Unum 2014 Annual Report Download - page 69

UNUM • 2014 ANNUAL REPORT 67
During 2014, we recognized an other-than-temporary impairment loss of $13.5 million on fixed maturity securities issued by a
U.S.-based oil and natural gas exploration and production company. The company has a high debt-to-equity ratio, and its projected liquidity
has recently decreased significantly as a result of the declines in oil and natural gas prices. We believe the company will need to sell non-
core assets to maintain liquidity and to build and develop its core assets. This process will be more difficult if the low oil price environment
persists for an extended period of time. At the time of the impairment loss, these securities had been in an unrealized loss position for a
period of greater than 90 days but less than 180 days. We had no individual realized investment losses of $10.0 million or greater from
other-than-temporary impairments during 2013 or 2012.
We had no individual realized investment losses of $10.0 million or greater from the sale of fixed maturity securities during 2014
or 2013. During 2012, we recognized a loss of $11.2 million on the sale of securities issued by a large U.S. department store chain. In 2011,
the company’s management was replaced by a new team of executives that embarked on a radically different retailing strategy. While the
company had ample liquidity and sizable value in real estate assets, initial operating results under this new strategy had been significantly
below market expectations, and there was uncertainty as to whether this new strategy would be successful. Because of this, we had
concerns that liquidity could be compromised over an extended period of time. At the time of disposition, these securities had been in an
unrealized loss position for a period of greater than three years.
At December 31, 2014, we had minimal exposure to investments for which the payment of interest and principal is guaranteed under
a financial guaranty insurance policy, and the securities in aggregate have a weighted average credit rating of investment-grade absent the
guaranty insurance policy. At December 31, 2014, we held $191.1 million fair value ($169.7 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, 2014, our mortgage/asset-backed securities had an average life of 4.85 years, effective duration of 4.14 years, and
a weighted average credit rating of Aaa. 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, 2014, the amortized cost and fair value of our below-investment-grade fixed maturity securities was
$3,454.2 million and $3,525.2 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.