Unum Group Q2 FY2022 Earnings Call

Hello everyone and welcome to the Unum Group Second Quarter 2022 Earnings Conference Call. My name is Daisy, and I will be coordinating today's call. I would now like to hand the call over to your host, Tom White, Senior Vice President of Investor Relations at Unum Group, to begin. So Tom, please go ahead.

Great. Thank you, Daisy. Good morning, everyone and welcome to the second quarter 2022 earnings call for Unum. One last time, our remarks today will include forward-looking statements which are statements that are not of current or historical fact. As a result, actual results might differ materially from results suggested by these forward-looking statements. Information concerning factors that could cause results to differ appears in our filings with the Securities and Exchange Commission and are also located in the sections titled Cautionary Statement Regarding Forward-Looking Statements and Risk Factors in our annual report on Form 10-K for the fiscal year ended December 31, 2021 and our subsequently filed Form 10-Q. Our SEC filings can be found in the Investors section of our website at unum.com. I remind you that the statements in today's call speak only as of the date they are made and we undertake no obligation to publicly update or revise any forward-looking statements. A presentation of the most directly comparable GAAP measures and reconciliations of any non-GAAP financial measures included in today's presentation can be found in our statistical supplement on our website in the Investors section. So yesterday afternoon, Unum reported second quarter 2022 net income of $370.4 million or $1.83 per diluted common share, an increase from $182.9 million or $0.89 per diluted common share in the second quarter of 2021. Net income for the second quarter of 2022 included the after-tax amortization of the cost of reinsurance of $13.1 million or $0.06 per diluted common share and a net after-tax investment loss on the company's investment portfolio of $3.1 million or $0.02 per diluted common share. Net income in the second quarter of 2021 included the after-tax costs related to the early retirement of debt of $53.2 million or $0.26 per diluted common share, an after-tax impairment loss on the right-of-use asset related to one of our operating leases for office space that we are no longer using of $11 million or $0.05 per diluted common share, the net tax expense related to a U.K. tax rate increase of $24.2 million or $0.12 per diluted common share, the after-tax amortization of the cost of reinsurance of $15.5 million or $0.08 per diluted common share, and a net after-tax investment gain on the company's investment portfolio of $600,000 or $0.01 per diluted common share. So excluding these items, after-tax adjusted operating income in the second quarter of 2022 was $386.6 million or $1.91 per diluted common share, an increase from $286.2 million or $1.39 per diluted common share in the year-ago quarter. Participating in this morning's conference call are Unum's President and CEO, Rick McKenney; Chief Financial Officer, Steve Zabel; Chief Operating Officer, Mike Simonds; as well as Mark Till, who heads our Unum International business; and Tim Arnold, who heads our Colonial Life and Voluntary benefits. And now I'll turn the call to Rick for his opening comments.

Thank you, Tom, and good morning, everyone. The second quarter was an outstanding one for Unum, highlighted by accelerating growth in premium income, favorable benefits experience across many of our business lines, and strong capital levels that give us great flexibility to carry out our strategic initiatives and invest in growth. Pulling it together, our after-tax adjusted operating income per share increased 37% from the year-ago quarter to $1.91 per diluted common share this quarter, the highest quarterly earnings levels we have seen. Reflecting on the first half of the year, our earnings have been on an accelerated realization of our expectations coming into the year. We now expect our adjusted operating earnings growth rate to be in the 40% to 45% range, much better than expected in the beginning of the year and also double the growth we expected coming out of the first quarter. Over the last several years, we have remained disciplined in how we price and been good stewards of capital. With an engaged workforce, we weathered a challenging period in the external environment. The fortitude of our team, combined with consistency in our strategic focus has allowed us to accelerate our growth path in 2022. This is an inflection point for our company. And as we unpack the results, you will see the multiple factors that enable the recovery ahead of what we had in addition coming into the year. To start, a return to higher profitability this quarter was driven by the lessening of COVID-related mortality across the U.S. population, which declined to approximately 35,000 lives in the second quarter compared to an estimated 155,000 lives in the first quarter. There is also a lower percentage impacting the age of the population that we cover. This improvement in mortality levels led to a significant increase in adjusted operating income in our Unum US Group Life and AD&D business with returned to pre-pandemic levels, following operating losses in five of the last six quarters. We are in a much better place today but it bears watching and it has not gone away completely. In addition, the current business environment has proven to be beneficial to many aspects of our business. High employment levels and rising wages have continued to generate higher levels of what we term natural growth. That is the incremental premium we realized from rising payrolls at our insured customers, which is now running at almost 5%. This rate is nearly double that of the benefit we are realizing prior to the onset of the pandemic. With this tailwind which primarily impacts our group lines, we realized year-over-year growth in premium income of 3.5% in our core business segments on a constant currency basis. This second quarter performance compares to growth of 1.9% in the first quarter, also measured on a year-over-year basis. In addition to this lift from favorable employment conditions, we were quite pleased with the level of new sales we recorded in the second quarter, with increases of 26% for Unum US, 6% for Colonial Life, and 20% for Unum UK on a local currency basis. In addition to favorable employment and wage growth, today's higher interest rates are also benefiting the company in multiple ways. New money yields continued to rise in the second quarter and we are now seeing the yields on many of our investment portfolios that back our product lines begin to stabilize after many years of persistent declines. Also in the second quarter, we raised the discount rate for new long-term disability claim incurrals for the first time in many years as a result of higher new money yields and healthy interest margins in their block. This change was a contributor to the strong financial performance for group disability this quarter and will be a modest mitigate to our pricing actions for LTD going forward. And finally, higher interest rates and the projection of continued higher interest rates are helpful to the long-term funding needs for the long-term care Closed Block. In addition to the significant improvement we saw in our Unum US group life business, benefits experienced in several other lines also showed good improvement. Most notably is the improvement we saw in the Unum US group disability line that had one of its lowest benefit ratios on record at 66.4% in the second quarter. This was due primarily to very favorable new claims incidents and claims recoveries, in addition to the benefit from the discount rate that I just referenced. Colonial Life also recorded one of its lowest benefit ratios at 47.6% this quarter, with favorable claim experience across all product lines. And finally, Unum U.S. supplemental and voluntary lines continue to produce very strong levels of operating income as it has throughout the pandemic. It's worth noting that the Unum US supplemental and voluntary lines, and Colonial Life too, lies with strong margins, solid growth, and table experience over long periods of time, continue to represent almost half of our before-tax adjusted operating income this quarter. These many positive operating trends that helped drive our GAAP earnings improvement also helped drive strong after-tax adjusted statutory income, which for the second quarter increased by almost 60% over the year-ago quarter. This further improves our cash flow and capital position as risk-based capital for the U.S. traditional insurance companies increased to approximately 45% at the end of the second quarter, Unum's highest ever. Holding company liquidity remains well above our targeted levels at $1.2 billion and leverage dropped below 25%. This capital strength gives us increased flexibility as we look to grow our high-margin core businesses returning capital to shareholders through dividends and share repurchases and fund the needs of the launch of carbon. In summary, I'm very pleased with our performance in the second quarter and the flexibility it creates for us as we move forward. Risks from the pandemic are still very real and there is growing concern over the direction of economic growth. However, I believe it's a testament to the strength of our business that we are in such a favorable position today from an earnings and capital perspective after navigating through the pandemic over the last two years. Now, I'll ask Steve to cover the details of the second quarter results.

Great. Thank you, Rick, and good morning, everyone. As Rick outlined for you, the second quarter was an exceptionally good one for the company, as we benefited from both a significant decline in the COVID-related impacts on our business this quarter and strong operating performance in many parts of our operation. As I cover our second quarter results, I will primarily focus on an analysis of our second quarter results compared to the first quarter of 2022, allowing me to describe how our business lines have been progressing through the pandemic. For items such as premium growth and sales growth, I will tend to focus more on the yearly comparisons. To start, I'd like to provide some broader context on the quarter and frame up for you the primary drivers of the strong performance we saw this quarter. First, as you are aware, there was a significant decline in COVID-related mortality in the U.S. in the second quarter relative to the first quarter declining to an estimated 35,000 national deaths this quarter according to Johns Hopkins compared to approximately 155,000 deaths in the first quarter. This absolute decline, coupled with the continued shift in the age demographics of the mortality away from working-age people to the more elderly population, helped drive a significant improvement in our Unum US Group Life results, which are policies that primarily cover employees in their working years. The decline in mortality also produced a more normal result for long-term care block as benefits experience more closely aligned with pre-pandemic levels of experience, especially for claimant mortality. Second, we saw exceptionally favorable performance in our Unum US group disability line with a strong acceleration in premium growth and historically low benefit ratio. I'll dig into those details in just a moment but the benefit ratio for the group disability line was favorable for both the short-term disability and long-term disability lines, leading to overall excellent performance for this business line. Third, we continue to see very favorable performance for our alternative investment portfolio. Our alternatives portfolio generated returns of approximately $54 million, which are higher than our expected average quarterly return exceeding both the first quarter income of $32 million and the year-ago second quarter of $52 million. Again, I'll dig into the drivers of the results in more detail in a moment. And one final trend to highlight is the favorable operating performance we experienced in our Colonial Life and supplemental and voluntary lines of business. These lines saw stable margins through the pandemic and continue to produce good top-line growth, very strong earnings contribution, and excellent adjusted operating returns on equity exceeding 18%. With that high-level setting, I'll begin my review of our operating performance, starting with the Unum US segment. Adjusted operating income increased sharply to $295.4 million in the second quarter of 2022 compared to $171.6 million in the first quarter primarily driven by strong sequential quarter improvement in the group disability and group life and AD&D lines as well as continued strong levels of operating income from the supplemental and lines. Within the Unum US segment, the group disability line reported an excellent quarter with adjusted operating income increasing to $107.5 million in the second quarter of 2022 compared to $62.6 million in the first quarter. The biggest driver of the earnings improvement was favorable benefits experience which produced further improvement in the benefit ratio in the second quarter to 66.4% from 73.8% in the first quarter. This improvement was driven in large part by strong performance in the long-term disability line as claim recoveries and new claim incidents were both favorable. Benefits experienced in the short-term disability line was also favorable in the second quarter as compared to our experience in the first quarter. The benefit ratio was also helped by an increase of 25 basis points in the discount rate for new LTD claim incurrals, a reflection of the significant increase we are seeing in new money yields. Now looking forward, we expect the group disability benefit ratio to average in the low to mid-70% range for the second half of 2022, though will likely remain volatile given the environment we are in. Results for Unum US Group Life and AD&D also showed strong improvement with adjusted operating income of $67.3 million for the second quarter of 2022 and compared to an adjusted operating loss of $9.4 million in the first quarter. This quarter-to-quarter improvement was also primarily the result of an improvement in benefits experience mostly driven by the significant decline in national COVID-related mortality to an estimated 35,000 in the second quarter from 155,000 in the first quarter. Additionally, the age demographics for mortality continue to shift away from the working-age population that was more significantly impacted in the second half of 2021 to the more elderly population. In the second quarter, 16% of the deaths were in the working-age population compared to 24% in the first quarter and 35% in the fourth quarter last year. For our group life block, we estimate that COVID-related mortality claims declined from an estimated 1,400 claims in the first quarter to approximately 200 claims in the second quarter. In addition, we also saw a lower average benefit size of just over $40,000 per claim this quarter compared to slightly less than $55,000 in the first quarter as more of the impact we saw was in the retiree population. We also saw favorable prior period one-off of incurred but not reported which reflects the faster than predicted improvement in our COVID claims experience. Finally, non-COVID-related mortality improved in the second quarter relative to the first quarter and the AD&D line performed more favorably as well, adding to the strong improvement this quarter. Now looking ahead, assuming national COVID-related mortality continues at its current levels and we see some moderation in the favorable volatility from non-COVID mortality in the AD&D line, we would expect the benefit ratio for this line to run in the low to mid-70% area for the second half of 2022. Moving on, adjusted operating income in the Unum US supplemental and voluntary lines continue to be very strong in the second quarter at $120.6 million compared to $118.4 million in the first quarter. For the first half of 2022, these business lines generated an adjusted operating return on equity of over 18%. So looking at the three primary business lines, first, the individual disability recently issued block of business continued to produce excellent results with the benefit ratio slightly lower at 41.3% in the second quarter compared to 42.5% in the first quarter. Likewise, the voluntary benefits line again reported a strong level of income with the benefit ratio stable at 40.8% for the second quarter compared to 40.4% in the first quarter, primarily reflecting continued strong performance in the life product line. And then finally, benefits experienced in the dental and vision line was generally consistent in the second quarter relative to the first quarter with a benefit ratio of 72.9% compared to 73.4%. Again, the supplemental and voluntary lines continue to perform very well and are generating strong levels of operating income for the company which we do anticipate to moderate slightly in the second half of the year. Looking out premium trends and drivers, we are very pleased to see momentum for Unum US accelerates further with growth in premium income of 3.3% in the second quarter on a year-over-year basis compared to the 1.3% increase we saw in the first quarter. Growth was especially strong in the group disability line with year-over-year growth of 5.1% in the second quarter compared to growth of 1.9% in the first quarter. Sales growth from Unum US was very encouraging with growth of 25.6% year-over-year in the second quarter and 16.2% for the first half of 2022. Sales growth trends in the second quarter were broad-based with strong results in the employee benefits lines, individual disability, and voluntary benefits and also by market size with favorable results in both the core and large case markets. Overall, we remain pleased with persistency trends this quarter which showed some variation by line of business but for our total group block was slightly higher at 89.9% for the first half of 2022. The contribution from natural growth continues to accelerate for us and was approximately 5% year-over-year as we benefit from strong employment levels in the U.S. as well as higher wage levels. So taken together with all these factors combined, Unum US premium income for the second quarter of 2022 has recovered to pre-pandemic levels and is now actually 3.3% higher than it was in the second quarter of 2020. And moving to the Unum International segment, adjusted operating income for the second quarter declined slightly to $24.9 million compared to $27.2 million in the first quarter. The weaker dollar to pound exchange rate was the primary driver of the decline. Adjusted operating income for the Unum UK's business was steady in the second quarter at GBP 19.3 million compared to GBP 19.2 million in the first quarter. The reported benefit ratio for Unum UK was 89.7% in the second quarter compared to 80.7% in the first quarter. The high levels of inflation in the U.K. during the second quarter did distort the reported benefit ratio. But adjusting for this impact, the underlying benefits experienced in the quarter was somewhat mixed. The benefits experienced in the group disability line were impacted by unfavorable mortality in the claimant block and experience was unfavorable in the critical illness line. Experience in the group life business was also unfavorable in the second quarter compared to the first quarter. For Unum Poland, adjusted operating income was slightly lower, though overall results remain consistent with our expectations for this business. Premium income for our International business segment declined on a year-over-year basis in dollars but continued to show strong growth in local currency. Unum UK generated premium growth of 8.6% year-over-year in the second quarter and our Poland operations produced growth of 15.4%. Both businesses continue to generate strong year-over-year sales growth in the second quarter with Unum UK up 20.3% and Unum Poland up 19.8% in local currency and persistency remains steady. Next, results for Colonial Life this quarter were among the best on record with adjusted operating income of $101.1 million compared to $90.1 million in the first quarter. We continue to see favorable experience in the accident and health product line, namely the cancer and critical illness products as well as improved experience in the life line which together produced an improvement in the benefits ratio to 47.6% in the second quarter compared to 49.3% in the first quarter. We anticipate the benefit ratio will trend in the 48% to 50% range for the remainder of 2022. We are pleased to see a continuation in the improving trend in premium growth for Colonial Life which increased 1.9% on a year-over-year basis compared to a 1% year-over-year increase recognized in the first quarter. Driving this improving trend is the rebound we have seen in new sales over the past several quarters, as well as generally stable to higher persistency. For the second quarter, sales for Colonial Life increased 6.4% compared to the year-ago second quarter and have increased 10.4% for the first half of the year. Persistency for Colonial Life was 78.6% for the first half compared to 78.3% for the first half of 2021. As we have indicated previously, it will take a couple of years to return to pre-pandemic levels of premium growth in the Colonial Life segment. However, we do feel very good with the progress we are making to build back premium income to pre-pandemic levels for this business, which this quarter are only 2.5% below the second quarter of 2020. In the Closed Block segment, adjusted operating income, excluding the amortization of cost of reinsurance related to the Closed Block individual disability reinsurance transaction was $79.3 million in the second quarter compared to $94.1 million in the first quarter. This decline largely reflects the more normal benefits experience we saw in the long-term care block as the effect of higher claimant mortality was diminished. In broader COVID trends, the adjusted operating income adjusted operating loss ratio for LTC was 85.9% in the second quarter compared to 70.2% in the first quarter as there was no excess claimant mortality this quarter after running about 10% higher than our seasonally adjusted expectations in the first quarter. This level of performance for LTC is consistent with our long-term expectations. For the Closed Block individual disability line, the interest-adjusted loss ratio increased slightly to 79.5% in the second quarter compared to 78.7% in the first quarter but remain within our long-term expectations. Miscellaneous investment income in the Closed Block increased in the second quarter compared to the first quarter by approximately $17 million with higher returns on the alternative investment portfolio, more than offsetting a reduction in bond call premiums. So then wrapping up my commentary on the quarter's financial results, the adjusted operating loss in the corporate segment was $36.9 million for the second quarter compared to $40.4 million in the first quarter with higher net investment income and more favorable operating expenses. Going forward, we anticipate quarterly losses in this segment to be more consistent with our first quarter results. Moving now to investments and net investment income. We continue to see a much better environment for new money yields given the rise in interest rates and the widening in corporate bond spreads so far this year. The new money yield for the second quarter was approximately 4.8% compared to 3.2% in the year-ago quarter. While there are many factors that impact these new money yields for our various product portfolios, we're starting to see portfolio yields for most of our product lines begin to stabilize after many years of decline as new money yields are currently exceeding the portfolio yields. Miscellaneous investment income increased in the second quarter to $57 million compared to $41 million in the first quarter. We continue to see strong above-average returns from our alternative investments portfolio, which produced returns of $54 million in the second quarter and $32 million in the first quarter. It is worth highlighting that second quarter returns benefited from about $17 million in year-end 2021 statements due to a lag in reporting final audited financial statements from those partnerships. Looking at this quarter's performance, returns from the real asset category performed very well in the second quarter, as did our credit funds with floating rate investments, benefiting from rising rates this quarter. The portion of our miscellaneous investment income from traditional bond calls did decline in the quarter relative to the first quarter and, thus far in 2022, is running well below the unusually high volume of bond calls we experienced in 2021. This is consistent with our expectations and while it does pressure net investment income in the short run, maintaining those higher-yielding securities for longer periods of time is beneficial to our portfolio yields. Our current run rate expectation for quarterly income from alternatives is in the $20 million to $25 million range. And our current estimate is that the third and fourth quarter returns will be slightly below that expected average run rate. Moving now to capital. The financial strength of the company continues to build and remains in excellent shape, giving us significant financial flexibility. The weighted average risk-based capital ratio for our traditional U.S. insurance companies improved to approximately 415% and holding company liquidity was $1.2 billion at the end of the second quarter. Both of these metrics are well above our targeted levels. In addition, leverage trended lower and ended the quarter at 24.7%. These strong capital metrics are driven by the strong improvement we are seeing in our statutory earnings results thus far this year. Statutory after-tax operating income was $281.3 million for the second quarter, a sharp increase from the second quarter of 2021 of $177.5 million. For the first half of 2022, our statutory earnings totaled $481.8 million and have exceeded the first half of 2021 by $168 million. Looking at capital deployment in the second quarter, we repurchased $45 million of our shares this quarter and $95 million for the first half of the year. We do continue to anticipate repurchasing approximately $200 million for the full year. Capital contributions in the Fairwind subsidiary were $135 million in the second quarter and for the first half of 2022 now totaled $350 million. With favorable performance in the LTC block and the rise in interest rates this quarter, we are trending favorably within the range of full-year capital contributions to Fairwind of $550 million to $650 million that we guided to at our investor meeting. One final comment to make regarding capital is to highlight the announcement that we made yesterday afternoon that we have issued a redemption notice for the $350 million notes due to mature in 2024. We intend to fund that redemption with the proceeds of a new 5-year bank term loan facility, which we also signed yesterday afternoon. The pricing on the loan facility is very attractive relative to current market spreads and we are able to effectively extend the maturity by three years. I'll then wrap up with a comment on our outlook for the year. As a reminder, at our outlook meeting in February, we initially set our expectation for growth in after-tax adjusted operating income per share in a range of 4% to 7% for 2022. We raised our outlook to an expectation for growth in the range of 15% to 20% following our first-quarter earnings report. With our strong performance in the second quarter and our improved outlook for the second half of 2022 relative to our original expectations, we are again increasing our outlook for growth in 2022 to a range of 40% to 45% off of our adjusted after-tax operating income per share in 2021 of $4.35. At our investor meeting in February, we also provided a longer-term outlook for after-tax adjusted operating income per share to increase within a range of 45% to 55% in 2024, off of our 2021 earnings per share of $4.35. Since we will be moving to the new LDTI accounting basis, beginning with the first quarter of 2023, we will not be updating this 3-year view under the current GAAP reporting standards. However, we believe that upside to our original growth expectations has developed, given our strong performance so far in 2022, including higher premium growth and faster improvement in benefits experienced in many of our business lines, as well as the benefits to our business from higher interest rates, rising wages, and strong employment conditions. We intend to provide 2021 and 2022 recasted results on the new LDTI basis in the first quarter of 2023 and transition our outlook expectations to the new accounting basis also in the first quarter. Now, I'll turn the call back to Rick for his closing comments and look forward to your questions.

Great. Thank you, Steve, for that summary of our second-quarter results. The quarter was an outstanding one and we were very pleased with the performance of the company as we continue to deliver on our promises to our customers throughout the pandemic. We believe we are very well positioned in today's business environment with a strong balance sheet, strong earnings momentum and remain very encouraged with our outlook going forward. Before I open up the call to questions, I want to take a moment to acknowledge and thank Tom White. After more than 40 years of service with the company, Tom will be retiring in the next month, and this will be his last earnings call. Tom has been a stable external voice of Unum for all these years and I know that he's built exceptional relationships with all of you. We will miss him greatly as he will now have more time to work on his golf game, and spend time with his growing family, including grandchildren. Matt Royal, our current Chief Risk Officer, will be our new Head of Investor Relations. Matt's unique combination of financial strategy and risk experience makes him an ideal person for this role. You will all begin to meet Matt as he and Tom work together over the next month. It is fitting that we have record results for Tom's last call. The team is here to respond to your questions. So, I'll ask Daisy to begin the Q&A session.

Our first question is from Alex Scott from Goldman Sachs.

First one I had is just on the favorable trends you're seeing. I assume some of that has to do with the strong labor market at the moment. And I would just be interested in your perspective on sort of the run rate you gave us, what that assumes about how the labor market will be sustained in the near term? And what kind of sensitivity you'd have if things do get a little choppier here?

Yes. Thanks, Alex. I just hit on it overall. Like we've mentioned in our results, they have a little bit faster given the very strong labor market, rising wages. I think we've outpaced as part of that. I don't think we count on that. When you think about how we think about our business and natural growth, we think of that 2%, 2.5% range of what that looks like. So the levels that we're seeing that we just don't count on and we really don't factor those in as we look out over the next several years. And you mentioned if it gets a little bit choppier. It's worth mentioning how the people think about the company and how we think about the company in a slowing period. I think, first of all, I'd say it's a top line question in terms of growing our premium levels. We've been very happy with the recovery we've seen in our premium growing 3.5%. We want to see that get back up into the 4% to 7% premium growth range we've gotten accustomed to prior to the pandemic. We might see that slow a little bit or not maybe not accelerate as fast as we want if the environment gets a little bit slower. A couple of other places to think about if the world does get choppier. And by the way, we don't have any particular insight on that. So we don't plan our business that way. And I think our business model is quite resilient. So even if things get a little bit less robust than they are currently, we don't get too concerned about that. The two other places you might see it is in our investment portfolio. So the team has done a really good job of going through the portfolio, taking a look at where things get impacted. Just not so long ago, they were looking at what happens in a rapidly rising interest rate environment. Now they're looking at what if things slow down and what is the impact to our credits. We feel very good about that and where the portfolio is positioned. Even I'd say in the pandemic, we actually decreased our exposure to some of the high yield, a couple of percentage points of the portfolio came down. And then the other place when things a little choppier, I think we get the question often about what happens in the long-term disability world. Mike, do you have some comments on that? We've seen recessions in the past and maybe some thoughts on that.

Yes. Thanks, Rick. It's just we managed through multiple times to think the last recession should we be in a similar spot again. What we saw was a little bit of a lag. That's kind of the first point. As you see it coming, it's generally two to four quarters before that incident starts to come through. And I would say that gives us an opportunity to think about the front end of the business through a pricing and underwriting point of view. And then most importantly, just to make sure that we're prepared from a claims management and you make sure that those clinical locational indicate specialists are well prepared. So in general, not something that we're looking to see happen. But should that occur, we are really well prepared.

I summarize it, Alex. The main discussion revolves around the potential effects of a recession. We feel optimistic as we navigated through a challenging time during the pandemic and are currently in a strong position. We appreciate the current environment and hope it continues, though predicting it can be difficult. Overall, we are confident in our current status.

I understand. The second question I have for you is about expenses, and more generally about your spending. It seems that in some parts of your business, there has been a significant need to increase staff to manage claims during COVID. Ideally, that level of staffing won't be necessary moving forward, but it remains to be seen. How do you view this situation? Additionally, inflation is obviously a concern. How does all of this influence your plans for expenses going forward?

That's a great question, Alex. In the current tight labor market, we are taking a broader view of our expenses while focusing on maintaining productivity as we grow. We faced some challenges during the pandemic with rising expenses to meet our customers' needs, which was necessary, and I believe we managed it well. Regarding the inflationary environment, our expenses will align with our efforts to remain competitive in the market. Our talent is very important to us, and it's crucial to stay competitive in that area. Steve, perhaps you can elaborate on how we foresee this evolving over the next couple of years, as that could provide some useful context.

Yes, Alex, it's Steve. Thanks for the question. So back in Investor Day, we did talk about some pressures to our operating expense level in the short term that we would be able to work through over time with just growth of the business as well as pricing actions. We had mentioned that we thought that our overall operating expense ratio would go up by somewhere between 125 and 175 basis points to do those things that Rick talked about, take care of our employees and invest back in the business. I would say we're probably tracking for 2022 to be at the lower end of that range but we did expect that our levels would go up during the year. Maybe a lot of those expenses are concentrated in our group disability line. It's very labor intensive in that line. And so Mike, maybe talk a little bit about what we're doing to invest specifically in group disability?

Got it. Yes. I think you feel most acutely in that for disability line because it is where we're most intently serving clients, as Rick mentioned. So Alex, to your point, as global volumes have come down here, we've seen more favorable incidents. That should put a little bit of tailwind for us in terms of operating expenses. At the same time, I would tell you, we're pretty much fully staffed for the first time in nine months. It is a tight labor market we're quite selective in terms of we agreed into on the team and we've arrived at a good spot there. And then the second piece is technology. And we continue to invest in technology. I think, again, that will represent a tailwind for us as we get into 2023, as technology, particularly around short-term disability, and lead comes online, but those are expenses we're incurring from an investment point of view. So in a reasonable spot, we want to make sure we take care of our people there that we are taking care of our customers. But I would expect a downward trend as some of those technology investments come online and hopefully sustain that improvement in expense.

Our next question is from Ryan Krueger from KBW.

Congrats to Tom. The first question is about the guidance for the second half of the year. Would you say that it is essentially back to normal, or are there still any challenges related to the current environment?

Yes, Ryan, this is Steve. I can take that one and I'll take the question up a little bit and just make sure everybody is clear on the guidance that we did put out there. We are looking for the second half of the year, quarterly run rate on EPS to obviously drop below what we saw in the second quarter. There's really probably three main areas that we think that will go back to a normal run rate. One, is just in our group disability benefits experience. I mentioned in my comments. We think that is more in the low to mid-70% range going forward. Also with our life insurance business, group life insurance business in the U.S., I mentioned in my comments as well, we did have some favorable impact of the runout of our IBNR at the end of the first quarter. We do think we'll have some ongoing impact from just COVID claims coming through, maybe $10 million a quarter. So that will be coming through the latter half of the year. And then with our alternative investment portfolio, we obviously had a very good quarter at $54 million in the second quarter. That's probably going to be in the high teens per quarter for the remainder of the year, a little bit lower than our longer-term expectations of the mid-20s. So you take that all in, you put that in there, we do think we're going to have more of regressing to a norm. It comes out to about $1.40 to about $1.45 a quarter probably for the remainder of the year. If you take that back to pre-pandemic, that's about where our jumping-off point was in 2019, 2020. So we feel like we're back to pretty much the earnings power that we have there and then we're able to grow off of that. I did mention in my comments, we're going to be on a different accounting basis going into next year. So not really giving any guidance beyond '22 but obviously, we feel really good about how we think we're going to end the year and be able to go into the future.

Great. That's helpful. And then on long-term care, could you give an update on any more thoughts you've had on potential ways you could hedge into straights as you've been evaluating that?

Yes. Thanks for the question. I would take it in two pieces because we really have two blocks that we manage somewhat differently just from an interest rate perspective because of the reserving construct we're on. We have our Unum America block, about 80% of the block seated in the Fairwind. We are on a premium deficiency reserve construct there. And then we have our first Unum block which is more on a traditional asset adequacy reserve testing. And I am happy to announce we actually did make a move in the second quarter on that block. We did execute on $164 million of notional hedge in our first Unum LTC portfolio. What that does is it effectively locks in the risk-free rate on about 50% of our positive cash flows for the next five years. And we locked in at different rates but on average, it's about 3.35% for the third year. So we really feel good about being able to take that first step. It also allows us to get a little bit more certainty around our asset adequacy reserve in the New York entity. We think that will support being able to release a bit more of our cash flow testing reserves by the end of the year and also be able to take a dividend out of our New York company this year. We'll have to let the year-end process play out but we feel like that's a pretty positive outcome. If you go back to the Unum America block, it is more complex just the interaction with the premium deficiency reserve. It's a funds-withheld portfolio. So we basically have the assets in Unum America and the liability has been Fairwind and we have to work through that. And just the collateral requirements on that block are going to be much greater. So I would say that's still working in process, Ryan but we're obviously evaluating it to see how best we can derisk the balance sheet, which is obviously, a big part of our strategy behind our long-term care block.

Our next question is from Erik Bass from Autonomous Research.

So sales and premium growth have been trending much stronger than assumed in your original 2022 outlook. Can you just talk about what's changed since then that's driving the upside and how we should think about the premium growth trajectory going forward?

Sure, I can address that. Erik, it's Mike. As Rick mentioned, several factors are contributing to the stronger premium growth exceeding our expectations for the year. First, overall sales results are impressive, with over 20% growth for the Unum brand in the U.S. Colonial Life is also performing well, and International growth is robust on a local currency basis. Our value proposition is resonating with new clients and enhancing benefits for existing clients. I'll let Tim elaborate on what's happening in voluntary life and in the International market shortly. Focusing on the group business, the combination of strong sales growth, solid persistency, and natural growth is slightly better than anticipated. Additionally, we discussed at the outlook meeting that balanced rate increases in our renewal program continue to meet our expectations. All these factors indicate we are experiencing over 3% growth in revenue, likely six months earlier than we expected, positioning us to return to the 4% to 7% range. We are optimistic about our standing in the U.S. group market. Tim, do you want to add anything?

Yes, thanks, Mike. You made a great point. I think the biggest surprise is that I've been saying it consistently through the pandemic in a way that has helped us maintain premium levels and perform well throughout this period. We have also observed improvements in agent productivity over the past couple of years. We took that support on the Colonial Life side, and we are continuing to make significant investments across the VB businesses, both Colonial Life and Unum, which are driving additional growth. Recently, we are very encouraged by the momentum we are starting to see in the VB side across small, mid, and large case markets. I appreciate the question and am pleased with the progress we are making, and we believe there is still a lot of opportunity ahead.

Yes. We are experiencing source growth in both Poland and the U.K., with premium growth of 20% in the U.K. and 8.5% in Poland, along with a 15% increase in persistency, which is slightly higher. I would highlight a few factors. In the U.K., we've improved our service levels, which has led to increased customer satisfaction and made our offerings more appealing. Additionally, wage inflation in the country has positively impacted premium income. A similar situation can be observed in Poland. These factors combined contribute to a positive outlook on sales persistency and premium growth over time.

Hopefully, that gives you a sense across markets. There's a lot going well, and there's good optimism in the team. To summarize, we're fully staffed in our claims area as well as in our onboarding, enrollment, implementation, and client service areas. We anticipate continued success in terms of new sales. As we progress through the second half and approach the important January effective date, we are prepared to onboard a significant number of new clients.

I have a follow-up question regarding your RBC ratio, which you've noted is at an all-time high, even after accounting for the impact of new C1 charges. It appears that free cash flow is normalizing more quickly than anticipated. Does this influence your perspective on the level of annual capital deployment you can support in the near term, or does it alter your priorities for that deployment?

Yes. Thanks, Erik, for the question. I mean, the capital deployment picture is getting clearer. You mentioned the strong capital generation has been tremendous. The statutory earnings we saw, as we mentioned, in the first half of the year, are returning to levels that we experienced prior to the pandemic. So it puts us in a very good spot. We want to make sure that we're doing a good job of thinking about how we deploy that. You would have seen in the second quarter, we increased our dividend by 10%. That's one of those pieces that we look at. But I take you back to, we really want to put it into the core business and grow the way that Mike talked about on the premium side. So we're going to continue to invest very strongly in the business today and then think about how we can grow both on the organic front. Think about acquisitions, not too large but certainly a place that we can help to enhance the overall offerings that we've got out there. And then the continued deployment that we see across the buybacks. And Steve, you want to mention a little bit about what's changed because there are other uses that we can use now as well and thinking about where we put that money to work?

Yes. Yes. I think we still are pretty consistent in our view of wanting to balance our stakeholders between getting the premium deficiency reserve kind of behind us from a recognition perspective as well as starting to deploy buybacks to our shareholders. I'll kind of take you back to the Investor Day discussion and bringing the whole PDR discussion into this a bit. I think important points. First of all, as you know, the discount rate that we use there comes into the calculation over a trailing 3-year period. So although we're really happy with where the 20-year and 30-year treasury rates are right now, we would like to give that a little bit more time to actually work its way into the calculation. That does amortize in over time. And so 2022 contributions for that are going to be pretty consistent with what we thought coming into the year. We did give a scenario that provided a 3% 30-year treasury and that would reduce the PDR to about $1.8 billion and we would love if that's where we end up but we need to play this out a little bit longer. We do think that scenario would imply that we could fully recognize the PDR in 2024. But we also think that right now, it makes sense to balance the stakeholders that are out there as far as moving forward with, gain, in the PDR period of practice behind this. And also having, I'd say, a moderate level of capital deployed back to our shareholders.

Got it. You mentioned PDR in 2024, which I believe was the initial plan. Did anything change regarding that?

Yes. I mean the original permitted practice or the permitted practice allows us to take until 2026. What we did discuss in our Investor Day is under certain interest rate paths and interest rate scenarios, we would have the ability to probably recognize that in the 2024 period. That would be something that if rates stays at the levels that they are, that would be something that we definitely want to contemplate doing.

Our last question today is from Jimmy Bhullar from JPMorgan.

I have a question about your overall margins, particularly in the disability business, which have exceeded expectations and outperformed many peers. I'm curious about how much of this improvement is due to enhancing core trends versus any reserve releases or other factors that may not carry over into the second half of the year and into next year.

Yes, Jimmy, it's Mike. I can address that question. I agree that we have a very favorable loss ratio, which reflects solid fundamentals. This is a result of the collaboration among our pricing, underwriting, field organization, and claims team. There are certain factors this quarter that we don't anticipate will repeat, which will eventually bring the group disability loss ratio back to the low to mid-70s that Steve mentioned. Notably, in the first quarter, we had a favorable trend in non-COVID-related short-term disability incidents. We discussed how the Omicron variant caused delays in scheduled surgeries and non-COVID short-term disability claims. This favorable short-term disability incidence has contributed positively to long-term disability incidents in the second quarter. We expect this to normalize as we progress through this year and into next year. Additionally, there was a one-time return of paid family leave premiums based on last year's risk experience, which provided a slight boost. Long-term disability recoveries in the segment were also quite favorable, and I anticipate this positivity to continue, though not at the same rate we saw in the second quarter. Considering all these factors, it seems likely, although there is always some uncertainty, that we will revert to the low 70% range over the next few quarters.

With the changes in taxes in the U.K., how should we think about your overall expected tax rate for 2023?

This is Steve. I'll address that. Looking back to last year, the U.K. government implemented a new tax rate that increased from 19% to 25%, which takes effect next year, likely in the first or early second quarter. When this was enacted, GAAP accounting required us to adjust our balance sheet, specifically our deferred tax assets and liabilities, to reflect this new effective rate. We made that adjustment to 25%. During the current period, we performed better than our usual expectations because the U.K. tax basis for income has a market value component. With rising interest rates in the U.K., we saw significant taxable income, which is taxed at 19%, while we are releasing our deferred balances on the balance sheet at 25%. This creates a net tax benefit for GAAP. This situation may persist until our current basis aligns with the deferred basis next year, resulting in our overall tax rate dropping to 16.6%. However, we don't expect this to continue. We believe a more appropriate overall effective tax rate would be between 20% and 21%. This dynamic contributed some volatility during the quarter.

Going forward, do you expect the company's overall tax rate to rise slightly above 20%, considering the contribution from the U.K. business or the overall results?

It might be a tick but it won't be much, just the relative taxable income in the U.K. versus our U.S. operations. The other way to think about it is from a timing difference perspective, we've already valued our balance sheet at 25%. So as those turn they'll turn at the same rate as what the deferreds are up at right now.

Our next question is from Tom Gallagher from Evercore.

And best of luck to Tom White from me as well. Just a quick question about capital management and potential risk transfer for LTC. Is that still some time away? I believe you mentioned that you are exploring options, but it might take up to two years for anything to materialize. Is that still the expectation, or has the timing changed at all?

Yes, Tom, I think it's hard to predict. To predict M&A and timing is difficult. It's about making sure that we can have buyers and sellers getting together. I think we're doing the work to make sure that we're prepared for the right environment and interacting with the right counterparties but very hard to predict timing around when something can come to fruition. So I really can't give you a better time frame, a couple of years, when would it take. We'd like it to be earlier but could it be later. It's one of those things. M&A is just unpredictable on that front. But we're doing the work and we'll be prepared if the market opens up and we think it will be a good thing for the company overall.

Okay. And just back on disability for a minute. Do you have any sense for what's really driving this good submitted incidence in claim recoveries? Just what are the main drivers behind the scenes if you've done any analysis on that?

Yes, thanks, Tom, it's Mike. Regarding the incidence for LTD, a significant part of it relates to the current quarter, and we had favorable STD incidents last quarter. The elimination period of 90 to 180 days is also coming into play in the second quarter, which is contributing to the favorable incidence. On the recovery side, we have observed an improving trend. While there was a slight increase, I believe it reflects some favorable fluctuations in this quarter. However, looking at our guidance for the latter half of the year, I expect recoveries to remain high but not at the current elevated levels. This is due to the strength of our benefits team and the successful return to work initiatives, as well as investments in the clinical area. The percentage of claims being addressed by a clinician has increased over the past several quarters. These factors collectively give us confidence in our outlook.

Okay. Finally, can you provide any insights on pricing for renewals in 2023? On one hand, there has been significant volatility in mortality and disability rates. A few quarters ago, the results were quite poor, and you received some rate adjustments last year. Given the recent favorable trends, do you anticipate that this will influence pricing, potentially leading to stabilization or even declines? What are your initial thoughts on the implications for pricing?

Sure, it's a great question, Tom. I can characterize it reasonably well. Most of our clients have multiple Unum benefits, so we’re looking at the overall price adjustments across product lines. The interest rate environment and some favorable factors from an LTE risk and recovery perspective are certainly beneficial and will help mitigate some of the necessary increases. We are also considering our life insurance experience and aiming to stay proactive regarding inflationary pressures on expenses to ensure that as we raise wages and benefits for our employees, we keep their needs in focus. We must accurately reflect these changes. Regarding our fee-based businesses, we've consistently emphasized the importance of including the costs for managing leave and claims in our pricing. Our approach aims to be balanced, but we will need to introduce some rate adjustments in the market. There will be a slight softening on the LTD front as part of that strategy. Given what we've observed with renewal plans so far, we're optimistic about persistency tracking.

Our next question is from Suneet Kamath from Jefferies.

And thanks to Tom for all the help over the many years. My question is, again, back on group disability. If I go back to the outlook presentation, I think you guys guided to mid- to low 70% range for '23 and '24. Feels like you're going to get there in the second half. So as we think about kind of the longer term, is there a reason to be confident that we could push kind of lower than that as we ended '23 and '24 if the current trends that you're seeing persist? Or do you think you'll have to give up some of that in terms of pricing?

Yes, Suneet, it's Mike. And as we've just talked about sort of reverting into those low 70%. And you think about kind of where we were pre-pandemic, coming down pretty consistently into that low 70% range. We know that is a good spot to be in because recall, with that kind of a loss ratio, we're looking at an ROE of sort of mid- to high teens. We think that's a really, really good return on a business. And we want to make sure that we're balancing pricing that's generating good strong returns with pricing that's going to enable us to grow that business. And we started to see that disability segment really start to grow again in terms of top line. We're encouraged with the pipeline. We're encouraged with the investments that we've made in new total leaves platform in new connections into winning HCM platforms. I think we just have a really good story to tell there. We want to make sure we've got fair and competitive pricing and feel like a loss ratio in the low 70s is a good spot for us to be in.

Got it. And then I guess for Steve, on LDTI, I know you're not going to give us any details but some companies have talked about sort of earnings benefit kind of going forward. Just kind of directionally, is there any color that you can give us on that front?

Yes. I won't provide specific directions, but I will give you some key details. When we file our Form 10-Q later today, we will offer more disclosure than we have in the past, focusing on two main areas. First, we will provide qualitative insights into the major factors affecting our earnings recast. There are likely three or four key drivers, which you may discern from our other disclosures. We are experiencing different amortization periods that vary by product line, with some having longer or shorter runoff periods for certain margins related to our reserves on the balance sheet, which aligns with what you may have heard previously. Additionally, we are establishing our new claims at a single A rate, and we are beginning to see some trends in the runoff, with a mix of positive and slightly negative outcomes. Secondly, we will update the initial impact disclosure. Our original estimate for the 1/1/21 adoption impact was in the range of $6.5 billion to $7 billion. When we adjust the June 30 rates back to January 1, 2021, that figure falls to about $2 billion to $2.5 billion. This change reflects the movements in the risk-free rate as well as shifts in credit spreads at the single A level, which have significantly lowered the initial impact. I want to emphasize that we consider this accounting guidance as just that—accounting, rather than a reflection of the actual economics of the business, especially given the fluctuations we see from period to period. We remain confident about the firm's cash generation and our outlook for growth.

Makes. Just one last quick, numbers one. Can you just give us the split in LTC reserves between sort of First Unum and then the piece that's at Fairwind?

Yes. Just rough numbers and this is kind of bi-reserve. First Unum makes up 80% of the business. New York accounts for about 15%. And then, I'm sorry, 80% is in Unum America Fairwind, 15% is in First Unum. Lastly, we have a small 5% block, which is our old reimbursement business in PL&A, our Tennessee company.

Our last question is from Tracy Benguigui from Barclays.

Based on your New York asset adequacy testing, you said you'd be able to take a dividend at out of First Unum. Could you size up what that may look like? And I also believe First Unum as the sister company, is not stacked. So can I assume that will go up to the holdco?

Yes. Tracy, this is Steve. You are correct. It's a sister company, so it doesn't have to pass through the holding company; they will go directly to the group. We need to complete the work at year-end and see where rates stand, but we anticipate a dividend similar to what we experienced last year, which was around $40 million. I expect something close to that. As you know, the rules regarding extraordinary and ordinary dividends require some calculations, and we believe that approximately $40 million is a reasonable estimate for this year, but we'll see how year-end unfolds.

Okay. Got it. I also want to follow up on an earlier discussion on Fairwind hedging. I get that your collateral needs is a consideration if rates go up substantially higher from here but what about hedging just a portion of Fairwind?

Yes. We are evaluating various options, including aligning cash flow for the entire business or specific segments, as well as implementing a broader macro hedge that would provide economic protection without directly targeting cash flow. We are considering all these options, each with its advantages and disadvantages, and we will continue to explore this as the summer and fall progress. Thank you, Tracy.

Thank you. This is all the questions we have today. So I'll hand back over for any closing remarks.

Great. Thanks, Daisy. I just want to thank everybody for joining us this morning. Good quarter. Certainly, we want to get out there and talk to all of you in the coming weeks. We'll see you at upcoming conferences and investor events and I do want to wrap the call today with thanking Tom White for his years of service. I'm very appreciative. Make sure to send him a note of congratulations. He's going on to do some different things. And with that, we'll wrap up the call. Thanks, everyone.

Thank you, everyone, for joining today's call. You may now disconnect your lines and have a lovely day.