Unum 2006 Annual Report Download - page 103

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As of December 31, 2006, our exposure to below-investment-grade fixed maturity securities was $2,134.0 million,
approximately 5.8 percent of the fair value of invested assets excluding ceded policy loans, compared to 6.0 percent
at the end of 2005. Below-investment-grade bonds are inherently more risky than investment-grade bonds since the
risk of default by the issuer, by definition and as exhibited by bond rating, is higher. Also, the secondary market for
certain below-investment-grade issues can be highly illiquid. Additional downgrades may occur, but we do not
anticipate any liquidity problem caused by our investments in below-investment-grade securities, nor do we expect
these investments to adversely affect our ability to hold our other investments to maturity.
We have a significant interest in, but are not the primary beneficiary of, a special purpose entity which is a
collateralized bond obligation asset trust in which we hold interests in several of the tranches and for which we act
as investment manager of the underlying securities. Our investment in this entity is reported at fair value with fixed
maturity securities in the consolidated balance sheets. The fair value of this investment was derived from the fair
value of the underlying assets. The fair value and amortized cost of this investment were $18.8 million and $18.4
million, respectively, at December 31, 2006, and $21.5 million and $21.0 million, respectively, at December 31,
2005.
Mortgage Loans and Real Estate
Our mortgage loan portfolio was $944.0 million and $739.4 million on an amortized cost basis at December 31,
2006 and 2005, respectively. We expect that we will continue to add investments in this category either through the
secondary market or through loan originations. We believe our mortgage loan portfolio is well diversified
geographically and among property types. The incidence of problem mortgage loans and foreclosure activity
remains low, and we expect the level of delinquencies and problem loans to remain low in the future. At December
31, 2006, impaired mortgage loans totaled $2.8 million. We had no impaired mortgage loans at December 31, 2005.
Real estate was $17.9 million and $18.2 million at December 31, 2006 and 2005, respectively. Investment real
estate is carried at cost less accumulated depreciation. Real estate acquired through foreclosure is valued at fair
value at the date of foreclosure and may be classified as investment real estate if it meets our investment criteria. If
investment real estate is determined to be permanently impaired, the carrying amount of the asset is reduced to fair
value. Occasionally, investment real estate is reclassified to real estate held for sale when it no longer meets our
investment criteria. Real estate held for sale, which is valued net of a valuation allowance that reduces the carrying
value to the lower of cost or fair value less estimated cost to sell, was $6.5 million at December 31, 2006 and $6.7
million at December 31, 2005.
We use a comprehensive rating system to evaluate the investment and credit risk of each mortgage loan and to
identify specific properties for inspection and reevaluation. We establish an investment valuation allowance for
mortgage loans based on a review of individual loans and the overall loan portfolio, considering the value of the
underlying collateral. Investment valuation allowances for real estate held for sale are established based on a review
of specific assets. If a decline in value of a mortgage loan or real estate investment is considered to be other than
temporary or if the asset is deemed permanently impaired, the investment is reduced to estimated net realizable
value, and the reduction is recognized as a realized investment loss. We monitor the risk associated with these
invested asset portfolios and regularly review and adjust the investment valuation allowance. At December 31,
2006, the balance in the valuation allowance for mortgage loans was $0.5 million. We had no valuation allowance
for mortgage loans at December 31, 2005. At December 31, 2006 and 2005, the balance in the valuation allowances
for real estate was $7.6 million.
Derivatives
We use derivative financial instruments to manage reinvestment risk, duration, and currency risk. Historically, we
have utilized interest rate futures contracts, current and forward interest rate swaps and options on forward interest
rate swaps, current and forward currency swaps, interest rate forward contracts, forward treasury locks, currency
forward contracts, and forward contracts on specific fixed income securities. All of these freestanding derivative
transactions are hedging in nature and not speculative. Positions under our hedging programs for derivative activity
that were open during 2006 involved current and forward interest rate swaps, current and forward currency swaps,
forward treasury locks, currency forward contracts, and options on forward interest rate swaps.