Unum 2013 Annual Report Download - page 26

Management’s Discussion and Analysis of
Financial Condition and Results of Operations
24 / UNUM 2013 ANNUAL REPORT
Reserves for Policy and Contract Benefits
Reserves for policy and contract benefits are our largest liabilities and represent claims that we estimate we will eventually pay
to our policyholders. The two primary categories of reserves are policy reserves for claims not yet incurred and claim reserves for claims
that have been incurred or are estimated to have been incurred but not yet reported to us. Reserves for policy and contract benefits
equaled $40.5 billion and $39.9 billion at December 31, 2013 and 2012, respectively, or approximately 79.8 percent and 74.4 percent of our
total liabilities, respectively. Reserves ceded to reinsurers were $6.8 billion and $6.7 billion at December 31, 2013 and 2012, respectively,
and are reported as a reinsurance recoverable in our consolidated balance sheets.
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 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 individual disability, long-term care,
and other products in our Closed Block segment. 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 generally 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, 2013
represented approximately 12.1 percent, 0.1 percent, and 9.9 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