As part of the settlement with the California DOI, we paid a civil penalty of $8.0 million and agreed to change certain practices and policy provisions related to our California business. The settlement also incorporated claims handling practices previously covered by the multistate settlement agreements and included certain additional claims handling changes. Under the terms of the settlement, we changed certain provisions specific to California disability
The California settlement also incorporated the claim reassessment process contained in the 2004 multistate settlement agreements. California claimants were included in the 2004 multistate settlement agreements and could have chosen to participate in that claim reassessment process even though California did not join the multistate settlement agreements. Under the California agreement, reassessment notices were mailed to approximately 26,000 individuals whose claims were denied or terminated between January 1, 1997, and September 30, 2005. Many of these individuals had already received reassessment notices under the multistate settlement agreements. Additionally, as part of the California agreement, an individual whose claim denial or termination was upheld by our reassessment unit could request an independent review by a member of a panel established for that purpose.
Claim reserves supporting the Unum US group life and accidental death and dismemberment products represent approximately 3.8 percent of our total claim reserves at December 31, 2007. 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) Equals the sum of “Policy and Contract Benefits” and “Reserves for Future Policy and Contract Benefits,” as reported in our consolidated balance sheets.
Presented below are our assumptions, both before and after the adoption of SOP 05-1, for the years 2007, 2006, and 2005, regarding the length of our amortization periods and the approximate DAC balance that remains at the end of years 3, 10, and 15, as a percentage of the cost initially deferred.
The long-term rate of return on assets used in the net periodic pension costs for our U.S. qualified defined benefit pension plan for 2008 and 2007 was 7.50 percent and 8.00 percent, respectively. The long-term rate of return on asset assumption used for 2008 and 2007 for our U.K. pension plan was 6.90 percent and 6.80 percent, respectively, and for our OPEB plan, 5.75 percent for both years.
Our expected return on plan assets and discount rate discussed above will not affect the cash contributions we are required to make to our U.S. pension and OPEB plans because we have met all minimum funding requirements set forth by the Employee Retirement Income Security Act of 1974 (ERISA). We had no regulatory contribution requirements for 2007 and 2006; however, we elected to make voluntary contributions of $110.0 million and $92.0 million, respectively, to our U.S. qualified defined benefit pension plan. We expect to make a voluntary contribution of approximately $55.0 million in 2008, based on current tax law.
Sales for Unum US increased slightly in 2006 compared to 2005, with a sales mix of approximately 52 percent core market and 48 percent large case in our group products.
Excluding the revisions to our estimate for claim reassessment costs, the benefit ratio for 2007 was lower than the benefit ratio for 2006 due primarily to lower paid claims in both group long-term and short-term disability and a higher rate of claim recoveries relative to the prior year.
Colonial Life’s sales in 2007 increased in comparison to the prior year primarily due to sales increases in the public sector market for educators and in the commercial market segment for employee groups with less than 100 lives. Also contributing to the sales increase was an increase in the number of new accounts over the prior year, offset partially by a decrease in the average new case size, which resulted in lower annualized premium per case sold.
Also during 2007, we recorded an adjustment to the book values and related unrealized loss of two securitized asset trusts acquired in 2001 to reflect the values that would have been present had we recorded the investment income as dividends rather than interest accretion. The book value adjustment of $20.2 million was recognized as a realized investment loss in the second quarter of 2007. Because the investments no longer satisfied our investment objectives, we subsequently sold the trusts in June of 2007 and recognized a realized investment gain of $24.9 million on the sale.
The following table provides the distribution of invested assets for the periods indicated. Ceded policy loans of $2.4 billion as of December 31, 2007 and $3.2 billion as of December 31, 2006, which are reported on a gross basis in the consolidated balance sheets contained herein in Item 8, are excluded from the table below. Ceded policy loans declined during 2007 due to the surrender of a portion of our ceded corporate-owned life insurance block of business. The investment income on ceded policy loans is not included in income. Therefore, the termination of this fully ceded business had no impact on our net investment income.
The principal protected equity linked note is a zero coupon bond, issued by a large, well capitalized Fortune 500 financial services company, the return of which is linked to a Vanguard S&P 500 index mutual fund. This bond matures on August 24, 2020 and carried the AA rating of the issuer, as determined by S&P as of December 31, 2007. This note has an embedded derivative contract and substitutes highly rated bonds in place of the underlying S&P 500 index mutual fund to provide principal protection if there is a significant decline in the equities market. The note derives its value from the underlying S&P 500 index mutual fund. This note is currently at an unrealized loss because the fixed rate of accretion on the note has exceeded the rate of return on the underlying S&P 500 index fund since the purchase date of the note. Based on historical long-term returns of the S&P 500 index, we believe that the value of the underlying S&P 500 index mutual fund will equate to or exceed the par value of the security at maturity. We believe that the decline in fair value of the note is temporary. We have the ability to hold this security to the earlier of recovery or maturity.
We use a comprehensive rating system to evaluate the investment and credit risk of each mortgage loan and to identify specific properties for inspection and reevaluation. We establish an investment valuation allowance for mortgage loans based on a review of individual loans and the overall loan portfolio, considering the value of the underlying collateral. Investment valuation allowances for real estate held for sale are established based on a review of specific assets. If a decline in value of a mortgage loan or real estate investment is considered to be other than temporary or if the asset is deemed permanently impaired, the investment is reduced to estimated net realizable value, and the reduction is recognized as a realized investment loss. We monitor the risk associated with these invested asset portfolios and regularly review and adjust the investment valuation allowance. We had no valuation allowance for mortgage loans at December 31, 2007. The balance in the valuation allowance for mortgage loans was $0.5 million at December 31, 2006. The balance in the valuation allowance for real estate was $7.6 million at December 31, 2007 and 2006.
The year to year fluctuation in the income tax adjustment to reconcile net income to net cash provided by operating activities is due mostly to a tax benefit recognized during 2006 which resulted from the reversal of tax liabilities related primarily to group relief benefits recognized from the use of net operating losses in a foreign jurisdiction.
Net purchases of short-term investments increased during 2007 as a result of the liquidity needed for our capital redeployment plan previously discussed. During the fourth quarter of 2007, we issued $800.0 million of debt and invested the proceeds in floating rate bonds and short-term investments. Short-term investments were used as an interim investment as we seek suitable floating rate investments to support the floating rate debt. We also purchased short-term investments throughout 2007 as we anticipated the funding needed for our common stock repurchase program.
Unum Group and/or certain of its finance subsidiaries may also receive dividends from its United Kingdom-based affiliate, Unum Limited, subject to applicable insurance company regulations and capital guidance in the United Kingdom. During 2006, the FSA completed its review of Unum Limited’s capitalization and determined that Unum Limited’s current capitalization is in excess of the amount considered to be sufficient capitalization. Approximately £202.1 million is available for the payment of dividends from Unum Limited during 2008, subject to regulatory approval.
The ability of Unum Group and certain of its intermediate holding company subsidiaries and/or finance subsidiaries to continue to receive dividends from their insurance subsidiaries without regulatory approval generally depends on the level of earnings of those insurance subsidiaries as calculated under law. In addition to regulatory restrictions, the amount of dividends that may be paid by insurance subsidiaries will depend on additional factors, such as RBC ratios, funding growth objectives at an affiliate level, and maintaining appropriate capital adequacy ratios to support desired ratings. Insurance regulatory restrictions do not limit the amount of dividends available for distribution from non-insurance subsidiaries except where the non-insurance subsidiaries are held directly or indirectly by an insurance subsidiary and only indirectly by Unum Group. Unum Group’s RBC ratio for its traditional U.S. insurance subsidiaries, calculated on a weighted average basis using the NAIC Company Action Level formula, was approximately 344 percent at the end of 2007, with the individual RBC ratios for Unum Group’s principal traditional U.S. insurance subsidiaries all in excess of our long-term target ratio of 300 percent. The individual RBC ratios for Northwind Re and Tailwind Re, calculated using the NAIC Company Action Level formula, were each slightly above the target level of 200 percent which was established for these special purpose financial captive insurance companies. The individual RBC ratio for each of our insurance subsidiaries is above the range that would require state regulatory action.
We have audited the accompanying consolidated balance sheets of Unum Group and subsidiaries as of December 31, 2007 and 2006, 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, 2007. Our audits also included the financial statement schedules listed in the index at Item 15(a). 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.
Premium Tax Expense: Premium tax expense is included in other operating expenses in the consolidated statements of income. For the years ended December 31, 2007, 2006, and 2005, premium tax expense was $130.8 million, $140.5 million, and $137.4 million, respectively.
As of December 31, 2007 and 2006, we had $80.0 million and $170.0 million, respectively, notional amount of open options on forward interest rate swaps to lock in a reinvestment rate floor for the reinvestment of cash flows, through the year 2008, from renewals on policies with a one to two year minimum premium rate guarantee.
During the years ended December 31, 2007, 2006, and 2005, we recognized net gains of $26.0 million, $183.6 million, and $120.7 million, respectively, on the termination of cash flow hedges and reported $26.1 million, $183.6 million, and $121.0 million, respectively, in other comprehensive income (loss). During the years ended December 31, 2007 and 2005 we reported a net loss of $0.1 million and $0.3 million, respectively, as a component of realized investment gains and losses. We amortized $20.2 million, $30.0 million, and $21.8 million of net deferred gains into net investment income during 2007, 2006, and 2005, respectively. The estimated amount of net deferred gains to be amortized into operating earnings during 2008 is $20.4 million.
In May 2003, Unum Group issued 23.0 million 8.25% adjustable conversion-rate equity security units (units) in a public offering for $575.0 million. Each unit had a stated amount of $25 and initially consisted of (a) a contract pursuant to which the holder agreed to purchase, for $25, shares of Unum Group’s common stock on May 15, 2006 and which entitled the holder to contract adjustment payments at the annual rate of 2.25 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, 2008 with a principal amount of $1,000, on which we paid interest at the initial annual rate of 6.00 percent, payable quarterly. The scheduled remarketing of the senior note element of these units occurred in February 2006, as stipulated by the terms of the original offering, and we reset the interest rate on $575.0 million of senior notes due May 15, 2008 to 5.997%. We purchased $400.0 million of the senior notes in the remarketing which were subsequently retired. Upon settlement of the common stock purchase contract in May 2006, we received proceeds of approximately $575.0 million and issued 43.3 million shares of common stock.
Our rate of compensation increase assumption is generally based on periodic studies of compensation trends.
All outstanding stock options at December 31, 2007 are expected to vest. The total intrinsic value of options exercised during 2007, 2006, and 2005 was $3.9 million, $0.9 million, and $1.9 million, respectively. The total fair value of options that vested during 2006 and 2005 was $0.5 million and $5.5 million, respectively. No stock options
Risk-free interest rate of 4.67 percent, based on the yield of treasury bonds at the date of grant.
The fourth quarter of 2007 includes costs related to early retirement of debt of $55.6 million before tax and $36.1million after tax.