Unum 2013 Annual Report Download - page 70

Management’s Discussion and Analysis of
Financial Condition and Results of Operations
68 / UNUM 2013 ANNUAL REPORT
At December 31, 2013, we had minimal exposure to investments for which the payment of interest and principal is guaranteed under a
financial guaranty insurance policy, and all such securities are rated investment-grade absent the guaranty insurance policy. At December 31,
2013, we held $201.4 million fair value ($185.7 million amortized cost) of perpetual debentures, or “hybrid” securities, that generally have
no fixed maturity date. Interest on these securities due on any payment date may be deferred by the issuer. The interest payments are
generally deferrable only to the extent that the issuer has suspended dividends or other distributions or payments to any of its shareholders
or any other perpetual debt instrument.
At December 31, 2013, our mortgage/asset-backed securities had an average life of 5.23 years, effective duration of 4.31 years, and
a weighted average credit rating of Aa1. 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. One of the risks involved in investing in
mortgage/asset-backed securities is the uncertainty of the timing of cash flows 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 no exposure to subprime mortgages, “Alt-A” loans, or collateralized debt obligations in our investment portfolios. 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. The credit quality of our mortgage-backed securities portfolio has not been negatively impacted by
the 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, 2013, the amortized cost and fair value of our below-investment-grade fixed maturity securities was
$3,101.7 million and $3,199.3 million, respectively. Below-investment-grade securities are inherently more risky than investment-grade
securities 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
problems resulting from 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.
Our investments in issuers in foreign countries are chosen for specific portfolio management purposes, including asset and liability
management and portfolio diversification across geographic lines and sectors to minimize non-market risks. In our approach to investing in
fixed maturity securities, specific investments within approved countries and industry sectors are evaluated for their market position and
specific strengths and potential weaknesses. For each security, we consider the political, legal, and financial environment of the sovereign
entity in which an issuer is domiciled and operates. The country of domicile is based on consideration of the issuer’s headquarters, in
addition to location of the assets and the country in which the majority of sales and earnings are derived. We continually evaluate our
foreign investment risk exposure. We do not have foreign currency risk, as the cash flows from these investments are either denominated
in currencies or hedged into currencies to match the related liabilities. We have no direct exposure to sovereign debt of these countries,
no unfunded commitments to issuers domiciled in these countries, and have not used credit derivatives to hedge our exposure or to sell
credit protection.
Our monitoring is heightened for investments in certain countries due to our concerns over the current economic and political
environments as well as the banking crisis, and we believe these investments are more vulnerable to potential credit problems. For those
countries for which we have heightened our monitoring, the following table lists our exposure by country, together with a discussion on
each exposure. We have neither direct nor indirect exposure to sovereign debt of any other countries for which we believe there is a
heightened risk of sovereign default.