Unum 2008 Annual Report Download - page 83

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79

Below-Investment-Grade Fixed Maturity Securities:
• The decline in fair value of the U.S. based recreational products company securities results from a signicant decline in consumer
durable goods spending. The company operates in highly cyclical industries, and demand for its products has deteriorated rapidly.
The company entered the current economic downturn with a significant cash balance and still retains adequate liquidity to
manage through the current economic cycle.
• The fair value of the U.S. based media conglomerate securities declined due to the increase in leverage from a leveraged buyout
transaction, as well as a general widening of credit spreads in the media industry. The company is expected to continue to generate
sufficient cash flow to service its debt obligations, and it has ownership interests in a variety of media businesses that could be sold to
further reduce leverage.
• The fair value of the securities of the U.S. based automotive supply company declined due to lower vehicle production from multiple
domestic automobile manufacturers. The company maintains a significant amount of cash and liquidity to manage through the current
economic cycle, with limited near-term debt maturities. The company has a dominant position in its markets.
• The decline in fair value of the Canadian based metals and mining company is due to the increased slowdown in global economic
activity, resulting in lower commodity prices and earnings pressure for this sector. As part of its diversification strategy, the company
recently increased its leverage due to an acquisition prior to the current market pressure on credit availability. The company has
ample cash flow to significantly reduce its debt burden in the coming year, which should allow for a timely refinance or extension of its
bridge debt. The company also owns marketable long-lived assets.
Our mortgage/asset-backed securities were approximately $3.7 billion and $4.0 billion on an amortized cost basis at December 31,
2008 and 2007, respectively. At December 31, 2008, the mortgage/asset-backed securities had an average life of 3.79 years, effective
duration of 4.04 years, and a weighted average credit rating of AAA. The mortgage/asset-backed securities are valued on a monthly basis
using valuations supplied by the brokerage firms that are dealers in these securities as well as independent pricing services. The primary
risk involved in investing in mortgage/asset-backed securities is the uncertainty of the timing of cashows from the underlying loans
due to prepayment of principal with the possibility of reinvesting the funds in a lower interest rate environment. We use models which
incorporate economic variables and possible future interest rate scenarios to predict future prepayment rates. The timing of prepayment
cash flows may also cause volatility in our recognition of investment income. We recognize investment income on these securities using a
constant effective yield based on projected prepayments of the underlying loans and the estimated economic life of the securities. Actual
prepayment experience is reviewed periodically, and effective yields are recalculated when differences arise between prepayments
originally projected and the actual prepayments received and currently projected. The effective yield is recalculated on a retrospective
basis, and the adjustment is reflected in net investment income.
We have not invested in mortgage-backed derivatives, such as interest-only, principal-only, or residuals, where market values can be
highly volatile relative to changes in interest rates. All of our mortgage-backed securities have fixed rate coupons. The credit quality of our
mortgage-backed securities portfolio has not been negatively impacted by the recent issues in the market concerning subprime mortgage
loans. The change in value of our mortgage-backed securities portfolio has moved in line with that of prime agency-backed mortgage-
backed securities.
As of December 31, 2008, our exposure to below-investment-grade fixed maturity securities was $1,633.9 million, approximately
4.6 percent of the carrying value of invested assets excluding ceded policy loans. 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.