. See Note 7 for further discussion regarding the claim reserve strengthening.
The Company’s goodwill is reported in the U.S. Brokerage Segment, the Unum Limited Segment, and the Other Segment, which are the segments expected to benefit from the originating business combinations. Stockholders’ equity is allocated to the operating segments on the basis of an internal allocation formula that reflects the volume and risk components of each operating segment’s business and aligns allocated equity with the Company’s target capital levels for regulatory and rating agency purposes. This formula is modified periodically to recognize changes in the views of capital requirements.
On September 2, 2003, the Judicial Panel on the Multidistrict Litigation entered an order transferring more than twenty putative class actions and derivative suits, described below, filed in various courts against the Company, several of its subsidiaries, and some of their officers to the U.S. District Court for the Eastern District of Tennessee for coordinated or consolidated pretrial proceedings. The defendants strongly deny the allegations in each of these actions and will vigorously defend the substantive and procedural aspects of the litigations.
Each of these actions purports to be brought on behalf of the Company against certain current and past members of its Board of Directors and certain executive officers alleging breaches of fiduciary duties and other violations of claims paying law by defendants. Plaintiffs allege, among other things, that the individual defendants breached their duties of good faith and loyalty by establishing or permitting to be established an unlawful policy of denying legitimate disability claims and improper financial reporting, and that certain defendants engaged in insider trading.
On February 12, 2003, the first of six virtually identical putative securities class actions was filed in the United States District Court for the Eastern District of Tennessee. In two orders dated May 21, 2003, and January 22, 2004, the district court consolidated these actions under the caption In re UnumProvident Corp. Securities Litigation.
On January 9, 2004, the Lead Plaintiff filed its consolidated amended complaint on behalf of a putative class of purchasers of Company stock between March 30, 2000 and April 24, 2003. The amended complaint alleges, among other things, that the Company issued misleading financial statements, improperly accounted for certain impaired investments, failed to properly estimate its disability claim reserves, and pursued certain improper claims handling practices. The complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. On March 19, 2004, the defendants filed a motion to dismiss the consolidated amended complaint.
On September 12, 2005, the court issued a Memorandum and Order denying in part, and granting in part, the motion to dismiss. The court granted the motion with respect to Lead Plaintiff’s claims concerning the Company’s investments and denied the motion challenging the other alleged misstatements. Discovery, which has been stayed in this action pursuant to the Private Securities Litigation Reform Act of 1995, has now begun.
Plaintiff alleges that the Company and certain of its officers violated the Securities Exchange Act of 1934 and that the underwriter defendants violated the Securities Act of 1933, all premised on the same factual allegations as the earlier-filed putative securities class action. A fourth action, Bernstein v. CorTs for Provident Financing Trust I, et al., was filed in the Eastern District of New York on July 7, 2003. The Bernstein action makes identical allegations, but with respect to a different series of CorTs securities. These actions all were transferred to the Eastern District of Tennessee for coordinated pre-trial proceedings.
On July 15, 2002, Rombeiro v. Unum Life Insurance Company of America, et al., was filed in the Superior Court of California and subsequently was removed to federal court, alleging that the plaintiff was wrongfully denied disability benefits under a group long-term disability plan. On January 21, 2003, an Amended Complaint was filed on behalf of a putative class of individuals that were denied or terminated from benefits under group long-term disability plans, seeking injunctive and declaratory relief and payment of benefits. On April 30, 2003, the court granted in part and denied in part the defendants’ motion to dismiss the complaint. On May 14, 2003, the plaintiff filed a Second Amended Complaint seeking similar relief.
These actions all were transferred to the Eastern District of Tennessee multidistrict litigation. On December 22, 2003, the Tennessee Federal District Court entered an order consolidating all of the above actions for all pretrial purposes under the caption In re UnumProvident Corp. ERISA Benefit Denial Actions and appointed a lead plaintiff. A consolidated amended complaint was filed on February 20, 2004. On March 26, 2004, the defendants answered the complaints and simultaneously filed a motion for judgment on the pleadings in the ERISA Benefit Denial Actions. The court has not yet ruled upon that motion.
On April 30, 2003, a separate putative class action, Taylor v. UnumProvident Corporation, et al., was filed in the Tennessee Circuit Court and subsequently removed to federal court. The complaint alleges claims against UnumProvident and certain subsidiaries on behalf of a putative class of long-term disability insurance policyholders who did not obtain their coverage through employer sponsored plans and who had a claim denied, terminated, or suspended by a UnumProvident subsidiary after January 1, 1995, seeking equitable and monetary relief. Plaintiff alleges that the defendants violated various state laws by engaging in unfair claim practices and improperly denying claims.
On April 9, 2004, the plaintiffs in Taylor and in the ERISA Benefit Denial Actions separately filed motions seeking certification of a plaintiff class. On July 1, 2005, the defendants also filed motions for summary judgment in each action.
On January 9, 2004, plaintiffs filed a consolidated amended complaint against the Company, several of its officers and directors, and several alleged Plan fiduciaries on behalf of a putative class of individuals that held Company stock in their 401(k) retirement accounts subsequent to November 17, 1999. Plaintiffs allege that the defendants violated ERISA by making misrepresentations and omissions regarding investment in Company stock and by acting imprudently in failing to take action to protect participants from losses sustained from investments in the Plan’s UnumProvident Stock Fund.
On March 10, 2005, the plaintiffs filed a motion to certify the class. The defendants filed an opposition on June 10, 2005, and the matter is under submission with the court.
On November 30, 2005, the court entered a schedule providing for the completion of pretrial discovery by October 17, 2006. No trial date has been set for the action.
The insurance commissioners of Maine, Massachusetts, and Tennessee initiated a multistate targeted market conduct examination in September 2003 that focused on the disability claims handling policies and practices of these subsidiaries. This multistate examination resulted in a report and regulatory settlement agreements that became effective on December 21, 2004, which was agreed to by 48 states and the District of Columbia. The examination report made no findings of violations of law or regulations. The examination identified areas of concern which became the focus of certain changes to the Company’s disability claims handling operations. The settlement agreements also include a reassessment of certain previously denied or closed claims, additional corporate and board governance, and payment of a fine in the amount of $15.0 million that was allocated among the states and jurisdictions participating in the agreements. The agreements will remain in place until the later of January 1, 2007, or the completion of an examination of claims handling practices and an examination of the reassessment process, both of which will be conducted by the lead state regulators. The settlement agreements also provide for a contingent fine up to $145.0 million on the Company’s subsidiaries in the event that they fail to satisfactorily meet the performance standards in the settlement agreements relating to the examinations referred to above, which will be conducted in
As part of the settlement with the California DOI, the Company paid a civil penalty of $8.0 million and agreed to change certain practices and policy provisions related to its California business. The settlement also incorporates claims handling practices previously covered by the multistate settlement agreements and includes certain additional claim handling changes. Under the terms of the settlement, the Company will change certain provisions specific to California disability policies, and it received approval from the California DOI for the use of new individual and group disability policy forms. Following the California settlement, the Company also amended the multistate settlement agreements to include mailing a notice of eligibility to participate in the claim reassessment process to approximately 29,500 individuals whose claims were denied or terminated between January 1, 1997 and December 31, 1999. Under the original multistate settlement agreements, claimants during this period could request participation in the reassessment process, but they were not sent a notice.
Separately, the Company is proceeding with a plan to offer to reassess private label, acquired, and reinsured block claims, as well as claims administered on behalf of certain employers.
Based on the California DOI settlement agreement and related matters described above, in the third quarter of 2005 the Company recorded a charge of $75.0 million before tax, or $51.6 million after tax, comprised of four elements: $14.3 million of incremental direct operating expenses to conduct the reassessment process; $37.3 million for benefit costs and reserves from claims reopened from the reassessment; $15.4 million for additional benefit costs and reserves for claims already incurred and currently in inventory that are anticipated as a result of the claim process changes being implemented; and the $8.0 million fine.
consolidated results of operations in a period, depending on the results of operations of the Company for the particular period. Determination by regulatory authorities that the Company or its insurance subsidiaries have engaged in improper conduct could also adversely affect the Company’s defense of various lawsuits described herein.
From time to time class action allegations are pursued, as in Weiller, where the claimant or policyholder purports to represent a larger number of individuals who are similarly situated. Since each insurance claim is evaluated based on its own merits, there is rarely a single act or series of actions, which can properly be addressed by a class action. Nevertheless, the Company monitors these cases closely and defends itself appropriately where these allegations are made.
The Company also has had discussions with the DOL regarding compliance with ERISA, relating to the Company’s interactions with insurance brokers and to regulations concerning insurance information provided by the Company to plan administrators of ERISA plans, including specifically the reporting of fees and commissions paid to agents, brokers, and others in accordance with the requirements of Schedule A of Form 5500. The DOL is pursuing an investigation of the Company concerning these issues, both generally and specifically in connection with certain brokers, including Universal Life Resources. The Company is cooperating with the DOL’s investigation.
The Company and certain of its 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 pre-trial 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, 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, and that motion is pending. Plaintiffs filed a motion for class certification on February 13, 2006, and the Company will oppose class certification on or before April 14, 2006 in accordance with the present scheduling order in this matter.
The Company is a defendant in an action styled, Palm Tree Computers Systems, Inc. v. ACE USA, et al., which was filed in the Florida state Circuit Court on February 16, 2005. The complaint is a putative class action and alleges violations of the Deceptive and Unfair Trade Practices Act of Florida and other states, breach of fiduciary duty, and unjust enrichment. The allegations are brought against numerous broker organizations and insurers and assert the Company and its subsidiaries engaged in illegal and unethical contingent commission arrangements. The case was removed to federal court and, on October 20, 2005, the case was transferred to the District of New Jersey multidistrict litigation. A motion to remand the case to the state court in Florida remains pending, but no further action has been taken in the case subsequent to the transfer.
The Company is a defendant in an action entitled, Bensley Construction, Inc. v. Marsh & McLennan Companies, Inc., et al., filed in Massachusetts Superior Court by the same counsel as in Palm Tree. The complaint names numerous insurance brokers and insurers and purports to be brought on behalf of Massachusetts insureds, alleging violations of breach of fiduciary duty and unjust enrichment under Massachusetts law. The case was removed to Federal Court and a tag-along notice filed seeking transfer to MDL No. 1663. The Judicial Panel on Multidistrict Litigation has the request to transfer the matter to MDL No. 1663 under advisement, and the District Court in Massachusetts has stayed further proceedings, including a ruling on plaintiff’s motion to remand the matter to state court, pending a ruling on the transfer motion.
In September 2003, United States of America ex. rel. Patrick J. Loughren v. UnumProvident Corporation and GENEX Services, Inc., was filed in the United States District Court for the District of Massachusetts. This is a qui tam action to recover damages and civil penalties on behalf of the United States of America alleging violations of the False Claims Act by the Company and its GENEX subsidiary. In accordance with the False Claims Act, the action was originally filed under seal to provide the government the opportunity to investigate the allegations and prosecute the action if they believed that the case had merit and warranted their attention. The government declined to prosecute the case and the case became a matter of public record on December 23, 2004. The complaint alleges that the Company defrauds the government by inducing and or assisting disability claimants to apply for disability benefits from the Social Security Administration (SSA) when the Company allegedly knows that the claimants are not disabled under SSA criteria. On September 13, 2005, the magistrate judge filed a recommended decision granting the Company’s motion to dismiss. The plaintiffs appealed that finding to the district court judge. On October 6, 2005, the district court judge adopted, in full, the recommended decision of the magistrate judge thereby granting dismissal of the case. The plaintiffs subsequently amended their pleading, and the Company filed a motion to dismiss the pleading as amended for the same reasons that the court dismissed the original pleading. On February 9, 2006, the Court denied the motion to dismiss. The Company will proceed forward to answer the complaint and otherwise defend the action.
Various other lawsuits against the Company have arisen in the normal course of its business. Contingent liabilities that might arise from such other litigation incurred in the normal course of business are not deemed likely to materially adversely affect the consolidated financial position or results of operations of the Company in a period, depending on the results of operations of the Company for the particular period.
Restrictions under applicable state insurance laws limit the amount of ordinary dividends that can be paid to the Company from its insurance subsidiaries without prior approval by regulatory authorities. For life insurance companies domiciled in the United States, that limitation typically 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 ordinary dividends to the Company from its insurance subsidiaries is further limited to the amount of statutory surplus as it relates to policyholders. Based on the restrictions under current law, $621.4 million is available for the payment of ordinary dividends to the Company from its domestic insurance subsidiaries during 2006.
The Company also has the ability to draw a dividend from its United Kingdom subsidiary, Unum Limited. Such dividends are limited based on insurance company legislation in the United Kingdom, which requires a minimum solvency margin. The amount available under current law for payment of dividends to the Company from Unum Limited during 2006 is approximately $240.3 million. Regulatory restrictions do not limit the amount of dividends available for distribution to the Company from its non-insurance subsidiaries.
At December 31, 2005, the Company’s insurance subsidiaries had on deposit with U.S. regulatory authorities securities with a book value of $289.5 million held for the protection of policyholders. Additionally, securities with a book value of $99.7 million are on deposit with Canadian regulatory authorities at December 31, 2005.
During the third quarter of 2005, the Company recognized a loss of $75.0 million before tax and $51.6 million after tax related to a settlement agreement with the California Department of Insurance. In the third and first quarters of 2005, the Company recognized income tax benefits of $10.8 million and $32.0 million, respectively, related to the reduction of income tax liabilities. See Notes 8 and 15 for further discussion.