Unum Group Q3 FY2022 Earnings Call

Hello, everyone, and welcome to the Unum Group Third Quarter 2022 Earning Results Conference Call. My name is Alex, and I will be coordinating the call today. I will now hand over to your host, Matt Royal, Senior Vice President of Investor Relations. Matt, please go ahead.

Thank you, Alex. Good morning, and welcome, everyone. I'm excited to be hosting my first call, where we will be discussing the third quarter 2022 earnings for Unum Group. Our remarks today will include forward-looking statements, which are statements that are not of current or historical fact. As a result, actual results may 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 subsequent quarterly reports on Form 10-Q. Our SEC filings can be found in the Investors section of our website at www.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. Yesterday afternoon, Unum reported third quarter 2022 net income of $410.7 million or $2.04 per diluted common share, an increase of $328.6 million or $1.60 per diluted common share in the third quarter of 2021. Net income for the third quarter of 2022 included the after-tax amortization of the cost of reinsurance of $12.1 million or $0.06 per diluted common share, a net after-tax investment loss on the company's investment portfolio of $3.4 million or $0.02 per diluted common share and the reserve decrease related to reserve assumption updates of $122.5 million or $0.61 per diluted common share. Net income in the third quarter of 2021 included the after-tax impairment loss on internal-use software of $9.6 million or $0.05 per diluted common share, the after-tax amortization of the cost of reinsurance of $15.5 million or $0.08 per diluted common share. The net after-tax reserve decrease related to reserve assumption updates of $143.3 million or $0.70 per diluted common share and an after-tax net realized investment loss on the company's investment portfolio of $100,000, a de minimis impact on earnings per diluted common share. Excluding these items, after-tax adjusted operating income in the third quarter of 2022 was $303.7 million or $1.51 per diluted common share, an increase from $210.5 million or $1.03 per diluted common share in the year ago quarter. Also 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 lines. Now I'll turn to Rick for his opening comments.

Thank you, Matt, and good morning, everyone. We're happy to be with you today to share the results of the third quarter as well as our positioning in the current environment. Our performance in the third quarter continued to build on the momentum of the first half of the year, with growth in operating earnings per share of 47% on a year-over-year basis. Starting with the top line. Premiums in our core businesses grew at a rate just shy of 4% on a constant currency basis. Additionally, we continue to see very strong benefits experience, particularly in U.S. group disability and Colonial Life. The growing top line, solid margins and a better interest rate environment layered on top of already strong capital levels provides us the ability to invest in our growth and positions us to navigate the multiple macro scenarios that may emerge. As we look to close out 2022, there are many things that give me confidence in our franchise and future growth prospects. When I reflect on our company's leadership in the employee benefit space, it is not a commentary on recent sales or even market share, though both are strong. It is more a statement that we are consistent in our purpose of serving employers and their employees. We have a deep understanding of the realities and dynamics of the workplace, whether it's managing leaves, comforting people through tragedy or continued focus and progress returning someone to work, our teams and processes deliver for our customers. This requires ongoing investments in our people, capabilities and operations, something we continue to build on over the past several years. With COVID shifting to a more endemic phase, we are poised to benefit from the advancements we've made to connect and serve our customers in new, leading digital-first ways. Further, the current environment is very good for our franchise. Our position is benefiting from awareness, full employment, related wage inflation and much higher interest rates. So let me unpack that for you. The pandemic brought an acute awareness of the financial fragility that many workers and their families face, reinforcing the need for the types of protections we provide and the importance of providing them through the employer. Changing workforce dynamics caused companies to rethink their overall employee value proposition inclusive of benefits as the competitive environment for talent continues. From a growth perspective, as you see in this quarter's results, our core businesses have rebounded nicely. Increasing employment levels and rising wages have continued to generate higher levels of what we call natural growth. That is our incremental premium we realized from rising payrolls at our insured customers. With this tailwind, which primarily impacts our group lines, we realized year-over-year growth in premium income of 3.9% in our core business segments on a constant currency basis. In addition, core business sales rose 14.1% on a constant currency basis, with growth across all segments. With regards to interest rates, we have prudently managed the company over many years of declining rates. Today's rising rates are a welcome change and benefit the company in multiple ways. New money yields continued to rise in the third quarter and are at levels that exceed portfolio rates that back our product lines. Higher interest rates also provide greater flexibility to manage interest rate risk. And as you may have seen in our earnings release, we took steps to lock in these benefits by entering into another series of treasury interest rate locks this quarter. These actions reduce uncertainty in our LTC business by locking in some of today's rates for future cash flows. We will continue to actively explore ways to further reduce risk associated with our LTC block. At the same time, we have always had a watchful eye on our investment portfolio. The underlying credit quality of the portfolio is strong, and the investment team remains diligent in their analysis of our credits through the changing market dynamics. We view credit analysis and management as a core competency over many years and through many different credit cycles. We have consistently shown favorable default rates compared to industry averages. Turning to less environmentally-driven dynamics and certainly at the heart of what we do, we are very pleased with the benefits experience we have seen across the board. We think this showcases our expertise and continuous investments in our underwriting, pricing, claims processes and technology. Specifically, performance in our U.S. group disability line was very strong for the second quarter in a row. It recorded one of the lowest benefit ratios on record. And for the second year in a row, we reduced reserves as favorable trends and recoveries repeated. In addition, the Unum US supplementary and voluntary lines and Colonial Life had another quarter of strong margins and combined to represent over 50% of our core business pretax adjusted operating income. Although results moderated slightly from the highs we saw in the second quarter, both segments posted ROEs in the high teens. These many positive operating trends that helped drive our GAAP earnings improvement also helped drive strong statutory income, which for the third quarter doubled over the year-ago quarter, and on a run rate basis is back to our pre-pandemic level of close to $1 billion a year. This is a great achievement by our team and a reflection of our business model's resiliency. These operating results drove notably strong capital metrics. Risk-based capital for the U.S. traditional insurance companies remained at approximately 415% at the end of the third quarter and our holding company liquidity of $1.1 billion remains well above our targeted levels, while we have also deleveraged to below 25%. This capital strength along with our contingent capital sources gives us ample flexibility as we look to grow our high-margin core businesses to fund the needs of our long-term care block and return capital to our shareholders through dividends and share repurchases. As we look to long-term care, we have committed over $1 billion to the premium deficiency reserve over the last several years. As you may recall, this contribution strengthened our long-term care reserves over and above our best estimate liability. At our outlook meeting in February, we provided sensitivities to help you better understand and approximate the impacts of interest rate movements on this PDR balance. It's important to note that the higher interest rates we're experiencing now work their way into this calculation over a 3-year look-back period. When you consider the recent sharp rise in rates and the capital contributions made, projections show positive moves in future funding needs if today's rates hold. To summarize, our highly profitable industry-leading core businesses are building momentum at a faster pace than we anticipated coming into the year. Coupled with a favorable operating environment, strong capital position and prudent risk management, we are in position to advance on our leading market positions to continue delivering excellent customer service and fulfill our purpose of helping the working world thrive throughout life's moments. Now I'll ask Steve to cover the details of the third quarter results. Steve?

Thank you, Rick, and good morning everyone. As Rick highlighted, we are very pleased with our operating results and the strategic actions taken during the third quarter. You may remember that the pandemic's most severe impacts were felt in the second quarter, and these effects are now transitioning to a more manageable state in the third quarter. With a more favorable interest rate environment, the performance this quarter positions us strongly as we move into the latter half of the year. I will focus on our third quarter results compared to the second quarter of 2022 to illustrate the progress across our business lines, and will emphasize year-over-year comparisons for metrics such as premium and sales growth. Additionally, I will discuss our adjusted operating income results without accounting for our GAAP reserve assumption updates, which typically occur in the third quarter. As noted in our press release, the reserve decrease associated with our annual update amounted to $155 million before tax, or $122.5 million after tax, impacting both Unum US group long-term disability and group life. The main component of the actuarial reserve review was a $121 million pre-tax reserve release in the Unum US group long-term disability line. We believe our claim reserves are our best estimate of future liabilities, and given our strong performance and ongoing investments, we are confident that these trends will remain. These reserves have been revised to reflect expected claim costs more accurately. This reserve update will have minimal effect on our earnings outlook or expected benefit ratios. Although these reserve updates are not included in adjusted operating income, they did contribute $0.61 per share to our book value. I want to mention that we have completed our GAAP reserve adequacy evaluation, which has been subject to external audit, and all impacts are reflected in this quarter's results. Third quarter earnings were robust, exceeding the improved outlook we provided last quarter, though moderating from the record-breaking achievements of the second quarter. Before diving into the individual segments, I’d like to give some broader context regarding the quarter and outline key themes we observed. First, sustained success has been partly attributed to our capacity to leverage the favorable operating environment. Growth in wages and payrolls supported U.S. group results and helped us align top-line growth with historical trends. Additionally, we recorded another group disability benefit ratio that was significantly lower than our long-term expectations, as claim recoveries continued to exceed our forecasts. This trend not only aids our operating results but we anticipate this favorability to persist in the near term. The rise in interest rates benefits us in various ways, including providing better new money rates for our investments that exceeded our portfolio yields for the third quarter, along with allowing us to manage risk in LTC through hedging, which I will elaborate on later. Second, following more than two years of significant pandemic impacts, we are observing a shift to a more stable state, with impacts more manageable than in previous quarters. Estimated U.S. deaths in the third quarter were about 40,000—slightly rising from the second quarter but significantly lower than prior levels. The stabilization in mortality trends also promotes more normal conditions for our long-term care segment, which has benefitted during the pandemic. Additionally, as the proportion of COVID-19 deaths in the working age population hovered around 15% for the quarter, our core businesses should experience reduced impacts. With these considerations in mind, let’s delve into our operating performance for the Unum US segment. Adjusted operating income fell to $275 million in the third quarter of 2022 from $295.4 million in the second quarter, primarily due to lower earnings in the Group Life and AD&D lines, though this was partially offset by stronger operating income from the group disability line. The group disability line demonstrated an excellent quarter, with adjusted operating income increasing to $129.8 million in the third quarter from $107.5 million in the second quarter. This improvement was mainly driven by favorable benefits experiences, leading to an improved benefit ratio of 62.7% for the third quarter. This marks consecutive quarters of advantageous claim recoveries in the group long-term disability product line, and we are pleased with its performance. We believe the group disability loss ratio will remain in the mid- to high 60% range in the fourth quarter. Results for Unum US Group Life and AD&D decreased from the last quarter, showing adjusted operating income of $30.9 million for the third quarter compared to $67.3 million in the second quarter. This quarter-to-quarter decline was influenced by a higher average claim size and a lack of the favorable IBNR runout seen in the second quarter. For our group life block, COVID-related mortality claims were roughly estimated at 200 and were generally consistent with the second quarter. Non-COVID-related mortality impacted results due to a slight average claim size increase, while the AD&D line experienced more normalized outcomes following a strong second quarter. Looking ahead, assuming national COVID-related mortality continues at these levels and we see moderation in non-COVID mortality volatility, we anticipate the benefit ratio for this line to be around the mid-70% range. Moving on, adjusted operating income in the Unum US supplemental and voluntary lines maintained strong performance in the third quarter at $114.3 million, a minor decrease from the favorable result of $120.6 million in the second quarter. This outcome was driven by the voluntary benefits line, offset slightly by the individual disability block, which also reported an excellent quarter with a benefit ratio improving from 41.3% in the second quarter to 40% in the third quarter. Finally, results for the dental and vision line were slightly below second-quarter results, as the benefit ratio increased to 74.5% from 72.9%. Overall, the supplemental and voluntary lines continue to perform very well, contributing high levels of operating income to the company. We expect fourth quarter results to be roughly in line with this quarter’s outcomes. Regarding premium trends and drivers, we are encouraged to see the momentum from the first half of the year carry into the third quarter, with premium income growth of 3.9% year-over-year, compared to a 3.3% increase in the second quarter. The group disability line experienced particularly strong growth at 7.4% year-over-year for the third quarter, compared to 5.1% in the second quarter, powered by sustained high levels of natural growth. Sales growth for Unum US was strong, with an 11% year-over-year increase in the third quarter and 14.9% for the first nine months of the year. Contributing to these trends, sales in our supplemental and voluntary lines grew by 13.9%, led by remarkable growth in individual disability and voluntary benefits lines, which were up 23.9% and 19.1%, respectively, alongside a 12.3% increase in the group disability line. From a market standpoint, we witnessed robust results in our core market segment of employers with under 2,000 lives, which offset diminished sales in larger cases. Persistency remained generally stable, with some variations across lines of business, and our total group block stood at 89.7% for the third quarter. The ongoing favorable operating environment has positively impacted our business, highlighted by natural growth contributions in our group product lines. This quarter, we saw natural growth accelerate to over 5% year-over-year in the third quarter. Hence, we are very satisfied with the top-line growth trends experienced in Unum US and believe this momentum will carry into the fourth quarter. Turning to the Unum International segment, adjusted operating income for the third quarter increased to $29.9 million from $24.9 million in the second quarter, despite unfavorable pound to dollar exchange rates. For Unum UK, adjusted operating income improved to £23.6 million in the third quarter from £19.3 million in the second quarter. The reported benefit ratio for Unum UK was 78.6% in the third quarter versus 89.7% in the second quarter. The high levels of inflation experienced in the U.K. have distorted the benefit ratio this quarter, as many of our UK policies have inflation riders backed by inflation-linked gilts. While inflation-linked benefits are capped, income from linked gilts is not, benefiting us during periods of high inflation. Adjusting for this impact, the underlying benefits experience was slightly improved from the second quarter due to favorable outcomes in the group disability line offsetting a rise in Group Life claims. For Unum Poland, third quarter adjusted operating income exceeded the second quarter, reflecting our satisfaction with the operation's growth and performance despite ongoing challenges. Premium income for our Unum International business segment declined year-over-year in dollars but showed solid growth in local currency terms. Unum UK reported a 12.1% year-over-year premium growth in the third quarter and our Poland operation saw 14.2% growth in local currency. Both entities generated very strong year-over-year sales growth in the third quarter, with Unum UK up 106% and Unum Poland up 21.8% in local currency. Next, Colonial Life's adjusted operating income was $90.4 million compared to $101.1 million in the second quarter, a solid outcome following one of the highest results on record last quarter. The benefit ratio improved to 46.8% in the third quarter from 47.6% in the second quarter, remaining favorable compared to historical trends. We expect the benefit ratio will trend toward the 48% to 50% range for the remainder of the year. Despite improved benefit ratios, expenses increased slightly as we continue to invest in our workforce and technology. However, overall company expenses, as measured by the expense ratio, remain below the outlook we shared during our Investor Day, expecting an increase of 125 to 175 basis points for the full year, with expectations to stay toward the low end of this range. As for Colonial Life's top line, we previously indicated it will take a few years to return to pre-pandemic premium growth levels. This quarter reflected positive trends, showing approximately 1% growth year-over-year, underlining the strong sales recovery we have experienced over recent quarters, with sales up 7.8% for the first nine months of the year and 3.2% in the third quarter. We are optimistic about our progress toward regaining premium income to pre-pandemic levels, evidenced by trailing 12-month premium income exceeding that of the full year 2019 by 1.2%. For the Closed Block segment, adjusted operating income, excluding the amortization of reinsurance costs related to the Closed Block individual disability reinsurance transaction, stood at $34.1 million compared to $79.3 million in the second quarter. The decline largely resulted from lower miscellaneous investment income, which dropped by $36.4 million from the second quarter as income from our alternative investment portfolio moderated as anticipated. Long-term care benefits experience remains stable, with the adjusted interest loss ratio at 85.7%, compared to 85.9% in the second quarter, and a 12-month rolling basis ratio of 81%. As the pandemic transitions to an endemic state, we will continue to watch how mortality impacts this block. This quarter's LTC performance aligns with our long-term expectations of an interest-adjusted loss ratio between 85% and 90%, while our previous 12-month ratio remains low due to pandemic-related claims. In the Closed Block individual disability line, the interest-adjusted loss ratio fell to 77.5% from 79.5% in the last quarter, staying within long-term expectations. Assuming normal conditions, we generally foresee adjusted operating earnings for the Closed Block between $45 million and $55 million, subject to fluctuations in income from the alternative asset portfolio. Wrapping up my remarks on the quarter’s financial outcomes, the adjusted operating loss in the corporate segment was $49.5 million compared to $36.9 million in the second quarter, mainly due to higher expenses related to debt management activities. We expect to see quarterly losses in this segment between $40 million and $45 million moving forward. Regarding debt management, last quarter we announced plans to call $350 million in notes due to mature in 2024, refinancing them with proceeds from a favorably priced five-year bank term loan. This allowed us to extend the maturity by three years, avoiding the need for issuance at current spreads. Moving on to investments, we continue to notice an excellent environment for new money yields, as interest rates rise and corporate bond spreads widen. In the third quarter, the 10-year treasury rose by 81 basis points, with this upward trend continuing into October. Consequently, new money rates are climbing and now surpass our portfolio yields. Miscellaneous investment income fell to $18 million in the third quarter from $57 million in the second quarter, with the prior quarter benefiting from exceptional alternative investment income of $54 million. We had anticipated this income would moderate below our run rate expectation of $20 million to $25 million due to market volatility in the second quarter. However, despite this volatility, our portfolio income was solid, generating $13 million as our exposure to real assets continues to yield benefits in this economic environment. We view this as a testament to our approach toward alternative asset investments and are pleased with its performance throughout the pandemic. Looking ahead, we estimate that fourth quarter income from alternative assets will be below our run rate expectations and likely under third quarter results, but still positive. Miscellaneous investment income from traditional bond calls saw a slight rise from the second quarter but remains lower than the unusually high volume in 2021. Though lower bond calls create short-term pressure on net investment income, retaining higher-yielding securities benefits our portfolio overall. As discussions about a possible recession continue, I want to take a moment to emphasize the strength of our investment portfolio. First, we actively manage our investment portfolio's composition, which is predominantly comprised of corporate credit. We have consistently observed favorable default rates compared to industry averages, and our exposures to equities, commercial mortgage loans, CLOs, RMBS, and various structured asset classes fall below industry averages, given our focus on corporate credit and liability profile. Second, since the end of 2020, we have reduced our exposure to below-investment-grade securities from just under 9% of fixed maturity investments to just under 6%. Lastly, year-to-date, we have recorded more upgrades than downgrades and perceive our portfolio as containing more rising stars than fallen angels in the near term. While the probability and severity of a macro event is up for debate, we are confident in our portfolio's positioning. Now, regarding capital, the company's financial strength continues to build, remaining in excellent condition. Our traditional U.S. insurance companies maintain a robust weighted average risk-based capital ratio of approximately 415%, while holding company liquidity was $1.1 billion at the end of the third quarter. Both metrics are significantly above our targets and are expected to strengthen further in the fourth quarter. Additionally, as previously disclosed, the upcoming C2 mortality factor adjustments at year-end will boost our capital metrics by approximately 25 points of RBC due to the positive effects on Group Life products. We also anticipate another year-end dividend from First Unum in the range of $30 million to $50 million, assuming a modest release of LTC asset adequacy reserves. These capital metrics have improved significantly thanks to the rebound in our statutory earnings results this year, with statutory after-tax operating income reaching $243.2 million in the third quarter and $725 million for the first nine months of the year, putting us on track for about $1 billion in statutory earnings this year, aligning with pre-pandemic levels. Regarding capital deployment in the third quarter, we distributed $66.1 million in common stock dividends and bought back $42.6 million of our shares. For the first nine months of the year, we've paid $189.5 million in dividends and repurchased $137.5 million of our stock, aiming for approximately $200 million in total repurchases for the full year. Capital contributions in our Fairwind subsidiary amounted to $115 million in the third quarter and $465 million year-to-date. Given the stable performance in the LTC block and the rise in interest rates, we continue to trend toward the low end or slightly below the guidance range of $550 million to $650 million in capital contributions to Fairwind provided at our February Investor Day. Alongside tempering capital contributions for 2022, higher rates positively impact LTC in the long run and advance our efforts to recognize premium deficiency reserves more quickly than previously allowed. Higher rates also offer attractive options for further hedging activities. As noted last quarter, we engaged in interest rate hedges through long-duration treasury forwards in our first Unum Block of LTC business and are continuing those efforts into the third quarter and beyond. As Rick mentioned, we hedged cash flows in the Unum America Block, which makes up about 80% of our LTC business, through a series of trades totaling $500 million of notional hedges at an average treasury rate in the mid-3% range. Since the end of the quarter, we have initiated an additional $100 million averaging over 4%. Such actions minimize uncertainty by narrowing the range of outcomes for this business block, and we will remain proactive in identifying methods to further mitigate risks associated with our LTC block. In summary, our outlook for the year remains strong. After initially guiding for 4% to 7% growth in adjusted after-tax operating income per share during our February Investor Day, we raised that expectation to 15% to 20% in the first quarter. Following favorable second quarter outcomes and a positive outlook for the second half, we adjusted it once more to a range of 40% to 45% off of last year's adjusted after-tax operating income of $4.35 per share. Following our third quarter results, we believe this range continues to be appropriate for 2022. I will now turn the call back to Rick for final comments, and I look forward to your questions.

Great. Thanks, Steve. Good summary of the quarter's results. I would say results were excellent. We are very pleased with our ability to execute on our strategy and capitalize for both the short term and longer term on an operating environment that is very favorable to us. We do believe that we are very well positioned to take on any environment that may present itself with a strong balance sheet and resilient earnings power, and we remain very encouraged for the future. I'll now hand the call over to Alex to begin our Q&A session. Alex?

Our first question for today comes from Erik Bass of Autonomous Research.

Can you provide some more color on the drivers of the disability margin improvement and why you think at least a portion of this is sustainable? And also, do you view a high 60% benefits ratio is the right expectation heading into 2023?

Erik, let me turn it over to Mike to talk about some of the drivers and then maybe Steve will have some comments on where we see this going.

I appreciate it. Yes, you highlighted another good quarter in terms of experience for the group disability line. And I would say, while there are a couple of things under the covers there, the primary drivers are the recovery experience. We've spent time on it, and it's pretty broad-based. So we look across industries. We've looked across different durations of claims and we are seeing favorability pretty broadly against our expectations. I think it is fair to conclude that we've got a conducive environment out there for helping people to return to work at a productive lifestyle. I would also say internally, we're well-positioned in that we are fully staffed, which is a really good place to be. We've got a really experienced and capable management team and our benefits organization that have implemented some process changes, focusing on different diagnoses and durations, all with the intent of delivering on that purpose of supporting people and supporting our employer clients in terms of driving productivity. So favorability continued probably a bit more so than what we had expected here in the third quarter. We would anticipate it will moderate a bit over time but probably not at the pace we would have thought otherwise. I don't know, Steve, if you have anything.

No, I think that's right. I mentioned in my comments that we're looking for something in the mid- to high-60% loss ratio in the fourth quarter. As we look ahead to '23, I probably won't comment on that right now. We're going through our process around LDTI and recasting what loss ratio is going to look like going forward. So a lot more for you as we talk about the '23 outlook.

And then on the hedging, it sounds like the actions you took in the third quarter as sort of a step in a larger process and something that you plan to continue legging into. Can you just help us think about the benefits in terms of future net investment income as well as locking in the discount rate for reserves?

Yes, yes. Let me just kind of recap what we did because I know we provided a little bit more information even in my script than what we would have had in the release. If you go back to the second quarter, we executed in First Unum, which was pretty straightforward, $164 million of notional pretty straightforward from how that flowed through to asset adequacy testing. It really derisks some of the downside scenarios that you have within that testing. And we were very focused on the first five years of investable cash for that block. And we've given a little bit of guidance that we're looking at about 50% of that. As we roll forward, we lagged in some transactions in Unum America. In the third quarter, we executed on $500 million in notional, same type of instrument. And then in the fourth quarter, we actually took another step and put another $100 million. It's a little bit more complicated when we get into Unum America. And let me just talk about the basics of what we're hedging. We're hedging investable cash flows, and think of that as the cash flows that come out of our liabilities, the premiums, the claims, expenses that we have to pay combined with the cash flow needs of our investment portfolio and really how that portfolio turns over. So we're very focused on the first five years. It's important to us that we get hedge accounting on this. And so we want to make sure there’s certainty of what those cash flows are. So that's where we're focused. I wouldn't view these being put on for any kind of future income enhancement these are risk management trades. We want to make sure that we're well protected for a downside risk in the interest rate environment. So I don't think you're going to see incremental investment income in the future on this. I do think, too, when you get into Unum America, it's a more diversified portfolio. So that makes it a little bit more complicated about which types of investment trades in the future we want to hedge. We have alternative assets in there, commercial mortgage loans, private placement, those would be harder to hedge because you need to be able to enter into a bond trade in the future to really look at the maturity of those trades. So far, we've hedged about 20%, I think, 15% to 20% of our expected cash flows in Unum America over the next five years. And we feel like this is a great start to leg into a program that we think is very important to manage downside risk in the future for this block.

Our next question comes from Ryan Krueger of KBW.

First, I just want to follow up on the last question. I guess, can you give us any thoughts on where you see the 15% to 20% headed? Do you think you'd go all the way up to the 50% of five-year cash flows that you did in First Unum or given the portfolio differences, would you likely stay a little below that?

Yes. Ryan, we're not going to really give any guidance kind of where we're going to take the program. We feel very good about the steps that we've taken. We do think that there's more room to advance the program here in the future, but we'll update the market as we leg into further transactions on that, but I don't really want to set any kind of, I guess, expectation out there for how this may grow to.

Got it. I have a more mechanical question regarding the PDR. You mentioned the rolling three-year impact on your results. My question is, if interest rates remain high and your PDR requirement is lower, will you need to make contributions now? And if rates stay high and the rolling three-year calculation improves, will you then be able to release those reserves from the entity?

Yes. Ryan, and I wouldn't think about it as releasing reserves. We have an overall premium deficiency reserve that we need to record. The state of Maine has given us the ability to do that over time. And so we're building towards that reserve in the current rate environment, it allows us to potentially do that at a faster pace as far as how we recognize that. I do think it's fair to say that if rates remain where they are today, and we gave you some scenarios last February, it would give us the ability to recognize that full premium deficiency reserve at a faster pace.

Our next question comes from Alex Scott of Goldman Sachs.

I would like to follow up on the situation with the premium deficiency reserve. Based on your previous sensitivity analysis indicating it has likely decreased to below $1 billion, will this lead to a tailwind that enables you to free up capital and access more than the usual $1 billion of statutory capital as we approach 2024? If that's correct, it seems you're nearing the stage where you can consider a larger capital deployment each year. I'm interested in understanding the mechanics of this and, more importantly, how you plan to deploy capital as we move beyond this period of increased drag.

Yes, Alex, it's Rick. Let me take a moment to discuss the overall dynamics, especially concerning the PDR you've mentioned. It's important to look at the broader picture of capital generation and deployment across the company, as this is just one aspect. The $1 billion of statutory earnings we have is a strong indicator of our ability to generate capital. This, combined with our current RBC and liquidity position, puts us in a favorable spot. Steve highlighted some factors to consider for the fourth quarter. We have several opportunities to invest that capital, with core growth being our top priority, focusing on the overall growth of the enterprise. We will look at inorganic ways to enhance our capabilities when necessary, building upon our existing platform in ways similar to past initiatives. Additionally, we're committed to maintaining a healthy dividend growth rate alongside our capital deployment strategy. It's essential to consider the PDR within this framework. As Steve pointed out, interest rates are one factor influencing the PDR's development. I want to emphasize that we have accelerated our funding and recognition of it in a balanced manner, keeping the $200 million in share repurchases in mind. We’re pleased with how we balance the needs of different stakeholders while returning capital to our shareholders through dividends and repurchases. Looking ahead, the sensitivities related to the PDR remain significant, and we'll monitor how that unfolds. I don't want to make any premature assumptions, but we will outline our strategy as part of the 2023 process. Overall, I'm confident in our current position and our ability to deploy capital responsibly moving forward.

Follow-up question on Unum US, could you talk a bit about the competitive environment, how things look sort of headed into the end of the year? In terms of competition and pricing and so forth and how that translates into your view of revenue growth heading into next year?

Alex, it's Mike. I'll take that one. And maybe we'll take a minute because we do have some good dynamics going across our markets. So maybe I'll tee up the Unum brand for group insurance here in the U.S., but going to ask Tim and Mark to comment on those markets as well. And as you highlighted, we've built some good momentum here as we're heading into a really important closeout to the year and the January 1 effective date. And encouraging buildup across all of our core operations and see sales up and 14% on a constant currency basis. The core market group insurance sales here in the U.S. are particularly encouraging up approximately 30% in the quarter. It's a relatively small quarter given seasonality, but it bodes well for us as we look into, again, that important fourth quarter. differentiators like we've been talking about the investments that we've been making in digital and things like our HR Connect solutions, our new Total Leave platform, those are really helping us drive strong sales results, particularly in our middle markets. And again, that's really encouraging. Our Individual Disability executive benefit doing supplemental disability to our clients near record sales quarter here again in the third quarter and a lot of momentum built. I think it ties to what Rick was talking about. This is a market that's increasingly cognizant of the exposure and the need for our products around financial protection. So we operate in very competitive markets. We have good competitors out there. But again, I think some of the investments that we've made and some of the environmental conditions are encouraging here in the U.S. And I think it's true also for voluntary, Tim.

Yes. Thanks, Mike, and Alex. Thanks for the question. Since you asked a question about Unum, I'll start there on the Unum brand for VB. We are pleased with the momentum that we see building in the Unum VB brand, and we're also pleased with what we're seeing in the pipeline for the rest of the year and for 2023 as well. On the Colonial Life brand, we're really pleased with the progress and momentum that we've seen since the pandemic. Remember that this lot of business does not benefit from natural growth that we see in some of our other lines. But through the investments we've made in digital capabilities and investments in our distribution system and team, we feel really good about prospects long term for the business. In the third quarter of '23, large case sales were a bit lumpy and they can be. And we've said previously that we view that market somewhat opportunistically. And so we saw a little bit of an impact there on large cases, but we're really encouraged by what we're seeing in our target markets, especially our public sector marketplace. I'll hand it over to Mark for a point of view on the international business.

Thanks, Tim. If I take the U.K. first, the market has been growing nicely off the back of COVID. There's certainly been a kicker there. You see us maintaining our market-leading position in long-term disability and in group critical illness, and we're starting to pick our game up in the group life market where we've been a little less well penetrated. And I think the drivers of that are the way in which we're differentiating our experience to the brokers who are the gatekeepers to the customers and the value-added services we've been able to add into the product for the benefit of the employee and the employer. So I think we're feeling pretty good about the growth we can drive here in the U.K. I think over in Poland, we've seen steady growth in our individual block of business, but really some exceptional growth in our group business, particularly the strength of the product that we've got there, but also we're adding additional distribution there. So I think you're seeing that come through in the sales growth in the overall international business, which I think this quarter in dollar terms is 62%, but in local currency is 82% growth. So that's everything from me.

Our next question comes from Tom Gallagher of Evercore.

First one is just the GAAP favorable reserving release for 3Q for the waiver claims recoveries. Is that also going to be reflected in statutory next quarter? Or is that a GAAP-only phenomenon?

This is Steve. I can take that one. Just a little bit of background about how we go through our reserving process and our assumption setting process. We look at assumptions over time based on the experience that we see. If you go back to last year, we felt like the experience we were seeing in recoveries was at such a level that we wanted to go ahead and reflect that in our GAAP reserves. The GAAP reserves and statutory reserves are on a little bit different construct just because you need to look at the levels of margin that you accumulate on those two bases. Last year, we felt like it was time to change the assumption set on GAAP. We did that. We've continued to have very favorable recovery experience. So we went ahead and adjusted that again on the GAAP side, but felt comfortable with the margins that we had on the statutory side. I will say with the latest updates to expectations, we are likely to determine an update as appropriate for the statutory basis in 2023, and I won't expect anything to happen this year, but that is something that we'll look at next year and determine whether we need to reflect that experience and how we think about our assumption set for statutory.

Got you. And Steve, for in terms of ring fencing what that might mean for statutory next year, would that be similar only to the change in the GAAP reserves this year? Or might it also include something cumulative on the earnings side, so you might have to add a few pieces there to think about what the statutory impact might be?

Yes. I wouldn't predict what the amount would be. We need to go through. We need to do the work. We do hold higher levels of margin on the statutory side. So we'll do the work next year. I would anticipate it will not be as much as the releases that we took on the GAAP side, but we'll inform the market as we go through that process.

Can you provide an update on long-term care risk transfer? Rates have significantly increased, and one recent concern in the market is some higher claim costs. However, these costs don't impact you due to your indemnity feature. With interest rates climbing, is there a greater potential for advancing discussions on possible risk transfer? Are we getting closer to a resolution, or is it still a distant prospect? Will any transactions likely involve just smaller blocks of your LTC? Please share any holistic insights on our current status.

Yes, Tom, it's Rick. I'll share some insights at the macro level regarding our observations. Considering the rising interest rate environment, it positively influences our long-term cash flow reporting, as Steve mentioned. When we evaluate risk transfer in the markets, I would say the situation has largely remained consistent in how others perceive it. The necessary work typically revolves around liability assumptions, not solely focused on interest rates. There is interest in the market, but I wouldn’t indicate that there have been significant changes. Our perspective has remained steady. As we consider potential transactions and various approaches, including segments of our business, all these elements are unchanged. I want to reaffirm your point about the expense nature and the indemnity aspect of our block, which doesn’t affect our capacity for risk transfer. While a higher interest rate environment is beneficial, we continue to actively engage in this area.

Our next question comes from Suneet Kamath from Jefferies.

I wanted to go back to the assumption review, particularly related to long-term care. Just curious what your experience around morbidity improvement has been of late? And if there were any other identifiable trends post-COVID that you can talk about with respect to long-term care?

This is Steve. I can take this one. I would say there's nothing of note that came out of our review. We obviously look at our margin in aggregate as we look at the experience that we've seen over the last year and we folded that into our experience set. So I would say our views haven't changed. I would note that like many others, as we looked at some of the experience we had through COVID, you have to kind of deemphasize some of that experience if you think about what our long-term expectations are. And so some of the claim of mortality, maybe some of the transition activity, we discount that pretty much when we're thinking about longer-term expectations unless any of that would continue over the longer term. So I would say there's really nothing to note. We're very happy about the process that we've gone through. And like I said in my opening remarks, from a GAAP perspective, we're done with our reserve adequacy work. Obviously, we'll go through our year-end statutory work, but don't view anything there of any significance either.

Okay. Got it. And then, I guess, for the core business, I mean, it's great to hear all this talk about natural growth, but at the same time, we continue to hear the word recession mentioned every single day. So I guess the question is, are you hearing anything from your corporate clients around headcount or potential layoffs? It does seem like everybody is talking about it. But when we look at your underlying trends, it doesn't seem to be showing up at least not yet.

Let me start off and then I'll hand it over to Mike for some details. But when you think about the recessionary impact, certainly, we hear what you hear and the discussions around it, you have to step back and think about the impacts of the business overall. One, you mentioned about the natural growth we've seen certainly been a good lift. And so you might see a little bit of slowing growth. But given all the great things that the team just talked about, we still see good growth, and that's really just protecting more people. So that's one piece of it. Got to think about the investment portfolio. Steve went through some of the details on that. I feel very good in their analysis. We stressed the portfolio through recessionary analysis. And then I think it comes back to questions around the core business and what happens in a recessionary environment on a couple of fronts. And Mike, maybe you can give some perspectives on that.

Yes. Sure. So Suneet, I think good observation. I would also say that what we see in natural growth is probably lagged by a couple 2, 3 months. So it wouldn't be a great forward-looking indicator. But in terms of conversation, it seems to feel pretty good about the diversification of the client base. When we think about potential changes macroeconomically, the fact that we've had a lot of success in industries like health care, a lot of success, certainly in some of the more cyclical but in some of the more steady as well. So I think that diversification has played well in prior cycles, and I expect it would going forward from a top line point of view. And then always a watch area for us will be disability risk through a recessionary environment. Starting with SSDI, you do typically see long-term disability incidents tick up a bit in the industry on the private side as well. We tend to be a bit more muted, I think, looking at the last two cycles, something in maybe 2 to 3 points on the loss ratio side from elevated incidents and then typically recovery, it was actually drifts up to offset that to a degree. So it's a watch area for us. We're obviously in a good spot when we think about group disability risk right now. So we start from a position of strength. And the last thing I'd mention when you think about risk, claim risk is that typically, you have four-plus quarters before recessionary impacts start to work their way into the book of business. So it gives you some time to take action.

Our next question comes from Tracy Benguigui from Barclays.

Rick, I'm glad you alluded to a more favorable PDR ultimate balance outcome than what you see per Slide 23 in your February outlook deck. I mean, interest rates are now well north. So that sensitivity table that cuts off at 2.5%. So I have a two-part question. First, can you quantify what would the 2026 PDR ultimate balance look like? Assuming a more normal shape of the yield curve? And if we see today's rates remain constant over 3 years? And then in contrast, can you quantify how the PR balance looks today on a trailing three-year basis and considering the current inverted shape of the yield curve?

Yes. A couple of things to mention, Tracy, is that the sensitivity we provided back in February was not focused on the yield curve but rather on the ultimate rate. If you take those numbers, which were based on the 10-year treasury at 30 or 50 basis points, it helps you understand the 30-year benchmark, and 30 years is where it really matters for our hedges. We are considering the longer end of the curve. The sensitivities you've mentioned perform reasonably well given the moves we've observed since then. However, as we've indicated multiple times, we are not focusing on 2026; instead, we are looking at how this develops over the next several years. We discussed where things are projected to be at the end of this year and how they will transition into next year. Steve, do you have anything to add?

Yes. I just kind of go back to how the premium deficiency reserve calculation looks. And although we feel great about where rates are today, it is going to take a few years for those rates to wind their way into the discount rate calculation. So I wouldn't expect a big drop in our PDR calculation at the end of this year, just to set expectations. We're very happy about what rates have done in the near term behind us here. But as we get through year end, it's going to take a few years for that to work its way into the calculation.

Yes. I totally got it. The 50 basis point spread, just a little bit more normal shape of the curve. That's right, I mentioned that. very basic question. So 80% of your LTC risk resides in Unum America and I get the relationship between Fairwind and the captive reinsurer and Unum America succeeded. But how does it work? Hedging Unum America cash flow does that help the PR calculation at all resulting in less contributions? Or is this just for risk management purposes?

Yes, Tracy, this is Steve. First and foremost, risk management. We just think it's a good way to manage an LTC block when you have interest rates at this level to go ahead and try to lock some of those in the near term. I would say just mechanically, how that would work is right now, our new money rate assumption is this trailing three-year average. So for those investable cash flows that we have hedged, we've kind of locked in what that new money yield assumption is currently. And so it kind of accelerates, I guess, reflecting the current interest rate environment. But we view it as downside protection so that if rates in the future do come down, we know we can achieve a certain yield on our future investable cash flows.

Our final question for today comes from Jamminder Bhullar from JPMorgan.

So most of my questions were answered. But just on disability margins. The results are obviously pretty strong, and I think they're significantly stronger than even you would have assumed earlier this year. So can you talk about what drivers of the momentum in the business you feel are related to the economy or to inflation or other things that might be somewhat temporary in nature versus anything that you've done on your end that might be helping your results beyond the environment?

Jimmy, it's Mike. And I would agree, favorable risk results in group disability, more favorable than we would have anticipated. And like I mentioned, we have definitely spent time really digging in, looking at various segments of that strength, comparing them to history and to our expectations. And like I mentioned earlier, it is quite broad-based across sectors and across duration of claims. I do think that it is reasonable to conclude that the environment is a conducive one for our people working with claimants to help them get back to a productive work back in the workplace. Teasing out how much is internal versus how much is environment is a really tricky thing as I'm sure that you can appreciate. We feel really good about the team that we have in our benefits organization. We feel really good about the team. And it is really a team that we have between our field organization, our underwriting groups, and our pricing actuaries that have just been very, very good over time at taking current experience and factoring that into our renewal and new business pricing process. So I know that's probably not as specific as an answer as you would like. But as Steve said, it does at this point with a few quarters here, positive experience suggests to us that it's likely to continue to a degree and sort of the moderation back towards long-term loss ratio expectations is probably going to take some amount of time.

And then I think other companies have had fairly good margins in disability as well. Yours have been even better. But are you seeing any signs of companies sort of giving up some of that in pricing as you looked at renewal season? Have you seen any indications of disability prices being a little softer because of it?

Yes. Good question, Jimmy. And you're right to ask your question about how this might translate into market pricing. And we are really actually pleased with how our January 1 renewals lead in the larger employer market, we were placing those in the summertime. We're continuing to work that all the way through down into the small end of the market now. And we're tracking well relative to our expectations. So that, I think, for us is job one and just making sure that we're keeping our clients and making adjustments as you always will, with your book of business based on risk outcomes. So that feels pretty good. We talked about the sales momentum across group insurance and I feel very good, particularly in that core market, which for us is a really important one and how that's playing through. And I guess I would take a step back when it comes to our approach to pricing, and again, you would have heard us talk about this, we do take a very long-term lens. That's what I think our clients really appreciate is some consistency in approach and not reacting quarter-to-quarter. So while we do have generally favorable risk experience, certainly, interest rates as well are a bit of a tailwind for us. We're going to look at that over time, often in combination with other products besides group disability, pulling in life insurance, pulling in voluntary benefits and really take a long-term lens to overall client relationships. So hopefully, that's helpful.

We have no further questions. I will hand back to Rick McKenney for any further remarks.

Great. Thanks, Alex. I want to thank everybody for taking the time to join us this morning. That does complete our call for the third quarter. We do look forward to seeing many of you in the upcoming weeks and months at investor conferences, and so I appreciate you spending the time with us this morning. Talk to you all soon. Goodbye.

Thank you for joining today's call. You may now disconnect.