Unum 2008 Annual Report Download - page 94

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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.
See “Investments” contained herein and 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 exposure to interest rate changes results from our holdings of financial instruments such as fixed rate investments, derivatives,
and interest-sensitive liabilities. Fixed rate investments include fixed maturity securities, mortgage loans, policy loans, and short-term
investments. Fixed maturity securities include U.S. and foreign government bonds, securities issued by government agencies, corporate
bonds, mortgage-backed securities, and redeemable preferred stock, all of which are subject to risk resulting from interest rate fluctuations.
Certain of our financial instruments, fixed maturity securities and derivatives, are carried at fair value in our consolidated balance sheets.
The fair value of these financial instruments may be adversely affected by changes in interest rates. A rise in interest rates may increase
the net unrealized loss related to these financial instruments, but may improve our ability to earn higher rates of return on new purchases
of fixed maturity securities. Conversely, a decline in interest rates may decrease the net unrealized loss, but new securities may be
purchased at lower rates of return. Although changes in fair value of fixed maturity securities and derivatives due to changes in interest
rates may impact amounts reported in our consolidated balance sheets, these changes will not cause an economic gain or loss unless we
sell investments, terminate derivative positions, determine that an investment is other than temporarily impaired, or determine that a
derivative instrument is no longer an effective hedge.
Other fixed rate investments, such as mortgage loans and policy loans, are carried at amortized cost and unpaid balances, respectively,
rather than fair value in our consolidated balance sheets. These investments may have fair values substantially higher or lower than the carrying
values reflected in our balance sheets. A change in interest rates could impact our financial position if we sold our mortgage loan investments at
times of low market value. A change in interest rates would not impact our financial position at repayment of policy loans, as ultimately the
cash surrender values or death benefits would be reduced for the carrying value of any outstanding policy loans. Carrying amounts for short-
term investments approximate fair value, and we believe we have minimal interest rate risk exposure from these investments.
We believe that the risk of being forced to liquidate investments or terminate derivative positions is minimal, primarily due to the level
of capital at our insurance subsidiaries, our holding company liquidity position, and our investment strategy which we believe provides for
adequate cash flows to meet the funding requirements of our business. We may in certain circumstances, however, need to sell investments
due to changes in regulatory or capital requirements, changes in tax laws, rating agency decisions, and/or unexpected changes in liquidity needs.
Although the majority of our liabilities related to insurance contracts are not interest rate sensitive and we therefore have minimal
exposure to policy withdrawal risk, the fair values of liabilities under all insurance contracts are taken into consideration in our overall
management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment cash flows
with amounts due under insurance contracts. Changes in interest rates and individuals’ behavior affect the amount and timing of asset and
liability cash flows. We actively manage our asset and liability cash flow match and our asset and liability duration match to minimize interest
rate risk. We 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 what we believe to be 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 current and forward interest rate swaps, currency forward contracts, forward treasury locks, and options on forward interest rate
swaps to hedge interest rate risks and to match asset durations and cash flows with corresponding liabilities.
Short-term and long-term debt are not carried at fair value in our consolidated balance sheets. If we modify or replace existing short-
term or long-term debt instruments at current market rates, we may incur a gain or loss on the transaction. We believe our debt-related risk
to changes in interest rates is relatively minimal. In the near term, we expect that our need for external financing is small, but changes in
our business could increase our need. Our short-term debt repayment requirements for 2009 can be met through existing cash flows.
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