Unum 2006 Annual Report Download - page 113

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to various market risk exposures, including interest rate risk and foreign exchange rate risk. The
following discussion regarding our risk management activities includes forward-looking statements that involve risk
and uncertainties. Estimates of future performance and economic conditions are reflected assuming certain changes
in market rates and prices were to occur (sensitivity analysis). Caution should be used in evaluating our overall
market risk from the information presented below, as actual results may differ. We employ various derivative
programs to manage these material market risks. See Notes 4 and 5 of the “Notes to Consolidated Financial
Statements” for further discussions of the qualitative aspects of market risk, including derivative financial
instrument activity.
Interest Rate Risk
Our operations are subject to risk resulting from interest rate fluctuations, primarily long-term U.S. interest rates.
Changes in interest rates and individuals’ behavior affect the amount and timing of asset and liability cash flows.
We continually model and test asset and liability portfolios to improve interest rate risk management and net yields.
Testing the asset and liability portfolios under various interest rate and economic scenarios allows us to choose the
most appropriate investment strategy, as well as to prepare for disadvantageous outcomes. This analysis is the
precursor to our activities in derivative financial instruments. We use interest rate swaps, interest rate forward
contracts, exchange-traded interest rate futures contracts, and options to hedge interest rate risks and to match asset
durations and cash flows with corresponding liabilities.
Assuming an immediate increase of 100 basis points in interest rates from year end levels, the net hypothetical
decrease in stockholders’ equity related to financial and derivative instruments was estimated to be $1.4 billion and
$1.5 billion at December 31, 2006 and 2005, respectively. The fair values of mortgage loans, which are reported in
our consolidated balance sheets at amortized cost, would decrease by approximately $50 million and $90 million at
December 31, 2006 and 2005, respectively.
At December 31, 2006 and 2005, assuming a 100 basis point decrease in long-term interest rates from year end
levels, the fair values of our long-term debt would increase approximately $210 million and $240 million,
respectively.
The effect of a change in interest rates on asset prices was determined using a duration implied methodology for
corporate bonds, private placement securities, and government and government agency securities whereby the
duration of each security was used to estimate the change in price for the security assuming an increase of 100 basis
points in interest rates. The effect of a change in interest rates on the mortgage-backed securities is estimated using
a mortgage analytic system which takes into account the impact of changing prepayment speeds resulting from a 100
basis point increase in interest rates on the change in price of the mortgage-backed securities. These hypothetical
prices were compared to the actual prices for the period to compute the overall change in market value. The changes
in the fair values of long-term debt were determined using discounted cash flows analyses. Because we actively
manage our investments and liabilities, actual changes could be less than those estimated above.
Foreign Currency Risk
We are also subject to foreign exchange risk arising from our foreign operations and certain investment securities
denominated in those local currencies. Foreign operations represented 7.4 percent and 6.4 percent of total assets at
December 31, 2006 and 2005, respectively, and 9.7 percent and 9.2 percent of total revenue from continuing
operations for 2006 and 2005, respectively. Assuming foreign exchange rates decreased 10 percent from the
December 31, 2006 and 2005 levels, stockholders’ equity and net income as of and for the periods then ended would
not have been materially affected.