We own and occupy two connected buildings in Chattanooga, Tennessee, with approximately 901,000 square feet of office space. We own and occupy five facilities in Portland, Maine, with approximately 838,000 square feet of office space. We own and occupy facilities totaling approximately 385,000 square feet in Worcester, Massachusetts. We lease and occupy approximately 89,000 square feet of office space in Glendale, California. These properties are used primarily for operations supporting Unum US, Individual Disability - Closed Block, and Corporate and Other.
We also occupy office buildings in the United Kingdom which serve as the home offices of Unum UK. We own and occupy property located in Dorking, with approximately 63,000 square feet of office space. In addition, approximately 65,000 square feet of office space is leased and occupied in two office buildings located in Bristol and Basingstoke.
(1) Included are regulatory claim reassessment charges of $65.8 million, $396.4 million, and $52.7 million in 2007, 2006, and 2005, respectively.
(2) Included are costs related to early retirement of debt of $0.4 million, $58.8 million, and $25.8 million in 2008, 2007, and 2006, respectively.
The discussion and analysis presented in this section should be read in conjunction with our consolidated financial statements and notes thereto in Item 8.
Maintain a strong investment portfolio. We maintained disciplined credit analysis in our selection of investment assets and continued to be conservative within our investment risk tolerances.
Build and effectively use capital. We continued to build capital and manage it effectively within our capital management strategy objectives.
Professional development of our employees. We continued our focus on employee training and development as well as talent management.
Our Unum UK segment reported a decrease in segment operating income of 7.3 percent for 2009, as measured in Unum UK’s local currency, relative to last year. The decrease was driven primarily by an 8.3 percent decline in premium income due to a smaller in-force block of group disability business resulting from lower sales and persistency during 2008 and 2007, primarily as a result of the competitive U.K. market. Similar to Unum US,
premium income for Unum UK was also negatively impacted during 2009 by lower premium growth from existing customers. The benefit ratio for Unum UK was 54.5 percent in 2009 compared to 57.5 percent in the prior year, with declining disability claim incidence and stable claim recoveries for group disability. Overall sales in Unum UK increased 42.9 percent in 2009 compared to the prior year, aided by the exit of another large insurance provider from the U.K. group risk market. Persistency generally improved over the levels of 2008. New initiatives in 2009 included the relaunch of our group life product and the development of new products intended to further expand the group market in the U.K.
Looking ahead, we have confidence in our overall financial position as well as our position in the markets in which we operate. While this economic environment continues to present a number of challenges, not the least of which is an uncertain employment outlook, we believe substantial opportunities exist for our business, and we will continue to take steps to ensure that we are well-positioned to capitalize on them.
Specifically, we will continue our disciplined approach to growth and risk management during 2010. We intend to closely monitor emerging risks and adjust our strategies as appropriate. We expect our capital to continue to build as we take a conservative approach to capital deployment and seek to retain significant financial flexibility.
During 2007, we completed the claim reassessment process required by the 2004 and 2005 regulatory settlement agreements. The lead regulators conducted a final examination and presented their findings to Unum Group’s board of directors and management on April 14, 2008. The report of the multistate market conduct examination for the Maine Bureau of Insurance, Massachusetts Division of Insurance, New York State Insurance Department, Tennessee Department of Commerce and Insurance, and other participating jurisdictions as well as the report of the California Department of Insurance market conduct examination both provided that we satisfactorily complied with each of the agreements’ mandates and that no fines will be assessed.
During the first quarter of 2008, we established a new company, Unum Ireland Limited, which is an indirect wholly-owned subsidiary of Unum Group. The purpose of Unum Ireland Limited is to expand our information technology resource options to ensure that our resource capacity keeps pace with the growing demand for information technology support. This subsidiary is located in Carlow, Ireland.
We prepare our financial statements in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in our financial statements and accompanying notes. The accounting estimates we deem to be most critical to our results of operations and balance sheets are those related to reserves for policy and contract benefits, deferred acquisition costs, valuation of investments, pension and postretirement benefit plans, income taxes, and contingent liabilities. Estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed in our financial statements.
The Corporate and Other segment includes certain products no longer actively marketed, the majority of which have been reinsured. Policy reserves for this segment represent $5.6 billion on a gross basis, or approximately 42.7 percent, of our total policy reserves. We have ceded $4.3 billion of the related policy reserves to reinsurers. The ceded reserve balance is reported in our consolidated balance sheets as a reinsurance recoverable. We continue to service a block of group pension products, which we have not ceded, and the policy reserves for these products are
based on expected mortality rates and retirement rates. Expected future payments are discounted at interest rates reflecting the anticipated investment returns for the assets supporting the liabilities.
Multiple estimation methods exist to establish claim reserve liabilities, with each method having its own advantages and disadvantages. Available reserving methods utilized to calculate claim reserves include the tabular reserve method, the paid development method, the incurred loss development method, the count and severity method, and the expected claim cost method. No singular method is better than the others in all situations and for all product lines. The estimation methods we have chosen are those that we believe produce the most reliable reserves at that time.
Claim reserves supporting the Unum US group life and accidental death and dismemberment products represent approximately 3.7 percent of our total claim reserves at December 31, 2009. Claim reserves for these products are related primarily to death claims reported but not yet paid, IBNR death claims, and a liability for waiver of premium benefits. The death claim reserve is based on the actual face amount to be paid, the IBNR reserve is calculated using the count and severity method, and the waiver of premium benefits reserve is calculated using the tabular reserve methodology.
1. The discount rate, which is used in calculating both policy reserves and incurred and IBNR claim reserves, is the interest rate that we use to discount future claim payments to determine the present
3. The incidence rate, used for policy reserves and IBNR claim reserves, is the rate at which new claims are submitted to us. 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. We establish our incidence assumption using a historical review of actual incidence results along with an outlook of future incidence expectations.
Because our actual experience regarding persistency and claim incidence has varied very little from our policy reserve and IBNR claim reserve assumptions, we have had minimal adjustments to our persistency assumptions and claim incidence assumptions during the years 2007 through 2009. Generally, we do not expect our mortality and morbidity claim incidence trends or our persistency trends to change significantly in the short-term, and to the extent that these trends do change, we expect those changes to be gradual over a longer period of time. However, we have historically experienced an increase in our group long-term disability morbidity claim incidence trends during and following a recessionary period, particularly in our Unum US operations. During the second half of 2009, claim incidence rates for Unum US group long-term disability were slightly elevated. Given the current economic conditions, it is possible that our claim incidence rates for this type of product may increase.
Both the mortality rate experience and the retirement rate experience for our block of group pension products have remained stable and consistent with expectations.
Approximately 90 percent of our DAC relates to traditional non interest-sensitive products, and we amortize DAC in proportion to the premium income we expect to receive over the life of the policies. Key assumptions used in developing the future amortization of DAC are future persistency and future premium income. We use our own historical experience and expectation of the future performance of our businesses in determining the expected persistency and premium income. The estimated premium income in the early years of the amortization period is generally 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. During 2009, our key assumptions used to develop the future amortization did not change materially from those used in the prior year. Generally, we do not expect our persistency or interest rates to change significantly in the short-term, and to the extent that these trends do change, we expect those changes to be gradual over a longer period of time.
In December 2009, the Financial Accounting Standards Board issued a proposed Accounting Standards Update which is intended to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify as deferred acquisition costs. If the proposed guidance is adopted as currently written, this update will result in a decrease in the level of costs we defer, effective January 1, 2011. We have not yet quantified the impact on our financial position or results of operations.
available inputs. When markets are less active, brokers may rely more on models with inputs based on the information available only to the broker. In weighing a broker quote as an input to fair value, we place less reliance on quotes that do not reflect the result of market transactions. We also consider the nature of the quote, particularly whether the quote is a binding offer. If prices in an inactive market do not reflect current prices for the same or similar assets, adjustments may be necessary to arrive at fair value. When relevant market data is unavailable, which may be the case during periods of market uncertainty, the income approach can, in suitable circumstances, provide a more appropriate fair value. During 2009, we have applied valuation techniques on a consistent basis to similar assets and liabilities and consistent with those techniques used at year end 2008. Because of market conditions existing during 2009 and 2008, the mix and availability of observable inputs for valuation techniques have been volatile, and the risk inherent in the inputs is elevated relative to prior years.
Inputs refer broadly to the assumptions that market participants use in pricing assets or liabilities, including assumptions about risk, for example, the risk inherent in a particular valuation technique used to measure fair value (such as a pricing model) and/or the risk inherent in the inputs to the valuation technique. Inputs may be observable or unobservable.
We review all prices obtained to ensure they are consistent with a variety of observable market inputs and to verify the validity of a security’s price. The overall valuation process for determining fair values may include adjustments to valuations obtained from our pricing sources when they do not represent a valid exit price. These adjustments may be made when, in our judgment and considering our knowledge of the financial conditions and industry in which the issuer operates, certain features of the financial instrument require that an adjustment be made to the value originally obtained from our pricing sources. These features may include the complexity of the financial instrument, the market in which the financial instrument is traded, counterparty credit risk, credit structure, concentration, or liquidity. Additionally, an adjustment to the price derived from a model typically reflects our judgment of the inputs that other participants in the market for the financial instrument being measured at fair value would consider in pricing that same financial instrument.
At December 31, 2009, approximately 11.6 percent of our fixed maturity securities were valued using active trades from TRACE pricing, or broker market maker prices for which there was current market activity in that specific security (comparable to receiving one binding quote). The prices obtained were not adjusted, and the assets were classified as Level 1, the highest category of the three-level fair value hierarchy classification wherein inputs are unadjusted and represent quoted prices in active markets for identical assets or liabilities.
We use a comprehensive rating system to evaluate the investment and credit risk of our mortgage loans and to identify specific properties for inspection and reevaluation. Mortgage loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. We establish an allowance for probable losses on mortgage loans based on a review of individual loans and the overall loan portfolio, considering the value of the underlying collateral. Mortgage loans are not reported at fair value in our consolidated balance sheets unless the decline in value is considered to be other than temporary, in which case the reduction is recognized as a realized investment loss in our consolidated statements of income.
The economic outlook, either domestic or foreign, may be less favorable or may have a more significant impact on the borrower than anticipated, and as such, the investment may not recover in value.
The assumptions chosen for our pension and OPEB plans are reviewed annually, and we use a December 31 measurement date for each of our plans. The discount rate assumptions and expected long-term rate of return assumptions have the most significant effect on our net periodic benefit costs associated with these plans. In addition to the effect of changes in our assumptions, the net periodic cost or benefit obligation under our pension and OPEB plans may change due to factors such as actual experience being different from our assumptions, special benefits to terminated employees, or changes in benefits provided under the plans.
The discount rate we used to determine our 2010 and 2009 net periodic benefit costs for our U.S. pension plans was 6.40 percent for both years. The discount rate used for the net periodic benefit costs for 2010 and 2009 for our U.K. pension plan was 5.70 percent and 6.40 percent, respectively. The discount rate used in the net periodic benefit cost for our OPEB plan for 2010 and 2009 was 5.90 percent and 6.10 percent, respectively.
Increasing the discount rate assumption by 50 basis points would have resulted in a decrease in our 2009 pension expense of approximately $8.9 million, before tax, and a decrease in our benefit obligation of approximately $107.9 million as of December 31, 2009, resulting in an after-tax increase in stockholders’ equity of approximately $71.5 million as of December 31, 2009. A 50 basis point increase in the discount rate assumption would not change our annual OPEB costs.
The long-term rate of return assumption is the best estimate of the average annual assumed return that will be produced from the pension trust assets until current benefits are paid. We use a compound interest method in computing the rate of return on pension plan assets. The investment portfolio for our U.S. pension plans contains a diversified blend of domestic and international large cap, mid cap, and small cap equity securities, U.S. government and corporate fixed income securities, private equity funds of funds, and hedge funds of funds. Assets for our U.K. pension plan are invested in pooled funds, such as global equities, hedge funds, commodities, below-investment-grade fixed income securities, and currencies, as well as a fixed-interest U.K. corporate bond fund and an index-linked U.K. government bond fund. Assets for our OPEB plan are invested primarily in life insurance contracts. We believe our investment portfolios are well diversified by asset class and sector, with no potential risk concentrations in any one category.
Changing the expected long-term rate of return on the plan assets by +/-50 basis points would have changed our 2009 pension plan expense by approximately $4.6 million before tax, but our OPEB plan expense would not change. A lower rate of return on plan assets increases our expense.
The market-related value equals the fair value of assets, determined as of the measurement date. The expected return on assets fully recognizes all asset gains and losses, including changes in fair value, through the measurement date.
During 2006, the federal government enacted the Pension Protection Act of 2006 which requires companies to fully fund defined benefit pension plans over a seven year period. We have evaluated this requirement and have made estimates of amounts to be funded in the future. Based on this assessment, we do not believe that the funding requirements of the Pension Protection Act will cause a material adverse effect on our liquidity.
See Note 9 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further discussion.
On a quarterly basis, we review relevant information with respect to litigation and contingencies to be reflected in our consolidated financial statements. An estimated loss is accrued when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. It is possible that our results of operations or cash flows in a particular period could be materially affected by an ultimate unfavorable outcome of pending litigation or regulatory matters depending, in part, on our results of operations or cash flows for the particular period. See Note 14 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further discussion.
The comparability of our financial results between years is affected by the fluctuation in the British pound sterling to dollar exchange rate. The functional currency of our U.K. operations is the British pound sterling. In periods when the pound weakens, translating pounds into dollars decreases current period results relative to the prior period. In periods when the pound strengthens, translating pounds into dollars increases current period results in relation to the prior period. Our weighted average pound/dollar exchange rate was 1.554, 1.871, and 2.004 for the years ended 2009, 2008, and 2007, respectively. Our operating revenue and operating income by segment would have been higher in 2009 by approximately $233.1 million and $77.0 million, respectively, and higher in 2008 by approximately $86.7 million and $24.2 million, respectively, if the results for our U.K. operations had been translated at a constant exchange rate of 2.004, the rate for 2007. However, it is important to distinguish between translating and converting foreign currency. Except for a limited number of transactions, we do not actually convert pounds into dollars. As a result, we view foreign currency translation as a financial reporting issue and not a reflection of operations or profitability in the U.K.
the in-force block also unfavorably impacted Unum UK premium growth during 2008 relative to 2007. Premium income in the Individual Disability - Closed Block segment continues to decline, as expected, in this closed block of business.
Net investment income was lower in 2009 relative to the prior year due to several factors: (i) the weaker pound in 2009 relative to 2008 unfavorably affected translated results for net investment income, (ii) we received lower interest income during 2009 on bonds in Unum UK for which interest income is linked to a U.K. inflation index, the impact of which was largely offset by lower claim reserves due to lower claim payments which are also linked to inflation, (iii) during 2009 we earned lower interest rates on our floating rate invested assets, largely offset by lower interest expense on our floating rate debt, and (iv) we received fewer bond call premiums and consent fees during 2009 compared to 2008. Somewhat mitigating the impact of these items is continued growth in the level of invested assets, an increase in the level of prepayment income on mortgage-backed securities, and an increase in our portfolio yield due to the investment of new cash at higher rates than that of prior periods.
Net investment income was marginally lower in 2008 relative to 2007. During 2008, we received fewer bond call premiums, and the level of prepayment income on mortgage-backed securities declined relative to the preceding year. The weaker pound in 2008 relative to 2007 also unfavorably affected translated results for net investment income. The impact of these items was mostly offset by continued growth in the level of invested assets and a slight increase in our portfolio yield due to the investment of new cash at higher rates.
We recognized in earnings a net realized investment gain of $11.7 million in 2009 compared to losses of $465.9 million in 2008 and $65.2 million in 2007. During 2009, we recognized other-than-temporary impairment losses of $215.5 million related to fixed maturity securities, $211.8 million of which was recognized in earnings and $3.7 million in other comprehensive income. Other-than temporary impairment losses on fixed maturity securities were $151.1 million and $53.7 million in 2008 and 2007, respectively, all of which were recognized in earnings.
Other income includes fees for administrative services only (ASO) products, which declined approximately 8.6 percent in 2009 relative to the prior year. Other income in 2008 also included a refund of interest attributable to certain tax years.
The deferral of acquisition costs in 2009 was generally consistent with the prior year, with continued growth in certain of our product lines and the associated increase in deferrable expenses offsetting the lower level of deferrable costs in product lines with lower growth. The amortization of acquisition costs was slightly higher in 2009 relative to the prior year due to the continued increase in the level of deferred acquisition costs as well as an acceleration of amortization resulting from lower persistency in the Unum US supplemental and voluntary lines. The deferral and amortization of deferred acquisition costs was higher in 2008 relative to the prior year due primarily to continued growth in certain of our product lines. Amortization increased in 2008 relative to 2007 due to an increase in the amortization related to Unum US internal replacement transactions as well as slightly elevated persistency in certain policy issue years.
Shown below are financial results for the Unum US segment. In the sections following, financial results and key ratios are also presented for the major lines of business within the segment.
(2) Included in this ratio for 2007 is an expense reduction of $10.3 million related to the claim reassessment process. Excluding this item, the other expense ratio for 2007 would have been 20.0%.
(3) Included in this ratio for 2007 is a charge of $66.2 million related to the claim reassessment process. Excluding this charge, the before-tax operating income ratio for 2007 would have been 12.1%.
Our supplemental and voluntary sales have been negatively impacted by the current economic conditions, including lower new account sales as well as lower sales to existing accounts. Sales of voluntary benefits increased by 2.1 percent, and the number of new accounts increased by 19.5 percent compared to 2008. Sales for our individual disability line of business, of which approximately 90 percent are in the multi-life market, decreased 10.9 percent compared to 2008, and sales of group long-term care decreased 30.4 percent. We discontinued selling individual long-term care during 2009.
(2) Included in this ratio for 2007 is an expense reduction of $10.3 million related to the claim reassessment process. Excluding this item, the other expense ratio for 2007 would have been 24.0%.
Interest and debt expense related to the debt issued by Tailwind Holdings decreased in 2009 relative to the prior year due to a decrease in the variable rate of interest during 2009 and a decrease in the amount of outstanding debt resulting from principal repayments.
The deferral of acquisition costs increased in comparison to 2008 due to a higher level of deferrable expenses partially resulting from increased group short-term disability sales. Amortization was lower in 2009 relative to the prior year due to a decrease in amortization related to internal replacement transactions. These transactions are accounted for as an extinguishment of the original policy and the issuance of a new policy.
During 2009, Unum America entered into a quota share reinsurance agreement with RGA Americas Reinsurance Company, Ltd. under which Unum America will cede a closed block of group long-term disability claims. The reinsurance transaction does not meet the conditions for reinsurance accounting and is therefore accounted for as a deposit. As such, there is no effect on reported premium income or benefits. The only impact on the income statement is the risk charge paid to the reinsurer.
Premium income for group disability decreased in 2008 relative to 2007 due primarily to our pricing, renewal, and risk selection strategy as well as the termination of one large case group in September 2007. However, premium persistency and case persistency both improved in 2008 over 2007 in both the core and large case markets. Net investment income declined in 2008 in comparison to 2007 primarily due to a lower yield on assets supporting this line of business resulting from the investment of new cash at a lower yield than that of the existing portfolio and also due to a decrease in bond call premiums. The decline in yield and bond call premiums was partially offset by an increase in the level of assets in the portfolio. ASO fees were $64.8 million and $65.2 million in 2008 and 2007, respectively.
The benefit ratio for 2008 was lower than the benefit ratio for 2007, excluding the 2007 revision to our estimate for the claim reassessment costs, due primarily to a higher rate of claim recoveries in group long-term disability and lower paid claims in short-term disability. Claim incidence rates for both group long-term and short-term disability were slightly lower in 2008 than 2007.
Amortization of deferred acquisition costs was higher in 2008 relative to 2007 due to an increase in amortization related to internal replacement transactions.
The other expense ratio increased in 2008 compared to 2007 due primarily to the decline in premium income and an increase in policy maintenance expenses and product service and development costs. Also contributing to the increase in the other expense ratio was $4.4 million of expense related to the broker compensation settlement.
Premium income for group life and accidental death and dismemberment decreased in 2009 relative to 2008, a portion of which was expected and is due to our pricing, renewal, and risk selection strategy. Consistent with the decline in premium income for group disability, premium growth for group life and accidental death and
The other expense ratio increased in 2009 in comparison to the prior year due to the decline in premium income as well as an increase in policy acquisition-related costs associated with increased sales and an increase in policy maintenance expenses associated with the change in the mix of in-force policies from the large case market to the core market segment.
Premium income for group life decreased in 2008 relative to 2007 due primarily to our pricing, renewal, and risk selection strategy. Premium persistency and case persistency both improved in 2008 in comparison to 2007. The decrease in net investment income in 2008 relative to 2007 resulted from a decline in the level of assets supporting these lines of business and from a lower yield on the portfolio due to the investment of new cash at a lower yield than that of the existing portfolio.
The deferral of acquisition costs increased in 2008 due primarily to increased sales in the group core market segment. Amortization of deferred acquisition costs was higher in 2008 relative to 2007 due to an increase in amortization related to internal replacement transactions.
Premium income increased in 2009 relative to the prior year due primarily to sales growth, particularly in the voluntary benefits product line, partially offset by a slight decline in premium persistency. Net investment income increased relative to the prior year due to higher investment income related to growth in the level of assets supporting these lines of business, an increased level of prepayment income on mortgage-backed securities, and a higher yield on the portfolio due to the investment of new cash at higher yields than that of the existing portfolio.
The interest adjusted loss ratio for the individual disability - recently issued line of business declined in 2009 relative to the prior year due primarily to a more favorable claim recovery rate and a lower number of reopened claims, partially offset by an increase in the paid incidence rate. The interest adjusted loss ratio for long-term care increased in 2009 relative to the prior year due primarily to an increase in paid claim incidence rates. The benefit ratio for voluntary benefits decreased in 2009 as compared to 2008 due primarily an increase in premium income, partially offset by an increase in the paid claim incidence rate for the voluntary disability product line.
Premium income increased in 2008 relative to 2007 due to sales growth in our supplemental and voluntary product lines, the impact of premium rate increases implemented for individual long-term care, and overall stable persistency. Net investment income increased in 2008 relative to 2007 primarily from growth in the level of assets supporting these lines of business.
The increase in commissions and the deferral and amortization of acquisition costs in 2008 relative to 2007 is due primarily to growth in these lines of business. The other expense ratio decreased slightly in 2008 in comparison to 2007 due to a higher rate of premium growth relative to expense growth.
During 2009, we experienced an unfavorable impact on premium growth which we believe was caused by the uncertain economic environment. Our 2009 sales were also negatively impacted by the economy, particularly sales to existing accounts. Opportunities for premium and sales growth are expected to re-emerge as the economy improves and employment growth resumes. We expect continued volatility in net investment income during 2010 as a result of fluctuations in bond calls and other types of miscellaneous net investment income. We intend to manage our expense levels relative to premium levels through operating effectiveness and performance management. Unum US has goodwill of approximately $190.0 million at year end 2009, none of which is currently believed to be at risk for future impairment.
Periods of economic downturns have historically affected disability claim incidence rates and, to a lesser extent, disability claim recovery rates in certain sectors of the market. Certain risks and uncertainties are inherent in disability business. Components of claims experience, such as incidence and recovery rates, may be worse than we expect. Disability claim incidence and claim recovery rates may be influenced by, among other factors, the rate of unemployment and consumer confidence. Within the group disability market, pricing and renewal actions can be taken to react to higher claim rates, but these actions take time to implement, and there is a risk that the market will not sustain increased prices. In addition, changes in economic and external conditions may not manifest themselves in claims experience for an extended period of time. The current economic downturn may lead to a higher rate of claim incidence or lower levels of claim recoveries. We have previously taken steps to improve our risk profile, including reducing our exposure to volatile business segments through diversification by market size, product segment, and industry segment. We believe our claims management organization is positioned for stable and sustainable performance levels. Although we did not experience significantly higher levels of disability claims incidence during 2009, we did experience slightly elevated levels in the second half of 2009. We are uncertain as to whether the higher claim incidence is due to the normal volatility that occurs in our group disability business or is
We believe our Unum US growth strategy is sound. We continue to see future growth opportunity based on employee choice, defined employer funding, simple administration, and effective communication. Our strategies for growth focus on (i) delivering product choice through an integrated, easy-to-manage, and flexible platform, (ii) providing communications to employees with a focus on education and enrollment efficiencies, (iii) continued expansion and improvement in distribution, and (iv) developing strong capabilities to cross-sell, re-enroll, and retain customers.
During 2010, we will continue to embed our culture of risk management while maintaining our operating effectiveness, with a focus on talent development across our businesses. We believe we are well-positioned strategically in our markets and that opportunities for growth exist in our group core market segment and in the voluntary markets. We will continue to manage our value businesses, which we define as the group large case market, individual disability, and long-term care product lines, in a disciplined manner for profitability. While the recession impacted our ability to grow premium income during 2009, we expect to achieve a slight increase in premium income during 2010. We anticipate that the benefit ratio in our group disability product line will begin to level out during 2010. We think future margin improvement is achievable, although at a slower rate of growth than was achieved for 2008 and 2009, driven primarily by our ongoing product mix shift and the growth of our voluntary benefits product line.
Fluctuations in the pound to dollar exchange rate have an effect on Unum UK’s reported financial results and our consolidated financial results. In periods when the pound weakens relative to the preceding period, as occurred in 2009 and in 2008, translating pounds into dollars decreases current periods’ results relative to the prior period. In periods when the pound strengthens, translating into dollars increases current periods’ results in relation to the prior periods.
Premium income declined in 2009 relative to the prior year due to lower premium growth from existing customers and also due to a decline in the in-force block of group long-term disability business resulting from lower persistency and lower sales during 2008 and 2007. Also contributing to the comparative decline was an increase in group long-term disability premium income of £2.8 million in 2008 relating to a non-recurring reinsurance premium on a previously acquired claims block. The decline in group long-term disability premium income was partially offset by increases in premium income for group life due to higher sales and improved persistency.
Net investment income decreased in 2009 relative to the prior year due primarily to a reduction in inflation which reduced the return on bonds for which interest income is linked to a U.K. inflation index. These index-linked bonds match the claim reserves associated with certain of our group long-term disability policies that provide for inflation-linked increases in disability benefits. The decrease in 2009 net investment income attributable to these index-linked bonds was generally offset by a decrease in the reserves for future claims payments related to the inflation index-linked group long-term disability policies. Although over the intermediate-term the investment return from index-linked bonds generally matches the index-linked claim payments and reserves, the effect on investment income from the inflation index-linked bonds may not be completely offset by lower claim payments and reserves. The benefits reset to a higher payment when the rate of inflation increases but are not reset to a lower payment due to a decrease in the rate of inflation, whereas investment income on the inflation index-linked bonds can fluctuate either positively or negatively depending on the movement in the inflation rate.
The deferral of acquisition costs in 2009 decreased in comparison to the prior year due primarily to a lower level of deferrable expenses resulting from the reduction in the overall expense level as well as a change in the mix of sales. The increase in amortization of acquisition costs in 2009 relative to the prior year is due primarily to an increase in amortization related to internal replacement transactions that are accounted for as an extinguishment of the original policy and the issuance of a new policy.
During 2009, we experienced an unfavorable impact on sales to existing customers and premium growth, and we expect this may continue in the near term if current economic conditions persist. Our sales and premium growth could also be further impacted by a prolonged competitive pricing environment in the U.K. We have thus far not experienced any significant deterioration in disability claims incidence or claim recoveries, but similar to Unum US, disability claim incidence and claim recovery rates may be influenced by the current economic environment. Unum UK has an immaterial amount of goodwill recorded on its balance sheet at year end 2009, none of which is currently believed to be at risk for future impairment. We continuously monitor key indicators to assess our risk to the economic slowdown and attempt to adjust our business plans accordingly. Continued fluctuations in the U.S. dollar relative to the British pound sterling impact our reported operating results.
The lower level of premium growth in 2009 compared to the 2008 growth rate was attributable primarily to lower sales during the first half of 2009 and lower persistency in the accident, sickness, and disability product line. The lower persistency primarily relates to the loss of a few large policyholder accounts. We believe our lower premium growth was partially due to the current economic conditions which affected the buying patterns of employees and caused employers to defer introduction of new plans. Net investment income increased in 2009 in comparison to the prior year due to growth in the level of assets, an increased level of prepayment income on mortgage-backed securities, and a higher yield on the portfolio due to the investment of new cash at a higher yield than that of the existing portfolio.
The overall benefit ratio for this segment remained stable in 2009 relative to the prior year, with a lower benefit ratio in the life and cancer and critical illness lines of business partially offset by a slightly higher benefit ratio in the accident, sickness, and disability line of business. The life product line reported a lower benefit ratio in 2009 relative to the prior year due to a change in the mix of life business and the resulting lower change in the active life reserve. The cancer and critical illness product line reported a lower benefit ratio in 2009 relative to the prior year due primarily to a release of active life reserves, partially offset by an increase in disabled life reserves associated with the older cancer products. The increase in the benefit ratio in the accident, sickness and disability line of business resulted primarily from a slight increase in the claim incidence rates relative to the favorable experience of last year.
The amortization of deferred acquisition costs was higher in 2009 due to the continued increase in the level of deferred acquisition costs as well as the fluctuation in amortization related to certain of our interest-sensitive policies.
The benefit ratio decreased in 2008 in comparison to 2007 due primarily to favorable risk experience in the accident, sickness, and disability line of business, offset somewhat by higher benefit ratios in the life and cancer and critical illness lines of business. The improvement in the accident, sickness, and disability line of business resulted from favorable experience related to several new products introduced between 2002 and 2004. The life line of business benefit ratio was higher in 2008 relative to 2007 due to a higher level of death claims and a higher average claim cost. The cancer and critical illness product line reported a higher benefit ratio in 2008 relative to 2007 due primarily to unfavorable claim experience associated with the older cancer products.
Colonial Life’s sales in 2009 increased 1.1 percent relative to last year, with 7.2 percent growth in new account sales and a decline of 2.3 percent in existing account sales. We experienced sales growth of 11.8 percent in the public sector market and a slight increase in sales in the commercial market segment with more than 500 lives. These sales increases were partially offset by a sales decline of 2.6 percent in the commercial core market segment, which we define for Colonial Life as employee groups with fewer than 500 lives. The number of new accounts in 2009 increased relative to 2008, while the new account annualized sales premium per case sold declined.
Colonial Life’s 2008 sales increased in the commercial core market segment as compared to 2007 sales levels. Partially offsetting this increase was a decrease in sales in the commercial market segment for employee groups with more than 500 lives and a decrease in the public sector markets for state and federal governments. The number of new accounts and the new account annualized sales premium per case sold both increased in 2008 over 2007.
During 2009, economic conditions had an unfavorable impact on existing account sales and on premium growth, and we expect this trend may continue in the near term if current economic conditions persist and continue to affect employment growth, the buying patterns of employees, and the deferral by employers of the introduction of new employee benefit plans. Periods of economic downturns have historically had minimal impact on the risk results of Colonial Life, due primarily to a diversified product portfolio that is designed with short duration, indemnity benefits. During 2009, we did not experience a significant increase in claim incidence levels in the aggregate or in any particular market sector. We continuously monitor key indicators to assess our risk to an economic slowdown or recession and attempt to adjust our business plans accordingly.
Given the general stability and consistency of our risk results, we intend to continue to concentrate on developing our agency distribution system and implementing marketing strategies to accelerate sales growth. We believe our value proposition, through which we serve as benefits counselors for employers and employees and as a single source for benefits communication, voluntary insurance products, and enrollment services, is well positioned for changes in the voluntary market. Our 2010 growth strategy will focus on (i) distribution expansion and effectiveness, (ii) benefits communication, primarily through one-to-one enrollment, (iii) targeted marketing programs to accelerate new account growth and better penetrate existing accounts, and (iv) balanced growth in our market segments.
The Individual Disability - Closed Block segment generally consists of those individual disability policies in-force before the substantial changes in product offerings, pricing, distribution, and underwriting, which generally occurred during the period 1994 through 1998. A small amount of new business continued to be sold after these changes, but we stopped selling new policies in this segment at the beginning of 2004 other than update features contractually allowable on existing policies.
(1) Included in this ratio for 2007 is a credit of $10.7 million related to the claim reassessment process. Excluding this credit, the interest adjusted loss ratio for 2007 would have been 85.2%.
(2) Included in this ratio for 2007 is an expense reduction of $2.5 million related to the claim reassessment process. Excluding this item, the other expense ratio for 2007 would have been 14.1%.
(3) Included in this ratio for 2007 is a credit of $13.2 million related to the claim reassessment process. Excluding this credit, the before-tax operating income ratio for 2007 would have been 9.5%.
The decrease in premium income for 2008 relative to 2007 is due to the expected run-off of this block of closed business due to persistency and policy maturities. Net investment income decreased in 2008 compared to 2007 due to a decrease in bond call premiums, a lower level of assets, and a decline in the portfolio yield for this segment. During the fourth quarter of 2007, we entered into an intercompany reinsurance transaction which allowed us to release excess statutory capital previously supporting this reinsured closed block of business. As a result, the capital allocated to our Individual Disability - Closed Block segment declined, with a resulting decrease in net investment income due to the lower asset levels needed to support allocated capital. Because this is an intercompany reinsurance arrangement, reported results remain unchanged for this segment other than the lower net investment income.
The interest adjusted loss ratio was lower in 2008 compared to 2007, excluding the decrease in our claim reassessment reserve estimate, due primarily to lower average size of new claims and fewer reopened claims.
The other expense ratio is higher for 2008 relative to 2007 due to a $4.7 million litigation settlement as well as higher legal fees related to two pending cases.
We expect that this segment may experience volatility in net investment income due to the variability in interest rates on floating rate assets and also due to a reduced level of bond call premiums relative to historical levels. A portion of the volatility in interest income will be offset by commensurate changes in the interest expense on our floating rate debt.
We expect that operating revenue and income will continue to decline over time as this closed block of business winds down. We believe that the interest adjusted loss ratio for this block of business will be relatively flat over the long term, but the segment may experience quarterly volatility. Claim resolution rates, which measure the resolution of claims from recovery, deaths, settlements, and benefit expirations, are very sensitive to operational and environmental changes and can be volatile. Our claim resolution rate assumption used in determining reserves is our expectation of the resolution rate we will experience over the life of the block of business and will vary from actual experience in any one period. It is possible that variability in our reserve assumptions could result in a material impact on our reserve levels.
The Corporate and Other segment includes investment income on corporate assets not specifically allocated to a line of business, interest expense on corporate debt other than non-recourse debt, and certain other corporate income and expense not allocated to a line of business. Corporate and Other also includes results from certain Unum US insurance products not actively marketed, including individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities. We expect operating revenue and income resulting from these insurance products to decline over time as these business lines wind down.
Interest and debt expense declined in 2009 relative to 2008 due primarily to lower average levels of outstanding debt. Interest expense declined in 2008 relative to 2007 due to the replacement, in the fourth quarter of 2007, of older fixed rate debt held in Corporate and Other with non-recourse debt issued in conjunction with the securitization of our closed block of individual disability reserves and held in the Individual Disability - Closed Block segment. Costs related to early retirement of debt were $58.8 million in 2007 and minimal in the other periods presented. See “Debt” contained in this Item 7 for further discussion.
The general economic outlook for corporate bond defaults continues to be high relative to historical levels. We have tested whether our capital plans have sufficient cushion to absorb possible losses. We believe the current level of cash and marketable securities at our holding companies as well as the level of our statutory risk-based capital position us well for the current economic environment. It is possible, however, that defaults in our investment portfolio will result in realized investment losses, reduced net investment income, and lower statutory capital. Depending on the magnitude of defaults, it is possible that we would need to seek external financing.
During the first quarter of 2007, we completed the sale of GENEX and recognized an after-tax gain on the transaction of approximately $6.2 million. This gain is included with income from discontinued operations in our consolidated statements of income. Also included in discontinued operations is after-tax income for GENEX of $0.7 million in 2007. See Note 2 of the “Notes to Consolidated Financial Statements” for additional information.
The majority of investments are in high quality publicly traded securities to ensure the desired liquidity and preserve the capital value of our portfolios.
Net investment income was $2,389.0 million in 2008, a decrease of 0.9 percent relative to 2007. The level of invested assets was higher in 2008 compared to 2007, but we received fewer bond call premiums during 2008. The weaker British pound in 2008 relative to 2007 also unfavorably affected translated results for net investment income. Our portfolio yield increased slightly in 2008 over 2007 due to the investment of new cash at higher rates than that of prior periods.
During 2009, we recognized an other-than-temporary impairment loss of $32.9 million on securities issued by a U.K. financial institution. The decline in value of the securities is primarily the result of the global credit crisis and the slowdown in the economy. In addition, this financial institution made a major acquisition during the peak of the past credit cycle. The financial institution then had to recognize impairments on loans and other assets held by the acquired company, resulting in the need for additional capital. This capital was initially provided by shareholders and others, but as the economic environment further deteriorated, the financial institution participated in the government guarantee of senior debt, capital injections, and an asset protection scheme. 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 impairment loss, these securities had been in an unrealized loss position for a period of greater than three years.
During 2008, we recognized an other-than-temporary impairment loss of $21.6 million on securities issued by a large publisher of yellow page advertising. The outlook for this industry had continued to worsen due to the secular change impacting the industry and due to weak economic conditions. The company’s third quarter 2008 earnings were down significantly as compared to prior periods, and bad debt expense and financial leverage increased significantly. These financial results increased the likelihood that the company might violate bank covenants and seek waivers from its bondholders. Additionally, the company had hired external consultants to advise it on potential capital restructuring alternatives. These events increased the likelihood that the company would seek to tender its bonds at a discounted value and that our bonds would not fully recover in value. At the time of the impairment loss, these securities had been in an unrealized loss position for a period of greater than one year but less than two years.
During 2007, we recognized an other-than-temporary impairment loss of $15.0 million on bonds issued by a large media company. The company was the subject of a leveraged buyout that placed a large amount of debt on the balance sheet during 2007. Because of our outlook for the future business prospects of this issuer, the length of time these securities had been in an unrealized loss position, and a change in our intent to retain the security for a sufficient period of time for it to recover, we determined that an other-than-temporary impairment had occurred. These securities were investment-grade at the time of purchase but were downgraded to below-investment-grade in the second quarter of 2006. At the time of the impairment, these securities had been in an unrealized loss position for a period of greater than two years.
During 2007, we recognized losses of $18.4 million related to the decline in fair value below amortized cost for certain securities for which it was determined during the third quarter of 2007 that we no longer had the intent to hold to recovery or maturity due to anticipated changes in our capital requirements resulting from the reinsurance transactions involving our Individual Disability - Closed Block segment business and the related issuance of $800.0 million of notes, as well as our capital redeployment plans.
other direct regulatory action. Cash settlements or collateral related to this embedded derivative are not required at any time during the reinsurance contract or at termination of the reinsurance contract, and any accumulated embedded derivative gain or loss reduces to zero over time as the reinsured business winds down. We therefore view the effect of realized gains and losses recognized for this embedded derivative as a reporting requirement that will not result in a permanent change in assets or stockholders’ equity.
The following two tables show the length of time our investment-grade and below-investment-grade fixed maturity securities had been in a gross unrealized loss position as of December 31, 2009 and at the end of the prior four quarters. The relationships of the current fair value to amortized cost 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 after December 31, 2009. The elevated level of unrealized losses at the end of 2008 and continuing into the early part of 2009 resulted primarily from the significant widening of credit spreads that occurred in the overall market.
The following table shows our fixed maturity securities with a gross unrealized loss of $10.0 million or greater, by industry type.
At December 31, 2009, our mortgage/asset-backed securities had an average life of 5.66 years, effective duration of 4.61 years, and a weighted average credit rating of AAA. The mortgage/asset-backed securities are valued on a monthly basis using valuations supplied by the brokerage firms that are dealers in these securities as well as independent pricing services. The primary risk involved in investing in mortgage/asset-backed securities is the uncertainty of the timing of cash flows from the underlying loans due to prepayment of principal with the possibility of reinvesting the funds in a lower interest rate environment. We use models which incorporate economic variables and possible future interest rate scenarios to predict future prepayment rates. The timing of prepayment cash flows may also cause volatility in our recognition of investment income. We recognize investment income on these securities using a constant effective yield based on projected prepayments of the underlying loans and the estimated economic life of the securities. Actual prepayment experience is reviewed periodically, and effective yields are recalculated when differences arise between prepayments originally projected and the actual prepayments received and currently projected. The effective yield is recalculated on a retrospective basis, and the adjustment is reflected in net investment income.
We have not invested in mortgage-backed derivatives, such as interest-only, principal-only, or residuals, where market values can be highly volatile relative to changes in interest rates. All of our mortgage-backed securities have fixed rate coupons. The credit quality of our mortgage-backed securities portfolio has not been negatively impacted by the recent issues in the market concerning subprime mortgage loans. The change in value of our mortgage-backed securities portfolio has moved in line with that of prime agency-backed mortgage-backed securities.
Our mortgage loan portfolio was $1,404.0 million and $1,274.8 million on an amortized cost basis at December 31, 2009 and 2008, respectively. Our mortgage loan portfolio is comprised entirely of commercial mortgage loans. We expect that we will continue to add investments in this category either through the secondary market or through loan originations. We believe our mortgage loan portfolio is well diversified geographically and among property types. The incidence of problem mortgage loans and foreclosure activity continues to be low. Due to conservative underwriting, we expect the level of problem loans to remain low relative to the industry. At December 31, 2009, we held one mortgage loan which was delinquent more than 30 days as to interest or principal payments and which we consider impaired. This loan is carried at the estimated net realizable value of $2.0 million, net of a valuation allowance of $3.2 million. At December 31, 2008, impaired mortgage loans totaled $5.2 million. We had no valuation allowance for mortgage loans at December 31, 2008.
See Note 4 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further discussion of our investments.
We use derivative financial instruments primarily to manage reinvestment risk, duration, and currency risk. Historically, we have utilized 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. Our current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position less collateral held, was $7.0 million at December 31, 2009. The carrying value of fixed maturity securities posted as collateral to our counterparties was $123.1 million at December 31, 2009. We believe that our credit risk is mitigated by our use of multiple counterparties, all of whom are rated A or better by both Moody’s and S&P. See Note 5 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for further discussion of our derivative financial instruments.
We have met all minimum pension funding requirements set forth by ERISA. We made a voluntary contribution of $67.0 million to our U.S. qualified defined benefit pension plan in February 2010. We do not anticipate making any additional contributions during 2010. We have estimated our future funding requirements under the Pension Protection Act of 2006 and do not believe that the funding requirements will cause a material adverse effect on our liquidity.
Our cash flows from discontinued operations are combined with cash flows from continuing operations within each cash flow statement category in our 2007 consolidated statement of cash flows. The absence of cash flows from discontinued operations did not materially affect liquidity and capital resources.
Proceeds from sales and maturities of available-for-sale securities in 2009 were lower than 2008 primarily due to lower sales of fixed maturity securities, a decrease in bond maturities and bonds that were called at par, and the translation of investment proceeds from our U.K. operations at lower exchange rates. Proceeds from sales and maturities of available-for-sale securities in 2008 were consistent with the level of 2007 primarily due to an increase in bond maturities and bonds that were called at par, offset by a decrease in sales of fixed maturity securities, a lower level of proceeds from mortgage-backed securities prepayments, and the translation of investment proceeds from our U.K. operations at lower exchange rates.
Proceeds from sales and maturities of other investments increased in 2009 primarily due to an increase in sales of other long-term investments and an increase in proceeds from terminations of derivatives within our cash flow hedging programs. This increase was partially offset by a decline in proceeds from commercial mortgage loan maturities and prepayments. Proceeds from sales and maturities of other investments decreased in 2008 relative to 2007 primarily due to lower proceeds from the sale of common stock investments and a reduction in commercial mortgage loan maturities and prepayments. The reduction in cash flows received from sales and maturities of other investments was partially offset by higher proceeds in 2008 from terminations of derivatives within our cash flow hedging programs.
Purchases of available-for-sale securities decreased during 2009 relative to 2008. This decrease resulted from fewer funds available for reinvestment as compared to the prior year due to the lower level of proceeds from sales of available-for-sale securities and from the lower exchange rate for translation of purchases within our U.K. operations. Purchases of available-for-sale securities decreased during 2008 relative to 2007 due to the lower exchange rate for translation of purchases within our U.K. operations and to investing more heavily in short-term investments rather than fixed maturity securities during the last half of 2008. During the first half of 2008, we invested more heavily in fixed maturity securities as we continued to transition out of short-term investments into floating rate fixed maturity securities to support the floating rate debt issued during the fourth quarter of 2007. Purchases of available for sale securities in 2007 included the investing of the net cash inflows of $98.8 million from the sale of GENEX and the $211.4 million in cash inflows from the reinsurance recapture.
Net short-term debt repayments in 2009 consist of the purchase and retirement of the remaining $132.2 million of our 5.859% notes and the repayment of $58.3 million of reverse repurchase agreements outstanding at December 31, 2008. Net short-term debt repayments in 2008 are comprised of the purchase and retirement of the remaining $175.0 million of our 5.997% senior notes and $17.8 million of our 5.859% notes, less the issuance of $58.3 million of reverse repurchase agreements.
During 2009, we received proceeds of $350.0 million, less debt issuance costs of $3.2 million, from the issuance of $350.0 million of 7.125% senior notes. During 2007, we received proceeds of $800.0 million, less debt issuance costs of $15.1 million, from the issuance of $800.0 million aggregate principal amount of debt by Northwind Holdings.
Long-term debt repayments include the 2009, 2008, and 2007 principal payments of $10.0 million, $10.0 million, and $17.5 million, respectively, on Tailwind Holdings’ floating rate, senior secured non-recourse notes. Debt repayments in 2009 and 2008 include principal payments of $48.0 million and $59.3 million, respectively, on Northwind Holdings’ floating rate, senior secured non-recourse notes. Long-term debt repayments also include the purchase and retirement of $1.2 million aggregate principal of our 7.19% medium-term notes and $0.6 million aggregate principal of our 6.75% notes in 2009 as well as $36.6 million of our 6.85% notes in 2008. During 2007, we also repurchased and/or made principal payments of an additional $752.0 million aggregate principal amount of outstanding debt and paid debt repurchase costs of $34.2 million.
During 2008, we completed a $700.0 million authorized share repurchase program by purchasing 29.9 million shares.
Unum Group and certain of its intermediate holding company subsidiaries depend on payments from subsidiaries to pay dividends to stockholders, to pay debt obligations, and/or to pay expenses. These payments by our insurance and non-insurance subsidiaries may take the form of interest payments on loans from the parent to a subsidiary, operating and investment management fees, and/or dividends.
The payment of ordinary dividends to a parent company from its insurance subsidiaries is generally further limited to the amount of statutory surplus as it relates to policyholders. Although it is unlikely we will utilize the entire amount of available dividends, based on the restrictions under current law, $719.7 million is available during 2010 for the payment of ordinary dividends to Unum Group from its traditional U.S. insurance subsidiaries, excluding Northwind Reinsurance Company (Northwind Re) and Tailwind Reinsurance Company (Tailwind Re). Northwind Holdings’ and Tailwind Holdings’ ability to meet their debt payment obligations will be dependent upon the receipt of dividends from Northwind Re and Tailwind Re, respectively. The ability of Northwind Re and Tailwind Re to pay dividends to their respective parent companies will depend on their satisfaction of applicable regulatory requirements and on the performance of the reinsured business.
The amount available during 2009 for the payment of ordinary dividends from Unum Group’s traditional U.S. insurance subsidiaries was $653.3 million, of which $90.0 million was declared and paid. The traditional U.S. insurance subsidiaries also paid extraordinary dividends of $110.0 million in 2009. The amount available during 2009 from Unum Limited was £145.5 million, of which £28.5 million was declared and paid. During 2009, Northwind Re received regulatory approval from the insurance department of its state of domicile to pay dividends of $32.7 million to Northwind Holdings, and Tailwind Re received regulatory approval from the insurance department of its state of domicile to pay dividends of $14.2 million to Tailwind Holdings. The payment of dividends to the parent company from our subsidiaries also requires the approval of the individual subsidiary’s board of directors.
At December 31, 2009, we had long-term debt, including senior secured notes and junior subordinated debt securities, totaling $2,549.6 million. We had no short-term debt at December 31, 2009. Our leverage ratio, when calculated excluding the non-recourse debt and associated capital of Tailwind Holdings and Northwind Holdings, was 20.5 percent at December 31, 2009 compared to 21.5 percent at December 31, 2008. Our leverage ratio, when calculated using consolidated debt to total consolidated capital, was 24.8 percent at December 31, 2009 compared to 26.6 percent at December 31, 2008.
confirmed the Baa1 debt rating of the non-recourse debt issued by Tailwind Holdings. Any further ratings downgrade from either S&P or Moody’s with respect to non-recourse debt issued by Tailwind Holdings or Northwind Holdings could cause additional increases in the fees paid to the third party guarantor on those debt issuances but would not cause a breach. We remain in compliance with all debt covenants and have not observed any current trends that would cause a breach of any debt covenants.
In 2008, we retired the remaining $175.0 million of our 5.997% senior notes due May 2008. We also purchased and retired $36.6 million of our 6.85% senior debentures due 2015 and $17.8 million of our 5.859% senior notes due May 2009.
In 2007, we purchased and retired $17.5 million of our outstanding 6.75% notes scheduled to mature in 2028. Pursuant to a cash tender offer, we purchased and retired $23.5 million aggregate liquidation amount of the 7.405% junior subordinated debt securities due 2038; $99.9 million aggregate principal amount of the 7.625% notes due 2011; $210.5 million aggregate principal amount of the 7.375% notes due 2032; and $66.1 million aggregate principal amount of the 6.75% notes due 2028. We also called and retired all $150.0 million principal amount of our outstanding 7.25% notes scheduled to mature in 2032. Also in 2007, in open market transactions, we purchased $34.5 million of our outstanding 6.85% notes due 2015.
In 2007, Northwind Holdings issued $800.0 million floating rate, insured, senior, secured notes, due 2037, in a private offering. Recourse for the payment of principal, interest, and other amounts due on the notes will be limited to the assets of Northwind Holdings, consisting primarily of the stock of its sole subsidiary Northwind Re, a Vermont special purpose financial captive insurance company. Northwind Holdings’ ability to meet its payment obligations under the notes will be dependent principally upon its receipt of dividends from Northwind Re. The ability of Northwind Re to pay dividends to Northwind Holdings will depend on its satisfaction of applicable regulatory requirements and on the performance of the reinsured claims of Provident, Paul Revere and Unum America (the ceding insurers) reinsured by Northwind Re. None of Unum Group, the ceding insurers, Northwind Re or any other affiliate of Northwind Holdings is an obligor or guarantor on the notes. The balance outstanding on these notes was $692.7 million at December 31, 2009.
In 2006, Tailwind Holdings issued $130.0 million floating rate, insured, senior, secured notes, due 2036, in a private offering. Recourse for the payment of principal, interest, and other amounts due on the notes will be limited to the assets of Tailwind Holdings, consisting primarily of the stock of its sole subsidiary Tailwind Re, a South Carolina
special purpose financial captive insurance company. Tailwind Holdings’ ability to meet its payment obligations under the notes will be dependent principally upon its receipt of dividends from Tailwind Re. The ability of Tailwind Re to pay dividends to Tailwind Holdings will depend on its satisfaction of applicable regulatory requirements and on the performance of the reinsured claims of Unum America reinsured by Tailwind Re. None of Unum Group, Unum America, Tailwind Re or any other affiliate of Tailwind Holdings is an obligor or guarantor on the notes. The balance outstanding on these notes was $92.5 million at December 31, 2009.
In 2005, Unum Group repatriated $454.8 million in unremitted foreign earnings from its U.K. subsidiaries, and as part of its repatriation plan, UnumProvident Finance Company plc, a wholly-owned subsidiary of Unum Group, issued $400.0 million of 6.85% senior debentures, due 2015, in a private offering. The debentures are fully and unconditionally guaranteed by Unum Group. The aggregate principal amount outstanding was $296.7 million at December 31, 2009.
In 2002, Unum Group completed two long-term offerings, issuing $250.0 million of 7.375% senior debentures due 2032 and $150.0 million of 7.25% public income notes due 2032. The public income notes were called and retired in 2007 as previously discussed. The 7.375% notes have an aggregate principal amount outstanding of $39.5 million at December 31, 2009.
In 2001, Unum Group issued $575.0 million of 7.625% senior notes due 2011. The aggregate principal amount outstanding was $225.1 million at December 31, 2009.
In 1998, Unum Group completed public offerings of $200.0 million of 7.25% senior notes due 2028, $200.0 million of 7.0% senior notes due 2018, and $250.0 million of 6.75% senior notes due 2028. None of these amounts have been reduced other than the 6.75% notes, which have an aggregate principal amount outstanding of $165.8 million at December 31, 2009.
We have a shelf registration, which became effective in December 2008, with the Securities and Exchange Commission to issue various types of securities, including common stock, preferred stock, debt securities, depository shares, stock purchase contracts, units and warrants, or preferred securities of wholly-owned finance trusts. As stated previously, we issued $350.0 million of senior notes against our open shelf registration on September 30, 2009. The shelf registration enables us to raise funds from the offering of any individual security covered by the shelf registration as well as any combination thereof, subject to market conditions and our capital needs.
See Note 8 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for additional information.
Policyholder liability maturities and the related reinsurance recoverable represent the projected payout of the current in-force policyholder liabilities and the expected cash inflows from reinsurers for liabilities ceded and therefore incorporate uncertainties as to the timing and amount of claim payments. We utilize extensive liability modeling to project future cash flows from the in-force business. The primary assumptions used to project future cash flows are claim incidence rates for mortality and morbidity, claim resolution rates, persistency rates, and interest rates. These cash flows are discounted to determine the current value of the projected claim payments. The timing and amount of payments on policyholder liabilities may vary significantly from the projections above. See our previous discussion of asset/liability management under “Investments” contained in this Item 7.
Pensions and other postretirement benefit obligations include our defined benefit pension and postretirement plans for our employees, including non-qualified pension plans. Pension plan obligations, other than the non-qualified plans, represent our contributions to the pension plans. Amounts in the one year or less category equal our planned contributions within the next 12 months. The remaining years’ contributions are projected based on the expected future contributions as required under ERISA. Non-qualified pension plan and other postretirement benefit
obligations represent the expected benefit payments related to these plans, discounted with respect to interest and reflecting expected future service, as appropriate. See Note 9 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 and “Critical Accounting Estimates” contained in this Item 7 for additional information.
Payable for collateral represents the obligation to return unrestricted cash collateral received from our counterparties in derivative transactions. The timing of the return of the collateral is uncertain and is therefore included in the one year or less category. See Note 5 of the “Notes to Consolidated Financial Statements” contained herein in Item 8 for additional information.
As noted in the preceding discussion, we have operating lease commitments and purchase obligations totaling $102.2 million and $92.8 million, respectively, at December 31, 2009.
As part of our regular investing strategy, we receive collateral from unaffiliated third parties through transactions which include both securities lending and also short-term agreements to purchase securities with the agreement to resell them at a later specified date. For both types of transactions, we require that a minimum of 102 percent of the fair value of the securities loaned or securities purchased under repurchase agreements be maintained as collateral. Generally, cash is received as collateral under these agreements. In the event that securities are received as collateral, we are not permitted to sell or re-post them. We also post our fixed maturity securities as collateral to unaffiliated third parties through transactions including both securities lending and also short-term agreements to sell securities with the agreement to repurchase them at a later specified date. At December 31, 2009, we had no fixed maturity securities posted as collateral to third parties under these programs.
On March 13, 2009, AM Best affirmed its ratings of Unum Group and its operating subsidiaries, maintaining the outlook for the Company as “stable.” On June 9, 2009, Moody’s affirmed its ratings of Unum Group and its operating subsidiaries, also maintaining the outlook for the Company as “stable.” On September 25, 2009, S&P affirmed its ratings of Unum Group and its operating subsidiaries, maintaining the outlook for the Company as “stable.” On December 23, 2009, at our request, AM Best withdrew its rating for Unum Limited and will no longer provide a rating for that subsidiary. On February 12, 2010, Fitch upgraded its ratings of Unum Group and its operating subsidiaries to BBB and A, respectively, and changed the outlook for the Company to “stable.”
We have audited the accompanying consolidated balance sheets of Unum Group and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, cash flows, and comprehensive income (loss) for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedules listed in the index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
Basis of Presentation: The accompanying consolidated financial statements of Unum Group and its subsidiaries (the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). Such accounting principles differ from statutory accounting principles (see Note 15). Intercompany transactions have been eliminated. In connection with our preparation of the consolidated financial statements, we evaluated events that occurred subsequent to December 31, 2009, for recognition or disclosure in our financial statements and notes to our financial statements.
In determining when a decline in fair value below amortized cost of a fixed maturity security is other than temporary, we evaluate available information, both positive and negative, in reaching our conclusions. Although all available and applicable factors are considered in our analysis, our expectation of recovering the entire amortized cost basis of the security, whether we intend to sell the security, whether we more likely than not will be required to sell the security before recovery of its amortized cost, and whether the security is current on principal and interest payments are the most critical factors in determining whether impairments are other than temporary. The significance of the decline in value and the length of time during which there has been a significant decline are also important factors, but we generally do not record an impairment loss based solely on these two factors, since often other more relevant factors will impact our evaluation of a security. See also Note 3.
Policy Loans: Policy loans are presented at unpaid balances directly related to policyholders. Interest income is accrued on the principal amount of the loan based on the loan’s contractual interest rate. Included in policy loans are $2,675.7 million and $2,555.6 million of policy loans ceded to reinsurers at December 31, 2009 and 2008, respectively.
Other Long-term Investments: Other long-term investments are comprised primarily of freestanding derivatives with a net positive fair value and private equity fund limited partnerships. Freestanding derivatives are more fully described in the derivatives accounting policy which follows. Private equity fund limited partnerships are accounted for using the equity or cost method, depending on the level of ownership and the degree of influence over partnership operating and financial policies.
reported at fair value. The accounting for changes in fair value 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 for hedge accounting, at the inception of the hedging transaction, we formally document the risk management objective and strategy for undertaking the hedging transaction, as well as the designation of the hedge as either a fair value hedge or a cash flow hedge. Included in this documentation is how the hedging instrument is expected to hedge the designated risk(s) related to the specific assets or liabilities on the balance sheet or to specific forecasted transactions as well as a description of the method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness and the method that will be used to measure ineffectiveness. A derivative designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk(s) of the hedged item. Hedge effectiveness is formally assessed at inception and periodically throughout the life of the designated hedging relationship, using qualitative and quantitative methods. Qualitative methods include comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other statistical analysis of changes in fair value or cash flows associated with the hedge relationship. 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 as a component of net realized investment gain or loss during the period of change in fair value. The gain or loss on the termination of an effective fair value hedge is recognized in current earnings as a component of net realized investment gain or loss.
Our freestanding derivatives all qualify as hedges and have been designated as either cash flow hedges or fair value hedges. We do not have any speculative positions in our freestanding derivatives. For a derivative not designated as a hedging instrument, the change in fair value is recognized in earnings during the period of change. Changes in the fair values of certain embedded derivatives are reported as realized investment gains and losses during the period of change.
Fair Value Measurement: All of our fixed maturity securities are reported at fair value. Our derivative financial instruments, including certain derivative instruments embedded in other contracts, are reported as either assets or liabilities and measured at fair value. We hold an immaterial amount of equity securities, which are also reported at fair value. We define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value represents an exit price, not an entry price. The exit price objective applies regardless of our intent and/or ability to sell the asset or transfer the liability at the measurement date.
Deferred acquisition costs related to interest-sensitive policies are amortized over the lives of the policies in relation to the present value of estimated gross profits from surrender charges, mortality margins, investment returns, and expense margins. Adjustments are made quarterly to reflect actual experience for assumptions which deviate significantly compared to anticipated experience.
Value of Business Acquired: Value of business acquired represents the present value of future profits recorded in connection with the acquisition of a block of insurance policies. The asset is amortized based upon expected future premium income for traditional insurance policies and estimated future gross profits for interest-sensitive insurance policies. The value of business acquired, which is included in other assets in our consolidated balance sheets, was $46.2 million and $50.5 million at December 31, 2009 and 2008, respectively. The accumulated amortization for value of business acquired was $108.2 million and $92.2 million as of December 31, 2009 and 2008, respectively.
The amortization of value of business acquired, which is included in other expenses in the consolidated statements of income, was $7.8 million, $7.8 million, and $7.9 million for the years ended December 31, 2009, 2008, and 2007, respectively. We periodically review the carrying amount of value of business acquired using the same methods used to evaluate deferred acquisition costs.
Stock-Based Compensation: The cost of stock-based compensation is measured based on the grant-date fair value of the award. We use the Black-Scholes options valuation model for estimating the fair value of stock options and stock purchased through participation in our employee stock purchase plan and the Monte-Carlo model for estimating the fair value of our performance restricted stock units. All other currently outstanding stock awards are valued based on the market value of common stock at the grant date. Stock-based awards that do not require future service are expensed immediately, and stock-based awards that require future service are amortized over the relevant service period, with an offsetting increase to additional paid-in capital in stockholders’ equity.
Accounting for Participating Individual Life Insurance: Participating policies issued by one of our 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 assets of the PFA were $359.8 million and $391.2 million at December 31, 2009 and 2008, respectively, and represented approximately 0.7 and 0.8 percent, respectively, of consolidated assets.
The amount of impairment recognized is equal to the difference between amortized cost and fair value. For all debt securities in unrealized loss positions that do not meet either of these two criteria, the standard requires that an entity analyze its ability to recover the amortized cost by comparing the present value of cash flows with the amortized cost of the security. If the present value of our best estimate of cash flows expected to be collected is less than the amortized cost of the security, an other-than-temporary impairment is recorded. The impairment loss is separated
In April 2009, the FASB issued a new accounting standard, now included in ASC 820, to provide additional guidance for estimating fair value but reemphasized that the objective of fair value measurement remained an exit price. This standard provides guidance for determining whether there has been a significant decrease in the volume and level of activity in the market and provides factors for companies to consider in identifying transactions that are not orderly. The standard also discusses the necessity of adjustments to transaction or quoted prices to estimate fair value when it is determined that there has been a significant decrease in the volume and level of activity or that the transaction is not orderly. We adopted this standard effective April 1, 2009. This standard expanded our disclosures but did not have a material effect on our financial position or results of operations.
In August 2009, the FASB issued an update to provide clarification concerning fair value measurements and disclosures for liabilities and, in particular, for circumstances in which a quoted price in an active market for an identical liability is not available. We adopted this update effective December 31, 2009. The adoption of this update had no effect on our financial position or results of operations.
In May 2009, the FASB issued a new accounting standard, now included in ASC 855, to provide subsequent events guidance. This topic was previously addressed only in the auditing literature, and is largely similar to the auditing guidance with limited exceptions which are not intended to result in significant changes in practice. We adopted this standard effective June 30, 2009. The FASB issued an update in February 2010 to remove the requirement, for certain entities, to disclose the date through which subsequent events have been evaluated. This standard and update had no effect on our financial position or results of operations.
In February 2006, the FASB issued a new accounting standard, now included in ASC 815, to amend previous guidance for certain hybrid financial instruments. This standard (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of ASC 815; (c) establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and, (e) eliminates restrictions on a qualifying special-purpose entity’s ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. We adopted this standard effective January 1, 2007. The adoption of this standard did not have a material effect on our financial position or results of operations.
In September 2005, the American Institute of Certified Public Accountants modified GAAP to provide accounting guidance, now included in ASC 944, for modifications or exchanges of certain insurance contracts. This modification provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of certain insurance and investment contracts. An internal replacement is defined as a modification in product benefits, features, or coverages that occurs by the exchange or replacement of an existing insurance policy for a new policy. We adopted this guidance effective January 1, 2007. The cumulative effect of applying the provisions of this guidance decreased our 2007 opening balance of retained earnings $445.2 million.
In June 2009, the FASB issued an update to require a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity and require enhanced disclosures about an enterprise’s involvement with a variable interest entity. This update is effective for annual and interim periods beginning after November 15, 2009. The adoption of this update will have no material effect on our financial position or results of operations.
In June 2009, the FASB issued an update to eliminate the exceptions for qualifying special-purpose entities from the consolidation guidance and eliminate the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, this update clarifies certain requirements for financial assets that are eligible for sale accounting and requires enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. This update is effective for annual and interim periods beginning after November 15, 2009. The adoption of this update will have no material effect on our financial position or results of operations.
As discussed in Note 1, the sale of GENEX closed effective March 1, 2007, and we recognized an after-tax gain of $6.2 million on the sale, which is included in income from discontinued operations in our consolidated statements of income. We intend to continue to purchase certain disability management services for a period of up to five years from the effective date of the sale. The cost of the services to be purchased was negotiated in an arm’s-length transaction and is not significant to our results of operations. The intercompany amount paid to GENEX for these types of services was $2.3 million for the two months ended February 28, 2007.
The results of GENEX are reported as discontinued operations and excluded from segment results. For the year ended December 31, 2007, results related to GENEX include revenue of $47.2 million and basic and diluted earnings per common share of $0.02.
Policy Loans: Fair values for policy loans, net of reinsurance ceded, are estimated using discounted cash flow analyses and interest rates currently being offered to policyholders with similar policies. The carrying amounts of ceded policy loans of $2,675.7 million and $2,555.6 million as of December 31, 2009 and 2008, respectively, are reported on a gross basis in our consolidated balance sheets and approximate fair value.
Fair values for insurance contracts other than investment contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in our overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.
At December 31, 2009, approximately 11.6 percent of our fixed maturity securities were valued using active trades from TRACE pricing or broker market maker prices for which there was current market activity in that specific security (comparable to receiving one binding quote). The prices obtained were not adjusted, and the assets were classified as Level 1, the highest category of the three-level fair value hierarchy classification wherein inputs are unadjusted and represent quoted prices in active markets for identical assets or liabilities.
Approximately 5.8 percent of our fixed maturity securities were valued based on one or more non-binding broker price levels, if validated by observable market data, or on TRACE prices for identical or similar assets absent current market activity. When only one price is available, it is used if observable inputs and analysis confirms that it is appropriate. These assets, for which we were able to validate the price using other observable market data, were classified as Level 2.
The categorization of fair value measurements by input level is as follows:
Realized and unrealized investment gains and losses presented in the preceding tables represent gains and losses only for the time during which the applicable financial instruments were classified as Level 3. The transfers between levels resulted primarily from a change in observability of three inputs used to determine fair values of the securities transferred: (1) transactional data for new issuance and secondary trades, (2) broker/dealer quotes and pricing, primarily related to changes in the level of activity in the market and whether the market was considered orderly, and (3) comparable bond metrics from which to perform an analysis. For fair value measurements of financial instruments that were transferred either into or out of Level 3, we reflect the transfers using the fair value at the beginning of the period. Gains (losses) for the years ended December 31, 2009 and 2008 which are included in earnings and are attributable to the change in unrealized gains or losses relating to assets or liabilities valued using significant unobservable inputs and still held at each year end were $243.1 million and $(291.7) million, respectively. These amounts relate entirely to the changes in fair value of an embedded derivative associated with a modified coinsurance arrangement which are reported as realized investment gains and losses.
At December 31, 2009, the fair value of investment-grade fixed maturity securities was $35,324.6 million, with a gross unrealized gain of $2,534.0 million and a gross unrealized loss of $443.0 million. The gross unrealized loss on investment-grade fixed maturity securities was 74.7 percent of the total gross unrealized loss on fixed maturity securities. 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.
As of December 31, 2009, we held 307 individual investment-grade fixed maturity securities and 82 individual below-investment-grade fixed maturity securities that were in an unrealized loss position, of which 188 investment-grade fixed maturity securities and 80 below-investment-grade fixed maturity securities had been in an unrealized loss position continuously for over one year.
our debt security ranks in terms of subordination. We may use the estimated fair value of collateral as a proxy for the present value of cash flows if we believe the security is dependent on the liquidation of collateral for recovery of our investment. For fixed maturity securities for which we have recognized an other-than-temporary impairment loss through earnings, if through subsequent evaluation there is a significant increase in expected cash flows, the difference between the new amortized cost basis and the cash flows expected to be collected is accreted as net investment income.
At December 31, 2008, we had a significant investment in, but were not the primary beneficiary of, a special purpose entity which was a collateralized bond obligation asset trust (CBO) in which we held interests in several of the tranches and for which we acted as investment manager of the underlying securities. The securities were fully redeemed by the trust during 2009. Prior to redemption, our investment in this entity was reported at fair value with fixed maturity securities in our consolidated balance sheets. The fair value and amortized cost of this investment were $2.5 million and $2.4 million, respectively, at December 31, 2008. We recognized no gain or loss on disposition of these securities.
At December 31, 2009, mortgage loans were collateralized by office buildings (39.9 percent), industrial buildings (29.5 percent), retail stores (19.9 percent), and other properties (10.7 percent). Our mortgage loan portfolio is geographically dispersed within the United States, with the largest concentrations in California (12.3 percent) and Pennsylvania (11.0 percent).
At December 31, 2009, we had commitments of approximately $53.1 million to fund certain of our private placement securities, including the previously disclosed $1.8 million commitment to fund a special purpose entity. 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 securities.
At December 31, 2009, we had no commitments for commercial mortgage loan originations.
In the normal course of business, we receive collateral from unaffiliated third parties through transactions which include both securities lending and also short-term agreements to purchase securities with the agreement to resell them at a later, specified date. For both types of transactions, we require that a minimum of 102 percent of the fair value of the securities loaned or securities purchased under repurchase agreements be maintained as collateral. Generally, cash is received as collateral under these agreements. In the event that securities are received as collateral, we are not permitted to sell or re-post them. We also post our fixed maturity securities as collateral to unaffiliated third parties through transactions including both securities lending and also short-term agreements to sell securities with the agreement to repurchase them at a later, specified date. At December 31, 2009, we had no fixed maturity securities posted as collateral to third parties under these programs. See Note 5 for discussion of collateral posted to our derivatives counterparties.
Foreign currency interest rate swaps are used to hedge the currency risk of certain foreign currency- denominated long-term bonds owned for portfolio diversification and to hedge the currency risk associated with certain of the interest payments and debt repayments of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries. For long-term bonds, we agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments in exchange for fixed rate payments in the functional currency of the operating segment. For debt issued, we agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments to the counterparty in exchange for fixed rate U.S. dollar-denominated interest payment.
Interest rate swaps are used to effectively convert certain of our fixed rate securities into floating rate securities which are used to fund our floating rate long-term debt. Under these swap agreements, we receive a variable rate of interest and pay a fixed rate of interest.
To help limit the credit exposure of the derivatives, we enter into master netting agreements with our counterparties whereby contracts in a gain position can be offset against contracts in a loss position. We also typically enter into bilateral, cross-collateralization agreements with our counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a loss position to submit acceptable collateral with the other counterparty in the event the net loss position meets or exceeds an agreed upon amount. Our current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position less collateral held, was $7.0 million at December 31, 2009. We held cash collateral of $24.9 million and $174.3 million from our counterparties as of December 31, 2009 and 2008, respectively. This unrestricted cash collateral is included in short-term investments and the associated obligation to return the collateral to our counterparties is included in other liabilities in our consolidated balance sheets. We post fixed maturity securities as collateral to our counterparties rather than cash. The carrying value of fixed maturity securities posted as collateral to our counterparties was $123.1 million at December 31, 2009.
The following table summarizes the timing of anticipated settlements of interest rate swaps outstanding under our cash flow hedging programs at December 31, 2009, whereby we receive a fixed rate and pay a variable rate. The weighted average interest rates assume current market conditions.
We have executed a series of cash flow hedges for certain of our long-term product portfolios using forward starting interest rate swaps. We plan to terminate these forward interest rate swaps and forward contracts at the time the projected cash flows are used to purchase fixed income securities. As of December 31, 2009 and 2008, we had $780.0 million and $1,160.0 million, respectively, notional amount of the forward starting interest rate swaps outstanding under this program.
As of December 31, 2009 and 2008, we had $666.7 million and $634.9 million, respectively, notional amount of open current and forward foreign currency swaps and foreign currency forwards to hedge fixed income foreign currency-denominated securities.
As of December 31, 2009, we expect to amortize approximately $28.5 million of net deferred gains on derivative instruments during the next twelve months. This amount will be reclassified from accumulated other comprehensive income into earnings and reported on the same income statement line item as the hedged item. The income statement line items that will be affected by this amortization are net investment income, other income, and/or interest and debt expense. The estimated amortization includes the impact of certain derivative contracts that have not yet been terminated as of December 31, 2009. Fluctuations in fair values of these derivatives between December 31, 2009 and the date of termination will vary our projected amortization. Amounts that will be reclassified from accumulated other comprehensive income into earnings to offset the earnings impact of foreign currency translation of hedged items are not estimable.
The following table summarizes the location and fair values of derivative financial instruments, as reported in our consolidated balance sheets at December 31, 2009.
The following table summarizes the location of and gains and losses on derivative financial instruments designated as cash flow hedging instruments, as reported in our consolidated statements of income and consolidated statements of comprehensive income for the year ended December 31, 2009.
The following table summarizes the location of and gain on our embedded derivative in a modified coinsurance arrangement, as reported in our consolidated statements of income.
The majority of the net balances are related to disability claims with long-tail payouts on which interest earned on assets backing liabilities is an integral part of pricing and reserving. Interest accrued on prior year reserves has been calculated on the opening reserve balance less one-half year’s cash payments at our average reserve discount rate used during 2009, 2008, and 2007.
A reconciliation of the income tax expense (benefit) attributable to income from continuing operations before income tax, computed at U.S. federal statutory tax rates, to the income tax expense (benefit) as included in our consolidated statements of income, is as follows:
During 2007, the U.K. enacted a tax rate decrease from 30 percent to 28 percent. The tax benefit recognized in 2007 operations as a result of this decrease was $1.7 million. We consider the unremitted earnings of our foreign operations to be permanently invested. The determination of a tax liability related to these earnings is not practicable.
We file federal and state income tax returns in the United States and in foreign jurisdictions. We are under continuous examination by the Internal Revenue Service (IRS) with regard to our U.S. federal income tax returns. The current IRS examination covers our tax years 2005 and 2006. During 2008, the IRS completed its examination of tax years 2002 through 2004 and issued its revenue agent’s report (RAR). We filed a protest to the RAR in 2008 with respect to all significant adverse proposed adjustments.
has been made for all uncertain tax positions and that any adjustments by tax authorities with respect to such positions would not have a material adverse effect on our financial position, liquidity, or results of operations.
As of December 31, 2009, we had no net operating loss carryforward in the U.S. We held a valuation allowance of $4.2 million related to basis differences in foreign subsidiaries and net operating loss carryforwards in foreign jurisdictions because, in our judgment, we will most likely not realize a tax benefit for these amounts. The $0.1 million increase in the valuation allowance during 2009 is due to the fluctuation in the British pound sterling to dollar exchange rate.
Total income taxes paid during 2009, 2008, and 2007 were $381.6 million, $369.0 million, and $189.9 million, respectively.
The aggregate contractual principal maturities are $225.1 million in 2011 and $2,324.7 million in 2015 and thereafter.
Northwind Holdings’ ability to meet its obligations to pay principal, interest, and other amounts due on the Northwind notes will be dependent principally on its receipt of dividends from Northwind Reinsurance Company (Northwind Re), the sole subsidiary of Northwind Holdings. Northwind Re reinsured the risks attributable to specified individual disability insurance policies issued by or reinsured by Provident Life and Accident Insurance Company, Unum Life Insurance Company of America (Unum America), and The Paul Revere Life Insurance Company (collectively, the ceding insurers) pursuant to separate reinsurance agreements between Northwind Re and each of the ceding insurers. The ability of Northwind Re to pay dividends to Northwind Holdings will depend on its satisfaction of applicable regulatory requirements and the performance of the reinsured policies.
Northwind Holdings is required to repay a portion of the outstanding principal under the Northwind notes at par on the quarterly scheduled payment dates under the Northwind notes in an amount equal to the lesser of (i) a targeted amortization amount as defined in the Northwind indenture and (ii) the amount of the remaining available funds in the Northwind DSCA minus an amount equal to the minimum balance that is required to be maintained in the Northwind DSCA under the Northwind indenture, provided that Northwind Holdings has sufficient funds available to pay its other expenses, including interest payments on the Northwind notes, and to maintain the minimum balance in the Northwind DSCA as required under the Northwind indenture. During 2009 and 2008, Northwind Holdings made principal payments of $48.0 million and $59.3 million, respectively, on the Northwind notes.
In 2008 and 2007, $36.6 million and $34.5 million, respectively, of the 6.85% senior debentures due 2015 were redeemed. These debentures were issued by UnumProvident Finance Company plc, a wholly-owned subsidiary of Unum Group, and are fully and unconditionally guaranteed by Unum Group.
In 2004, Unum Group issued 12.0 million 8.25% adjustable conversion-rate equity security units (units) in a private offering for $300.0 million. We subsequently registered the privately placed securities for resale by the private investors. Each unit had a stated amount of $25 and consisted of (a) a contract pursuant to which the holder agrees to purchase, for $25, shares of Unum Group common stock on May 15, 2007 and which entitled the holder to contract adjustment payments at the annual rate of 3.165 percent, payable quarterly, and (b) a 1/40 or 2.5 percent ownership interest in a senior note issued by Unum Group due May 15, 2009 with a principal amount of $1,000, on which we paid interest at the initial annual rate of 5.085 percent, payable quarterly. The scheduled remarketing of the senior note element of these units occurred in February 2007, as stipulated by the terms of the original offering, and we reset the interest rate on $300.0 million of senior notes due May 15, 2009 to 5.859%. We purchased $150.0 million of the senior notes in the remarketing which were subsequently retired. In May 2007, we settled the purchase contract element of the units by issuing 17.7 million shares of common stock. We received proceeds of approximately $300.0 million from the transaction.
The cost related to early retirement of debt during 2008 and 2007 decreased income approximately $0.4 million and $58.8 million, respectively, before tax, or $0.3 million and $38.3 million, respectively, after tax.
The amounts recognized in our consolidated balance sheets for our pension and OPEB plans at December 31, 2009 and 2008 are as follows:
The investment portfolio for our U.S. pension plans contain a diversified blend of domestic and international large cap, mid cap, and small cap equity securities, U.S. government and corporate fixed income securities, private equity funds of funds, and hedge funds of funds. The domestic large cap, mid cap, and small cap equity securities are mainly comprised of equity index funds that are designed to track the Standard & Poor’s (S&P) 500, S&P 400 Mid Cap Index, and Russell 2000 indices, respectively. International equity investments and emerging market equity investments consist of equity index funds that track the Morgan Stanley Capital International (MSCI) Europe Australasia Far East Index and the MSCI Emerging Markets Index, respectively. Corporate fixed income securities consist of investment-grade and below-investment-grade corporate bonds. Alternative investments, which include private equity funds of funds and hedge funds of funds, utilize proprietary strategies that tend to have a low correlation to the U.S. stock market. The target allocations for invested assets are 60 percent equity securities, 30 percent fixed income securities, and 10 percent alternative investments. Prohibited investments include, but are not limited to, unlisted securities, futures contracts, options, short sales, and investments in securities issued by the Company or its affiliates.
Assets for our U.K. pension plan are primarily invested in a pooled fund consisting of diversified growth assets. The remaining assets in the U.K. plan are invested in a fixed-interest U.K. corporate bond fund and an index-linked U.K. government bond fund. The diversified growth fund is designed to generate a return that matches the U.K. Retail Price Index plus five percent over a five to seven year period. This fund is comprised primarily of domestic (U.K.) and international equity securities, emerging market fixed income securities, and a blend of investment-grade and below-investment-grade fixed income securities. Investment in fixed-interest U.K. corporate bonds is achieved through the ownership of a fund that primarily invests in corporate bonds with maturity dates greater than 10 years. Investment in U.K. index-linked bonds is achieved through ownership of a fund that traces the Financial Times Stock Exchange 5 year Index-linked Index. The target allocation for the assets is 60 percent equity securities and 40 percent fixed income securities. There are no categories of investments that are specifically prohibited by the U.K. plan, but there are general guidelines that ensure prudent investment action is taken. Such guidelines include the prevention of the plan from using derivatives for speculative purposes and limiting the concentration of risk in any one type of investment.
Level 1 equity and fixed income securities consist of individual holdings and funds that are valued based on unadjusted quoted prices from active markets for identical securities. Level 2 equity and fixed income securities consist of funds that are valued based on the net asset value (NAV) of the underlying holdings.
Changes in our U.S. pension plans’ assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2009 are as follows:
Changes in our OPEB plan assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2009 are as follows:
The methodology underlying the return assumption included the various elements of the expected return for each asset class such as 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 consideration of plan liabilities, plan funded status, and corporate financial condition.
For measurement purposes at December 31, 2009 and 2008, the annual rate of increase in the per capita cost of covered postretirement health care benefits assumed for the next calendar year 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 was assumed to change gradually to 5.00 percent by the end of 2018 and remain at that level thereafter.
The following table provides the components of the net periodic benefit cost for the plans described above for the years ended December 31.
The 2007 settlement cost and curtailment loss shown in the preceding chart relate to pension plan benefits for employees of our former Canadian branch operation and our previously owned subsidiary GENEX. These benefits were either terminated or frozen.
The unrecognized net actuarial loss, prior service credit, and transition asset included in accumulated other comprehensive income and expected to be amortized and included in net periodic pension cost during 2010 is $31.8 million before tax and $20.8 million after tax. The prior service credit expected to be amortized and included as a reduction to net periodic cost for our OPEB plan during 2010 is $2.6 million before tax and $1.7 million after tax.
The funding policy for our U.S. qualified defined benefit plan is to contribute annually an amount at least equal to the minimum annual contribution required under ERISA and other applicable laws, but generally not greater than the maximum amount that can be deducted for federal income tax purposes. We had no regulatory contribution requirements for 2009 and 2008; however, we elected to make voluntary contributions of $70.0 million and $130.0 million, respectively. We made a voluntary contribution of $67.0 million to our U.S. qualified defined benefit pension plan in February 2010. We do not anticipate making any additional contributions during 2010. The funding policy for our U.S. non-qualified defined benefit pension plan is to contribute the amount of the benefit payments made during the year. We contribute to our U.K. plan in accordance with a schedule of contributions which requires us to contribute to the plan at the rate of at least 15.0 percent of employee salaries sufficient to meet the minimum funding requirement under U.K. legislation. We made contributions of $5.5 million and $7.3 million in 2009 and 2008, respectively, or approximately £3.5 million and £4.0 million. We expect to make contributions of £3.4 million during 2010.
The purchase contract element of the units issued in 2004 had a threshold appreciation price of $16.95 per share. The outstanding stock options have exercise prices ranging from $11.37 to $58.56, the nonvested stock awards have grant prices ranging from $10.59 to $26.25, and the performance restricted stock units have a threshold stock price of $26.00.
In computing earnings per share assuming dilution, only potential common shares that are dilutive (those that reduce earnings per share) are included. Potential common shares not included in the computation of dilutive earnings per share because their impact would be antidilutive, based on current market prices, approximated 7.1 million, 8.3 million, and 6.2 million shares of common stock for the years ended December 31, 2009, 2008, and 2007, respectively.
Under the stock incentive plan of 2007, up to 35.00 million shares of common stock are available for awards to our employees, officers, consultants, and directors. Awards may be in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, and other stock-based awards. Each full value award, defined as any award other than a stock option or stock appreciation right, is counted as 2.7 shares.
The exercise price for stock options issued cannot be less than the fair market value of the underlying common stock as of the grant date. Stock options have a maximum term of ten years after the date of grant and generally vest after three years. At December 31, 2009, approximately 23.44 million shares were available for future grants.
Under the stock plan of 1999, comprised of the Provident Companies, Inc. stock plan of 1999 and the UnumProvident Corporation stock plan of 1999, an aggregate of up to 17.50 million shares of common stock were available for awards to our employees, officers, brokers, and directors. Awards could be in the form of stock options, stock appreciation rights, stock awards, dividend equivalent awards, or any other right or interest relating to stock. The plan was terminated in May 2007 for purposes of any further grants, other than reload grants, for which 250,000 shares were available at December 31, 2009. Stock options have a maximum term of ten years after the date of grant and generally vest after three years.
Substantially all of our employees are eligible to participate in an employee stock purchase plan (ESPP). Under the plan, up to 3.46 million shares of common stock are authorized for issuance, of which approximately 1.23 million remain available for issuance at December 31, 2009. Stock may be purchased at the end of each financial quarter at a purchase price of 85 percent of the market price.
Stock awards vest over a one to three year service period, beginning at the date of grant, and the compensation cost is recognized ratably during the vesting period. Compensation cost for stock awards subject to accelerated vesting upon retirement is recognized over the implicit service period. Forfeitable dividend equivalents on nonvested stock awards are accrued in the form of additional restricted stock units. The weighted average grant date fair values per share for nonvested stock awards granted during 2009, 2008, and 2007 were $12.32, $23.66, and $21.99, respectively.
The total fair value of shares vested during 2009, 2008, and 2007 was $17.5 million, $11.3 million, and $20.6 million, respectively.
At December 31, 2009, we had $2.3 million of unrecognized compensation cost related to PRSUs that will be recognized over a weighted average period of 0.6 years. The PRSU expense and unrecognized compensation cost assume the performance goals are attained at 100 percent. Actual performance may result in zero to 100 percent of the units ultimately being earned. We use the accelerated method of amortization for recognizing compensation expense, which treats each of the three vesting tranches as a separate award over the expected life of the unit.
All outstanding stock options at December 31, 2009 are expected to vest. Stock options vest over a three year service period, beginning at the date of grant, and the compensation cost is recognized ratably during the vesting period. The total intrinsic value of options exercised during 2009, 2008, and 2007 was $2.6 million, $1.0 million, and $3.9 million, respectively. The total fair value of options that vested during 2009 and 2008 was $2.0 million and $0.5 million, respectively. No stock options vested in 2007. At December 31, 2009, we had $0.5 million of unrecognized compensation cost related to stock options that will be recognized over a weighted average period of 0.9 years.
Expected dividend yield of 1.68 percent, 1.30 percent, and 1.57 percent, respectively, based on the dividend rate at the date of grant.
Reinsurance activity is accounted for on a basis consistent with the terms of the reinsurance contracts and the accounting used for the original policies issued. Premium income and benefits and change in reserves for future benefits are presented in our consolidated statements of income net of reinsurance ceded.
During 2007, we recaptured a closed block of individual disability business in our Individual Disability - Closed Block segment, with approximately $204.3 million in reserves and $7.0 million of annual premium. The recapture had an immaterial effect on operating results.
The Unum US segment includes group long-term and short-term disability insurance, group life and accidental death and dismemberment products, and supplemental and voluntary lines of business, comprised of individual disability - recently issued, group and individual long-term care, and brokerage voluntary benefits products. These products are marketed through our field sales personnel who work in conjunction with independent brokers and consultants. We discontinued selling individual long-term care insurance effective in 2009.
The Corporate and Other segment includes investment income on corporate assets not specifically allocated to a line of business, interest expense on corporate debt other than non-recourse debt, and certain other corporate income and expense not allocated to a line of business. The Corporate and Other segment also includes results from certain Unum US insurance products not actively marketed, including individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities.
The following table provides the changes in deferred acquisition costs by segment:
We report goodwill in our Unum US segment and in our Unum UK segment, which are the segments expected to benefit from the originating business combinations. At December 31, 2009 and 2008, goodwill was $201.6 million and $200.5 million, respectively, with $190.0 million attributable to Unum US and the remainder attributable to Unum UK. The increase during 2009 is due entirely to the fluctuation in the British pound sterling to dollar exchange rate.
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 our target capital levels for regulatory and rating agency purposes. We modify this formula periodically to recognize changes in the views of capital requirements.
We have noncancelable lease obligations on certain office space and equipment. As of December 31, 2009, the aggregate net minimum lease payments were $102.2 million payable as follows: $25.7 million in 2010, $20.2 million in 2011, $16.3 million in 2012, $11.5 million in 2013, $8.9 million in 2014, and $19.6 million thereafter. Rental expense for the years ended December 31, 2009, 2008, and 2007 was $30.1 million, $34.5 million, and $35.7 million, respectively.
We and our insurance subsidiaries, as part of our normal operations in managing disability claims, are engaged in claim litigation where disputes arise as a result of a denial or termination of benefits. Most typically these lawsuits are filed on behalf of a single claimant or policyholder, and in some of these individual actions punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. For our general claim litigation, we maintain reserves based on experience to satisfy judgments and settlements in the normal course. We expect that the ultimate liability, if any, with respect to general claim litigation, after consideration of the reserves maintained, will not be material to our consolidated financial condition. Nevertheless, given the inherent unpredictability of litigation, it is possible that an adverse outcome in certain claim litigation involving punitive damages could, from time to time, have a material adverse effect on our consolidated results of operations in a period, depending on the results of operations for the particular period.
On June 13, 2005, following a trial in the U.S. District Court of Nevada in the matter of G. Clinton Merrick vs. UnumProvident Corporation, Paul Revere Life Insurance Company, et al., judgment was entered in plaintiff’s favor on his breach of contract and bad faith claims, and the plaintiff was awarded contract, emotional distress, and punitive damages, as well as attorneys’ fees. We appealed that judgment. The Ninth Circuit Court of Appeals reversed that portion of the judgment that awarded attorneys’ fees and punitive damages award and remanded for a new trial on the issue of punitive damages that should be awarded, if any. We thereafter paid the portion of the verdict that had been upheld and proceeded to a second trial on the limited issue of the amount of punitive damages to be awarded against Unum Group and one of our insurance subsidiaries, if any. A second jury verdict was entered on July 3, 2008, in the amount of $24.0 million as to one of our insurance subsidiaries and $36.0 million as to Unum Group. Following post trial motions, the trial court affirmed the judgment as to our insurance subsidiary and reduced the judgment as to Unum Group to $26.4 million. We have appealed the amended judgment to the Ninth Circuit. We believe that we have strong legal arguments to raise on appeal that create significant uncertainty regarding the ultimate outcome of this matter. However, since our efforts to reduce or overturn this award are at an early stage in the appeals process, an estimate of the liability to resolve this matter was established in 2008. The accrual was not material to our operating results.
Beginning in 2004, several of our insurance subsidiaries’ insurance regulators requested information relating to the subsidiaries’ policies and practices on one or more aspects of broker compensation, quoting insurance business, and related matters. Additionally, we have responded to investigations about certain of these same matters by state attorneys general and the U.S. Department of Labor. The National Association of Insurance Commissioners (NAIC) has undertaken to provide a uniform Compensation Disclosure Amendment to the Producer Licensing Model Act that can be adopted by states in an effort to provide uniform guidance to insurers, brokers, and customers relating to disclosure of broker compensation. We expect there may be continued uncertainty surrounding this matter until clearer regulatory guidelines are established.
On August 31, 2007 and September 28, 2007, plaintiffs’ federal antitrust and RICO claims were dismissed with prejudice. Defendants’ motion for summary judgment on the ERISA counts was granted on January 14, 2008. All pending state law claims were dismissed without prejudice. Plaintiffs have filed an appeal with the Third Circuit Court of Appeals of the order dismissing their federal antitrust and RICO claims.
In September 2003, United States of America ex. rel. Patrick J. Loughren v. UnumProvident Corporation and GENEX Services, Inc. (GENEX) 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 us and our former 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 alleged that we defrauded the government by inducing and or assisting disability claimants to apply for disability benefits from the Social Security Administration (SSA) when we allegedly knew that the claimants were not disabled under SSA criteria. Relator identified 95 individual claims that he alleged to be false and sought to present expert testimony from a statistician who would say that each of those claims found to be false could be extrapolated to support a finding of a much larger number of false claims. We filed a motion for summary judgment which was denied on September 15, 2008. The case proceeded to trial at which seven out of the 95 claims were adjudicated. We prevailed on four of the claims, the Relator prevailed on two of the claims, and the jury could not reach a verdict on one of the claims. The jury awarded the Relator $850 in damages which was trebled. The court also assessed a penalty of $11,000 for each of the two claims. On February 24, 2009, the court also ruled that the testimony of the Relator’s expert in support of extrapolation would be excluded. The court has since granted our request that it enter a final and separate judgment on the two claims decided against us, and we have filed an appeal with the First Circuit Court of Appeals. The District Court has stayed further trial of the remaining claims pending the outcome of our appeal.
In May 2007, Roy Mogel, Todd D. Lindsay and Joseph R. Thorley individually and on behalf of those similarly situated v. Unum Life Insurance Company, was filed in the United States District Court for the District of Massachusetts. This is a putative class action alleging that we breached fiduciary duties owed to certain beneficiaries under certain group life insurance policies when we paid life insurance proceeds by establishing interest-bearing retained asset accounts rather than by mailing checks. Plaintiffs seek to represent a class of beneficiaries under group life insurance contracts that were employee welfare benefit plans under ERISA and under which we paid death benefits pursuant to a retained asset account. Plaintiffs seek to recover on behalf of the class the difference between the interest paid to them and amounts alleged to have been realized by us through our investment of the retained assets. On February 4, 2008, the court granted our motion to dismiss all claims, but on November 6, 2008 the First Circuit Court of Appeals vacated the District Court’s order. Our petition for rehearing in the First Circuit Court of Appeals was denied on January 21, 2009, and the case was remanded to the District Court. On August 19, 2009, the District Court denied plaintiffs’ motion for class certification under Federal Rules of Civil Procedure Rule 23(b)(2). Plaintiffs filed a motion for leave to file an amended complaint and to file a renewed motion for class certification under Rules of Civil Procedure Rule 23(b)(3). On December 16, 2009, the court denied plaintiffs’ motion. Summary judgment motions are pending on plaintiffs’ remaining claims.
Statutory net income for U.S. life insurance companies is reported in conformity with statutory accounting principles prescribed by the NAIC and adopted by applicable domiciliary state laws. The commissioners of the states of domicile have the right to permit other specific practices that may deviate from prescribed practices. For the years ended December 31, 2009, 2008 or 2007, none of the states of domicile for our U.S. insurance subsidiaries had adopted accounting practices that differed materially from statutory accounting principles prescribed by the NAIC.
At December 31, 2009 and 2008, our U.S. insurance subsidiaries had on deposit with U.S. regulatory authorities securities with a book value of $292.1 million and $293.7 million held for the protection of policyholders.