Unum 2012 Annual Report Download - page 84

82 UNUM 2012 ANNUAL REPORT
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. See “Investments”
contained herein and Notes 2, 3, and 4 of the “Notes to Consolidated Financial Statements” contained herein 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 decrease
the net unrealized gain 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 increase the net unrealized gain, 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, the level of cash and marketable securities at our holding companies, 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 our policy benefits are primarily in the form of claim payments and we therefore have minimal exposure to the policy
withdrawal risk associated with deposit products such as individual life policies or annuities, 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 limit interest rate risk. Due to the long duration of our long-term care product, we may be unable to
purchase appropriate assets with cash flows and durations such that the timing and/or amount of our investment cash flows may not
match those of our maturing liabilities. Sustained periods of low interest rates could result in lower than expected profitability or increases
in reserves. 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 enables us to choose what we believe to be the most appropriate
investment strategy, as well as to limit the risk of disadvantageous outcomes. We use this analysis in determining hedging strategies
and utilizing derivative financial instruments. We use current and forward interest rate swaps, options on forward interest rate swaps,
and forward treasury locks to hedge interest rate risks and to match asset durations and cash flows with corresponding liabilities.