Unum 2009 Annual Report Download - page 26

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Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Unum
2009
Policy Reserves
Policy reserves are established in the same period we issue a policy and equal the difference between projected future policy benefits
and future premiums, allowing a margin for expenses and profit. These reserves relate primarily to our traditional non interest-sensitive
products, including our individual disability, individual and group long-term care, and voluntary benefits products in our Unum US segment;
individual disability products in our Unum UK segment; disability and cancer and critical illness policies in our Colonial Life segment; and,
the Individual Disability — Closed Block segment products. The reserves are calculated based on assumptions that were appropriate at the
date the policy was issued and are not subsequently modified unless the policy reserves become inadequate (i.e., loss recognition occurs).
• Persistency assumptions are based on our actual historical experience adjusted for future expectations.
• Claim incidence and claim resolution rate assumptions related to mortality and morbidity are based on actual experience or industry
standards adjusted as appropriate to reflect our actual experience and future expectations.
• Discount rate assumptions are based on our current and expected net investment returns.
In establishing policy reserves, we use assumptions that reflect our best estimate while considering the potential for adverse variances
in actual future experience, which results in a total policy reserve balance that has an embedded reserve for adverse deviation. We do not,
however, establish an explicit and separate reserve as a provision for adverse deviation from our assumptions.
We perform loss recognition tests on our policy reserves annually, or more frequently if appropriate, using best estimate assumptions
as of the date of the test, without a provision for adverse deviation. We group the policy reserves for each major product line within a
segment when we perform the loss recognition tests. If the policy reserves determined using these best estimate assumptions are higher
than our existing policy reserves net of any deferred acquisition cost balance, the existing policy reserves are increased or deferred acquisition
costs are reduced to immediately recognize the deficiency. Thereafter, the policy reserves for the product line are calculated using the same
method we used for the loss recognition testing, referred to as the gross premium valuation method, wherein we use our best estimate as
of the gross premium valuation (loss recognition) date rather than the initial policy issue date to determine the expected future claims,
commissions, and expenses we will pay and the expected future gross premiums we will receive.
Because the key policy reserve assumptions for policy persistency, mortality and morbidity, and discount rates are all locked in at policy
issuance based on assumptions appropriate at that time, policy reserve assumptions are not changed due to a change in claim status from
active to disabled subsequent to policy issuance. Therefore, we maintain policy reserves for a policy for as long as the policy remains in-force,
even after a separate claim reserve is established. Incidence rates in industry standard valuation tables for policy reserves have traditionally
included all lives, active and disabled. In addition, the waiver of premium provision provides funding for the policy reserve while a policyholder
is disabled. As a result, the funding mechanisms and the cost of claims are aligned and require a policy reserve to be held while on claim.
In addition, most policies allow for multiple occurrences of claims, and a policy reserve is consequently still maintained at the time of claim
to fund any potential future claims. The policy reserves build up and release over time based on assumptions made at the time of policy
issuance such that the reserve is eliminated as policyholders reach the terminal age for coverage, die, or voluntarily lapse the policy.
Policy reserves for Unum US, Unum UK, and Colonial Life products, which at December 31, 2009 represented approximately 37.4 percent,
0.2 percent, and 9.3 percent, respectively, of our total gross policy reserves, are determined using the net level premium method as prescribed
by GAAP. In applying this method, we use, as applicable by product type, morbidity and mortality incidence rate assumptions, claim resolution
rate assumptions, and policy persistency assumptions, among others, to determine our expected future claim payments and expected future
premium income. We then apply an interest, or discount, rate to determine the present value of the expected future claims, commissions,
and expenses we will pay and the expected future premiums we will receive, with a provision for profit allowed.
Policy reserves for our Individual Disability — Closed Block segment, which at December 31, 2009, represented approximately 10.4 percent
of our total gross policy reserves, are determined using the gross premium valuation method based on assumptions established as of
January 1, 2004, the date of loss recognition. Key assumptions are policy persistency, claim incidence, claim resolution rates, commission
rates, and maintenance expense rates. We then apply an interest, or discount, rate to determine the present value of the expected future
claims, commissions, and expenses we will pay as well as the expected future premiums we will receive. There is no provision for profit. The