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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2015

or

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 1-14925

STANCORP FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Oregon		93-1253576
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1100 SW Sixth Avenue, Portland, Oregon, 97204

(Address of principal executive offices, including zip code)

(971) 321-7000

(Registrant’s telephone number, including area code)

NONE

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Large Accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of April 24, 2015, there were 42,208,309 shares of the registrant’s common stock, no par value, outstanding.

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TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
ITEM 1.		FINANCIAL STATEMENTS
		Unaudited Condensed Consolidated Statements of Income for the three months ended March 31, 2015 and 2014			3
		Unaudited Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2015 and 2014			4
		Unaudited Condensed Consolidated Balance Sheets at March 31, 2015 and December 31, 2014			5
		Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2015 and the year ended December 31, 2014			6
		Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2015 and 2014			7
		Notes to the Unaudited Condensed Consolidated Financial Statements			8
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			40
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			71
ITEM 4.		CONTROLS AND PROCEDURES			71
PART II. OTHER INFORMATION
ITEM 1.		LEGAL PROCEEDINGS			72
ITEM 1A.		RISK FACTORS			72
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			75
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES			76
ITEM 4.		MINE SAFETY DISCLOSURES			76
ITEM 5.		OTHER INFORMATION			76
ITEM 6.		EXHIBITS			76
SIGNATURES					77

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PART I.

FINANCIAL INFORMATION

ITEM 1:

FINANCIAL STATEMENTS

STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in millions—except per share data)

 

		Three Months Ended March 31,
		2015				2014
Revenues:
Premiums		$	532.1			$	510.1
Administrative fees			32.7				31.6
Net investment income			153.3				153.9
Net capital losses:
Total other-than-temporary impairment losses on fixed maturity securities—available-for-sale			---				---
All other net capital losses			(8.6)				(1.1)
Total net capital losses			(8.6)				(1.1)
Total revenues			709.5				694.5
Benefits and expenses:
Benefits to policyholders			398.7				401.1
Interest credited			41.1				43.5
Operating expenses			121.9				113.1
Commissions and bonuses			60.7				51.8
Premium taxes			9.1				9.1
Interest expense			7.8				8.4
Net increase in deferred acquisition costs (“DAC”), value of business acquired (“VOBA”) and other intangible assets			(7.2)				(1.2)
Total benefits and expenses			632.1				625.8
Income before income taxes			77.4				68.7
Income taxes			20.9				20.6
Net income		$	56.5			$	48.1
Net income per common share:
Basic		$	1.34			$	1.10
Diluted			1.32				1.08
Weighted-average common shares outstanding:
Basic			42,130,728				43,896,627
Diluted			42,673,025				44,381,944

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME

(In millions)

 

		Three Months Ended March 31,
		2015				2014
Net income		$	56.5			$	48.1
Other comprehensive income, net of tax:
Unrealized gains (losses) on fixed maturity securities—available-for-sale:
Net unrealized capital gains on securities—available-for-sale(1)			37.3				51.2
Reclassification adjustment for net capital gains included in net income(2)			(0.3)				(0.9)
Employee benefit plans:
Prior service credit and net losses arising during the period, net(3)			(0.1)				(0.4)
Reclassification adjustment for amortization to net periodic pension cost, net(4)			2.1				0.3
Total other comprehensive income, net of tax			39.0				50.2
Comprehensive income		$	95.5			$	98.3

 

(1)

Net of tax expenses of $20.1 million and $25.1 million for the three months ended March 31, 2015 and 2014, respectively.

(2)

Net of tax benefits of $0.2 million and $0.5 million for the three months ended March 31, 2015 and 2014, respectively.

(3)

Net of tax benefit of $0.3 million for the three months ended March 31, 2014.

(4)

Net of tax expenses of $1.1 million and $0.2 million for the three months ended March 31, 2015 and 2014, respectively.

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in millions)

 

		March 31, 2015				December 31, 2014
A S S E T S
Investments:
Fixed maturity securities—available-for-sale (amortized cost of $7,431.5 and $7,390.0)		$	7,885.7			$	7,773.7
Commercial mortgage loans, net			5,366.8				5,321.1
Real estate, net			33.8				37.0
Other invested assets			313.8				301.6
Total investments			13,600.1				13,433.4
Cash and cash equivalents			320.6				251.1
Premiums and other receivables			132.1				118.4
Accrued investment income			108.2				108.0
Amounts recoverable from reinsurers			1,000.3				994.2
DAC, VOBA and other intangible assets, net			380.7				381.0
Goodwill			36.0				36.0
Property and equipment, net			79.5				79.3
Other assets			71.4				129.4
Separate account assets			7,458.5				7,179.8
Total assets		$	23,187.4			$	22,710.6
L I A B I L I T I E S  A N D  S H A R E H O L D E R S’  E Q U I T Y
Liabilities:
Future policy benefits and claims		$	5,842.0			$	5,832.3
Other policyholder funds			6,628.9				6,537.8
Deferred tax liabilities, net			84.1				60.0
Short-term debt			1.1				1.1
Long-term debt			504.1				503.9
Other liabilities			411.9				440.1
Separate account liabilities			7,458.5				7,179.8
Total liabilities			20,930.6				20,555.0
Commitments and contingencies (See Note 10)
Shareholders’ equity:
Preferred stock, 100,000,000 shares authorized; none issued			---				---
Common stock, no par, 300,000,000 shares authorized; 42,186,489 and 42,077,825 shares issued and outstanding at March 31, 2015 and December 31, 2014, respectively			11.0				5.3
Accumulated other comprehensive income			153.3				114.3
Retained earnings			2,092.5				2,036.0
Total shareholders’ equity			2,256.8				2,155.6
Total liabilities and shareholders’ equity		$	23,187.4			$	22,710.6

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in millions—except per share data)

 

										Accumulated Other Comprehensive Income (Loss)
		Common Stock												Retained Earnings				Total Shareholders’ Equity
		Shares				Amount
Balance, January 1, 2014			44,126,389			$	68.0			$	134.7			$	1,950.1			$	2,152.8
Cumulative effect adjustment—ASU 2014-01			---				---				---				(7.2)				(7.2)
Adjusted balance, January 1, 2014			44,126,389				68.0				134.7				1,942.9				2,145.6
Net income			---				---				---				210.3				210.3
Other comprehensive loss, net of tax			---				---				(20.4)				---				(20.4)
Common stock:
Repurchased			(2,383,175)				(84.5)				---				(62.5)				(147.0)
Issued under share-based compensation plans, net			334,611				21.8				---				---				21.8
Dividends declared on common stock ($1.30 per share)			---				---				---				(54.7)				(54.7)
Balance, December 31, 2014			42,077,825				5.3				114.3				2,036.0				2,155.6
Net income			---				---				---				56.5				56.5
Other comprehensive income, net of tax			---				---				39.0				---				39.0
Common stock:
Issued under share-based compensation plans, net			108,664				5.7				---				---				5.7
Balance, March 31, 2015			42,186,489			$	11.0			$	153.3			$	2,092.5			$	2,256.8

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

 

		Three Months Ended March 31,
		2015				2014
Operating:
Net income		$	56.5			$	48.1
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized capital losses			8.6				1.1
Depreciation and amortization			38.1				35.2
DAC, VOBA and other intangible assets, net			(25.0)				(20.2)
Deferred income taxes			2.9				8.5
Changes in other assets and liabilities:
Receivables and accrued income			(20.0)				2.5
Future policy benefits and claims			2.3				(15.1)
Other, net			18.1				(46.3)
Net cash provided by operating activities			81.5				13.8
Investing:
Proceeds from sale, maturity, or repayment of fixed maturity securities—available-for-sale			308.9				232.1
Proceeds from sale or repayment of commercial mortgage loans			281.5				258.6
Proceeds from sale of real estate			0.8				4.9
Proceeds from sale of other invested assets			3.8				---
Acquisition of fixed maturity securities—available-for-sale			(354.3)				(431.2)
Acquisition or origination of commercial mortgage loans			(327.7)				(240.8)
Acquisition of real estate			(0.3)				(0.2)
Acquisition of other invested assets			(15.7)				(9.0)
Acquisition of property and equipment, net			(4.1)				(3.7)
Net cash used in investing activities			(107.1)				(189.3)
Financing:
Policyholder fund deposits			722.0				687.0
Policyholder fund withdrawals			(630.9)				(564.1)
Repayment of debt			---				(47.1)
Issuance of common stock			3.8				7.8
Repurchases of common stock			---				(34.6)
Other, net			0.2				0.2
Net cash provided by financing activities			95.1				49.2
Increase (decrease) in cash and cash equivalents			69.5				(126.3)
Cash and cash equivalents, beginning of period			251.1				379.3
Cash and cash equivalents, end of period		$	320.6			$	253.0
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	44.4			$	47.0
Income taxes			9.9				20.6
Non-cash transactions:
Real estate acquired through commercial mortgage loan foreclosure			---				2.6

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As used in this Form 10-Q, the terms “StanCorp,” “Company,” “we,” “us” and “our” refer to StanCorp Financial Group, Inc. and its subsidiaries, unless the context otherwise requires.

 

1.	ORGANIZATION, PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

StanCorp, headquartered in Portland, Oregon, is a holding company and conducts business through wholly-owned operating subsidiaries throughout the United States. Through its subsidiaries, StanCorp has the authority to underwrite insurance products in all 50 states. The Company collectively views and operates its businesses as Insurance Services and Asset Management. Insurance Services contains two reportable product segments, Employee Benefits and Individual Disability. Asset Management is a separate reportable segment. See “Note 5—Segments.”

StanCorp has the following wholly-owned operating subsidiaries: Standard Insurance Company (“Standard”), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. (“Standard Retirement Services”), StanCorp Equities, Inc. (“StanCorp Equities”), StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”), StanCorp Investment Advisers, Inc. (“StanCorp Investment Advisers”), StanCorp Real Estate, LLC (“StanCorp Real Estate”), Standard Management, Inc. (“Standard Management”) and StanCap Insurance Company, Inc. (“StanCap Insurance Company”).

Standard, the Company’s largest subsidiary, underwrites group and individual disability insurance and annuity products, group life and accidental death and dismemberment (“AD&D”) insurance, and provides group dental and group vision insurance, absence management services and retirement plan products. Founded in 1906, Standard is domiciled in Oregon, licensed in all states except New York, and licensed in the District of Columbia and the U.S. territories of Guam, Puerto Rico and the Virgin Islands.

The Standard Life Insurance Company of New York was organized in 2000 and is licensed to provide group and individual disability insurance, group life and AD&D insurance, group dental insurance and vision insurance in New York.

The Standard is a service mark of StanCorp and its subsidiaries and is used as a brand mark and marketing name by Standard and The Standard Life Insurance Company of New York.

Standard Retirement Services administers and services StanCorp’s retirement plans group annuity contracts and trust products. Retirement plan products are offered in all 50 states through Standard or Standard Retirement Services.

StanCorp Equities is a limited business broker-dealer and member of the Financial Industry Regulatory Authority. As a wholesaler, StanCorp Equities activities are limited to soliciting and supporting third-party broker-dealers and investment advisers that offer or advise their retirement plan clients on using an unregistered group annuity contract or a mutual fund trust platform.

StanCorp Mortgage Investors originates and services fixed-rate commercial mortgage loans for the investment portfolios of the Company’s insurance subsidiaries. StanCorp Mortgage Investors also generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors.

StanCorp Investment Advisers is a Securities and Exchange Commission (“SEC”) registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment advisory and investment management services. In January 2015, StanCorp reached an agreement to sell the assets of its private client wealth management business within StanCorp Investment Advisers to a third party. StanCorp expects the sale to be completed during the second quarter of 2015. StanCorp Investment Advisers will remain a wholly-owned subsidiary of StanCorp.

StanCorp Real Estate is a property management company that owns and manages the Hillsboro, Oregon home office properties and other properties held for investment and held for sale. StanCorp Real Estate also manages the Portland, Oregon home office properties.

Standard Management manages certain real estate properties held for sale from time to time in conjunction with the Company’s real estate business.

StanCap Insurance Company is a pure captive insurance company domiciled in Oregon. Effective September 30, 2014, StanCap Insurance Company entered into a reinsurance agreement with Standard to reinsure Standard’s group life and AD&D insurance business.

Standard holds interests in tax-advantaged investments. The carrying value of these interests was $279.0 million and $277.0 million at March 31, 2015 and December 31, 2014, respectively. The majority of the tax-advantaged investments qualify as affordable housing investments and are accounted for under the proportional amortization method (“PAM”). The carrying value of the investments accounted for under PAM was $262.8 million and $257.5 million at March 31, 2015 and December 31, 2014, respectively. For tax-advantaged investments with state premium tax credits, the state premium tax credits and the amortization of the investment are recorded in net investment income. Tax-advantaged investments that do not qualify as affordable housing investments are accounted for under the equity method of accounting.

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. This ASU permits entities to account for qualified affordable housing projects under PAM. Under PAM, the cost of the investments is amortized in each period as a proportion of the tax credits and benefits of tax losses received in that period to total benefits to be received over the life of the investments and allows amortization of the investments and tax benefits to be recognized in income taxes on the consolidated statements of income. The Company has adopted this ASU retrospectively as of January 1, 2015, and comparative financial statements of prior periods have been adjusted. The adoption of this ASU will change the timing of the benefit realized in net income, but will not change the cumulative total benefit to net income over the life of the investments.

 

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The following tables set forth below show the affected financial statement line items that were adjusted compared to the original as reported financial results for the first quarter of 2014 and as of December 31, 2014.

STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

AFFECTED LINE ITEMS ADJUSTED FOR ASU NO. 2014-01

(In millions—except per share data)

 

		Three Months Ended March 31, 2014
		Adjusted				As Originally Reported
Net investment income		$	153.9			$	150.6
Income before income taxes			68.7				65.4
Income taxes			20.6				15.3
Net income			48.1				50.1
Net income per common share:
Basic		$	1.10			$	1.14
Diluted			1.08				1.13

STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

AFFECTED LINE ITEMS ADJUSTED FOR ASU NO. 2014-01

(In millions)

 

		December 31, 2014
		Adjusted				As Originally Reported
A S S E T S
Other invested assets		$	301.6			$	320.9
L I A B I L I T I E S  A N D  S H A R E H O L D E R S’  E Q U I T Y
Deferred tax liabilities, net		$	60.0			$	63.1
Retained earnings			2,036.0				2,052.2

STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

AFFECTED LINE ITEMS ADJUSTED FOR ASU NO. 2014-01

(In millions)

 

		Three Months Ended March 31, 2014
		Adjusted				As Originally Reported
Operating:
Net income		$	48.1			$	50.1
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			35.2				29.4
Deferred income taxes			8.5				8.8
Other, net			(46.3)				(42.8)

 

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The accompanying unaudited condensed consolidated financial statements of StanCorp and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in conformance with the requirements of Form 10-Q pursuant to the rules and regulations of the SEC. As such, they do not include all of the information and disclosures required by GAAP for complete financial statements. Intercompany balances and transactions have been eliminated on a consolidated basis. The Company’s unaudited condensed consolidated financial statements have been prepared in accordance with GAAP which requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the Company’s financial condition at March 31, 2015, and for the results of operations and cash flows for the three months ended March 31, 2015 and 2014. Interim results for the three months ended March 31, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. This report should be read in conjunction with the Company’s 2014 annual report on Form 10-K.

 

2.	NET INCOME PER COMMON SHARE

Net income per basic common share was calculated by dividing net income by the weighted-average common shares outstanding. Net income per diluted common share was calculated using the treasury stock method and reflects the dilutive effects of stock awards and potential exercises of dilutive outstanding stock options. Diluted weighted-average common shares outstanding does not include stock options with an option exercise price greater than the average market price because they are antidilutive and inclusion would increase net income per common share.

The following table sets forth the calculation of net income per basic and diluted weighted-average common shares outstanding:

 

		Three Months Ended March 31,
		2015				2014
Net income (In millions)		$	56.5			$	48.1
Basic weighted-average common shares outstanding			42,130,728				43,896,627
Stock options			370,436				419,256
Stock awards			171,861				66,061
Diluted weighted-average common shares outstanding			42,673,025				44,381,944
Net income per common share:
Basic		$	1.34			$	1.10
Diluted			1.32				1.08
Antidilutive shares not included in net income per diluted common share calculation			11,636				7,986

 

3.	SHARE-BASED COMPENSATION

The Company has two active share-based compensation plans: the 2002 Stock Incentive Plan (“2002 Plan”) and the 1999 Employee Share Purchase Plan (“ESPP”). The 2002 Plan authorizes the Board of Directors to grant incentive or non-statutory stock options and stock awards to eligible employees and certain specified parties. The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a discount. Of the 7,000,000 shares of common stock authorized for the 2002 Plan, 2,445,466 shares or options for shares remain available for grant at March 31, 2015. Of the 3,500,000 shares authorized for the ESPP, 1,358,099 shares remain available for issuance at March 31, 2015.

The following table sets forth the total compensation cost and related income tax benefit under the Company’s share-based compensation plans:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Compensation cost		$	3.3			$	2.0
Related income tax benefit			1.2				0.7

2002 Plan

The Company has provided two types of share-based compensation pursuant to the 2002 Plan: option grants and stock award grants.

 

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Option Grants

Options are granted to officers and certain non-officer employees. Options are granted with an exercise price per share equal to the closing market price of StanCorp common stock on the grant date. Options typically vest in four equal installments on the first four anniversaries of the vesting reference date.

The Company granted options to purchase 133,968 and 105,060 shares of StanCorp common stock for the first quarters of 2015 and 2014, respectively, at a weighted-average per share exercise price of $66.21 and $63.74, respectively. The fair value of each option award granted was estimated using the Black-Scholes option pricing model as of the grant date. The weighted-average grant date fair value of options granted for the first quarters of 2015 and 2014 was $18.83 and $24.53, respectively.

The compensation cost of stock options is recognized over the vesting period, which is also the period over which the grantee must provide services to the Company. At March 31, 2015, the total cost related to unvested option awards that had not yet been recognized in the financial statements was $7.5 million. This cost will be recognized over a weighted-average remaining period of 2.7 years.

Stock Award Grants

The Company currently grants three types of stock awards: restricted stock unit awards (“RSUs”), performance-based stock awards (“Performance Shares”) and non-employee director stock awards (“Director Stock Grants”). Under the 2002 Plan, the Company had 937,019 shares available for issuance as stock award grants at March 31, 2015.

RSUs

The Company grants annual RSUs to officers and senior officers of the Company. RSUs typically cliff vest three years from the grant date. The actual number of shares issued is based on continued employment with a portion of shares withheld to cover required tax withholding.

The Company granted 50,555 and 45,869 RSUs for the first quarters of 2015 and 2014, respectively. The fair value of the RSUs is determined based on the closing market price of StanCorp common stock on the grant date.

The compensation cost of RSUs is recognized over the vesting period, which is the period over which the grantee must provide services to the Company. At March 31, 2015, the total compensation cost related to unvested RSUs that had not yet been recognized in the financial statements was $5.6 million. This cost will be recognized over a weighted-average remaining period of 1.7 years.

Performance Shares

The Company grants Performance Shares to designated senior officers as long-term incentive compensation. The payout for these awards is based on the Company’s financial performance over a three-year period. Performance Share grants represent the maximum number of shares of StanCorp common stock issuable to the designated senior officers if specified criteria are met. The actual number of shares issued at the end of the performance period is based on continued employment and satisfaction of the Company’s financial performance conditions, with a portion of the shares withheld to cover required tax withholding.

The Company granted 97,512 and 77,634 Performance Shares for the first quarters of 2015 and 2014, respectively.

The Company issued 32,310 and 8,846 of StanCorp common stock under previous performance share awards for the first quarters of 2015 and 2014, respectively.

The fair value of Performance Shares is based on the closing market price of StanCorp common stock on the grant date.

The compensation cost of Performance Shares is based on an estimate of the number of shares that will be earned and cost is recognized over the vesting period. The cost the Company will ultimately recognize as a result of these stock awards is dependent on the Company’s financial performance. Assuming that the maximum performance is achieved for each performance goal, $12.3 million in additional compensation cost would be recognized through 2017. Assuming that the target performance is achieved, this cost would be recognized over a weighted-average period of 2.1 years. The target payout is 50% of the maximum performance shares. Assuming that the target performance is achieved for each performance goal, $4.2 million in additional compensation cost would be recognized through 2017.

Director Stock Grants

Each non-employee director receives annual stock grants with fair value equal to $100,000 based on the closing market price of StanCorp common stock on the day of the annual shareholder meeting. The stock grants generally vest after one year.

Employee Share Purchase Plan

The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a 5% discount of the lesser of the closing market price of StanCorp common stock on either the commencement date or the final date of each six-month offering period. Under the terms of the plan, each eligible employee may elect to have the lesser of up to 5% of the employee’s gross total cash compensation or $5,000 per offering period withheld to purchase StanCorp common stock. No employee may purchase StanCorp common stock having a fair market value in excess of $25,000 in any calendar year.

 

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The following table sets forth the compensation cost and related income tax benefit under the Company’s ESPP:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Compensation cost		$	0.1			$	0.1
Related income tax benefit			---				---

 

4.	RETIREMENT BENEFITS

Pension Benefits

The Company has two non-contributory defined benefit pension plans: the employee pension plan and the agent pension plan. The employee pension plan is generally limited to eligible employees of the Company whose date of employment began before 2003 and a participant is entitled to a normal retirement benefit at age 65. The agent pension plan is for former field employees and agents. The defined benefit pension plans provide benefits based on years of service and final average pay. The employee pension plan is sponsored by StanCorp and the agent pension plan is sponsored by Standard. Both plans are administered by Standard Retirement Services and are closed to new participants.

The Company recognizes the funded status of the pension plans as an asset or liability on the balance sheet. The funded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation as of the balance sheet date.

The following table sets forth the components of net periodic benefit (credit) cost and other changes in plan assets and benefit obligations recognized in other comprehensive income for pension benefits:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Components of net periodic benefit cost (credit):
Service cost		$	2.6			$	2.2
Interest cost			5.1				4.8
Expected return on plan assets			(9.0)				(8.4)
Amortization of prior service cost			0.2				0.2
Amortization of net actuarial loss			2.6				0.1
Net periodic benefit cost (credit)			1.5				(1.1)
Other changes in plan assets and benefit obligation recognized in other comprehensive income:
Amortization of prior service cost			(0.2)				(0.2)
Amortization of net actuarial loss			(2.6)				(0.1)
Total recognized in other comprehensive income			(2.8)				(0.3)
Total recognized in net periodic benefit cost (credit) and other comprehensive income		$	(1.3)			$	(1.4)

Postretirement Benefits Other Than Pensions

Standard sponsors and administers a postretirement benefit plan that includes medical, prescription drug benefits and group term life insurance. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. The postretirement benefit plan is limited to eligible participants who retired prior to July 1, 2013.

The Company recognizes the funded status of the postretirement benefit plan as an asset or liability on the unaudited condensed consolidated balance sheet. The funded status is measured as the difference between the fair value of the plan assets and the accumulated postretirement benefit obligation.

 

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The following table sets forth the components of net periodic benefit credit and other amounts recognized in other comprehensive income for postretirement benefits:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Components of net periodic benefit credit:
Interest cost		$	0.1			$	0.2
Expected return on plan assets			(0.2)				(0.2)
Amortization of net actuarial gain			---				(0.6)
Net periodic benefit credit			(0.1)				(0.6)
Other changes in plan assets and benefit obligation recognized in other comprehensive income:
Amortization of net actuarial gain			---				0.6
Total recognized in other comprehensive income			---				0.6
Total recognized in net periodic benefit credit and other comprehensive income		$	(0.1)			$	---

Deferred Compensation Plans

Eligible employees are covered by a qualified deferred compensation plan sponsored by Standard under which a portion of the employee contribution is matched. Employees not eligible for the employee pension plan are eligible for an additional non-elective employer contribution. Employer contributions to the plan were $4.2 million and $3.7 million for the first quarters of 2015 and 2014, respectively.

Eligible executive officers, directors, agents and group producers may participate in one of several non-qualified deferred compensation plans under which a portion of the deferred compensation for participating executive officers, agents and group producers is matched. The liability for the plans was $12.9 million and $12.6 million at March 31, 2015 and December 31, 2014, respectively.

Non-Qualified Supplemental Retirement Plan

Eligible executive officers are covered by a non-qualified supplemental retirement plan (“non-qualified plan”). Under the non-qualified plan, a participant is entitled to a normal retirement benefit once the participant reaches age 65. A participant can also receive a normal, unreduced retirement benefit once the sum of his or her age plus years of service is at least 90. The Company recognizes the unfunded status of the non-qualified plan in other liabilities on the unaudited condensed consolidated balance sheet. The unfunded status was $42.9 million and $42.8 million at March 31, 2015 and December 31, 2014, respectively. Expenses were $0.8 million and $0.7 million for the first quarters of 2015 and 2014, respectively. The net loss and prior service cost, net of tax, excluded from the net periodic benefit cost and reported as a component of accumulated other comprehensive income (“AOCI”) was $11.4 million and $11.7 million at March 31, 2015 and December 31, 2014, respectively.

 

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5.

SEGMENTS

The Company collectively views and operates its businesses as Insurance Services and Asset Management. Insurance Services contains two reportable product segments, Employee Benefits and Individual Disability. Insurance Services offers group and individual disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services. Asset Management is a separate reportable segment. Asset Management provides investment and asset management products and services. Asset Management offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. Asset Management also offers investment advisory and management services, origination and servicing of fixed-rate commercial mortgage loans, individual fixed and indexed annuity products, group annuity contracts and retirement plan trust products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses primarily related to the impairment or the disposition of the Company’s invested assets and adjustments made in consolidation. Resources are allocated and performance is evaluated at the segment level.

Intersegment revenues are comprised of administrative fees charged by Asset Management to manage the fixed maturity securities—available-for-sale (“fixed maturity securities”) and commercial mortgage loan portfolios for the Company’s insurance subsidiaries. Intersegment fees are determined based on the level of assets in the insurance subsidiaries’ fixed maturity securities and commercial mortgage loan portfolios.

The following table sets forth intersegment revenues:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Intersegment administrative fees		$	5.0			$	4.8

 

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The following table sets forth premiums, administrative fees and net investment income by major product line or category within each of the Company’s segments:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Premiums:
Insurance Services:
Group life and AD&D		$	214.3			$	200.2
Group long term disability			195.1				189.2
Group short term disability			60.1				54.3
Group other			21.1				19.2
Experience rated refunds			(12.6)				(3.5)
Total Employee Benefits			478.0				459.4
Individual Disability			50.4				48.1
Total Insurance Services premiums			528.4				507.5
Asset Management:
Retirement plans			0.5				1.1
Individual annuities			3.2				1.5
Total Asset Management premiums			3.7				2.6
Total premiums		$	532.1			$	510.1
Administrative fees:
Insurance Services:
Employee Benefits		$	4.0			$	4.2
Total Insurance Services administrative fees			4.0				4.2
Asset Management:
Retirement plans			24.8				24.0
Other financial services businesses			8.9				8.2
Total Asset Management administrative fees			33.7				32.2
Other administrative fees			(5.0)				(4.8)
Total administrative fees		$	32.7			$	31.6
Net investment income:
Insurance Services:
Employee Benefits		$	63.9			$	65.2
Individual Disability			13.7				13.4
Total Insurance Services net investment income			77.6				78.6
Asset Management:
Retirement plans			29.7				27.0
Individual annuities			36.6				40.3
Other financial services businesses			4.9				2.2
Total Asset Management net investment income			71.2				69.5
Other net investment income			4.5				5.8
Total net investment income		$	153.3			$	153.9

 

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The following tables set forth select segment information:

 

		Three Months Ended March 31, 2015
		Employee Benefits				Individual Disability				Total Insurance Services				Asset Management				Other				Total
		(In millions)
Revenues:
Premiums		$	478.0			$	50.4			$	528.4			$	3.7			$	---			$	532.1
Administrative fees			4.0				---				4.0				33.7				(5.0)				32.7
Net investment income			63.9				13.7				77.6				71.2				4.5				153.3
Net capital losses			---				---				---				---				(8.6)				(8.6)
Total revenues			545.9				64.1				610.0				108.6				(9.1)				709.5
Benefits and expenses:
Benefits to policyholders			369.5				22.3				391.8				6.9				---				398.7
Interest credited			0.7				---				0.7				40.4				---				41.1
Operating expenses			83.0				7.6				90.6				31.3				---				121.9
Commissions and bonuses			37.6				12.9				50.5				10.2				---				60.7
Premium taxes			8.1				1.0				9.1				---				---				9.1
Interest expense			---				---				---				---				7.8				7.8
Net (increase) decrease in DAC, VOBA and other intangible assets			(5.2)				(2.4)				(7.6)				0.4				---				(7.2)
Total benefits and expenses			493.7				41.4				535.1				89.2				7.8				632.1
Income (loss) before income taxes		$	52.2			$	22.7			$	74.9			$	19.4			$	(16.9)			$	77.4
Total assets		$	6,032.4			$	2,378.1			$	8,410.5			$	14,407.8			$	369.1			$	23,187.4

 

		Three Months Ended March 31, 2014
		Employee Benefits				Individual Disability				Total Insurance Services				Asset Management				Other				Total
		(In millions)
Revenues:
Premiums		$	459.4			$	48.1			$	507.5			$	2.6			$	---			$	510.1
Administrative fees			4.2				---				4.2				32.2				(4.8)				31.6
Net investment income			65.2				13.4				78.6				69.5				5.8				153.9
Net capital losses			---				---				---				---				(1.1)				(1.1)
Total revenues			528.8				61.5				590.3				104.3				(0.1)				694.5
Benefits and expenses:
Benefits to policyholders			370.4				26.0				396.4				4.7				---				401.1
Interest credited			0.7				---				0.7				42.8				---				43.5
Operating expenses			77.4				6.8				84.2				29.9				(1.0)				113.1
Commissions and bonuses			33.3				11.1				44.4				7.4				---				51.8
Premium taxes			8.1				1.0				9.1				---				---				9.1
Interest expense			---				---				---				---				8.4				8.4
Net (increase) decrease in DAC, VOBA and other intangible assets			(2.5)				(1.8)				(4.3)				3.1				---				(1.2)
Total benefits and expenses			487.4				43.1				530.5				87.9				7.4				625.8
Income (loss) before income taxes		$	41.4			$	18.4			$	59.8			$	16.4			$	(7.5)			$	68.7
Total assets		$	5,761.5			$	2,341.8			$	8,103.3			$	12,950.8			$	589.6			$	21,643.7

 

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6.	FAIR VALUE

Assets and liabilities recorded at fair value are disclosed using a three-level hierarchy. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources while unobservable inputs reflect the Company’s estimates about market data.

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels: Level 1 inputs are based upon quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 inputs are generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use in pricing the asset or liability.

There are three types of valuation techniques used to measure assets and liabilities recorded at fair value:

•

The market approach uses prices or other relevant information generated by market transactions involving identical or comparable assets or liabilities.

•

The income approach uses the present value of cash flows or earnings.

•

The cost approach, which uses replacement costs more readily adaptable for valuing physical assets.

The Company uses both the market and income approach in its fair value measurements. These measurements are discussed in more detail below.

The following tables set forth the carrying value and the estimated fair value of each financial instrument:

 

		March 31, 2015
		Carrying Value				Fair Value				Level 1				Level 2				Level 3
		(In millions)
Assets:
Fixed maturity securities:
Corporate bonds		$	7,389.2			$	7,389.2			$	---			$	7,298.8			$	90.4
U.S. government and agency bonds			289.4				289.4				---				289.4				---
U.S. state and political subdivision bonds			142.1				142.1				---				140.3				1.8
Foreign government bonds			65.0				65.0				---				65.0				---
Total fixed maturity securities		$	7,885.7			$	7,885.7			$	---			$	7,793.5			$	92.2
Commercial mortgage loans, net		$	5,366.8			$	6,029.1			$	---			$	---			$	6,029.1
S&P 500 Index options			13.0				13.0				---				---				13.0
Policy loans			2.1				2.1				---				---				2.1
Separate account assets			7,458.5				7,458.5				7,343.7				114.8				---
Liabilities:
Other policyholder funds, investment-type contracts		$	6,046.9			$	6,387.1			$	---			$	---			$	6,387.1
Index-based interest guarantees			79.0				79.0				---				---				79.0
Interest rate swaps			9.7				9.7				---				9.7				---
Short-term debt			1.1				1.2				---				1.2				---
Long-term debt			504.1				533.5				---				533.5				---

 

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		December 31, 2014
		Carrying Value				Fair Value				Level 1				Level 2				Level 3
		(In millions)
Assets:
Fixed maturity securities:
Corporate bonds		$	7,272.6			$	7,272.6			$	---			$	7,183.6			$	89.0
U.S. government and agency bonds			300.1				300.1				---				300.1				---
U.S. state and political subdivision bonds			136.1				136.1				---				136.1				---
Foreign government bonds			64.9				64.9				---				64.9				---
Total fixed maturity securities		$	7,773.7			$	7,773.7			$	---			$	7,684.7			$	89.0
Commercial mortgage loans, net		$	5,321.1			$	6,021.5			$	---			$	---			$	6,021.5
S&P 500 Index options			13.6				13.6				---				---				13.6
Policy loans			2.2				2.2				---				---				2.2
Separate account assets			7,179.8				7,179.8				7,066.4				113.4				---
Liabilities:
Other policyholder funds, investment-type contracts		$	5,961.1			$	6,232.5			$	---			$	---			$	6,232.5
Index-based interest guarantees			77.0				77.0				---				---				77.0
Interest rate swaps			4.7				4.7				---				4.7				---
Short-term debt			1.1				1.5				---				1.5				---
Long-term debt			503.9				538.4				---				538.4				---

Financial Instruments Not Recorded at Fair Value

The Company did not elect to measure and record commercial mortgage loans, policy loans, other policyholders funds that are investment-type contracts, short-term debt, or long-term debt at fair value on the unaudited condensed consolidated balance sheets.

For disclosure purposes, the fair values of commercial mortgage loans were estimated using an option-adjusted discounted cash flow valuation. The valuation includes both observable market inputs and estimated model parameters.

Significant observable inputs to the valuation include:

•

Indicative quarter-end pricing for a package of loans similar to those originated by the Company near quarter-end.

•

U.S. Government treasury yields.

•

Indicative yields from industrial bond issues.

•

The contractual terms of nearly every mortgage subject to valuation.

Significant estimated parameters include:

•

A liquidity premium that is estimated from historical loan sales and is applied over and above base yields.

•

Adjustments in interest rate spread based on an aggregate portfolio loan-to-value ratio, estimated from historical differential yields with respect to loan-to-value ratios.

•

Projected prepayment activity.

For policy loans, the carrying value represents historical cost but approximates fair value. While potentially financial instruments, policy loans are an integral component of the insurance contract and have no maturity date.

The fair value of other policyholder funds that are investment-type contracts was calculated using the income approach in conjunction with the cost of capital method. The parameters used for discounting in the calculation were estimated using the perspective of the principal market for the contracts under consideration. The principal market consists of other insurance carriers with similar contracts on their books.

The fair value for long-term debt was predominantly based on quoted market prices as of March 31, 2015 and December 31, 2014, and trades occurring close to March 31, 2015 and December 31, 2014.

Financial Instruments Measured and Recorded at Fair Value

Fixed maturity securities, Standard & Poor’s (“S&P”) 500 Index call spread options (“S&P 500 Index options”), interest rate swaps and index-based interest guarantees embedded in indexed annuities (“index-based interest guarantees”) are recorded at fair value on a recurring basis. In the Company’s unaudited condensed consolidated statements of comprehensive income, unrealized gains and losses are reported in other comprehensive income (loss) for fixed maturity securities. In the Company’s unaudited condensed consolidated statements of income, the change in fair value for S&P 500 Index options is reported in net investment income. For interest rate swaps that are designated as a fair value hedge, the change in the fair values of the interest rate swap and the hedged item are reported in net capital gains and losses. The fair value of interest rate swaps is determined through Level 2 inputs using quoted prices from an independent pricing service. The change in fair value for index-based interest guarantees is reported in interest credited.

 

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Separate account assets represent segregated funds held for the exclusive benefit of contract holders. The activities of the account primarily relate to participant-directed 401(k) contracts. Separate account assets are recorded at fair value on a recurring basis, with changes in fair value recorded to separate account liabilities. Separate account assets consist of mutual funds. The mutual funds’ fair value is determined through Level 1 and Level 2 inputs. The majority of the separate account assets are valued using quoted prices in an active market with the remainder of the assets valued using quoted prices from an independent pricing service. The Company reviews the values obtained from the pricing service for reasonableness through analytical procedures and performance reviews.

Fixed maturity securities are comprised of the following classes:

•

Corporate bonds.

•

U.S. government and agency bonds.

•

U.S. state and political subdivision bonds.

•

Foreign government bonds.

The fixed maturity securities are diversified across industries, issuers and maturities. The Company calculates fair values for all classes of fixed maturity securities using valuation techniques described below. They are placed into three levels depending on the valuation technique used to determine the fair value of the securities.

The Company uses an independent pricing service to assist management in determining the fair value of these assets. The pricing service incorporates a variety of information observable in the market in its valuation techniques, including:

•

Reported trading prices.

•

Benchmark yields.

•

Broker-dealer quotes.

•

Benchmark securities.

•

Bids and offers.

•

Credit ratings.

•

Relative credit information.

•

Other reference data.

The pricing service also takes into account perceived market movements and sector news, as well as a bond’s terms and conditions, including any features specific to that issue that may influence risk, and thus marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary. The Company generally obtains one value from its primary external pricing service. On a case-by-case basis, the Company may obtain further quotes or prices from additional parties as needed.

The pricing service provides quoted market prices when available. Quoted prices are not always available due to bond market inactivity. The pricing service obtains a broker quote when sufficient information, such as security structure or other market information, is not available to produce a valuation. Valuations and quotes obtained from third-party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.

The significant unobservable inputs used in the fair value measurement of the reporting entity’s bonds are valuations and quotes received from the secondary pricing service, analytical reviews and broker quotes. Significant increases or decreases in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, a change in the assumption used for the pricing evaluation is accompanied by a directionally similar change in the assumption used for the methodologies.

The Company performs control procedures over the external valuations at least quarterly through a combination of procedures that include an evaluation of methodologies used by the pricing service, analytical reviews and performance analysis of the prices against statistics, trends, and secondary pricing sources, back testing of sales activity and maintenance of a list of fixed maturity securities with characteristics that could indicate potential impairment. As necessary, the Company compares prices received from the pricing service to prices independently estimated by the Company utilizing discounted cash flow models or through performing independent valuations of inputs and assumptions similar to those used by the pricing service in order to ensure prices represent a reasonable estimate of fair value. Although the Company does identify differences from time to time as a result of these validation procedures, the Company did not make any significant adjustments as of March 31, 2015 or December 31, 2014.

S&P 500 Index options and certain fixed maturity securities were valued using Level 3 inputs. The Level 3 fixed maturity securities were valued using matrix pricing, independent broker quotes and other standard market valuation methodologies. The fair value was determined using inputs that were not observable or could not be derived principally from, or corroborated by, observable market data. These inputs included assumptions regarding liquidity, estimated future cash flows and discount rates. Unobservable inputs to these valuations are based on management’s judgment or estimation obtained from the best sources available. The Company’s valuations maximize the use of observable inputs, which include an analysis of securities in similar sectors with comparable maturity dates and bond ratings. Broker quotes are validated by management for reasonableness in conjunction with information obtained from matrix pricing and other sources.

        The Company calculates the fair value for its S&P 500 Index options using the Black-Scholes option pricing model and parameters derived from market sources. The Company’s valuations maximize the use of observable inputs, which include direct price quotes from the Chicago Board Options Exchange (“CBOE”) and values for on-the-run treasury securities and London Interbank Offered Rate (“LIBOR”) as reported by Bloomberg. Unobservable inputs are estimated from the best sources available to the Company and include estimates of future gross dividends to be paid on the stocks underlying the S&P 500 Index, estimates of bid ask spreads, and estimates of implied volatilities on options. Valuation parameters are calibrated to replicate the actual end-of-day market quotes for options trading on the CBOE. The Company performs additional validation procedures such as the daily observation of market activity and conditions and the tracking and analyzing of actual quotes provided by banking counterparties each time the Company purchases options from them. Additionally, in order to help validate the values derived through the procedures noted above, the Company obtains indicators of value from representative investment banks.

 

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The Company uses the discounted cash flow valuation model to determine the fair value of the interest rate swaps. The inputs used in the model are observable in the market. The interest rate swaps qualify as Level 2 under the fair value hierarchy since their valuation is based on a model for which all significant assumptions are observable in the market.

The Company uses the income approach valuation technique to determine the fair value of index-based interest guarantees. The liability is the present value of future cash flows attributable to the projected index growth in excess of cash flows driven by fixed interest rate guarantees for the indexed annuity product. Level 3 assumptions for policyholder behavior and future index crediting rate declarations significantly influence the calculation. Index-based interest guarantees are included in the other policyholder funds line on the Company’s unaudited condensed consolidated balance sheets.

While valuations for the S&P 500 Index options are sensitive to a number of variables, valuations for S&P 500 Index options purchased are most sensitive to changes in the estimates of bid ask spreads, or the S&P 500 Index value, and the implied volatilities of this index. Significant fluctuations in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, an increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change in the fair value of the asset.

Valuations for the index-based interest guarantees are sensitive to a number of variables, but are most sensitive to the S&P 500 Index value, the implied volatilities of this index and the interest rate environment. Generally, a significant increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change, while an increase or decrease in interest rate environment would result in a directionally opposite change in the fair value of the liability.

Valuations for commercial mortgage loans measured at fair value on a nonrecurring basis using significant unobservable Level 3 inputs are sensitive to a number of variables, but are most sensitive to net operating income and the applied capitalization rate. Generally, an increase or decrease resulting from a change in the stabilized net operating income from the collateralized property would result in a directionally similar change in the fair value of the asset. An increase or decrease in the assumption for the capitalization rate would result in a directionally opposite change in the fair value of the asset.

Valuations for real estate acquired in satisfaction of debt through foreclosure or acceptance of deeds in lieu of foreclosure on commercial mortgage loans (“Real Estate Owned”) measured at fair value on a nonrecurring basis using significant unobservable Level 3 inputs are sensitive to a number of variables. They are most sensitive to the reductions taken on appraisals obtained, which may result in a fair value and carrying value below the appraised value. Generally, an increase in the reductions taken on appraisals obtained would result in a reduction in the fair value of the asset.

The following table sets forth quantitative information regarding significant unobservable inputs used in Level 3 valuation of assets and liabilities measured and recorded at fair value:

 

						March 31, 2015								December 31, 2014
		Valuation Technique		Unobservable Input		Fair Value				Range of inputs				Fair Value				Range of inputs
		(Dollars in millions)
S&P 500 Index options		Black-Scholes option pricing model		Various assumptions		$	13.0				(a)			$	13.6				(a)
Index-based interest guarantees		Discounted cash flow		Expected future option purchase		$	79.0				1% -   3%			$	77.0				1% -   3%
				Various assumptions							(b)								(b)
		Black-Scholes option pricing model		Various assumptions							(a)								(a)
Commercial mortgage loans		Appraisals		Reduction on appraisal		$	54.9				0% - 37%			$	56.0				0% - 37%
		Cash flows		Capitalization rate (c)							7% - 16%								7% - 16%
Real Estate Owned		Appraisals		Reduction on appraisal		$	3.1				0% - 11%			$	10.3				0% - 11%

 

(a)

Represents various assumptions derived from market data, which include estimates of bid ask spreads and the implied volatilities for the S&P 500 Index.

(b)

Represents various actuarial assumptions which include combined lapse, mortality and withdrawal decrement rates which generally have a range of inputs from 5% - 36% for both March 31, 2015 and December 31, 2014.

(c)

Capitalization rates are used as an internal analysis in converting the underlying property income to an estimated property value.

 

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The following tables set forth the reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable Level 3 inputs:

 

		Three Months Ended March 31, 2015
		Assets																Liabilities
		Corporate Bonds				U.S. State and Political Subdivision Bonds				S&P 500 Index Options				Total Assets				Index- Based Interest Guarantees
		(In millions)
Beginning balance		$	89.0			$	---			$	13.6			$	102.6			$	77.0
Total realized/unrealized gains:
Included in net income			---				---				1.4				1.4				2.4
Included in other comprehensive income			0.2				---				---				0.2				---
Purchases, issuances, sales and settlements:
Purchases			---				---				1.7				1.7				---
Issuances			---				---				---				---				3.2
Sales			---				---				---				---				---
Settlements			---				---				(3.7)				(3.7)				(3.6)
Transfers into Level 3			1.2				1.8				---				3.0				---
Transfers out of Level 3			---				---				---				---				---
Ending balance		$	90.4			$	1.8			$	13.0			$	105.2			$	79.0

 

		Three Months Ended March 31, 2014
		Assets																Liabilities
		Corporate Bonds				U.S. State and Political Subdivision Bonds				S&P 500 Index Options				Total Assets				Index- Based Interest Guarantees
		(In millions)
Beginning balance		$	116.0			$	---			$	15.8			$	131.8			$	67.6
Total realized/unrealized gains (losses):
Included in net income			---				---				2.0				2.0				3.2
Included in other comprehensive income (loss)			(1.9)				---				---				(1.9)				---
Purchases, issuances, sales and settlements:
Purchases			---				---				1.8				1.8				---
Issuances			---				---				---				---				0.9
Sales			---				---				---				---				---
Settlements			---				---				(4.2)				(4.2)				(1.9)
Transfers into Level 3			---				---				---				---				---
Transfers out of Level 3			---				---				---				---				---
Ending balance		$	114.1			$	---			$	15.4			$	129.5			$	69.8

For all periods disclosed above, fixed maturity securities transferred into Level 3 from Level 2 are the result of the Company being unable to obtain observable assumptions for these investments in the market. Fixed maturity securities transferred out of Level 3 into Level 2 are the result of the Company being able to obtain observable assumptions for these investments in the market. There were no transfers between Level 1 and Level 2 for the first quarter of 2015. There were no transfers between Level 1 and Level 2 and between Level 2 and Level 3 for the first quarter of 2014.

 

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The following table sets forth the changes in unrealized gains (losses) included in net income relating to Level 3 assets and liabilities that the Company continued to hold:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Assets:
S&P 500 Index options		$	1.1			$	1.9
Liabilities:
Index-based interest guarantees		$	2.5			$	(3.6)

Changes in the fair value of fixed maturity securities that are not designated as part of a hedging relationship are recorded to other comprehensive income. Changes in the fair value of the S&P 500 Index options are recorded to net investment income. Changes in the fair value of the index-based interest guarantees are recorded to interest credited and are sensitive to a number of variables and assumptions.

Certain assets and liabilities are measured at fair value on a nonrecurring basis, such as impaired commercial mortgage loans with specific allowances for losses and Real Estate Owned. The impaired commercial mortgage loans and Real Estate Owned are valued using Level 3 measurements. These Level 3 inputs are reviewed for reasonableness by management and evaluated on a quarterly basis. The commercial mortgage loan measurements include valuation of the market value of the asset using general underwriting procedures and appraisals. Real Estate Owned is initially recorded at net realizable value, which includes an estimate for disposal costs. These amounts may be adjusted in a subsequent period as additional information is received.

The following table sets forth the assets measured at fair value on a nonrecurring basis as of March 31, 2015 that the Company continued to hold:

 

		March 31, 2015
		Total				Level 1				Level 2				Level 3
		(In millions)
Commercial mortgage loans		$	54.9			$	---			$	---			$	54.9
Real Estate Owned			3.1				---				---				3.1
Total assets measured at fair value on a nonrecurring basis		$	58.0			$	---			$	---			$	58.0

Commercial mortgage loans measured on a nonrecurring basis with a carrying amount of $73.1 million were written down to their fair value of $54.9 million, less selling costs, at March 31, 2015. The specific commercial mortgage loan loss allowance related to these commercial mortgage loans was $23.7 million at March 31, 2015. The Real Estate Owned measured on a nonrecurring basis as of March 31, 2015, and still held at March 31, 2015 had net capital losses totaling $0.3 million for the first quarter of 2015. Real Estate Owned measured on a nonrecurring basis represents properties whose value has been adjusted based on pending sale or other market information.

The following table sets forth the assets measured at fair value on a nonrecurring basis as of December 31, 2014 that the Company continued to hold:

 

		December 31, 2014
		Total				Level 1				Level 2				Level 3
		(In millions)
Commercial mortgage loans		$	56.0			$	---			$	---			$	56.0
Real Estate Owned			10.3				---				---				10.3
Total assets measured at fair value on a nonrecurring basis		$	66.3			$	---			$	---			$	66.3

Commercial mortgage loans measured on a nonrecurring basis with a carrying amount of $74.2 million were written down to their fair value of $56.0 million, less selling costs, at December 31, 2014. The specific commercial mortgage loan loss allowance related to these commercial mortgage loans was $23.8 million at December 31, 2014. The Real Estate Owned measured on a nonrecurring basis as of December 31, 2014, and still held at December 31, 2014 had net capital losses totaling $1.2 million for 2014. See “Note 7—Investments—Commercial Mortgage Loans” for further disclosures regarding the commercial mortgage loan loss allowance.

 

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7.	INVESTMENTS

Fixed Maturity Securities

The following tables set forth amortized costs, gross unrealized gains and losses and fair values of the Company’s fixed maturity securities:

 

		March 31, 2015
		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
		(In millions)
Corporate bonds		$	6,992.3			$	416.2			$	(19.3)			$	7,389.2
U.S. government and agency bonds			249.8				39.6				---				289.4
U.S. state and political subdivision bonds			131.1				11.2				(0.2)				142.1
Foreign government bonds			58.3				6.7				---				65.0
Total fixed maturity securities		$	7,431.5			$	473.7			$	(19.5)			$	7,885.7

 

		December 31, 2014
		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
		(In millions)
Corporate bonds		$	6,943.8			$	367.9			$	(39.1)			$	7,272.6
U.S. government and agency bonds			262.0				38.3				(0.2)				300.1
U.S. state and political subdivision bonds			125.8				10.4				(0.1)				136.1
Foreign government bonds			58.4				6.5				---				64.9
Total fixed maturity securities		$	7,390.0			$	423.1			$	(39.4)			$	7,773.7

The following table sets forth the amortized costs and fair values of the Company’s fixed maturity securities by contractual maturity:

 

		March 31, 2015								December 31, 2014
		Amortized Cost				Fair Value				Amortized Cost				Fair Value
		(In millions)
Due in one year or less		$	595.4			$	605.4			$	649.0			$	658.0
Due after one year through five years			3,039.9				3,204.6				3,060.8				3,215.4
Due after five years through ten years			2,955.6				3,067.8				2,847.9				2,916.7
Due after ten years			840.6				1,007.9				832.3				983.6
Total fixed maturity securities		$	7,431.5			$	7,885.7			$	7,390.0			$	7,773.7

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Callable bonds, excluding bonds with make-whole provisions and bonds with provisions that allow the borrower to prepay near maturity, represented 3.7%, or $288.7 million, of the Company’s fixed maturity securities portfolio at March 31, 2015. At March 31, 2015, the Company did not have any direct exposure to sub-prime or Alt-A mortgages in its fixed maturity securities portfolio.

 

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Gross Unrealized Losses

The following tables set forth the gross unrealized losses and fair value of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

 

		March 31, 2015
		Total								Less than 12 months								12 or more months
		Number				Amount				Number				Amount				Number				Amount
		(Dollars in millions)
Unrealized losses:
Corporate bonds			542			$	19.3				420			$	12.4				122			$	6.9
U.S. state and political subdivision bonds			5				0.2				4				0.1				1				0.1
Total			547			$	19.5				424			$	12.5				123			$	7.0
Fair market value of securities with unrealized losses:
Corporate bonds			542			$	839.9				420			$	604.0				122			$	235.9
U.S. state and political subdivision bonds			5				12.1				4				9.6				1				2.5
Total			547			$	852.0				424			$	613.6				123			$	238.4
		December 31, 2014
		Total								Less than 12 months								12 or more months
		Number				Amount				Number				Amount				Number				Amount
		(Dollars in millions)
Unrealized losses:
Corporate bonds			995			$	39.1				683			$	21.3				312			$	17.8
U.S. government and agency bonds			5				0.2				---				---				5				0.2
U.S. state and political subdivision bonds			4				0.1				---				---				4				0.1
Total			1,004			$	39.4				683			$	21.3				321			$	18.1
Fair market value of securities with unrealized losses:
Corporate bonds			995			$	1,763.2				683			$	1,162.2				312			$	601.0
U.S. government and agency bonds			5				6.4				---				---				5				6.4
U.S. state and political subdivision bonds			4				6.9				---				---				4				6.9
Total			1,004			$	1,776.5				683			$	1,162.2				321			$	614.3

The unrealized losses on the fixed maturity securities set forth above were partly due to increases in market interest rates subsequent to their purchase by the Company and have also been affected by overall economic factors. The Company expects the fair value of these fixed maturity securities to recover as the fixed maturity securities approach their maturity dates or sooner if market yields for such fixed maturity securities decline. The Company does not believe that any of the fixed maturity securities are impaired due to credit quality or due to any company or industry specific event. Based on management’s evaluation of the securities and the Company’s intent to hold the securities, and as it is unlikely that the Company will be required to sell the securities, none of the unrealized losses summarized in this table are considered other-than-temporary.

Commercial Mortgage Loans

The Company underwrites mortgage loans on commercial property throughout the United States. In addition to real estate collateral, the Company requires either partial or full recourse on most loans. At March 31, 2015, the Company did not have any direct exposure to sub-prime or Alt-A mortgages in its commercial mortgage loan portfolio.

 

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The following table sets forth the commercial mortgage loan portfolio by property type, by geographic region within the U.S. and by U.S. state:

 

		March 31, 2015								December 31, 2014
		Amount				Percent				Amount				Percent
		(Dollars in millions)
Property type:
Retail		$	2,655.3				49.5 %			$	2,627.1				49.4 %
Office			1,010.2				18.8				1,013.4				19.1
Industrial			1,001.0				18.7				1,001.5				18.8
Commercial			221.2				4.1				213.6				4.0
Hotel/motel			171.6				3.2				165.7				3.1
Apartment and other			307.5				5.7				299.8				5.6
Total commercial mortgage loans, net		$	5,366.8				100.0 %			$	5,321.1				100.0 %
Geographic region*:
Pacific		$	1,915.4				35.7 %			$	1,914.6				36.0 %
South Atlantic			1,062.3				19.8				1,065.5				20.0
West South Central			700.6				13.0				676.9				12.7
Mountain			628.3				11.7				606.5				11.4
East North Central			471.0				8.8				466.0				8.8
Middle Atlantic			209.7				3.9				215.3				4.0
East South Central			196.6				3.7				188.7				3.6
West North Central			135.9				2.5				140.1				2.6
New England			47.0				0.9				47.5				0.9
Total commercial mortgage loans, net		$	5,366.8				100.0 %			$	5,321.1				100.0 %
U.S. state:
California		$	1,427.4				26.6 %			$	1,434.2				27.0 %
Texas			643.5				12.0				623.4				11.7
Florida			305.3				5.7				309.4				5.8
Georgia			305.2				5.7				306.6				5.8
Other states			2,685.4				50.0				2,647.5				49.7
Total commercial mortgage loans, net		$	5,366.8				100.0 %			$	5,321.1				100.0 %

 

*

Geographic regions obtained from the American Council of Life Insurers Mortgage Loan Portfolio Profile.

Due to the concentration of commercial mortgage loans in California, the Company could be exposed to potential losses as a result of an economic downturn in California as well as certain catastrophes, such as earthquakes and fires, which may affect the region.

The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general and a specific loan loss allowance.

Impairment Evaluation

The Company monitors its commercial mortgage loan portfolio for potential impairment by evaluating the portfolio and individual loans. Key factors that are monitored include:

•

Loan loss experience.

•

Delinquency history.

•

Debt coverage ratio.

•

Loan-to-value ratio.

•

Refinancing and restructuring history.

•

Request for payment forbearance history.

If the analysis above indicates a loan might be impaired, it is further analyzed through the consideration of the following additional factors:

•

Delinquency status.

•

Foreclosure status.

 

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•

Restructuring status.

•

Borrower history.

If it is determined a loan is impaired, a specific loan loss allowance is recorded.

General Loan Loss Allowance

The general loan loss allowance is based on the Company’s analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan-to-value ratios, actual loan loss experience and individual loan analysis.

Specific Loan Loss Allowance

An impaired commercial mortgage loan is a loan where the Company does not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected based on the terms of the original note. The Company also holds specific loan loss allowances on certain performing commercial mortgage loans that it continues to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which the Company has determined that it remains probable that all amounts due will be collected although the timing or nature may be outside the original contractual terms. In addition, for impaired commercial mortgage loans, the Company evaluates the cost to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur and other quantitative information management has concerning the loan. Negotiated reductions of principal are generally written off against the allowance, and recoveries, if any, are credited to the allowance.

The following table sets forth changes in the commercial mortgage loan loss allowance:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Commercial mortgage loan loss allowance:
Beginning balance		$	40.0			$	43.6
Provision change (gain) loss			(0.3)				1.7
Charge-offs, net			(0.8)				(1.8)
Ending balance		$	38.9			$	43.5
Specific loan loss allowance		$	23.7			$	26.4
General loan loss allowance			15.2				17.1
Total commercial mortgage loan loss allowance		$	38.9			$	43.5

Changes in the commercial mortgage loan loss allowance can result from the number of commercial mortgage loans with a specific loan loss allowance and general loan loss allowance and the composition factors of the commercial mortgage loan portfolio. Changes in the provision and charge-offs can result from losses related to foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans in the commercial mortgage loan portfolio.

The following table sets forth the recorded investment in commercial mortgage loans:

 

		March 31, 2015				December 31, 2014
		(In millions)
Commercial mortgage loans collectively evaluated for impairment		$	5,307.4			$	5,255.2
Commercial mortgage loans individually evaluated for impairment			98.3				105.9
Commercial mortgage loan loss allowance			(38.9)				(40.0)
Total commercial mortgage loans, net		$	5,366.8			$	5,321.1

The Company assesses the credit quality of its commercial mortgage loan portfolio quarterly by reviewing the performance of its portfolio, which includes evaluating its performing and nonperforming commercial mortgage loans. Nonperforming commercial mortgage loans include all commercial mortgage loans that are 60 days or more past due and commercial mortgage loans that are not 60 days past due but are not substantially performing to other original contractual terms.

 

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The following tables set forth performing and nonperforming commercial mortgage loans by property type:

 

		March 31, 2015
		Retail				Office				Industrial				Commercial				Hotel/ Motel				Apartment and Other				Total
		(In millions)
Performing commercial mortgage loans		$	2,653.3			$	1,010.0			$	1,000.7			$	221.2			$	171.6			$	307.5			$	5,364.3
Nonperforming commercial mortgage loans			2.0				0.2				0.3				---				---				---				2.5
Total commercial     mortgage loans		$	2,655.3			$	1,010.2			$	1,001.0			$	221.2			$	171.6			$	307.5			$	5,366.8
		December 31, 2014
		Retail				Office				Industrial				Commercial				Hotel/ Motel				Apartment and Other				Total
		(In millions)
Performing commercial mortgage loans		$	2,622.4			$	1,012.7			$	1,001.4			$	213.6			$	165.7			$	299.1			$	5,314.9
Nonperforming commercial mortgage loans			4.7				0.7				0.1				---				---				0.7				6.2
Total commercial     mortgage loans		$	2,627.1			$	1,013.4			$	1,001.5			$	213.6			$	165.7			$	299.8			$	5,321.1

The following tables set forth impaired commercial mortgage loans identified in management’s specific review of probable loan losses and the related allowance:

 

		March 31, 2015
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Amount on Nonaccrual Status
		(In millions)
Impaired commercial mortgage loans:
Without specific loan loss allowances:
Retail		$	24.3			$	24.3			$	---			$	0.3
Office			0.2				0.2				---				---
Industrial			0.2				0.2				---				0.2
Commercial			0.5				0.5				---				---
Total impaired commercial mortgage loans without specific loan loss allowances			25.2				25.2				---				0.5
With specific loan loss allowances:
Retail			50.1				50.1				11.5				2.0
Office			9.7				9.7				3.6				0.2
Industrial			4.5				4.5				1.6				0.1
Commercial			8.5				8.5				7.0				0.6
Apartment and other			0.3				0.3				---				---
Total impaired commercial mortgage loans with specific loan loss allowances			73.1				73.1				23.7				2.9
Total impaired commercial mortgage loans		$	98.3			$	98.3			$	23.7			$	3.4

 

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		December 31, 2014
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Amount on Nonaccrual Status
		(In millions)
Impaired commercial mortgage loans:
Without specific loan loss allowances:
Retail		$	25.0			$	25.0			$	---			$	10.5
Office			1.6				1.6				---				---
Commercial			2.3				2.3				---				0.5
Apartment and other			2.8				2.8				---				---
Total impaired commercial mortgage loans without specific loan loss allowances			31.7				31.7				---				11.0
With specific loan loss allowances:
Retail			52.2				52.2				12.3				7.7
Office			8.6				8.6				2.9				---
Industrial			4.6				4.6				1.6				0.1
Commercial			8.5				8.5				7.0				0.6
Apartment and other			0.3				0.3				---				---
Total impaired commercial mortgage loans with specific loan loss allowances			74.2				74.2				23.8				8.4
Total impaired commercial mortgage loans		$	105.9			$	105.9			$	23.8			$	19.4

Changes in the carrying value of impaired commercial mortgage loans can result from a change in the number of commercial mortgage loans with a specific loan loss allowance. As of March 31, 2015 and December 31, 2014, the Company did not have any commercial mortgage loans greater than 90 days delinquent that were accruing interest.

A modification is considered to be a troubled debt restructuring when the debtor is experiencing financial difficulties and the restructured terms constitute a concession. Granting payment forbearance is not a modification of the loan if the payment forbearance is considered to be an insignificant timing difference associated with the borrowing. The Company evaluates all restructured commercial mortgage loans for indications of troubled debt restructurings and the potential losses related to these restructurings. If a loan is considered a troubled debt restructuring, the Company impairs the loan and records a specific allowance for estimated losses. In some cases, the recorded investment in the loan may increase post-restructuring. The Company assessed all restructurings that occurred during the period to determine if they were troubled debt restructurings. The Company did not identify any troubled debt restructurings that were not already considered impaired.

The following tables set forth information related to the troubled debt restructurings of financing receivables:

 

		Three Months Ended March 31, 2015
		Number of Loans				Pre- Restructuring Recorded Investment				Post- Restructuring Recorded Investment
		(Dollars in millions)
Troubled debt restructurings:
Retail			3			$	1.5			$	1.5
Office			2				1.1				1.2
Total troubled debt restructurings			5			$	2.6			$	2.7

 

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		Three Months Ended March 31, 2014
		Number of Loans				Pre- Restructuring Recorded Investment				Post- Restructuring Recorded Investment
		(Dollars in millions)
Troubled debt restructurings:
Industrial			2			$	1.7			$	1.9

There were no troubled debt restructurings identified in the previous 12 months that subsequently defaulted during the first quarter of 2015.

The following table sets forth the average recorded investment in impaired commercial mortgage loans before specific loan loss allowances:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Average recorded investment		$	102.1			$	110.6

Interest Income

The Company records interest income in net investment income and continues to recognize interest income on delinquent commercial mortgage loans until the loans are more than 90 days delinquent. Interest income and accrued interest receivable are reversed when a loan is more than 90 days delinquent. For loans that are less than 90 days delinquent, management may reverse interest income and the accrued interest receivable if there is a question on the collectability of the interest. Interest income on loans in the 90-day delinquent category is recognized in the period the cash is collected. The Company resumes the recognition of interest income when the loan becomes less than 90 days delinquent and management determines it is probable that the loan will remain performing.

The amount of interest income recognized on impaired commercial mortgage loans was $1.1 million and $1.3 million for the first quarters of 2015 and 2014, respectively. The cash received by the Company in payment of interest on impaired commercial mortgage loans was $1.1 million and $0.8 million for the first quarters of 2015 and 2014, respectively.

The following tables set forth the aging of commercial mortgage loans by property type:

 

		March 31, 2015
		30 Days Past Due				60 Days Past Due				Greater Than 90 Days Past Due				Total Past Due				Allowance Related to Past Due				Current, Net				Total Commercial Mortgage Loans
		(In millions)
Commercial mortgage loans:
Retail		$	1.1			$	---			$	3.5			$	4.6			$	(1.5)			$	2,652.2			$	2,655.3
Office			0.2				---				0.6				0.8				(0.4)				1,009.8				1,010.2
Industrial			---				---				0.5				0.5				(0.2)				1,000.7				1,001.0
Commercial			---				---				---				---				---				221.2				221.2
Hotel/motel			---				---				---				---				---				171.6				171.6
Apartment and other			---				---				---				---				---				307.5				307.5
Total commercial mortgage loans		$	1.3			$	---			$	4.6			$	5.9			$	(2.1)			$	5,363.0			$	5,366.8

 

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		December 31, 2014
		30 Days Past Due				60 Days Past Due				Greater Than 90 Days Past Due				Total Past Due				Allowance Related to Past Due				Current, Net				Total Commercial Mortgage Loans
		(In millions)
Commercial mortgage loans:
Retail		$	0.2			$	2.0			$	4.8			$	7.0			$	(2.1)			$	2,622.2			$	2,627.1
Office			1.9				---				0.8				2.7				---				1,010.7				1,013.4
Industrial			0.5				---				0.3				0.8				(0.2)				1,000.9				1,001.5
Commercial			---				---				---				---				---				213.6				213.6
Hotel/motel			---				---				---				---				---				165.7				165.7
Apartment and other			0.2				0.7				---				0.9				---				298.9				299.8
Total commercial mortgage loans		$	2.8			$	2.7			$	5.9			$	11.4			$	(2.3)			$	5,312.0			$	5,321.1

The Company closely monitors all past due commercial mortgage loans. Additional attention is given to those loans at least 60 days past due. Commercial mortgage loans that have been granted payment forbearance are not considered to be past due and totaled $5.2 million at March 31, 2015 and December 31, 2014. Commercial mortgage loans that were at least 60 days past due totaled $4.6 million and $8.6 million at March 31, 2015 and December 31, 2014, respectively. Commercial mortgage loans that were at least 60 days past due were 0.08% and 0.16% of the commercial mortgage loan portfolio at March 31, 2015 and December 31, 2014, respectively.

Net Investment Income

The following table sets forth net investment income summarized by investment type:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Fixed maturity securities		$	75.5			$	74.8
Commercial mortgage loans			79.6				82.3
Real estate			0.5				---
S&P 500 Index options			1.4				2.0
Other			(0.1)				2.3
Gross investment income			156.9				161.4
Investment expenses			(4.2)				(7.0)
Tax-advantaged investments			0.6				(0.5)
Net investment income		$	153.3			$	153.9

Tax-advantaged investments that do not qualify as affordable housing investments are accounted for under the equity method of accounting as a component of net investment income. For tax-advantaged investments with state premium tax credits, the state premium tax credits and the related investment operating losses are recorded as a component of net investment income. See “Note 1 – Organization, Principles of Consolidation and Basis of Presentation.”

 

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Realized Gross Capital Gains and Losses

The following table sets forth gross capital gains and losses by investment type:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Gains:
Fixed maturity securities		$	1.3			$	1.9
Commercial mortgage loans			0.4				0.4
Real estate			---				0.7
Gross capital gains			1.7				3.0
Losses:
Fixed maturity securities			(0.8)				(0.5)
Provision for commercial mortgage loan losses			---				(1.7)
Real estate			(0.5)				(0.9)
Other (1)			(9.0)				(1.0)
Gross capital losses			(10.3)				(4.1)
Net capital losses		$	(8.6)			$	(1.1)

 

(1)

In the first quarter of 2015, the Company recorded a $5.6 million impairment related to the expected sale of the assets of the Company’s private client wealth management business.

Securities Deposited as Collateral

Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $7.2 million at March 31, 2015 and December 31, 2014.

Standard is a member of the Federal Home Loan Bank of Seattle (“FHLB of Seattle”). Standard issues collateralized funding agreements to the FHLB of Seattle and invests the cash received from advances to support various spread-based businesses and enhance its asset-liability management. Membership also provides an additional funding source and access to financial services that can be used as an alternative source of liquidity. At March 31, 2015, Standard had $158.0 million outstanding under funding agreements with the FHLB of Seattle and pledged $198.7 million of commercial mortgage loans as collateral for its outstanding advances. At December 31, 2014, Standard had $139.0 million outstanding under funding agreements with the FHLB of Seattle and pledged $174.4 million of commercial mortgage loans as collateral for its outstanding advances. The Federal Home Loan Bank of Des Moines (“FHLB of Des Moines”) and the FHLB of Seattle have announced that they have entered into a definitive agreement to merge the two banks. The merger agreement has been unanimously approved by the boards of directors of both banks, by the Federal Housing Finance Agency (“FHFA”), and was ratified by the members of both banks in February 2015. The Company does not expect the merger to have a material effect on our business, financial position, results of operations, cash flows or existing funding agreements with the FHLB of Seattle.

 

8.	DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to mitigate business risks including interest rate risk exposure. The Company has the following derivatives on its unaudited condensed consolidated balance sheets: interest rate swaps, index-based interest guarantees and S&P 500 Index options.

Interest Rate Swaps

In the second quarter of 2014, the Company began the use of interest rate swaps to reduce risks from changes in interest rates, to manage interest rate exposures arising from asset and liability mismatches, and to protect the value of investments held on the unaudited condensed consolidated balance sheets. The interest rate swaps used by the Company are designed to qualify for hedge accounting. Therefore, recognized changes in the fair value of the interest rate swaps and the changes in the fair value of the hedged items attributable to the hedged risk are offset in net capital gains and losses. Valuations for interest rate swaps are sensitive to changes in the interest rate environment.

Interest income, interest expense and fees related to interest rate swaps are recorded as a component of net investment income.

Interest rate swaps are recognized as either other invested assets or other liabilities on the unaudited condensed consolidated balance sheets and are reported at fair value. To qualify for hedge accounting, the Company documents the risk management objective and strategy for undertaking the hedging transaction and the designation of the hedge as either a fair value hedge or a cash flow hedge at the inception of the hedging transaction. Included in this documentation is how the interest rate swap is expected to hedge the designated risk related to specific assets or liabilities on the balance sheet as well as a description of the method that will be used to retrospectively and prospectively assess the hedge effectiveness, the method that will be used to measure ineffectiveness and how this ineffectiveness will be recorded.

 

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A derivative instrument designated as part of a hedging relationship must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is assessed at inception and periodically throughout the life of the designated hedging relationship, using qualitative and quantitative methods. Qualitative methods include comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other statistical analysis of changes in the fair value or cash flows associated with the hedge relationship.

In the event a hedged item is disposed, the Company will terminate the related interest rate swap and recognize the gain or loss on termination in the unaudited condensed consolidated statements of income.

Cash settlement activity of derivative contracts is reported in the unaudited condensed consolidated statements of cash flows as a component of proceeds from or acquisition of other invested assets.

Index-based Interest Guarantees

The Company sells indexed annuities, which permit the holder to allocate their deposit between a fixed interest rate return and an indexed return, where interest credited to the contracts is based on the performance of the S&P 500 Index, subject to an upper limit or cap and minimum guarantees. The index-based interest guarantees do not qualify for hedge accounting. Policyholders may elect to rebalance between interest crediting options at renewal dates annually. At each renewal date, the Company has the opportunity to re-price the indexed component by changing the cap, subject to minimum guarantees. The Company estimates the fair value of the index-based interest guarantees for the current period and for all future reset periods until contract maturity. Changes in the fair value of the index-based interest guarantees are recorded to interest credited. The liability represents an estimate of the cost of the options to be purchased in the future to manage the risk related to the index-based interest guarantees. The liability for index-based interest guarantees is the present value of future cash flows attributable to the projected index growth that is in excess of cash flows attributable to fixed interest rates guarantees. The excess cash flows are discounted back to the date of the balance sheet using current market indicators for future interest rates and option costs. Cash flows depend on actuarial estimates for policyholder lapse behavior and management’s discretion in setting renewal index-based interest guarantees.

S&P 500 Index Options

The Company purchases S&P 500 Index options for its interest crediting strategy used in its indexed annuity product. The S&P 500 Index options do not qualify for hedge accounting. The S&P 500 Index options are purchased from investment banks and are selected in a manner that supports the amount of interest that is expected to be credited in the current year to annuity policyholder accounts that are dependent on the performance of the S&P 500 Index. The purchase of S&P 500 Index options is a pivotal part of the Company’s risk management strategy for indexed annuity products. The S&P 500 Index options are exclusively used for risk management. While valuations of the S&P 500 Index options are sensitive to a number of variables, valuations for S&P 500 Index options purchased are most sensitive to changes in the S&P 500 Index value and the implied volatilities of this index. Changes in the fair value of the S&P 500 Index options are recorded to net investment income. The Company generally purchases two S&P 500 Index option contracts per month, which have expiry dates of one year from the date of purchase.

Option premiums paid for the Company’s index option contracts were $1.7 million and $1.8 million for the first quarters of 2015 and 2014, respectively. The Company received $3.7 million and $4.2 million for options exercised for the first quarters of 2015 and 2014, respectively.

The following table sets forth the fair value of the Company’s derivative assets and liabilities:

 

		March 31, 2015								December 31, 2014
Qualifying Fair Value Hedging Instruments		Notional Amount				Fair Value				Notional Amount				Fair Value
		(In millions)
Liabilities:
Other liabilities:
Interest rate swaps		$	350.0			$	9.7			$	350.0			$	4.7
Non-Qualifying Hedging Instruments
Assets:
Other invested assets:
S&P 500 Index options			435.2				13.0				418.2				13.6
Liabilities:
Other policyholder funds:
Index-based interest guarantees			---	(1)			79.0				---	(1)			77.0

 

(1)

The underlying factors for index-based interest guarantees vary by contract and other criteria, such as floors and ceilings on rates and future payouts.

 

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The following table sets forth the gross amounts of derivative instruments recorded on the unaudited condensed consolidated balance sheets and the collateral pledged related to the derivative instruments:

 

Offsetting of Interest Rate Swaps		March 31, 2015				December 31, 2014
		(In millions)
Interest rate swaps, liabilities		$	(9.7)			$	(5.1)
Interest rate swaps, assets			---				0.4
Net interest rate swaps			(9.7)				(4.7)
Accrued interest payable			(2.0)				(2.2)
Collateral pledged			17.5				12.2
Net amount		$	5.8			$	5.3

The following table sets forth the amount of gains or losses recognized in the unaudited condensed consolidated statements of income from the changes in fair value of the Company’s derivative assets and liabilities:

 

		Three Months Ended March 31,
Qualifying Fair Value Hedging Instruments		2015				2014
		(In millions)
Net capital losses:
Interest rate swaps		$	(5.0)			$	---
Non-Qualifying Hedging Instruments
Net investment income:
S&P 500 Index options			1.4				2.0
Interest credited:
Index-based interest guarantees			(2.4)				(3.2)
Net losses		$	(6.0)			$	(1.2)

Fluctuations in the fair value of the interest rate swaps are driven by changes in the interest rate environment. Fluctuations in the fair value of the S&P 500 Index options are related to the volatility of the S&P 500 Index. Changes in fair value of the index-based interest guarantees are sensitive to a number of variables, but are most sensitive to the volatility of the S&P 500 Index and to changes in the interest rate environment.

The ineffective portion of derivatives accounted for using hedge accounting was a loss of $0.5 million for the first quarter of 2015.

Counterparty Credit Risk

Interest rate swaps

As the Company uses a central counterparty (“CCP”) to clear all of its interest rate swaps, the Company is only exposed to the default of the CCP. Transactions with the CCP require the Company to pledge initial and variation margin collateral. The Company pledged $17.5 million and $12.2 million of cash and cash equivalents on its unaudited condensed consolidated balance sheets as collateral to the CCP at March 31, 2015 and December 31, 2014, respectively.

S&P 500 Index options

The Company is exposed to the credit worthiness of the institutions from which it purchases its S&P 500 Index options and these institutions’ continued abilities to perform according to the terms of the contracts. The current values for the credit exposure have been affected by fluctuations in the S&P 500 Index. The Company’s maximum credit exposure would require an increase of 6.0% in the value of the S&P 500 Index. The maximum credit risk is calculated using the cap strike price of the Company’s S&P 500 Index options less the floor price, multiplied by the notional amount of the S&P 500 Index options.

 

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The following table sets forth the fair value of the Company’s S&P 500 Index options and its maximum credit risk exposure related to these instruments:

 

		March 31, 2015
		Assets at Fair Value				Maximum Credit Risk
		(In millions)
Counterparty:
The Bank of New York Mellon		$	2.8			$	3.2
Goldman Sachs			2.3				2.9
Merrill Lynch International			7.9				12.6
Total		$	13.0			$	18.7

 

9.	DEFERRED ACQUISITION COSTS (“DAC”), VALUE OF BUSINESS ACQUIRED (“VOBA”) AND OTHER INTANGIBLE ASSETS

DAC, VOBA and other acquisition related intangible assets are generally originated through the issuance of new business or the purchase of existing business, either by purchasing blocks of insurance policies from other insurers or by the outright purchase of other companies. The Company’s other intangible assets consist of certain customer lists from Asset Management businesses acquired and an individual disability marketing agreement.

The following table sets forth activity for DAC, VOBA and other intangible assets:

 

		Three Months Ended March 31, 2015				Year Ended December 31, 2014
		(In millions)
Carrying value at beginning of period, net:
DAC		$	336.9			$	319.1
VOBA			17.8				20.1
Other intangible assets			26.3				32.1
Total balance at beginning of period, net			381.0				371.3
Deferred or acquired during period:
DAC			25.0				80.1
Total deferred or acquired during period			25.0				80.1
Amortized during period:
DAC			(17.7)				(62.3)
VOBA			(0.6)				(2.3)
Other intangible assets			(1.4)				(5.8)
Total amortized during period			(19.7)				(70.4)
Impairment during period:
Other intangible assets			(5.6)				---
Total impairment during period			(5.6)				---
Carrying value at end of period, net:
DAC			344.2				336.9
VOBA			17.2				17.8
Other intangible assets			19.3				26.3
Total carrying value at end of period, net		$	380.7			$	381.0

The Company defers certain acquisition costs that vary with and are directly related to the origination of new business. Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred and will be amortized to accomplish matching against related future premiums or gross profits as appropriate. The Company normally defers certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. Assumptions used in developing DAC and amortization amounts each period include the amount of business in-force, expected future persistency, withdrawals, interest rates and profitability. These assumptions are modified to reflect actual experience when appropriate. Additional amortization of DAC is charged to current earnings, to the extent it is determined that future premiums or gross profits are not adequate to cover the remaining amounts deferred. Changes in actual persistency are reflected in the calculated DAC balance. Costs that are not directly associated with the acquisition of new business are not deferred as DAC and are charged to expense as incurred. Generally, annual commissions are considered expenses and are not deferred.

 

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DAC for group and individual disability insurance products and group life insurance products is amortized over the life of related policies in proportion to future premiums. The Company amortizes DAC for group disability and life insurance products over the initial premium rate guarantee period, which averages 2.5 years. DAC for individual disability insurance products is amortized in proportion to future premiums over the life of the contract, averaging 20 to 25 years with approximately 50% and 75% expected to be amortized by years 10 and 15, respectively.

The Company’s individual deferred annuities and group annuity products are classified as investment contracts. DAC related to these products is amortized over the life of related policies in proportion to expected gross profits. For the Company’s individual deferred annuities, DAC is generally amortized over 30 years with approximately 45% and 95% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 80% expected to be amortized by year five.

VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. The Company has established VOBA for a block of individual disability business assumed from Minnesota Life Insurance Company (“Minnesota Life”) and a block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life products. However, the VOBA related to the TIAA transaction associated with an in-force block of group long term disability claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with the Company’s assumptions, the Company could be required to make adjustments to VOBA and related amortization. The VOBA associated with the TIAA transaction is amortized in proportion to expected gross profits with an amortization period of up to 20 years. For the VOBA associated with the Minnesota Life block of business assumed, the amortization period is up to 30 years and is amortized in proportion to future premiums. The accumulated amortization of VOBA was $71.6 million and $71.0 million at March 31, 2015 and December 31, 2014, respectively.

The following table sets forth the amount of DAC and VOBA balances amortized in proportion to expected gross profits and the percentage of the total balance of DAC and VOBA amortized in proportion to expected gross profits:

 

		March 31, 2015								December 31, 2014
		Amount				Percent				Amount				Percent
		(Dollars in millions)
DAC		$	81.3				23.6 %			$	82.4				24.5 %
VOBA			3.6				20.9				3.7				20.8

Key assumptions, which will affect the determination of expected gross profits for determining DAC and VOBA balances, are:

•

Persistency.

•

Interest rates, which affect both investment income and interest credited.

•

Stock market performance.

•

Capital gains and losses.

•

Claim termination rates.

•

Amount of business in-force.

These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, the Company revises these assumptions annually to reflect its current best estimate of expected gross profits. As a result of this process, known as “unlocking,” the cumulative balances of DAC and VOBA are adjusted with an offsetting benefit or charge to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. As a result of unlocking, the amortization schedule for future periods is also adjusted.

The following table sets forth the impact of unlocking on DAC and VOBA balances:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Decrease to DAC and VOBA		$	---			$	(0.1)

Significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits, may result in a large unlocking event that could have a material effect on the Company’s financial position or results of operations. However, future changes in DAC and VOBA balances due to changes in underlying assumptions are not expected to be material.

 

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The Company’s other intangible assets are subject to amortization and consist of certain customer lists from Asset Management businesses acquired and an individual disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of 3.8 years. The marketing agreement that accompanied the Minnesota Life transaction provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The Minnesota Life marketing agreement will be fully amortized by the end of 2023. The accumulated amortization of other intangible assets was $55.4 million and $48.4 million at March 31, 2015 and December 31, 2014, respectively. In the first quarter of 2015, the Company recorded a $5.6 million impairment to other intangible assets. The impairment was related to the expected sale of the assets of the Company’s private client wealth management business. The Company did not record an impairment to other intangible assets in the first quarter of 2014.

The following table sets forth the estimated net amortization of VOBA and other intangible assets for the remainder of 2015 and for each of the next five years:

 

		Amount
		(In millions)
2015		$	4.8
2016			4.9
2017			3.5
2018			3.5
2019			3.3
2020			3.3

 

10.	COMMITMENTS AND CONTINGENCIES

Litigation Contingencies

In the normal course of business, the Company is involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending at March 31, 2015. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material effect on the Company’s business, financial position, results of operations or cash flows.

Senior Unsecured Revolving Credit Facility (“Facility”) Contingencies

The Company maintains a $250 million Facility. Upon the request of StanCorp and with the consent of the lenders under the Facility, the Facility can be increased to $350 million. The termination date of the Facility is June 22, 2018. The Company expects to use the Facility for working capital, general corporate purposes and for the issuance of letters of credit.

Under the agreement, the Company is subject to two financial covenants, which are based on the Company’s ratio of total debt to total capitalization and consolidated net worth. The Company is also subject to covenants that limit subsidiary indebtedness. The Facility is subject to pricing levels based upon the Company’s publicly announced debt ratings and includes an interest rate option at the election of the borrower of a base rate plus the applicable margin or LIBOR plus the applicable margin, plus facility and utilization fees. At March 31, 2015, the Company was in compliance with all financial covenants under the Facility and had no outstanding balance on the Facility.

Other Financing Obligations

The Company has $250 million of 5.00% 10-year senior notes (“Senior Notes’’), which mature on August 15, 2022. Interest is paid semi-annually on February 15 and August 15.

The Company has $252.9 million of 6.90%, junior subordinated debentures (“Subordinated Debt”), which matures on June 1, 2067 and is non-callable prior to June 1, 2017. In 2014, the Company repurchased $47.1 million in principal amount of Subordinated Debt. Interest is payable semi-annually on June 1 and December 1 for the first 10 years up to June 1, 2017, and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. StanCorp has the option to defer interest payments for up to five years. The declaration and payment of dividends to shareholders would be restricted if the Company elected to defer interest payments on its Subordinated Debt. If elected, the restriction would be in place during the interest deferral period. StanCorp is currently not deferring interest on the Subordinated Debt. See “Note 14—Subsequent Events” for more information.

At March 31, 2015, the Company had $158.0 million outstanding under funding agreements with the FHLB of Seattle, with fixed interest rates ranging from 0.38% to 3.79% that mature in 1 to 15 years. The funding agreements with the FHLB of Seattle are recorded as other policyholder funds on the Company’s unaudited condensed consolidated balance sheets.

At March 31, 2015, the Company had $68.0 million of commitments to fund tax-advantaged investments, which included $66.6 million of commitments to fund tax-advantaged investments that qualify as affordable housing investments. These commitments are recorded as other liabilities in the Company’s unaudited condensed consolidated balance sheets, with a corresponding amount recorded as other invested assets.

 

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The following table sets forth the commitments to fund tax-advantaged investments that qualify as affordable housing investments for the remainder of 2015 and the following consecutive years in which they are expected to be paid:

 

		Amount
		(In millions)
2015		$	36.9
2016			17.4
2017			6.6
2018			0.4
2019			0.3
Thereafter			5.0

In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 90 days in advance. At March 31, 2015, the Company had outstanding commitments to fund commercial mortgage loans totaling $224.4 million, with fixed interest rates ranging from 3.50% to 6.25%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company will retain the commitment fee and good faith deposit. Alternatively, if the Company terminates a commitment due to the disapproval of a commitment requirement, the commitment fee and good faith deposit may be refunded to the borrower, less an administrative fee.

 

11.	ACCOUNTING PRONOUNCEMENTS

ASU No. 2014-09, Revenue from Contracts with Customers

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The main objective of ASU No. 2014-09 is to provide a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This ASU does not apply to insurance contracts, financial instruments, and various other topics within the FASB Accounting Standards Codification. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services.

ASU No. 2014-09 is effective for annual periods and interim reporting periods within those annual periods beginning after December 15, 2016. Early adoption is not permitted. The Company’s revenue is primarily from insurance contracts and financial instruments; therefore, the Company does not expect this ASU to have a material effect on its results of operations.

ASU No. 2015-01, Income Statement – Extraordinary and Unusual Items

In January 2015, the FASB issued ASU No. 2015-01, Income Statement – Extraordinary and Unusual Items. The main objective of ASU No. 2015-01 is to eliminate from GAAP the concept of extraordinary items; however, the requirement to disclose unusual and infrequent items still exists. Under this guidance, an entity will no longer segregate extraordinary items from the results of ordinary operations; separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or disclose income taxes and earnings-per-share data applicable to an extraordinary item. The ASU affects the reporting and disclosure requirements for an event that is unusual in nature or that occurs infrequently.

ASU No. 2015-01 is effective for annual periods and interim reporting periods within those annual periods beginning after December 15, 2015. Early adoption is permitted if guidance is applied as of the beginning of the annual period of adoption. The Company does not expect this ASU to have a material effect on its results of operations or disclosures.

ASU No. 2015-03, Interest – Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs

In April 2015, the FASB issued ASU No. 2015-03, Interest – Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs. The main objective of ASU No. 2015-03 is to simplify the presentation of debt issuance costs by requiring that debt issuance costs be presented as a direct reduction in the carrying value of the debt liability. Amortization of debt issuance costs will be reported as interest expense.

ASU No. 2015-03 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. As of March 31, 2015, the Company had $4.3 million in debt issuance costs, which were recorded to other assets on the unaudited condensed consolidated balance sheets. The Company does not expect this ASU to have a material effect on its financial position or results of operations.

 

12.	INCOME TAXES

Income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% to pre-tax income because of the net results of permanent differences between book and taxable income, tax credits, amortization of tax-advantaged investments that qualify as affordable housing investments and the inclusion of state and local income taxes, net of the federal tax benefit.

 

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The following table sets forth the combined federal and state effective income tax rates:

 

		Three Months Ended March 31,
		2015				2014
Combined federal and state effective income tax rates			27.0 %				30.0 %

The decrease in the effective income tax rate for the first quarter of 2015 compared to the same period of 2014 was primarily due to higher utilization of tax credits during the first quarter of 2015 due to purchases of tax-advantaged investments.

The following table sets forth the amounts recorded in income taxes related to tax credits, the benefits from tax losses and the amortization of the tax-advantaged investments that qualify as affordable housing investments:

 

		Three Months Ended March 31,
		2015				2014
		(In millions)
Tax credits		$	(9.1)			$	(7.0)
Benefits from tax losses			(1.9)				(1.5)
Amortization of tax-advantaged investments			7.9				5.6
Total amounts recorded in income taxes		$	(3.1)			$	(2.9)

 

13.	ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table sets forth the changes in accumulated other comprehensive income (loss) by component:

 

		Net Unrealized Gains (Losses) on Fixed  Maturity Securities Available-for-Sale				Employee Benefit Plans				Total Accumulated Other Comprehensive Income (Loss)
		(In millions)
Balance, January 1, 2014		$	173.2			$	(38.5)			$	134.7
Other comprehensive income (loss), net of tax before reclassification adjustment(1)			50.3				(70.4)				(20.1)
Amounts reclassified from accumulated other comprehensive income (loss), net of tax(2)			(2.0)				1.7				(0.3)
Net other comprehensive income (loss), net of tax			48.3				(68.7)				(20.4)
Balance, December 31, 2014			221.5				(107.2)				114.3
Other comprehensive income (loss), net of tax before     reclassification adjustment(3)			37.3				(0.1)				37.2
Amounts reclassified from accumulated other comprehensive income, net of tax(4)			(0.3)				2.1				1.8
Net other comprehensive income, net of tax			37.0				2.0				39.0
Balance, March 31, 2015		$	258.5			$	(105.2)			$	153.3

 

(1)

Net of tax expense of $24.6 million for net unrealized gains on fixed maturity securities and net of tax benefit of $37.9 million for employee benefits.

(2)

Net of tax benefit of $1.1 million for net unrealized gains on fixed maturity securities and net of tax expense of $0.9 million for employee benefits.

(3)

Net of tax expense of $20.1 million for net unrealized gains on fixed maturity securities and net of tax benefit of $0.3 million for employee benefits.

(4)

Net of tax benefit of $0.2 million for net unrealized gains on fixed maturity securities and net of tax expense of $1.1 million for employee benefits.

 

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14.	SUBSEQUENT EVENTS

On April 21, 2015, the Company entered into an interest rate swap to fix the interest rate to 5.05% on $200 million of the $252.9 million Subordinated Debt outstanding from June 1, 2017 until June 1, 2042. Interest on the Company’s Subordinated Debt is payable at a fixed rate of 6.90% until June 1, 2017 and at a floating rate equal to three-month LIBOR plus 2.51% beginning June 1, 2017. The interest rate swap is designated as a cash flow hedge for accounting purposes with the changes in fair value of the interest rate swap recognized in other comprehensive income as long as the hedge remains effective.

 

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ITEM 2:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As used in this Form 10-Q, the terms “StanCorp,” “Company,” “we,” “us” and “our” refer to StanCorp Financial Group, Inc. and its subsidiaries, unless the context otherwise requires. The following analysis of the consolidated financial condition and results of operations of StanCorp should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto. See Item 1, “Financial Statements.”

Our filings with the Securities and Exchange Commission (“SEC”) include our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, registration statements and amendments to those reports. Access to all filed reports is available free of charge on our investor relations website at www.stancorpfinancial.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The SEC also maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov.

The following management assessment of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto in our 2014 Form 10-K. Those consolidated financial statements and certain disclosures made in this Form 10-Q have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during each reporting period. The estimates most susceptible to material changes due to significant judgment are identified as critical accounting policies. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. See “Critical Accounting Policies and Estimates.”

Financial measures that exclude after-tax net capital gains and losses and accumulated other comprehensive income (“AOCI”) are non-GAAP measures. To provide investors with a broader understanding of earnings, we provide net income per diluted share excluding after tax net capital gains and losses, along with the GAAP measure of net income per diluted share, because capital gains and losses are not likely to occur in a stable pattern.

Management believes that measuring net income return on average equity excluding after-tax net capital gains and losses from net income and AOCI from equity is important to investors because the low turnover of our portfolio of fixed maturity securities—available-for-sale (“fixed maturity securities”) may not be such that unrealized gains and losses reflected in AOCI are ultimately realized. Furthermore, management believes exclusion of AOCI provides investors with a better measure of return.

This management’s discussion and analysis of financial condition and results of operations contain forward-looking statements. See “Forward-looking Statements.”

EXECUTIVE SUMMARY

StanCorp Financial Group, Inc., through its subsidiaries marketed as The Standard — Standard Insurance Company (“Standard”), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. (“Standard Retirement Services”), StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”), StanCorp Investment Advisers, Inc., StanCorp Real Estate, LLC and StanCorp Equities, Inc. (“StanCorp Equities”) — is a leading provider of financial products and services. StanCorp’s subsidiaries offer group and individual disability insurance, group life and accidental death and dismemberment insurance (“AD&D”), group dental and group vision insurance, absence management services, retirement plans products and services, individual annuities, origination and servicing of fixed-rate commercial mortgage loans and investment advice.

 

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Financial Results Overview

The following table sets forth selected consolidated financial results:

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in millions — except per share data)
Net income		$	56.5			$	48.1
After-tax net capital losses			(5.4)				(0.7)
Net income excluding after-tax net capital losses		$	61.9			$	48.8
Net capital losses		$	(8.6)			$	(1.1)
Tax benefit on net capital losses			(3.2)				(0.4)
After-tax net capital losses		$	(5.4)			$	(0.7)
Net income per diluted common share:
Net income		$	1.32			$	1.08
After-tax net capital losses			(0.13)				(0.02)
Net income excluding after-tax net capital losses		$	1.45			$	1.10
Shareholders’ equity		$	2,256.8			$	2,218.7
Accumulated other comprehensive income			153.3				184.9
Shareholders’ equity excluding accumulated other comprehensive income		$	2,103.5			$	2,033.8
Diluted weighted-average common shares outstanding			42,673,025				44,381,944

Net income excluding after-tax net capital losses was $1.45 per diluted share for the first quarter of 2015, compared to $1.10 per diluted share for the first quarter of 2014. The increase was primarily due to more favorable claims experience and premium growth in Employee Benefits and Individual Disability, partially offset by higher operating expenses and higher commissions and bonuses for the first quarter of 2015.

Primary Drivers of First Quarter 2015 Results

Employee Benefits premiums increased 4.0% to $478.0 million for the first quarter of 2015 from $459.4 million for the first quarter of 2014. The increase was primarily due to higher Employee Benefits sales and favorable persistency for the first quarter of 2015 compared to the first quarter of 2014. Employee Benefits annualized new sales were $123.3 million for the first quarter of 2015, compared to $62.5 million for the first quarter of 2014. The increase in sales for the first quarter of 2015 reflected an increase in proposal activity. The Employee Benefits benefit ratio was 77.4% for the first quarter of 2015, compared to 80.8% for the first quarter of 2014. The decrease in the benefit ratio was primarily due to more favorable claims experience for the first quarter of 2015 compared to the first quarter of 2014.

Individual Disability premiums were $50.4 million for the first quarter of 2015, compared to $48.1 million for the first quarter of 2014. The Individual Disability benefit ratio was 44.2% for the first quarter of 2015, compared to 54.1% for the first quarter of 2014. Due to the relatively small size of the Individual Disability business, the benefit ratio generally fluctuates more on a quarterly basis and tends to be more stable when measured on an annual basis.

Asset Management reported income before income taxes of $19.4 million for the first quarter of 2015, compared to $16.4 million for the first quarter of 2014. The increase was primarily due to higher net investment income and higher administrative fees, partially offset by an increase in operating expenses, which was primarily to support business growth, consistent with growth in assets under administration.

For a discussion of our consolidated results of operations and business segment results, see “Consolidated Results of Operations.”

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our consolidated financial statements and certain disclosures made in this Form 10-Q have been prepared in accordance with GAAP and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The estimates most susceptible to material changes due to significant judgment (identified as the “critical accounting policies”) are those used in determining investment valuations, the reserves for future policy benefits and claims, deferred acquisition costs (“DAC”), value of business acquired (“VOBA”) and other intangible assets, pension and postretirement benefit plans and the provision for income taxes. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. These estimates have a material effect on our results of operations and financial condition.

 

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Investment Valuations

Fixed Maturity Securities

Capital gains and losses for fixed maturity securities are recognized using the specific identification method. If the fair value of a fixed maturity security declines below its amortized cost, we assess whether the decline is other than temporary.

In our quarterly impairment analysis, we evaluate whether a decline in fair value of the fixed maturity security is other than temporary by considering the following factors:

•

The nature of the fixed maturity security.

•

The duration until maturity.

•

The duration and extent the fair value has been below amortized cost.

•

The financial quality of the issuer.

•

Estimates regarding the issuer’s ability to make the scheduled payments associated with the fixed maturity security.

•

Our intent to sell or whether it is more likely than not we will be required to sell a fixed maturity security before recovery of the security’s cost basis through the evaluation of facts and circumstances including, but not limited to, decisions to rebalance our portfolio, current cash flow needs and sales of securities to capitalize on favorable pricing.

If we determine an other-than-temporary impairment (“OTTI”) exists, we separate the OTTI of fixed maturity securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income (loss). The cost basis of the fixed maturity security is permanently adjusted to reflect the credit loss. Once an impairment has been recorded, we continue to review the OTTI securities for further potential impairment.

We maintain an internally identified list of fixed maturity securities with characteristics that could indicate potential impairment (“watch list”). At March 31, 2015, our fixed maturity securities watch list totaled $6.1 million at fair value and $7.9 million at amortized cost after OTTI. We recorded no OTTI related to credit loss or noncredit loss due to impairments for the first quarters of 2015 and 2014. See Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 7—Investments” for further disclosures.

We will continue to evaluate our holdings; however, we currently expect the fair values of our investments to recover either prior to their maturity dates or upon maturity. Should the credit quality of our fixed maturity securities significantly decline, there could be a material adverse effect on our business, financial position, results of operations or cash flows.

In conjunction with determining the extent of credit losses associated with fixed maturity securities, we utilize certain information in order to determine the present value of expected cash flows discounted using pre-impairment yields. The information includes, but is not limited to, original scheduled contractual cash flows, current market spread information, risk-free rates, fundamentals of the industry and sector in which the issuer operates, and general market information.

Fixed maturity securities are classified as available-for-sale and are carried at fair value on the unaudited condensed consolidated balance sheets. See Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 6—Fair Value” for a detailed explanation of the valuation methods we use to calculate the fair value of our financial instruments. Valuation adjustments for fixed maturity securities not accounted for as OTTI are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the unaudited condensed consolidated statements of comprehensive income.

Commercial Mortgage Loans

The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general loan loss allowance and a specific loan loss allowance. The general loan loss allowance is based on our analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan-to-value ratios, actual loan loss experience and individual loan analysis. An impaired commercial mortgage loan is a loan where we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired. We also hold specific allowances for losses on certain performing loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that we will collect all amounts due. In addition, for impaired commercial mortgage loans, we evaluate the loss to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur, the loan-to-value ratio and other quantitative information we have concerning the loan. Negotiated reductions of principal are generally written off against the allowance, and recoveries, if any, are credited to the allowance. See “Liquidity and Capital Resources—Investing Cash Flows—Commercial Mortgage Loans.”

Real Estate

Real estate is comprised of two components: real estate investments and real estate acquired in satisfaction of debt through foreclosure or the acceptance of deeds in lieu of foreclosure on commercial mortgage loans (“Real Estate Owned”).

Our real estate investments are recorded at the lower of cost or net realizable value. We generally depreciate real estate investments using the straight-line depreciation method with property lives varying from 30 to 40 years.

 

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We record impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment is recorded to net capital losses, and the carrying value of the investment is adjusted to reflect the impairment.

Real Estate Owned is initially recorded at net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Our Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment is recorded if we do not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment has been recorded, we continue to review the investment for further potential impairment.

Total real estate was $33.8 million at March 31, 2015, compared to $37.0 million at December 31, 2014. The $3.2 million decrease in total real estate for the first quarter of 2015 was primarily due to the sale of Real Estate Owned and the impairments on Real Estate Owned.

Other Invested Assets

Other invested assets include tax-advantaged investments, derivative instruments, policy loans and common stock. Valuation adjustments for these investments are recognized using the specific identification method.

Tax-advantaged Investments

Our tax-advantaged investments are structured as limited partnerships. We have purchased tax-advantaged investments opportunistically due to the higher risk-adjusted returns. The primary sources of investment return are tax credits and the benefits from tax losses.

We have adopted Accounting Standards Update (“ASU”) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects as of January 1, 2015, which permits entities to account for qualified affordable housing projects under the proportional amortization method (“PAM”). The majority of our tax-advantaged investments qualify as affordable housing investments and are accounted for under PAM. Under PAM, the cost of the investment is amortized in each period in proportion to the tax credits and benefits from tax losses received in that period to total benefits to be received over the life of the investment and allows the amortization of the investment and the tax benefits to be recorded in income taxes on the unaudited condensed consolidated statements of income. For tax-advantaged investments with state premium tax credits, the state premium tax credits and the related investment losses are recorded in net investment income. We believe this presentation is a more accurate matching of the costs and benefits for these investments.

Tax-advantaged investments that do not qualify as affordable housing investments are accounted for under the equity method of accounting. Under the equity method of accounting, tax credits received from these investments are reported in the unaudited condensed consolidated statements of income as a reduction of income taxes. Our share of the operating losses of the limited partnerships decreases the carrying value of the investments and is reported as a component of net investment income.

If the net present value of expected future cash flows of a tax-advantaged investment is less than the current book value of the investment, we evaluate whether a decline in value is other than temporary. If it is determined an OTTI exists, the investment is written down to the net present value of expected future cash flows and the OTTI is recognized as a capital loss in the period in which it was determined to be impaired. We recorded no OTTI related to tax-advantaged investments that qualify as affordable housing investments for the first quarters of 2015 and 2014. We recorded OTTI of $2.9 million related to tax-advantaged investments that did not qualify as affordable housing investments for the first quarter of 2015. No impairment was recorded for the first quarter of 2014.

Derivative Instruments

We use interest rate swaps to reduce the risks from changes in interest rates, to manage interest rate exposures arising from asset/liability mismatches, and to protect the value of investments held on the unaudited condensed consolidated balance sheets. Interest rate swaps are recognized as either other invested assets or other liabilities in our unaudited condensed consolidated balance sheets and are reported at fair value. The accounting for an interest rate swap depends on whether it has been designated and qualifies as part of a hedging relationship and on the type of hedging relationship. To qualify for hedge accounting, we document the risk management objective and strategy for undertaking the hedging transaction and the designation of the hedge as either a fair value hedge or a cash flow hedge at the inception of the hedging transaction. Included in this documentation is how the interest rate swap is expected to hedge the designated risk related to specific assets or liabilities on our balance sheets, the method that will be used to prospectively and retrospectively assess the hedge effectiveness, the method that will be used to measure ineffectiveness and how this ineffectiveness will be recorded.

An interest rate swap designated as part of a hedging relationship must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is assessed at inception and periodically throughout the life of the designated hedging relationship, using qualitative and quantitative methods. Qualitative methods include comparison of critical terms of the interest rate swap to the hedged item. Quantitative methods include regression or other statistical analysis of changes in the fair value or cash flows associated with the hedge relationship.

Changes in the fair value of an interest rate swap designated as a fair value hedge, including amounts measured as ineffective, and changes in the fair value of the hedged item, are recognized in the unaudited condensed consolidated statements of income as a component of net capital gains and losses. The gain or loss on the termination of a fair value hedge is recognized in the unaudited condensed consolidated statements of income as a component of net capital gains and losses during the period in which the termination occurs. When interest rate swaps are used in hedge accounting relationships, periodic settlements are recorded in net investment income.

 

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The gain or loss on the termination of an ineffective fair value hedge is reported in the unaudited condensed consolidated statements of income as a component of net capital gains or losses. Additionally, when a hedged item is disposed, we will terminate the related derivative instrument and recognize the gain or loss on termination in the unaudited condensed consolidated statements of income as a component of net capital gains or losses.

Index-based interest guarantees embedded in indexed annuities (“index-based interest guarantees”) and Standard & Poor’s (“S&P”) 500 Index call spread options (“S&P 500 Index options”) do not qualify for hedge accounting. We sell indexed annuities, which permit the holder to elect a fixed interest rate return or an indexed return, where interest credited to the contracts is based on the performance of the S&P 500 Index, subject to an upper limit or cap and minimum guarantees. Policyholders may elect to rebalance between interest crediting options at renewal dates annually. At each renewal date, we have the opportunity to re-price the indexed component by changing the cap, subject to minimum guarantees. We estimate the fair value of the index-based interest guarantees for the current period and for all future reset periods until contract maturity. Changes in the fair value of the index-based interest guarantees are recorded in interest credited.

We purchase S&P 500 Index options for our interest crediting strategy used in our indexed annuity product. The S&P 500 Index options are purchased from investment banks and are selected in a manner that supports the amount of interest that is expected to be credited in the current year to annuity policyholder accounts that are dependent on the performance of the S&P 500 Index. The purchase of S&P 500 Index options is a pivotal part of our risk management strategy for indexed annuity products. The S&P 500 Index options are exclusively used for risk management. Changes in the fair value of S&P 500 Index options are recorded in net investment income.

Cash settlement activity of derivative contracts is reported in the unaudited condensed consolidated statements of cash flows as a component of proceeds from or acquisition of other invested assets. See Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 8—Derivative Financial Instruments.”

Policy Loans

Policy loans are stated at their aggregate unpaid principal balances and are secured by policy cash values.

Common Stock

Standard is a member of the Federal Home Loan Bank of Seattle (“FHLB of Seattle”). Standard owns common stock of FHLB of Seattle related to Standard’s membership and activity in the FHLB of Seattle. The FHLB of Seattle common stock is carried at par value and accounted for under the cost method. We periodically evaluate FHLB of Seattle common stock for OTTI. Our determination of whether this investment is impaired is based on our assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. We recorded no impairment to the FHLB of Seattle common stock for the first quarters of 2015 and 2014, respectively. The Federal Home Loan Bank of Des Moines (“FHLB of Des Moines”) and the FHLB of Seattle have announced that they have entered into a definitive agreement to merge the two banks. The merger agreement has been unanimously approved by the boards of directors of both banks, by the Federal Housing Finance Agency (“FHFA”), and was ratified by the members of both banks in February 2015. We do not expect the merger to have a material effect on our business, financial position, results of operations, cash flows or existing funding agreements with the FHLB of Seattle.

Reserves for Future Policy Benefits and Claims

Reserves include policy reserve liabilities and claim reserve liabilities and represent amounts to pay future benefits and claims. Claim reserve liabilities are for claims that have been incurred or are estimated to have been incurred but not yet reported to us. Policy reserve liabilities reflect our best estimate of assumptions at the time of policy issuance including adjustments for adverse deviations in actual experience.

The following table sets forth total reserve balances by reserve type:

 

		March 31, 2015				December 31, 2014
		(In millions)
Reserves:
Policy reserves		$	1,089.8			$	1,082.9
Claim reserves			4,752.2				4,749.4
Total reserves		$	5,842.0			$	5,832.3

Developing the estimates for reserves, and thus the resulting impact on earnings, requires varying degrees of subjectivity and judgment, depending upon the nature of the reserve. For most of our reserves, the reserve calculation methodology is prescribed by various accounting and actuarial standards, although judgment is required in the determination of assumptions used in the calculation. We also hold reserves that lack a prescribed methodology but instead are determined by a formula that we have developed based on our own experience. Because this type of reserve requires a higher level of subjective judgment, we closely monitor its adequacy. These reserves are primarily incurred but not reported (“IBNR”) claim reserves associated with our disability products. Finally, a small amount of reserves is held based entirely upon subjective judgment. These reserves are generally set up as a result of unique circumstances that are not expected to continue far into the future and are released according to pre-established conditions and timelines.

 

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The following table sets forth total reserve balances by calculation methodology:

 

		March 31, 2015				Percent of Total				December 31, 2014				Percent of Total
		(Dollars in millions)
Reserves:
Reserves determined through prescribed methodology		$	5,185.6				88.8 %			$	5,182.5				88.8 %
Reserves determined by internally-developed formulas			642.5				11.0				634.8				10.9
Reserves based on subjective judgment			13.9				0.2				15.0				0.3
Total reserves		$	5,842.0				100.0 %			$	5,832.3				100.0 %

Policy Reserves

Policy reserves include reserves established for individual disability insurance, individual and group immediate annuity businesses and individual life insurance. Policy reserves are calculated using our best estimates of assumptions and considerations at the time the policy was issued, which includes an adjustment for the effect of adverse deviations in actual experience. These assumptions may need to be subsequently modified if policy reserves are projected to be inadequate. We maintain a policy reserve for as long as a policy is in-force, even after a separate claim reserve is established.

The following table sets forth policy reserves by block of business:

 

		March 31, 2015				December 31, 2014
		(In millions)
Policy reserves:
Individual disability insurance		$	269.7			$	266.7
Individual and group immediate annuity businesses			227.9				219.9
Individual life insurance			592.2				596.3
Total policy reserves		$	1,089.8			$	1,082.9

Individual disability insurance 

Policy reserves for our individual disability insurance block of business are established at the time of policy issuance using the net level premium method as prescribed by GAAP and represent the current value of projected future benefits including expenses less projected future premium. Assumptions used to calculate individual disability insurance policy reserves may vary by the age, gender and occupation class of the insured, the year of policy issue and specific contract provisions and limitations.

Individual disability insurance policy reserves are sensitive to assumptions and considerations regarding:

•

Claim incidence rates.

•

Claim termination rates.

•

Discount rates used to value expected future claim payments and premiums.

•

Persistency rates.

•

The amount of monthly benefit paid to the insured less reinsurance recoveries and other offsets.

•

Expense rates including inflation.

Individual and group immediate annuity businesses 

Policy reserves for our individual and group immediate annuity business are established when a policy is issued and represent the present value of future payments due under the annuity contracts. As the contracts are single premium contracts, there is no projected future premium. Assumptions used to calculate immediate annuity policy reserves may vary by the age and gender of the annuitant and year of policy issue.

Immediate annuity policy reserves are sensitive to assumptions and considerations regarding:

•

Annuitant mortality rates.

•

Discount rates used to value expected future annuity payments.

Individual life insurance 

Effective January 1, 2001, substantially all of our individual life insurance policies and the associated reserves were ceded to Protective Life Insurance Company (“Protective Life”) under a reinsurance agreement. Effective February 1, 2015, Protective Life was acquired by The Dai-ichi Life Insurance Company, Limited (“Dai-ichi Life”) and is a wholly-owned subsidiary of Dai-ichi Life. If Protective Life were to become unable to meet its obligations, Standard would retain the reinsured liabilities. We do not expect the acquisition to have a material effect on our business, financial position, results of operations or cash flows. The associated reserves remain on Standard’s unaudited condensed consolidated balance sheets and an equal amount is recorded as recoverable from the reinsurer. We also retain a small number of individual policies arising out of individual conversions from our group life policies.

 

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Claim Reserves

Claim reserves are established when a claim is incurred or is estimated to have been incurred but not yet reported to us and, as prescribed by GAAP, equal our best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. Reserves for IBNR claims are determined using our experience and historical incidence rates, claim-reporting patterns and the average cost of claims. The IBNR claim reserves are calculated using a company derived formula based primarily upon premiums, which is validated through an examination of reserve run-out experience. The claim reserves are related to group and individual disability insurance and group life insurance products offered within Employee Benefits and Individual Disability.

Claim reserves are subject to revision based on credible changes in claim experience and expectations of future factors that may influence claim experience. During each quarter, we monitor our emerging claims experience to ensure that the claim reserves remain appropriate. We make adjustments to our assumptions based on emerging trends that are credible and are expected to persist, and expectations of future factors that may influence our claims experience. Assumptions used to calculate claim reserves may vary by the age, gender and occupation class of the claimant, the year the claim was incurred, time elapsed since disablement, and specific contract provisions and limitations.

The following table sets forth total claim reserves by block of business:

 

		March 31, 2015				December 31, 2014
		(In millions)
Claim reserves:
Group disability insurance		$	3,198.6			$	3,199.6
Individual disability insurance			822.5				822.1
Group life insurance			731.1				727.7
Total claim reserves		$	4,752.2			$	4,749.4

Group and individual disability insurance 

Claim reserves for our disability insurance products are sensitive to assumptions and considerations regarding:

•

Claim incidence rates for IBNR claim reserves.

•

Claim termination rates.

•

Discount rates used to value expected future claim payments.

•

The amount of monthly benefit paid to the insured less reinsurance recoveries and other offsets.

•

Expense rates including inflation.

•

Historical delay in reporting of claims incurred.

Certain of these factors could be materially affected by changes in social perceptions about work ethics, emerging medical perceptions and legal interpretations regarding physiological or psychological causes of disability, emerging or changing health issues and changes in industry regulation. If there are changes in one or more of these factors or if actual claims experience is materially inconsistent with our assumptions, we could be required to change our reserves.

Group life insurance

Claim reserves for our group life insurance products are established for death claims reported but not yet paid, IBNR for death and waiver claims and waiver of premium benefits. The death claim reserve is based on the actual amount to be paid. The IBNR claim reserves are calculated using historical information, and the waiver of premium benefit is calculated using a tabular reserve method that takes into account company experience and published industry tables.

Trends in Key Assumptions

Key assumptions affecting our reserve calculations include:

•

The discount rate.

•

The claim termination rate.

•

The claim incidence rate for policy reserves and IBNR claim reserves.

The discount rate used for newly incurred long term disability insurance claim reserves and life waiver reserves was 4.00% at March 31, 2015, December 31, 2014 and March 31, 2014.

The reserve discount rate is reviewed quarterly and reflects our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets attributable to the corresponding line of business during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. A 25 basis point increase or decrease in the discount rate currently results in a corresponding increase or decrease in quarterly pre-tax income of approximately $2 million. We do not adjust Employee Benefits premium rates based on short term fluctuations in investment yields. Any offsetting adjustments of Employee Benefits premium rates due to sustained changes in investment yields can take from one to three years given that most contracts have rate guarantees in place.

 

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Claim termination rates can vary widely from quarter to quarter. The claim termination assumptions used in determining our reserves represent our expectation for claim terminations over the life of our block of business and will vary from actual experience in any one quarter. While we have experienced some variation in our claim termination experience, we did not see any prolonged or systemic change in the first quarter of 2015 that would indicate a sustained underlying trend that would affect the claim termination rates used in the calculation of reserves.

As a result of studies of our long-term trends compared to reserving assumptions for our group long term disability insurance, we did not adjust our IBNR claim reserves for the first quarter of 2015.

We monitor the adequacy of our reserves relative to our key assumptions. In our estimation, scenarios based on reasonably possible variations in claim termination assumptions could produce a percentage change in reserves for our Employee Benefits lines of business of approximately +/-0.2% or $8 million. However, given that claims experience can fluctuate widely from quarter to quarter, significant unanticipated changes in claim termination rates over time could produce a change in reserves for our Employee Benefits lines outside of this range.

DAC, VOBA and Other Intangible Assets

DAC, VOBA and other acquisition related intangible assets are generally originated through the issuance of new business or the purchase of existing business, either by purchasing blocks of insurance policies from other insurers or by the outright purchase of other companies. Our intangible assets are subject to impairment tests on an annual basis or more frequently if circumstances indicate that carrying values may not be recoverable.

The following table sets forth the balances of DAC, VOBA and other intangible assets:

 

		March 31, 2015				December 31, 2014				Percent Change
		(Dollars in millions)
DAC		$	344.2			$	336.9				2.2%
VOBA			17.2				17.8				(3.4)
Other intangible assets			19.3				26.3				(26.6)
Total DAC, VOBA and other intangible assets		$	380.7			$	381.0				(0.1)

We defer certain acquisition costs that vary with and are directly related to the origination of new business and placing that business in-force. Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred and will be amortized to match related future premiums or gross profits as appropriate. We normally defer certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. Assumptions used in developing DAC and amortization amounts each period include the amount of business in-force, expected future persistency, withdrawals, interest rates and profitability. These assumptions are modified to reflect actual experience when appropriate. Additional amortization of DAC is charged to current earnings to the extent it is determined that future premiums or gross profits are not adequate to cover the remaining amounts deferred. Changes in actual persistency are reflected in the calculated DAC balance. Costs that are not directly associated with the acquisition of new business are not deferred as DAC and are charged to expense as incurred. Generally, annual commissions are considered expenses and are not deferred.

DAC for group and individual disability insurance products and group life insurance products is amortized over the life of related policies in proportion to future premiums. We amortize DAC for group disability and life insurance products over the initial premium rate guarantee period, which averages 2.5 years. DAC for individual disability insurance products is amortized in proportion to future premiums over the life of the contract, averaging 20 to 25 years with approximately 50% and 75% expected to be amortized by years 10 and 15, respectively.

Our individual deferred annuities and group annuity products are classified as investment contracts. DAC related to these products is amortized over the life of related policies in proportion to expected gross profits. For our individual deferred annuities, DAC is generally amortized over 30 years with approximately 45% and 95% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 80% expected to be amortized by year five.

VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. We have established VOBA for a block of individual disability insurance business assumed from Minnesota Life Insurance Company (“Minnesota Life”) and a block of group disability insurance and group life insurance business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life insurance products. However, the VOBA related to the TIAA transaction associated with an in-force block of group long term disability insurance claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with our assumptions, we could be required to make adjustments to VOBA and related amortization. The VOBA associated with the TIAA transaction is amortized in proportion to expected gross profits with an amortization period of up to 20 years. For the VOBA associated with the Minnesota Life block of business assumed, the amortization period is up to 30 years and is amortized in proportion to future premiums. The accumulated amortization of VOBA was $71.6 million and $71.0 million at March 31, 2015 and December 31, 2014, respectively.

 

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The following table sets forth the amount of DAC and VOBA balances amortized in proportion to expected gross profits and the percentage of the total balance of DAC and VOBA amortized in proportion to expected gross profits:

 

		March 31, 2015								December 31, 2014
		Amount				Percent				Amount				Percent
		(Dollars in millions)
DAC		$	81.3				23.6 %			$	82.4				24.5 %
VOBA			3.6				20.9				3.7				20.8

Key assumptions, which will affect the determination of expected gross profits for determining DAC and VOBA balances, include:

•

Persistency.

•

Interest rates, which affect both investment income and interest credited.

•

Stock market performance.

•

Capital gains and losses.

•

Claim termination rates.

•

Amount of business in-force.

These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, we review and, if necessary, revise these assumptions annually to reflect our current best estimate of expected gross profits. As a result of this process, known as “unlocking”, the cumulative balances of DAC and VOBA are adjusted with an offsetting increase or decrease to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. As a result of unlocking in prior periods, the amortization schedule for future periods is also adjusted.

There was no impact of unlocking in prior periods on DAC and VOBA balances for either the first quarter of 2015 or the first quarter of 2014.

Significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits, may result in a large unlocking event that could have a material adverse effect on our financial position or results of operations. However, future changes in DAC and VOBA due to changes in underlying assumptions are not expected to be material.

Our other intangible assets are subject to amortization and consist of certain customer lists from Asset Management businesses acquired and an Individual Disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of approximately 3.8 years. The marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The Minnesota Life marketing agreement will be fully amortized by the end of 2023. The accumulated amortization of other intangible assets was $55.4 million and $48.4 million at March 31, 2015 and December 31, 2014, respectively. In the first quarter of 2015, we recorded a $5.6 million impairment to other intangible assets. The impairment was related to the expected sale of the assets of our private client wealth management business. We did not record an impairment to other intangible assets in the first quarter of 2014.

Pension and Postretirement Benefit Plans

We have two non-contributory defined benefit pension plans: the employee pension plan and the agent pension plan. The employee pension plan is generally limited to eligible employees whose dates of employment began before 2003 and a participant is entitled to normal retirement benefits at age 65. The agent pension plan is for former field employees and agents. The defined benefit pension plans provide benefits based on years of service and final average pay. The employee pension plan is sponsored by StanCorp and the agent pension plan is sponsored by Standard. Both plans are administered by Standard Retirement Services and are closed for new participants. In addition, eligible executive officers are covered by a non-qualified supplemental retirement plan.

We also have a postretirement benefit plan that includes medical, prescription drug benefits and group term life insurance. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. The postretirement benefit plan is limited to eligible participants that retired prior to July 1, 2013.

We are required to recognize the funded status of our pension and postretirement benefit plans as an asset or liability on our balance sheet. For pension plans, this is measured as the difference between the plan assets at fair value and the projected benefit obligation as of the balance sheet date. For our postretirement plan, this is measured as the difference between the plan assets at fair value and the accumulated postretirement benefit obligation as of the balance sheet date. Unrecognized actuarial gains or losses, prior service costs or credits, and transition assets are amortized, net of tax, out of accumulated other comprehensive income or loss as components of net periodic benefit cost.

 

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In accordance with the accounting principles related to our pension and other postretirement plans, we are required to make a significant number of assumptions to calculate the related liabilities and expenses each period. The major assumptions that affect net periodic benefit cost and the funded status of the plans include the weighted-average discount rate, the expected return on plan assets, changes in actuarial assumptions and the rate of compensation increase.

The weighted-average discount rate is an interest assumption used to convert the benefit payment stream to present value. The discount rate is selected based on the yield of a portfolio of high quality corporate and municipal bonds with durations that are similar to the expected distributions from the employee benefit plan.

The expected return on plan assets assumption is the best long-term estimate of the average annual return that will be produced from the pension trust assets until current benefits are paid. Our expectations for the future investment returns of the asset categories are based on a combination of historical and projected market performance. The expected return for the total portfolio is calculated based on each plan’s strategic asset allocation.

The long-term rate of return for the employee pension plan portfolio is derived by calculating the average return for the portfolio monthly, from 1971 to the present, using the average mutual fund manager returns in each asset category, weighted by the target allocation to each category.

The actuarial present value of accumulated plan benefits is determined annually by applying actuarial assumptions to adjust the accumulated plan benefits to reflect the discount rate and the probability of payment between the valuation date and the expected date of payment. Changes in these assumptions, including the assumptions for mortality, are inherent in the estimations and assumptions process.

In the fourth quarter of 2014, we adopted an updated mortality table which was a significant driver of the increase in the projected benefit obligation at December 31, 2014 and related increase in operating expenses for the first quarter of 2015 compared to the first quarter of 2014.

The rate of compensation increase is a long-term assumption that is based on an estimated inflation rate in addition to merit and promotion-related compensation increase components.

For the postretirement benefit plan, the expected long-term rate of return on assets was developed by considering the historical returns and the future expectations for returns, as well as the target asset allocation. In addition, the assumption for the health care cost trend rates also affect expenses and liabilities for the postretirement benefit plan. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:

 

		1% Point Increase				1% Point Decrease
		(In millions)
Effect on total of service and interest cost		$	0.1			$	(0.1)
Effect on postretirement benefit obligation			2.8				(2.3)

Our discount rate assumption is reviewed annually, and we use a December 31 measurement date for each of our plans. For more information concerning our pension and postretirement plans, see Item 1, “Financial Statements—Notes to Unaudited Consolidated Financial Statements—Note 4—Retirement Benefits.”

Income Taxes

We file a U.S. consolidated income tax return that includes all subsidiaries. Our U.S. income tax is calculated using regular corporate income tax rates on a tax base determined by laws and regulations administered by the Internal Revenue Service (“IRS”). We also file corporate income tax returns in various states. The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply when the temporary differences are expected to reverse.

GAAP requires management to use a more likely than not standard to evaluate whether, based on available evidence, each deferred tax asset will be realized. A valuation allowance is recorded to reduce a deferred tax asset to the amount expected to be realized. We have recorded a deferred tax asset for loss carryforwards. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that the deferred tax asset for federal loss carryforwards will be realized. The amount of the deferred tax asset considered realizable; however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. Management has established a valuation allowance on some state and local loss carryforwards, which it believes are not likely to be realized.

Income tax expense may differ from the amount computed by applying the federal corporate tax rate of 35% to pre-tax income because of the net results of permanent differences between book and taxable income, tax credits, amortization of tax-advantaged investments that qualify as affordable housing investments and the inclusion of state and local income taxes, net of the federal tax benefit. See Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 12—Income Taxes.”

 

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Management is required to determine whether tax return positions are more likely than not to be sustained upon audit by taxing authorities. Tax benefits of uncertain tax positions, as determined and measured by this interpretation, cannot be recognized in our financial statements.

We record interest paid on income tax liabilities as interest expense and income tax penalties incurred as an operating expense. Currently, the years 2011 through 2015 are open for audit by the IRS.

BASIS OF PRESENTATION

Revenues

Revenues consist of premiums, administrative fees, net investment income and net capital gains and losses. Historically, premium and net investment income growth in Insurance Services and administrative fee and net investment income growth in Asset Management have been the primary drivers of consolidated revenue growth.

Premiums

Premiums for Insurance Services are the primary driver of consolidated premiums and are affected by sales, persistency, organic growth in Employee Benefits and experience rated refunds (“ERRs”). Organic growth in Employee Benefits is derived from existing policyholders’ employment and wage growth. ERRs represent cost sharing arrangements with certain group contract holders that provide refunds to the contract holders when claims experience is more favorable than contractual benchmarks, and provide for additional premiums to be paid when claims experience is less favorable than contractual benchmarks. ERRs can fluctuate widely from quarter to quarter depending on the underlying experience of specific contracts.

Premiums for Asset Management are generated from sales of life-contingent annuities, which are a single-premium product. Due to the competitive nature of single-premium products, premiums received by Asset Management can fluctuate widely from quarter to quarter due to low sales volume of life-contingent annuities and the varying size of single premiums. Increases or decreases in premiums for life-contingent annuities generally correlate with corresponding increases or decreases in benefits to policyholders.

Administrative Fees

Administrative fees for Asset Management include asset-based and plan-based fees related to our retirement plans and private client wealth management businesses, and fees related to the origination and servicing of commercial mortgage loans. The primary driver for administrative fees is the level of assets under administration for retirement plans, which is driven by equity and debt market performance and net customer deposits. Assets under administration that produce administrative fees include retirement plan group annuity and separate account products, retirement plan trust products, private client wealth management and commercial mortgage loans under administration for other investors.

Administrative fees for Insurance Services are primarily derived from insurance products for which we provide only administrative services and absence management services.

Net Investment Income

Net investment income is primarily affected by changes in levels of invested assets, portfolio yields, fluctuations in the change in fair value of our S&P 500 Index options related to our equity-indexed annuity product, commercial mortgage loan prepayment fee revenues, bond call premiums on fixed maturity securities, operating losses related to our tax-advantaged investments that do not qualify as affordable housing investments and state premium tax credits and the related investment losses for tax-advantaged investments with state premium tax credits.

Net Capital Gains and Losses

Net capital gains and losses are reported in the Other category and are not likely to occur in a stable pattern. Net capital gains and losses primarily occur as a result of sales of our assets for more or less than carrying value, OTTI of assets in our bond portfolio, provisions to our commercial mortgage loan loss allowance, impairments of real estate and impairments of other invested assets.

Benefits and Expenses

Benefits and expenses are amounts we pay to or on behalf of policyholders, interest credited to policyholders, commissions and bonuses, and other expenses.

Benefits to Policyholders

Benefits to policyholders for Insurance Services are primarily affected by the following factors:

•

Reserves that are established in part based on premium levels.

•

Claims experience – the predominant factors affecting claims experience are claims incidence, measured by the number of claims, and claims severity, measured by the magnitude of the claim and the length of time a disability claim is paid.

•

Reserve assumptions – the assumptions used to establish the related reserves reflect expected incidence and severity, and the discount rate. The discount rate is affected by new money investment rates and the overall portfolio yield. See “Critical Accounting Policies and Estimates—Reserves for Future Policy Benefits and Claims.”

Benefits to policyholders for Asset Management primarily represent current benefits and the change in reserves for future benefits on life-contingent annuities. Changes in the level of benefits to policyholders will generally correlate to changes in premium levels because these annuities are primarily single-premium life-contingent annuity products with a significant portion of all premium payments established as reserves.

 

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Benefit Ratio

The benefit ratio for Employee Benefits is calculated as benefits to policyholders and interest credited as a percentage of premiums and is used to provide a measurement of claims normalized for growth in our in-force block. The benefit ratio for Employee Benefits can fluctuate widely from quarter to quarter. The benefit ratio for Individual Disability is calculated as benefits to policyholders as a percentage of premiums. Due to the relatively small size of the Individual Disability business, the benefit ratio for Individual Disability generally fluctuates more than Employee Benefits. See “Critical Accounting Policies and Estimates—Reserves for Future Policy Benefits and Claims” for more information.

Discount Rate

The discount rate for newly established claim reserves is reviewed quarterly and reflects our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets attributable to the corresponding line of business during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. A 25 basis point increase or decrease in the discount rate currently results in a corresponding increase or decrease in the quarterly pre-tax income of approximately $2 million. See “Critical Accounting Policies and Estimates—Reserves for Future Policy Benefits and Claims—Claim Reserves.”

Interest Credited

Interest credited represents interest paid to policyholders on retirement plan general account assets, individual fixed-rate annuity deposits and index-based interest guarantees in Asset Management and interest paid on life insurance proceeds on deposit in Insurance Services. Interest credited is primarily affected by the following factors:

•

Changes in general account assets under administration.

•

Changes in new investment interest rates and overall portfolio yield, which influence our interest-crediting rate for our customers.

•

Persistency.

•

Changes in the fair value of the index-based interest guarantees. The changes may fluctuate from quarter to quarter due to changes in interest rates and equity market volatility.

Commissions and Bonuses

Commissions and bonuses primarily represent sales-based compensation, which can vary depending on the product, the structure of the commission program and other factors such as customer retention, sales, in-force premium, growth in assets under administration and the profitability of business in each of our segments.

Net Change in DAC, VOBA and Other Intangible Assets

We normally defer certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting. These costs are then amortized into expenses over a period not to exceed the life of the related policies, which for Employee Benefits contracts is the initial premium rate guarantee period and averages 2.5 years. VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. A portion of VOBA is amortized each year to achieve matching against expected gross profits. Our other intangible assets, consisting of customer lists and marketing agreements, are also subject to amortization. See “Critical Accounting Policies and Estimates—DAC, VOBA and Other Intangible Assets.”

Income Taxes

Income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% to pre-tax income because of the net result of permanent differences between book and taxable income, tax credits, amortization of tax-advantaged investments that qualify as affordable housing investments and the inclusion of state and local income taxes, net of the federal tax benefit.

 

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Consolidated Results of Operations

The following table sets forth our consolidated results of operations and key indicators:

 

		Three Months Ended March 31,
		2015				2014				Change
		(Dollars in millions —except per share data)
Revenues:
Premiums		$	532.1			$	510.1				4.3 %
Administrative fees			32.7				31.6				3.5
Net investment income			153.3				153.9				(0.4)
Net capital losses:
Total other-than-temporary impairment losses on fixed maturity securities—available-for-sale			---				---				---
All other net capital losses			(8.6)				(1.1)				681.8
Total net capital losses			(8.6)				(1.1)				681.8
Total revenues			709.5				694.5				2.2
Benefits and expenses:
Benefits to policyholders			398.7				401.1				(0.6)
Interest credited			41.1				43.5				(5.5)
Operating expenses			121.9				113.1				7.8
Commissions and bonuses			60.7				51.8				17.2
Premium taxes			9.1				9.1				---
Interest expense			7.8				8.4				(7.1)
Net increase in DAC, VOBA and other intangible assets			(7.2)				(1.2)				500.0
Total benefits and expenses			632.1				625.8				1.0
Income before income taxes			77.4				68.7				12.7
Income taxes			20.9				20.6				1.5
Net income		$	56.5			$	48.1				17.5
Net Income per common share:
Basic		$	1.34			$	1.10			$	0.24
Diluted			1.32				1.08				0.24
Weighted-average common shares outstanding:
Basic			42,130,728				43,896,627				(1,765,899)
Diluted			42,673,025				44,381,944				(1,708,919)
Key indicators:
Benefit ratio (% of premiums):
Employee Benefits (including interest credited)			77.4 %				80.8 %
Individual Disability			44.2				54.1
Total assets under administration		$	27,354.4			$	25,129.3				8.9 %
Consolidated portfolio yields:
Fixed maturity securities			3.97 %				4.18 %
Commercial mortgage loans			5.53				5.80
Combined federal and state effective income tax rate			27.0				30.0

First Quarter of 2015 Compared to First Quarter of 2014

Net income for the first quarter of 2015 was $56.5 million, compared to $48.1 million for the first quarter of 2014. The increase in net income was primarily due to more favorable claims experience and premium growth in Employee Benefits and Individual Disability, partially offset by higher operating expenses and higher commissions and bonuses for the first quarter of 2015.

Revenues

The increase in revenues for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to higher premiums in Employee Benefits and Individual Disability. See “Business Segments—Insurance Services.”

 

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Premiums

The increase in premiums for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in Employee Benefits premiums as a result of higher Employee Benefits sales and favorable persistency. See “Business Segments—Insurance Services.”

Administrative Fees

The increase in administrative fees for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to the increase in administrative fees from Asset Management as a result of growth in assets under administration. See “Business Segments—Asset Management.”

Net Investment Income

The decrease in net investment income for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to a decrease in portfolio yields for both fixed maturity securities and commercial mortgage loans, partially offset by an increase in retirement plan general account assets. See “Business Segments—Asset Management.”

Net Capital Losses

The increase in net capital losses for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to impairments recorded in the first quarter of 2015 related to the expected sale of the assets of our private client wealth management business and impairments for certain tax-advantaged investments. See “Business Segments—Other.”

Benefits to Policyholders

The decrease in benefits to policyholders for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to more favorable claims experience in Employee Benefits and Individual Disability. See “Business Segments—Insurance Services.”

Interest Credited

The decrease in interest credited for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to the change in fair value of the index-based interest guarantees. The decrease was partially offset by growth in our retirement plan general account assets under administration and individual fixed-rate annuity assets under administration. See “Business Segments—Asset Management.”

Operating Expenses

The increase in operating expenses for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to additional expenses related to business growth, and an expense increase of $2.5 million due to the adoption of a new mortality table for our retirement plans. See “Business Segments—Insurance Services” and “Business Segments—Asset Management.”

Commissions and Bonuses

The increase in commissions and bonuses for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in Employee Benefits premiums and sales. See “Business Segments—Insurance Services.”

Net Change in DAC, VOBA and Other Intangible Assets

The net increase in DAC, VOBA and other intangible assets for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in deferrals for individual annuities and Employee Benefits, which was a result of higher sales. See “Business Segments—Asset Management” and “Business Segments—Insurance Services.”

Income Taxes

The decrease in the effective income tax rate for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to higher utilization of tax credits for the first quarter of 2015, partially offset by higher taxable income relative to permanent book-to-tax differences. See Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 12—Income Taxes” for more information.

 

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BUSINESS SEGMENTS

We collectively view and operate our businesses as Insurance Services and Asset Management. Insurance Services contains two reportable product segments, Employee Benefits and Individual Disability. Insurance Services include our traditional risk acceptance businesses that reflect the application of our specialized expertise in the development, underwriting and administration of insurance products and services. Within Insurance Services, Employee Benefits offers group disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services. Asset Management is a separate reportable segment. Asset Management provides investment and asset management products and services and offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. Asset Management also offers investment advisory and management services, origination and servicing of fixed-rate commercial mortgage loans, individual fixed and indexed annuity products, group annuity contracts and retirement plan trust products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses primarily related to the impairment or the disposition of our invested assets and adjustments made in consolidation. We allocate resources and measure performance at the segment level.

The following table sets forth segment revenues measured as a percentage of total revenues, excluding revenues from the Other category:

 

		Three Months Ended March 31,
		2015				2014
Employee Benefits			76.0 %				76.1 %
Individual Disability			8.9				8.9
Total Insurance Services			84.9				85.0
Asset Management			15.1				15.0
Total			100.0 %				100.0 %

 

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Insurance Services

Insurance Services is comprised of our Employee Benefits and Individual Disability segments.

The following tables set forth our Insurance Services results of operations and key indicators:

 

		Three Months Ended March 31, 2015
		Employee Benefits				Individual Disability				Total Insurance Services				Percent Change From 2014
		(Dollars in millions)
Revenues:
Premiums:
Group life and AD&D		$	214.3			$	---			$	214.3				7.0%
Group long term disability			195.1				---				195.1				3.1
Group short term disability			60.1				---				60.1				10.7
Group other			21.1				---				21.1				9.9
Experience rated refunds			(12.6)				---				(12.6)				260.0
Total Employee Benefits			478.0				---				478.0				4.0
Individual Disability			---				50.4				50.4				4.8
Total Premiums			478.0				50.4				528.4				4.1
Administrative fees			4.0				---				4.0				(4.8)
Net investment income			63.9				13.7				77.6				(1.3)
Total revenues			545.9				64.1				610.0				3.3
Benefits and expenses:
Benefits to policyholders			369.5				22.3				391.8				(1.2)
Interest credited			0.7				---				0.7				---
Operating expenses			83.0				7.6				90.6				7.6
Commissions and bonuses			37.6				12.9				50.5				13.7
Premium taxes			8.1				1.0				9.1				---
Net increase in DAC, VOBA and other intangible assets			(5.2)				(2.4)				(7.6)				76.7
Total benefits and expenses			493.7				41.4				535.1				0.9
Income before income taxes		$	52.2			$	22.7			$	74.9				25.3

 

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		Three Months Ended March 31, 2014
		Employee Benefits				Individual Disability				Total Insurance Services
		(In millions)
Revenues:
Premiums:
Group life and AD&D		$	200.2			$	---			$	200.2
Group long term disability			189.2				---				189.2
Group short term disability			54.3				---				54.3
Group other			19.2				---				19.2
Experience rated refunds			(3.5)				---				(3.5)
Total Employee Benefits			459.4				---				459.4
Individual Disability			---				48.1				48.1
Total Premiums			459.4				48.1				507.5
Administrative fees			4.2				---				4.2
Net investment income			65.2				13.4				78.6
Total revenues			528.8				61.5				590.3
Benefits and expenses:
Benefits to policyholders			370.4				26.0				396.4
Interest credited			0.7				---				0.7
Operating expenses			77.4				6.8				84.2
Commissions and bonuses			33.3				11.1				44.4
Premium taxes			8.1				1.0				9.1
Net increase in DAC, VOBA and other intangible assets			(2.5)				(1.8)				(4.3)
Total benefits and expenses			487.4				43.1				530.5
Income before income taxes		$	41.4			$	18.4			$	59.8
		Three Months Ended March 31,
		2015				2014				Percent Change
		(Dollars in millions)
Key indicators:
Annualized new sales:
Employee Benefits		$	123.3			$	62.5				97.3%
Individual Disability			5.7				4.5				26.7
Benefit ratio (% of premiums):
Employee Benefits (including interest credited)			77.4 %				80.8 %
Individual Disability			44.2				54.1
Operating expense ratio (% of premiums):
Employee Benefits			17.4				16.8
Individual Disability			15.1				14.1
Discount rate			4.00				4.00

First Quarter of 2015 Compared to First Quarter of 2014

Income before income taxes for Insurance Services was $74.9 million for the first quarter of 2015, compared to $59.8 million for the first quarter of 2014. The increase in income before income taxes was primarily due to more favorable claims experience and higher premiums in Employee Benefits and Individual Disability, partially offset by higher operating expenses and higher commissions and bonuses.

Premiums

The increase in premiums for Employee Benefits for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to higher Employee Benefits sales and favorable persistency for the first quarter of 2015 compared to first quarter of 2014. The increase in sales for the first quarter of 2015 reflected an increase in proposal activity and was in-line with our five-year average for the first quarter sales. See “Basis of Presentation—Premiums.”

 

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The increase in premiums for Individual Disability for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to new policy sales for 2014 and the first quarter of 2015.

Net Investment Income

The decrease in net investment income for Insurance Services for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to a decrease in portfolio yields for both fixed maturity securities and commercial mortgage loans.

Benefits to Policyholders (including interest credited)

The decrease in benefits to policyholders (including interest credited) for Insurance Services for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to more favorable claims experience in the group life and group disability businesses of Employee Benefits. Benefits to policyholders related to incurred claims for the first quarter of 2015 decreased for both group life and group long term disability compared to the first quarter of 2014. Long term disability insurance claims incidence for the first quarter of 2015 decreased by 6.3%, compared to the first quarter of 2014.

The discount rate used for newly established long term disability insurance claim reserves and life waiver reserves was 4.00% for both the first quarters of 2015 and 2014. See “Critical Accounting Policies and Estimates—Reserves for Future Policy Benefits and Claims—Claim Reserves” for more information.

The benefit ratio for Employee Benefits was 77.4% for the first quarter of 2015, compared to 80.8% for the first quarter of 2014 due to more favorable claims experience for the first quarter of 2015 compared to the first quarter of 2014. The favorable claims experience for the first quarter of 2015 did not result in a significant change in our underlying assumptions or methods used to determine the claim reserves, primarily due to the long-term nature of our group long term disability insurance business and the materiality of other factors, including the potential impact of economic uncertainty. We monitor trends in reserve assumptions and when these trends become credible and are expected to persist, we incorporate these factors into our reserves to ensure the best estimates are established.

The benefit ratio for Individual Disability decreased to 44.2% for the first quarter of 2015, compared to 54.1% for first quarter of 2015. Due to the relatively small size of the Individual Disability business, the benefit ratio generally fluctuates more than Employee Benefits. See “Critical Accounting Policies and Estimates—Reserves for Future Policy Benefits and Claims—Claim Reserves” for more information.

Operating Expenses

The increase in operating expenses for Insurance Services for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in compensation related costs.

Commissions and bonuses

The increase in commissions and bonuses for Insurance Services for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to higher sales for both Employee Benefits and Individual Disability.

Net Change in DAC, VOBA and Other Intangible Assets

The increase in DAC, VOBA and other intangible assets for Insurance Services for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in deferrals for Employee Benefits which was a result of higher sales.

 

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Asset Management

The following tables set forth our Asset Management results of operations and key indicators:

 

		Three Months Ended March 31,
		2015				2014				Percent Change
		(Dollars in millions)
Revenues:
Premiums:
Retirement plans		$	0.5			$	1.1				(54.5)%
Individual annuities			3.2				1.5				113.3
Total premiums			3.7				2.6				42.3
Administrative fees:
Retirement plans			24.8				24.0				3.3
Other financial services businesses			8.9				8.2				8.5
Total administrative fees			33.7				32.2				4.7
Net investment income:
Retirement plans			29.7				27.0				10.0
Individual annuities			36.6				40.3				(9.2)
Other financial services businesses			4.9				2.2				122.7
Total net investment income			71.2				69.5				2.4
Total revenues			108.6				104.3				4.1
Benefits and expenses:
Benefits to policyholders			6.9				4.7				46.8
Interest credited			40.4				42.8				(5.6)
Operating expenses			31.3				29.9				4.7
Commissions and bonuses			10.2				7.4				37.8
Net decrease in DAC, VOBA and other intangible assets			0.4				3.1				(87.1)
Total benefits and expenses			89.2				87.9				1.5
Income before income taxes		$	19.4			$	16.4				18.3
		Three Months Ended March 31,
		2015				2014				Percent Change
		(Dollars in millions)
Key indicators:
Interest credited (% of net investment income):
Retirement plans			56.6  %				58.5  %
Individual annuities			62.8				67.0
Retirement plans annualized operating expenses (% of average assets under administration)			0.45  %				0.48  %
Commercial mortgage loans originated		$	335.0			$	245.1				36.7 %
Individual annuity sales			119.8				55.8				114.7
Assets under administration:
Retirement plans general account			2,819.2				2,541.5				10.9 %
Retirement plans separate account			7,458.5				6,528.3				14.2
Total retirement plans insurance products			10,277.7				9,069.8				13.3
Retirement plans trust products			9,555.1				8,720.8				9.6
Individual annuities			3,338.3				3,310.9				0.8
Commercial mortgage loans for other investors			3,324.9				3,114.0				6.8
Private client wealth management			858.4				913.8				(6.1)
Total assets under administration		$	27,354.4			$	25,129.3				8.9

 

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First Quarter of 2015 Compared to First Quarter of 2014

Income before income taxes for Asset Management was $19.4 million for the first quarter of 2015, compared to $16.4 million for the first quarter of 2014. The increase was primarily due to a higher net investment income and higher administrative fees and lower interest credited. This was partially offset by an increase in operating expenses, which was primarily to support business growth, consistent with growth in assets under administration.

Administrative Fees

The increase in administrative fees for Asset Management for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in assets under administration. Assets under administration increased 8.9% to $27.35 billion at March 31, 2015, compared to $25.13 billion at March 31, 2014 primarily reflecting higher equity values and positive cash flows for retirement plan assets under administration.

Net Investment Income

The increase in net investment income for Asset Management for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in retirement plan general account assets under administration of 10.9% for the first quarter of 2015 compared to the first quarter of 2014.

Benefits to Policyholders

The increase in benefits to policyholders for Asset Management for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in premiums for single-premium life-contingent annuity products. See “Basis of Presentation—Premiums.”

Interest Credited

The decrease in interest credited for Asset Management for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to a decrease in the average interest-crediting rate for our annuity products and the change in fair value of the index-based interest guarantees. The change in fair value of the index-based interest guarantees increased interest credited by $2.4 million for the first quarter of 2015, compared to an increase of $3.2 million for the first quarter of 2014. The decrease was partially offset by growth in our retirement plan general account assets under administration.

Operating Expenses

The increase in operating expenses for Asset Management for the first quarter of 2015 compared to the first quarter of 2014 was primarily to support business growth, consistent with growth in assets under administration.

Commissions and Bonuses

The increase in commissions and bonuses for Asset Management for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to higher individual annuity sales.

Net Change in DAC, VOBA and Other Intangible Assets

The net decrease in DAC, VOBA and other intangible assets for Asset Management for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to an increase in the margin between net investment income and interest credited for our fixed deferred annuity products. This was partially offset by an increase in deferrals for individual annuities, which was primarily due to higher individual annuity sales for the first quarter of 2015. See “Critical Accounting Policies and Estimates—DAC, VOBA and Other Intangible Assets” for more information.

 

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Other

We report our holding company and corporate activities in the Other category. This category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses primarily related to the impairment or the disposition of our invested assets and adjustments made in consolidation.

The following table sets forth results and key indicators for the Other category:

 

		Three Months Ended March 31,
		2015				2014				Dollar Change
		(In millions)
Revenues:
Administrative fees		$	(5.0)			$	(4.8)			$	(0.2)
Net investment income			4.5				5.8				(1.3)
Net capital losses:
OTTI on fixed maturity securities			---				---				---
All other net capital losses			(8.6)				(1.1)				(7.5)
Total net capital losses			(8.6)				(1.1)				(7.5)
Total revenues			(9.1)				(0.1)				(9.0)
Benefits and expenses:
Operating expenses			---				(1.0)				1.0
Interest expense			7.8				8.4				(0.6)
Total benefits and expenses			7.8				7.4				0.4
Loss before income taxes		$	(16.9)			$	(7.5)			$	(9.4)
Key indicators:
Net capital gains (losses):
Fixed maturity securities		$	0.5			$	1.4			$	(0.9)
Commercial mortgage loans			0.4				(1.3)				1.7
Real estate			(0.5)				(0.2)				(0.3)
Other			(9.0)				(1.0)				(8.0)
Total net capital losses		$	(8.6)			$	(1.1)			$	(7.5)
Provision change gain (loss) to our commercial mortgage loan loss allowance		$	0.3			$	(1.7)			$	2.0

First Quarter of 2015 Compared to First Quarter of 2014

The Other category reported a loss before income taxes of $16.9 million for the first quarter of 2015, compared to a loss before income taxes of $7.5 million for the first quarter of 2014. Net capital losses were $8.6 million for the first quarter of 2015, compared to $1.1 million for the first quarter of 2014. The loss before income taxes excluding net capital losses was $8.3 million for the first quarter of 2015, compared to $6.4 million for the first quarter of 2014. The increase in the loss before income taxes excluding net capital losses was primarily due to a decrease in net investment income.

Net Investment Income

The decrease in net investment income for the Other category for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to a decrease in the amount of invested assets allocated to the Other category.

Net Capital Losses

The increase in net capital losses for the Other category for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to impairments recorded in the first quarter of 2015 related to the expected sale of the assets of our private client wealth management business and impairments of certain tax-advantaged investments. Partially offsetting the increase in net capital losses was a decrease in the provision to our commercial mortgage loan loss allowance for the first quarter of 2015 compared to the first quarter of 2014.

Interest Expense

The decrease in interest expense for the Other category for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to the $47.1 million repurchase of junior subordinated debentures (“Subordinated Debt”) in the first quarter of 2014. See “Liquidity and Capital Resources—Financing Cash Flows.”

 

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Liquidity and Capital Resources

Asset-Liability Matching and Interest Rate Risk Management

Asset-liability management is a part of our risk management structure. The risks we assume related to asset-liability mismatches vary with economic conditions. The primary sources of economic risk are interest rate related and include changes in interest rate term risk, credit risk and liquidity risk. It is generally management’s objective to align the characteristics of assets and liabilities to meet our financial obligations under a wide variety of economic conditions. From time to time, management may choose to liquidate certain investments and reinvest in different investments to increase the likelihood of meeting our financial obligations. See “—Investing Cash Flows.”

Interest rate risk management, along with asset-liability analysis informs us of an appropriate allocation of invested assets to mitigate our interest rate risk exposure. We also use interest rate swaps, whereby we agree with another party to exchange, at specific intervals, the difference between fixed-rate and floating rate interest amounts as calculated by reference to an agreed notional amount, in fair value hedging relationships to reduce interest rate exposure arising from asset and liability duration mismatches. In accordance with presently accepted actuarial standards, we have made adequate provisions for the anticipated cash flows required to meet contractual obligations and related expenses through the use of statutory reserves and related items in light of the assets held at March 31, 2015.

Our interest rate risk analysis reflects the influence of call and prepayment rights present in our fixed maturity securities and commercial mortgage loans. The majority of these investments have contractual provisions that require the borrower to compensate us in part or in full for reinvestment losses if the security or loan is retired before maturity. Callable bonds, excluding bonds with make-whole provisions and bonds with provisions that allow the borrower to prepay near maturity, represented 3.7%, or $288.7 million, of our fixed maturity securities portfolio at March 31, 2015. We also originate commercial mortgage loans containing a make-whole prepayment provision requiring the borrower to pay a prepayment fee. As interest rates decrease, potential prepayment fees increase. These larger prepayment fees deter borrowers from refinancing during a low interest rate environment. Approximately 96% of the commercial mortgage loan portfolio contains this type of prepayment provision. In addition, approximately 2% of the commercial mortgage loan portfolio contains fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flows in the event of prepayment.

Operating Cash Flows

Net cash provided by operating activities is net income adjusted for non-cash items and accruals, and was $81.5 million for the first quarter of 2015, compared to $13.8 million for the first quarter of 2014. The increase in operating cash flows for the first quarter of 2015 compared to the same period in 2014 was primarily due to fluctuations in other assets and liabilities, mainly attributable to timing differences. We typically generate positive cash flows from operating activities, as premiums collected from our insurance products and income received from our investments exceed policy acquisition costs, benefits paid, redemptions and operating expenses. These positive cash flows are then invested to support the obligations of our insurance products and required capital supporting these products. Our cash flows provided by operating activities are affected by the timing of premiums, administrative fees and investment income received and expenses paid.

Investing Cash Flows

We maintain a diversified investment portfolio primarily consisting of fixed maturity securities and fixed-rate commercial mortgage loans. Investing cash inflows primarily consist of the proceeds from investments sold, matured or repaid. Investing cash outflows primarily consist of payments for investments acquired or originated.

Net cash used in investing activities was $107.1 million and $189.3 million for the first quarters of 2015 and 2014, respectively. The decrease in net cash used in investing activities for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to higher proceeds from the sale or repayment of fixed maturity securities, net of fixed maturity security acquisitions, partially offset by higher commercial mortgage loan acquisitions for the first quarter of 2015 compared to the first quarter of 2014.

Our target investment portfolio allocation is approximately 60% fixed maturity securities and 40% commercial mortgage loans with a maximum allocation of 45% to commercial mortgage loans. At March 31, 2015, total cash and investments consisted of 56.6% fixed maturity securities, 38.6% commercial mortgage loans, 2.3% cash and cash equivalents and 2.5% real estate and other invested assets.

Fixed Maturity Securities

We maintain prudent diversification across industries, issuers and maturities. Our corporate bond industry diversification targets are based on the Bank of America Merrill Lynch U.S. Corporate Master Index, which we believe reasonably reflects the mix of issuers broadly available in the market. Our fixed maturity securities rated below investment grade are primarily managed by a third party.

Our fixed maturity securities portfolio generates unrealized gains or losses primarily resulting from market interest rates that are lower or higher relative to our book yield at the reporting date. In addition, changes in the spread between the risk-free rate and market rates for any given issuer can fluctuate based on the demand for the instrument, the near term prospects of the issuer and the overall economic climate.

 

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The following tables set forth the composition of our fixed maturity securities portfolio by industry category with the associated unrealized gains and losses:

 

		March 31, 2015
		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
		(In millions)
Fixed maturity securities:
Corporate bonds:
Basic industry		$	443.4			$	22.9			$	(1.0)			$	465.3
Capital goods			954.6				48.6				(1.1)				1,002.1
Communications			325.7				19.4				(1.0)				344.1
Consumer cyclical			576.1				28.8				(1.6)				603.3
Consumer non-cyclical			965.8				74.8				(1.0)				1,039.6
Energy			616.7				28.7				(8.4)				637.0
Finance			1,883.8				91.7				(1.8)				1,973.7
Utilities			958.8				84.6				(3.1)				1,040.3
Transportation and other			267.4				16.7				(0.3)				283.8
Total corporate bonds			6,992.3				416.2				(19.3)				7,389.2
U.S. government and agency bonds			249.8				39.6				---				289.4
U.S. state and political subdivision bonds			131.1				11.2				(0.2)				142.1
Foreign government bonds			58.3				6.7				---				65.0
Total fixed maturity securities		$	7,431.5			$	473.7			$	(19.5)			$	7,885.7
		December 31, 2014
		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
		(In millions)
Fixed maturity securities:
Corporate bonds:
Basic industry		$	451.1			$	19.6			$	(2.2)			$	468.5
Capital goods			952.7				40.7				(4.3)				989.1
Communications			321.6				18.0				(2.0)				337.6
Consumer cyclical			566.7				25.3				(2.9)				589.1
Consumer non-cyclical			982.8				69.4				(2.5)				1,049.7
Energy			606.6				24.6				(13.1)				618.1
Finance			1,870.8				78.8				(5.0)				1,944.6
Utilities			911.4				76.1				(6.2)				981.3
Transportation and other			280.1				15.4				(0.9)				294.6
Total corporate bonds			6,943.8				367.9				(39.1)				7,272.6
U.S. government and agency bonds			262.0				38.3				(0.2)				300.1
U.S. state and political subdivision bonds			125.8				10.4				(0.1)				136.1
Foreign government bonds			58.4				6.5				---				64.9
Total fixed maturity securities		$	7,390.0			$	423.1			$	(39.4)			$	7,773.7

 

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The following table sets forth key indicators of our fixed maturity securities portfolio:

 

		March 31, 2015				December 31, 2014				Change
		(Dollars in millions)
Fixed maturity securities		$	7,885.7			$	7,773.7				1.4 %
Weighted-average credit quality of our fixed maturity securities portfolio (S&P)			A-				A-
Fixed maturity securities below investment grade:
As a percent of total fixed maturity securities			5.6 %				5.5 %
Managed by a third party		$	380.4			$	375.8				1.2 %
Fixed maturity securities on our watch list:
Fair value		$	6.1			$	12.7			$	(6.6)
Amortized cost after OTTI			7.9				15.2				(7.3)
Gross unrealized capital gains in our fixed maturity securities portfolio			473.7				423.1				50.6
Gross unrealized capital losses in our fixed maturity securities portfolio			(19.5)				(39.4)				19.9

We recorded no OTTI for the first quarters of 2015 and 2014. See “Critical Accounting Policies and Estimates—Investment Valuations—Fixed Maturity Securities.” We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at March 31, 2015.

Commercial Mortgage Loans

StanCorp Mortgage Investors originates and services fixed-rate commercial mortgage loans for the investment portfolios of our insurance subsidiaries and generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors. The level of commercial mortgage loan originations in any period is influenced by market conditions as we respond to changes in interest rates, available spreads and borrower demand.

 

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The following table sets forth commercial mortgage loan servicing data:

 

		March 31, 2015				December 31, 2014				Percent Change
		(Dollars in millions)
Commercial mortgage loans serviced:
For subsidiaries of StanCorp		$	5,366.8			$	5,321.1				0.9 %
For other institutional investors			3,324.9				3,304.1				0.6
Capitalized commercial mortgage loan servicing rights associated with commercial mortgage loans serviced for other institutional investors		$	9.7			$	9.5				2.1 %

The estimated average loan-to-value ratio for the overall portfolio was less than 70% at March 31, 2015. The average loan balance of our commercial mortgage loan portfolio was approximately $0.8 million at March 31, 2015. We have the contractual ability to pursue personal recourse on approximately 73% of our loans and partial personal recourse on a majority of the remaining loans. The weighted-average capitalization rate for the portfolio at March 31, 2015 was approximately 8%. Capitalization rates, which vary by property type and geographic region, are used as part of our annual internal analysis of the commercial mortgage loan portfolio. The rate is used in converting the property’s income to an estimated property value.

At March 31, 2015, we did not have any direct exposure to sub-prime or Alt-A mortgages in our commercial mortgage loan portfolio. When we undertake mortgage risk, we do so directly through loans that we originate ourselves rather than in packaged products such as commercial mortgage-backed securities. Given that we service the vast majority of loans in our portfolios, we are prepared to deal with them promptly and proactively. Should the delinquency rate or loss performance of our commercial mortgage loan portfolio increase significantly, the increase could have a material adverse effect on our business, financial position, results of operations or cash flows.

Our largest concentration of commercial mortgage loan property type was retail properties, which primarily consisted of convenience related properties in strip malls, convenience stores and restaurants. Our exposure to retail properties is diversified among various borrowers, properties and geographic regions. In addition, retail commercial lending represents an area of experience and expertise, where careful underwriting and consistent surveillance mitigate risks surrounding our commercial mortgage lending in this area.

At March 31, 2015, our ten largest borrowers represented less than 7% of our total commercial mortgage loan portfolio balance. Our largest borrower concentrations within our commercial mortgage loan portfolio consisted of one borrower that comprised less than 2% of our total commercial mortgage loan portfolio balance. The second largest borrower comprised less than 1% of our total commercial mortgage loan portfolio balance.

Due to the concentration of commercial mortgage loans in California, we could be exposed to potential losses as a result of an economic downturn in California as well as certain catastrophes. See Part II, Item 1A, “Risk Factors.”

Under the laws of certain states, environmental contamination of a property may result in a lien on the property to secure recovery of the costs of cleanup. In some states, such a lien has priority over the lien of an existing mortgage against such property. As a commercial mortgage lender, we customarily conduct environmental assessments prior to making commercial mortgage loans secured by real estate and before taking title through foreclosure on real estate collateralizing delinquent commercial mortgage loans held by us. Based on our environmental assessments, we believe that any compliance costs associated with environmental laws and regulations or any remediation of affected properties would not have a material effect on our business, financial position, results of operations or cash flows. However, we cannot provide assurance that material compliance costs will not be incurred by us.

In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At March 31, 2015, we had outstanding commitments to fund commercial mortgage loans totaling $224.4 million, with fixed interest rates ranging from 3.50% to 6.25%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and good faith deposit may be refunded to the borrower, less an administrative fee.

The following table sets forth key commercial mortgage loan statistics:

 

		March 31, 2015				December 31, 2014				Percent Change
		(Dollars in millions)
Commercial mortgage loans sixty-day delinquencies:
Book value		$	4.6			$	8.6				(46.5)%
Delinquency rate			0.08 %				0.16 %
In process of foreclosure		$	0.8			$	0.5				60.0
Restructured commercial mortgage loans			110.9				108.8				1.9

 

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The performance of our commercial mortgage loan portfolio may fluctuate in the future. However, based on our business approach of diligently underwriting high-quality loans, we believe our delinquency rate will remain low. The increase in restructured commercial mortgage loans of $2.1 million during the first quarter of 2015 was associated with an increase in the number of loans restructured.

The following table sets forth details of our commercial mortgage loans foreclosed or accepted as deeds in lieu of foreclosure:

 

		Three Months Ended March 31,
		2015				2014				Change
		(Dollars in millions)
Number of loans foreclosed			---				2				(2)
Book value of loans foreclosed		$	---			$	2.9			$	(2.9)
Number of properties foreclosed and transferred to Real Estate Owned			---				2				(2)
Real estate acquired		$	---			$	2.6			$	(2.6)

Commercial mortgage loan foreclosures may result in the sale of the property to a third party at the time of foreclosure, resulting in fewer properties transferred to Real Estate Owned than the number of loans foreclosed during the period. Commercial mortgage loans may have multiple properties as collateral, resulting in more properties transferred to Real Estate Owned than the number of loans foreclosed during the period. Real Estate Owned is initially recorded at estimated net realizable value, which includes an estimate for disposal costs. These amounts may be adjusted in a subsequent period as additional market information regarding fair value is received, however, these adjustments would not result in a carrying value greater than the initial recorded amount. There were no commercial mortgage loans foreclosed in the first quarter of 2015. See “Critical Accounting Policies and Estimates—Investment Valuations—Commercial Mortgage Loans” for our commercial mortgage loan loss allowance policy.

The following table sets forth changes in the commercial mortgage loan loss allowance:

 

		Three Months Ended March 31,
		2015				2014				Dollar Change
		(In millions)
Commercial mortgage loan loss allowance:
Beginning balance		$	40.0			$	43.6			$	(3.6)
Provision change (gain) loss			(0.3)				1.7				(2.0)
Charge-offs, net			(0.8)				(1.8)				1.0
Ending balance		$	38.9			$	43.5			$	(4.6)
Specific loan loss allowance		$	23.7			$	26.4			$	(2.7)
General loan loss allowance			15.2				17.1				(1.9)
Total commercial mortgage loan loss allowance		$	38.9			$	43.5			$	(4.6)

The decrease in the commercial mortgage loan loss allowance at March 31, 2015 compared to March 31, 2014 was primarily due to a decrease in the specific loan loss allowance at March 31, 2015 compared to March 31, 2014. The decrease in the charge-offs for the first quarter of 2015 compared to first quarter of 2014 were primarily related to lower losses related to charges associated with commercial mortgage loans leaving the portfolio during the first quarter of 2015.

The following table sets forth impaired commercial mortgage loans identified in management’s specific review of probable loan losses and the related allowance:

 

		March 31, 2015				December 31, 2014				Dollar Change
		(In millions)
Impaired commercial mortgage loans with specific allowances for losses		$	73.1			$	74.2			$	(1.1)
Impaired commercial mortgage loans without specific allowances for losses			25.2				31.7				(6.5)
Specific allowance for losses on impaired commercial mortgage loans, end of the period			(23.7)				(23.8)				0.1
Net carrying value of impaired commercial mortgage loans		$	74.6			$	82.1			$	(7.5)

A commercial mortgage loan is impaired when we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected based on the terms of the original note. We also hold specific loan loss allowances

 

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on certain performing commercial mortgage loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that all amounts due will be collected although the timing or nature may be outside the original contractual terms. The decrease to the net carrying value of impaired commercial mortgage loans at March 31, 2015 compared to December 31, 2014 was primarily due to a decrease in impaired commercial mortgage loans with a specific allowance for losses.

See Item 1, “Financial Statements—Notes to the Unaudited Condensed Consolidated Financial Statements—Note 7—Investments—Commercial Mortgage Loans” for policies regarding interest income for delinquent commercial mortgage loans.

Financing Cash Flows

Financing cash flows primarily consist of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, borrowings and repayments on long-term debt, issuances and repurchases of common stock and dividends paid on common stock. Net cash provided by financing activities was $95.1 million and $49.2 million for the first quarters of 2015 and 2014, respectively. The increase in funds provided by financing cash flows for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to a $47.1 million decrease in cash used to repurchase debt, $34.6 million decrease in share repurchases, partially offset by a $31.8 million decrease in policyholder fund deposits, net of withdrawals. See “Capital Management—Share Repurchases” for further discussion on share repurchases.

We maintain a four-year, $250 million senior unsecured revolving credit facility (“Facility”). Upon our request and with consent of the lenders under the Facility, the Facility can be increased to $350 million. In June 2014, the termination date of the Facility was extended by one year to June 22, 2018. We expect to use any borrowings under the Facility for working capital, general corporate purposes and for issuance of letters of credit.

Under the Facility, we are subject to customary covenants that take into consideration the impact of material transactions, changes to the business, compliance with legal requirements and financial performance. Under the two financial covenants, we are required to maintain a total debt to total capitalization ratio that does not exceed 35% and a consolidated net worth that is equal to at least $1.50 billion. The financial covenants exclude the unrealized gains and losses related to fixed maturity securities that are held in accumulated other comprehensive income (loss). At March 31, 2015, we had a total debt to total capitalization ratio of 20.2% and consolidated net worth of $1.99 billion as defined by the financial covenants. The Facility is subject to pricing levels based upon our publicly announced debt ratings and includes an interest rate option at the election of the borrower of a base rate plus the applicable margin or London Interbank Offered Rate (“LIBOR”) plus the applicable margin, plus facility and utilization fees. At March 31, 2015, we were in compliance with all covenants under the Facility and had no outstanding balance on the Facility. We believe we will continue to meet the financial covenants throughout the life of the Facility.

We have $250 million of 5.00% 10-year senior notes (“Senior Notes”), which mature on August 15, 2022. Interest is paid semi-annually on February 15 and August 15.

We have $252.9 million of Subordinated Debt, which matures on June 1, 2067, and is non-callable prior to June 1, 2017. In the first quarter of 2014, we repurchased $47.1 million in principal amount of Subordinated Debt. Interest is payable semi-annually on June 1 and December 1 until June 1, 2017, and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. We have the option to defer interest payments for up to five years. The declaration and payment of dividends to shareholders would be restricted if we elect to defer interest payments on our Subordinated Debt. If elected, the restriction would be in place during the interest deferral period. We are not currently deferring interest on the Subordinated Debt. See Item 1, “Financial Statements—Notes to the Unaudited Condensed Consolidated Financial Statements—Note 14—Subsequent Events” for more information.

In 2013, Standard became a member of the FHLB of Seattle. Standard issues collateralized funding agreements to the FHLB of Seattle and invests the cash received from advances to support various spread-based businesses and enhance our asset-liability management. Membership also provides an additional funding source and access to financial services that can be used as an alternative source of liquidity. At March 31, 2015, Standard had $158.0 million outstanding under funding agreements with the FHLB of Seattle compared to $139.0 million at December 31, 2014. At March 31, 2015, Standard pledged $198.7 million of commercial mortgage loans as collateral to the FHLB of Seattle for our outstanding advances compared to $174.4 million at December 31, 2014. The FHLB of Des Moines and the FHLB of Seattle have announced that they have entered into a definitive agreement to merge the two banks. The merger agreement has been unanimously approved by the boards of directors of both banks, by the FHFA and was ratified in February 2015. We do not expect the merger to have a material effect on our business, financial position, results of operations, cash flows or existing funding agreements with the FHLB of Seattle.

Capital Management

State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. Our target for our statutory insurance subsidiaries is generally to maintain statutory capital and surplus at 300% of the Company Action Level of Risk-Based Capital (“RBC”) required by regulators, which is 600% of the Authorized Control Level RBC required by our states of domicile. The statutory insurance subsidiaries capital and surplus as a percentage of the Company Action Level RBC was approximately 445% at March 31, 2015. At March 31, 2015, capital and surplus, adjusted to exclude asset valuation reserves, for our regulated statutory insurance subsidiaries totaled $1.34 billion.

Capital and surplus growth from our statutory insurance subsidiaries is generally a result of generated income, less a charge for business growth, measured by insurance premium growth, which includes individual annuity sales. The level of capital and surplus in excess of targeted RBC we generate generally varies inversely in relation to the level of our premium growth. As premium growth

 

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increases, capital and surplus is used to fund additional reserve requirements, meet increased regulatory capital requirements based on premium and cover certain acquisition costs associated with policy issuance, leaving less available capital beyond our target level. Higher levels of premium growth can result in increased utilization of capital and surplus beyond that which is generated by the business, and at very high levels of premium growth, we could generate the need for capital infusions. At lower levels of premium growth, additional capital and surplus produced by the business exceeds the capital and surplus utilized to meet these requirements, which can result in additional capital and surplus above our targeted RBC level. In assessing our capital and surplus position, we also consider cash and capital at the holding company and non-insurance subsidiaries.

In the third quarter of 2014, Standard transferred its group life reinsurance from an external party to StanCap Insurance Company, Inc. (“StanCap Insurance Company”), who also reinsures Standard’s AD&D insurance business. The result of this transaction increased the RBC ratio at our statutory insurance subsidiaries by approximately 25%.

Investments

The insurance laws of the states of domicile and other states in which the insurance subsidiaries conduct business regulate the investment portfolios of the insurance subsidiaries. Relevant laws and regulations generally limit the admissibility of investments to bonds and other fixed maturity securities, commercial mortgage loans, common and preferred stock and real estate. Decisions to acquire and dispose of investments are made in accordance with guidelines adopted and modified from time to time by the Boards of Directors of our insurance subsidiaries. Each investment transaction requires the approval of one or more members of senior investment staff, with increasingly higher approval authorities required for transactions that are more significant. Transactions are reported quarterly to the Audit Committee of the Board of Directors for Standard and to the Board of Directors for The Standard Life Insurance Company of New York.

Dividends from Subsidiaries

Our ability to pay dividends to shareholders, repurchase shares and meet obligations substantially depends upon the receipt of distributions from Standard. Standard’s ability to pay dividends to StanCorp is affected by factors deemed relevant by Standard’s Board of Directors and by Oregon law, which limits Standard’s dividend payments and other distributions to the earned surplus arising from its business. If the proposed dividend or other distribution exceeds certain statutory limitations, Standard must receive prior approval of the Director of the Oregon Department of Consumer and Business Services—Insurance Division (“Oregon Insurance Division”). The current statutory dividend limitations are the greater of (a) 10% of Standard’s combined capital and surplus as of December 31 of the preceding year, or (b) the net gain from operations after dividends to policyholders and federal income taxes and before realized capital gains or losses for the 12-month period ended on the preceding December 31. In each case, the limitation must be determined under statutory accounting practices. Oregon law gives the Oregon Insurance Division broad discretion to approve or decline requests for dividends and other distributions in excess of these limits. With the exception of StanCorp Equities, a limited broker-dealer and member of the Financial Industry Regulatory Authority, there are no regulatory restrictions on dividends from our non-insurance subsidiaries.

As of December 31, 2014, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $208.5 million and capital and surplus was $1.15 billion. Based upon Standard’s results for 2014, the amount of ordinary dividends and other distributions available in 2015, without prior approval from the Oregon Insurance Division is $208.5 million.

Standard has a $250.0 million subordinated surplus note (“Surplus Note”), payable to StanCorp. The Surplus Note matures in 2042 and bears an interest rate of 5.25%, with interest payments due March 31, June 30, September 30 and December 31, of each year. Standard has the right to prepay the principal balance of the Surplus Note, in whole or in part, at any time or from time to time, without penalty. In accordance with the requirements of the National Association of Insurance Commissioners (“NAIC”), the Surplus Note provides that no interest or principal payments may be made by Standard without the prior approval of the Oregon Insurance Division, interest will not be represented as an addition to the instrument, interest will not accrue additional interest and any payments with respect to the Surplus Note will be subordinate to Standard’s other obligations to policyholders, lenders and creditors.

In September 2014, Standard made an extraordinary distribution totaling $240.0 million to StanCorp that was used to capitalize StanCap Insurance Company. Effective September 30, 2014, StanCap Insurance Company entered into a reinsurance agreement with Standard to reinsure Standard’s group life and AD&D business. This reinsurance agreement between StanCap Insurance Company and Standard replaced the yearly renewable term group life reinsurance agreement with Canada Life Assurance Company, which was terminated effective September 30, 2014. As a result of the extraordinary distribution in September 2014, future dividends will require approval from the Oregon Insurance Division through September 2015 and will be considered extraordinary.

Dividends paid from Standard to StanCorp will be based on levels of available capital and needs at the holding company, which are driven by the financial results of Standard and the Company as a whole. Standard paid an extraordinary cash distribution to StanCorp of $50.0 million for the first quarter of 2015. Standard paid an ordinary cash dividend to StanCorp of $40.0 million for the first quarter of 2014.

Dividends to Shareholders

The declaration and payment of dividends to shareholders is subject to the discretion of our Board of Directors. We anticipate that an annual dividend to shareholders will be paid in December of each year depending on our financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on dividends from the insurance subsidiaries, the ability of the insurance

 

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subsidiaries to maintain adequate capital and other factors deemed relevant by our Board of Directors. In addition, the declaration and payment of dividends would be restricted if we elect to defer interest payments on our Subordinated Debt issued May 7, 2007. If elected, the restriction would be in place during the interest deferral period, which cannot exceed five years. We have not deferred interest on the Subordinated Debt, and have paid dividends each year since our initial public offering in 1999. In December 2014, StanCorp paid an annual cash dividend of $1.30 per common share, totaling $54.7 million.

Share Repurchases

On February 11, 2014, our Board of Directors authorized the repurchase of up to 3.0 million shares of StanCorp common stock through December 31, 2015 (“February 2014 Authorization”). The February 2014 Authorization took effect upon the completion of a prior repurchase authorization during the second quarter of 2014. As of March 31, 2015, there were 2.0 million shares remaining under the February 2014 Authorization. Share repurchases under the repurchase program are made in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934 (“Exchange Act”). Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock, capital levels, our assessment of the overall economy and other potential growth opportunities or priorities for capital use.

The following table sets forth share repurchases activity:

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in millions —except per share data)
Share repurchases:
Shares repurchased			---				553,200
Cost of share repurchases		$	---			$	34.6
Weighted-average price per common share			---				62.63
Shares remaining under repurchase authorizations			1,972,337				3,802,312

Financial Strength and Credit Ratings

Financial strength ratings are gauges of our claims paying ability and are an important factor in establishing the competitive position of insurance companies. In addition, ratings are important for maintaining public confidence in our Company and in our ability to market our products. Rating organizations regularly review the financial performance and condition of insurance companies. In addition, credit ratings on our Senior Notes and Subordinated Debt are tied to our financial strength ratings. A ratings downgrade could increase surrender levels for our annuity products, adversely affect our ability to market our products and increase costs of future debt issuances.

S&P, Moody’s Investors Service, Inc. (“Moody’s”) and A.M. Best Company (“A.M. Best”) provide financial strength ratings on Standard.

 

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The following table sets forth Standard’s financial strength ratings as of April 2015:

 

S&P		Moody’s		A.M. Best
A+ (Strong)		A2 (Good)		A (Excellent)(1)
5th of 20 ratings		6th of 21 ratings		3rd of 13 ratings
Outlook: Stable		Outlook: Stable		Outlook: Stable

 

(1)

Also includes The Standard Life Insurance Company of New York

Debt ratings assess credit quality and the likelihood of issuer default. S&P, Moody’s and A.M. Best provide ratings on StanCorp’s Senior Notes and Subordinated Debt. S&P and A.M. Best also provide issuer credit ratings for both Standard and StanCorp.

The following table sets forth our debt ratings and issuer credit ratings as of April 2015:

 

		S&P		Moody’s		A.M. Best
StanCorp debt ratings:
Senior Notes		BBB+		Baa2		bbb
Subordinated Debt		BBB-		Baa3		bb+
Issuer credit ratings:
Standard		A+		---		a(1)
StanCorp		BBB+		---		bbb
Outlook		Stable		Stable		Stable(1)

 

(1)

Also includes The Standard Life Insurance Company of New York

We believe our well-managed underwriting and claims operations, high-quality invested asset portfolios, enterprise risk management processes and strong capital position will continue to support our ability to meet policyholder obligations. See “Liquidity and Capital Resources—Asset-Liability Matching and Interest Rate Risk Management,” and “Capital Management.” In addition, we remain well within our line of credit financial covenants. See “Liquidity and Capital Resources—Financing Cash Flows.”

Contingencies and Litigation

See Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 10—Commitments and Contingencies.”

Off-Balance Sheet Arrangements

See discussion of loan commitments in “Liquidity and Capital Resources—Investing Cash Flows—Commercial Mortgage Loans.”

Insolvency Assessments

Insolvency regulations exist in many of the jurisdictions where our subsidiaries do business. Such regulations may require insurance companies operating within the jurisdiction to participate in guaranty associations. The associations levy assessments against their members to pay benefits to policyholders of impaired or insolvent insurance companies. Association assessments levied against us were $0.6 million and $0.2 million for the first three months of 2015 and 2014, respectively. At March 31, 2015, we maintained a reserve of $0.4 million for future assessments with respect to currently impaired, insolvent or failed insurers.

Statutory Financial Accounting

Standard and The Standard Life Insurance Company of New York prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their states of domicile. Prescribed statutory accounting principles include state laws, regulations, and general administrative rules, as well as the Statements of Statutory Accounting Practices set forth in publications of the NAIC.

Statutory accounting practices differ in some respects from GAAP. The principal statutory practices that differ from GAAP are:

•

Bonds and commercial mortgage loans are reported principally at amortized cost and adjusted carrying value, respectively.

•

Asset valuation and the interest maintenance reserves are provided as prescribed by the NAIC.

•

Certain assets designated as non-admitted, principally deferred tax assets, furniture, equipment, and unsecured receivables, are not recognized as assets, resulting in a charge to statutory surplus.

•

Annuity considerations with life contingencies, or purchase rate guarantees, are recognized as revenue when received.

•

Reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates.

 

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•

Commissions, including initial commissions and expense allowance paid for reinsurance assumed, and other policy acquisition expenses are expensed as incurred.

•

Initial commissions and expense allowance received for a block of reinsurance ceded net of taxes are reported as deferred gains in surplus and recognized as income in subsequent periods.

•

Federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided.

•

Deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements but are limited to those deferred tax assets that will be realized within three years.

•

Annuity reserves follow the commissioner’s annuity reserve valuation methodology rather than GAAP guidance for investment contracts.

•

Surplus notes are classified as a component of surplus for statutory reporting and are classified as a liability for GAAP reporting.

The following table sets forth the difference between the statutory net gains from insurance operations before federal income taxes and net capital gains and losses (“Statutory Results”) and GAAP income before income taxes excluding net capital gains and losses (“Adjusted GAAP Results”):

 

		Three Months Ended March 31,
		2015				2014				Dollar Change
		(In millions)
Statutory Results		$	70.3			$	50.6			$	19.7
Adjusted GAAP Results			86.0				69.8				16.2
Difference		$	(15.7)			$	(19.2)			$	3.5

The increase in Statutory Results for the first quarter of 2015 compared to the first quarter of 2014 was primarily due to more favorable claims experience in Employee Benefits and Individual Disability.

The fluctuations in the difference between the Statutory Results and Adjusted GAAP Results for the first quarter of 2015 compared to the first quarter of 2014 were primarily due to net income or loss from the holding company and noninsurance subsidiaries, partially offset by differences in the prescribed accounting treatments between GAAP and Statutory accounting practices for reserves.

The following table sets forth statutory capital and the associated asset valuation reserve:

 

		March 31, 2015				December 31, 2014				Percent Change
		(Dollars in millions)
Statutory capital and surplus adjusted to exclude asset valuation reserve		$	1,339.2			$	1,334.6				0.3 %
Asset valuation reserve			105.5				106.2				(0.7)

Accounting Pronouncements

See Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 11—Accounting Pronouncements.”

Forward-looking Statements

From time to time StanCorp or its representatives make written or oral statements, including some of the statements contained or incorporated by reference in this Form 10-Q and in other reports, filings with the Securities and Exchange Commission, press releases, conferences or otherwise, that are other than purely historical information. These statements, including estimates, projections, expected operating results, statements related to business plans, strategies, objectives and the assumptions upon which those statements are based, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Exchange Act. Forward-looking statements also include, without limitation, any statement that includes words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “seeks,” “will be,” “will continue,” “will likely result” and similar expressions that are predictive in nature or that depend on or refer to future events or conditions. Our forward-looking statements are not guarantees of future performance and involve uncertainties that are difficult to predict. They involve risks and uncertainties, which may cause actual results to differ materially from the forward-looking statements and include, but are not limited to, the following:

•

Growth of sales, premiums, annuity deposits, cash flows, assets under administration including performance of equity investments in the separate account, gross profits and profitability.

 

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•

Availability of capital required to support business growth and the effective use of capital, including the ability to achieve financing through debt or equity.

•

Changes in liquidity needs and the liquidity of assets in our investment portfolios, including the ability to pledge collateral as required.

•

Performance of business acquired through reinsurance or acquisition.

•

Changes in financial strength and credit ratings.

•

Changes in the regulatory environment at the state or federal level.

•

Changes in accounting standards, practices or policies.

•

Findings in litigation or other legal proceedings.

•

Intent and ability to hold investments consistent with our investment strategy.

•

Receipt of dividends from, or contributions to, our subsidiaries.

•

Adequacy of the diversification of risk by product offerings and customer industry, geography and size, including concentration of risk, especially inherent in group life products.

•

Adequacy of asset-liability management.

•

Events of terrorism, natural disasters or other catastrophic events, including losses from a disease pandemic.

•

Benefit ratios, including changes in claims incidence, severity and recovery.

•

Levels of customer persistency.

•

Adequacy of reserves established for future policy benefits.

•

The effect of changes in interest rates on reserves, policyholder funds, investment income, bond call premiums and commercial mortgage loan prepayment fees.

•

Levels of employment and wage growth and the impact of rising benefit costs on employer budgets for employee benefits.

•

Competition from other insurers and financial services companies, including the ability to competitively price our products.

•

Ability of reinsurers to meet their obligations.

•

Availability, adequacy and pricing of reinsurance and catastrophe reinsurance coverage and potential charges incurred.

•

Achievement of anticipated levels of operating expenses.

•

Adequacy of diversification of risk within our fixed maturity securities portfolio by industries, issuers and maturities.

•

Adequacy of diversification of risk within our commercial mortgage loan portfolio by borrower, property type and geographic region.

•

Credit quality of the holdings in our investment portfolios.

•

The condition of the economy and expectations for interest rate changes.

•

The effect of changing levels of bond call premiums, commercial mortgage loan prepayment fees and commercial mortgage loan participation levels on cash flows.

•

Experience in delinquency rates or loss experience in our commercial mortgage loan portfolio.

•

Adequacy of commercial mortgage loan loss allowance.

•

Concentration of commercial mortgage loan assets collateralized in certain states such as California.

•

Environmental liability exposure resulting from commercial mortgage loan and real estate investments.

 

ITEM 3:

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in market risks faced by StanCorp Financial Group, Inc. since those reported in the Company’s annual report on Form 10-K for the year ended December 31, 2014.

 

ITEM 4:

CONTROLS AND PROCEDURES

Management of StanCorp Financial Group, Inc. (the “Company”) has evaluated, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (“Exchange Act”) Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective at March 31, 2015, and designed to provide reasonable assurance that material information relating to the Company and its consolidated subsidiaries is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There were no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to affect materially, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1:

LEGAL PROCEEDINGS

See Part 1, Item 1, “Financial Statements—Notes to Unaudited Condensed Consolidated Financial Statements—Note 10—Commitments and Contingencies.”

 

ITEM 1A:

RISK FACTORS

Risk factors that may affect our business are as follows:

•

Our reserves for future policy benefits and claims related to our current and future business may prove to be inadequate—For certain of our product lines, we establish and carry, as a liability, actuarially determined reserves to meet our obligations for future policy benefits and claims. These reserves do not represent an exact calculation of our future benefit liabilities but instead are estimates based on assumptions, which can be materially affected by changes in the economy, changes in social perceptions about work ethics, emerging medical perceptions regarding physiological or psychological causes of disability, emerging or changing health issues and changes in industry regulation. Claims experience on our products can fluctuate widely from period to period. If actual events vary materially from our assumptions used when establishing the reserves to meet our obligations for future policy benefits and claims, we may be required to increase our reserves, which could have a material adverse effect on our business, financial position, results of operations or cash flows.

•

Differences between actual claims experience and underwriting and reserving assumptions may adversely affect our financial results—Our long term disability insurance products provide coverage for claims incurred during the policy period. Generally, group policies offer rate guarantees for periods from one to three years. While we can prospectively re-price and re-underwrite coverages at the end of these guarantee periods, we must pay benefits with respect to claims incurred during these periods without being able to increase guaranteed premium rates during these periods. Longer duration claims, in addition to a higher volume of claims than we expect, expose us to the possibility that we may pay benefits in excess of the amount that we anticipated when the policy was underwritten. The profitability of our long term disability insurance products is thus subject to volatility resulting from the difference between our actual claims experience and our assumptions at the time of underwriting.

•

We are exposed to concentration risk on our group life insurance business—Due to the nature of group life insurance coverage, we are subject to geographical concentration risk from the occurrence of a catastrophe.

•

We may be exposed to disintermediation risk during periods of increasing interest rates—In periods of increasing interest rates, withdrawals of group and individual annuity contracts may increase as policyholders seek investments with higher perceived returns. This process, referred to as disintermediation, may lead to net cash outflows. These outflows may require investment assets to be sold at a time when the prices of those assets are adversely affected by the increase in interest rates, which may result in realized investment losses. A significant portion of our investment portfolio consists of commercial mortgage loans, which are relatively illiquid, thus increasing our liquidity risk in the event of disintermediation during a period of rising interest rates.

•

Our profitability may be adversely affected by declining or low interest rates—During periods of declining or low interest rates, annuity products may be relatively more attractive investments, resulting in increases in the percentage of policies remaining in-force from year to year during a period when our new investments carry lower returns. During these periods, actual returns on our investments could prove inadequate for us to meet contractually guaranteed minimum payments to holders of our annuity products. In addition, the profitability of our life and disability insurance products can be affected by declining or low interest rates. A factor in pricing our insurance products is prevailing interest rates. Longer duration claims and premium rate guarantees can expose us to interest rate risk when portfolio yields are less than those assumed when pricing these products. Commercial mortgage loans and fixed maturity securities—available-for-sale (“fixed maturity securities”) in our investment portfolio are more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates, and we may be required to reinvest those funds in lower interest-bearing investments.

•

Our investment portfolio is subject to risks of market value fluctuations, defaults, delinquencies and liquidity—Our general account investments primarily consist of fixed maturity securities, commercial mortgage loans and tax-advantaged investments. The fair values of our investments vary with changing economic and market conditions and interest rates. In addition, we are subject to default risk on our fixed maturity securities portfolio and its corresponding impact on credit spreads. Our commercial mortgage loan portfolio is subject to delinquency, default and borrower concentration risks. Related declines in market activity due to overall declining values of fixed maturity securities may result in our fixed maturity securities portfolio becoming less liquid. In addition, our commercial mortgage loans are relatively illiquid and the demand for our real estate acquired in satisfaction of debt through foreclosure or acceptance of deeds in lieu of foreclosure on commercial mortgage loans (“Real Estate Owned”) may remain low due to macroeconomic conditions. We may have difficulty selling our fixed maturity securities, commercial mortgage loans and Real Estate Owned at attractive prices, in a timely manner, or both if we require significant amounts of cash on short notice. Substantially all of our tax-advantaged investments and related tax credits are related to development projects that are subject to ongoing compliance requirements over certain periods of time to fully realize their value. If these projects are not operated in full compliance with the required terms, the tax credits could be subject to recapture or restructuring. Declines in the value of our invested assets could also affect our ability to pledge collateral as required.

 

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•

Our business is subject to significant competition—Each of our business segments faces competition from other insurers and financial services companies, such as banks, broker-dealers, mutual funds, and managed care providers for employer groups, individual consumers and distributors. Since many of our competitors have greater financial resources, offer a broader array of products and, with respect to other insurers, may have higher financial strength ratings than we do, the possibility exists that any one of our business segments could be adversely affected by competition, which in turn could have a material adverse effect on our business, financial position, results of operations or cash flows.

•

A downgrade in our financial strength ratings may negatively affect our business—Financial strength ratings, which are an indicator of our claims paying ability, are an important factor in establishing the competitive position of insurance companies. Ratings are important to maintaining public confidence in our company and in our ability to market our products. Rating organizations regularly review the financial performance and condition of insurance companies, including our company. A ratings downgrade could increase our surrender levels for our annuity products, could adversely affect our ability to market our products, could increase costs of future debt issuances, and could thereby have a material adverse effect on our business, financial position, results of operations or cash flows.

•

Our profitability may be affected by changes in state and federal regulation—Our business is subject to comprehensive regulation and supervision throughout the United States including rules and regulations relating to income taxes and accounting principles generally accepted in the U.S. While we cannot predict the impact of potential or future state or federal legislation or regulation on our business, future laws and regulations, or the interpretation thereof, could have a material adverse effect on our business, financial position, results of operations or cash flows.

•

Our deferred tax assets include net operating losses (“NOLs”), which depend on future taxable income to be realized and may be limited or impaired by future ownership changes—Our deferred tax assets include federal, state and local NOLs. Certain of our subsidiaries as a group have generated losses in recent years. NOLs can be available to reduce income taxes that might otherwise be incurred on future taxable income. There can be no assurance that we will generate the future taxable income necessary to utilize our NOLs. Furthermore, the availability of these losses to be utilized in the future can become limited if certain changes in company structure or income levels occur. In such a circumstance, we may be unable to utilize the losses even if the Company generates future taxable income.

•

Our business is subject to litigation risk—In the normal course of business, we are a plaintiff or defendant in actions arising out of our insurance business and investment operations. We are from time to time involved in various governmental and administrative proceedings. While the outcome of any pending or future litigation cannot be predicted, as of the date hereof, we do not believe that any pending litigation will have a material adverse effect on our results of operations or financial condition. However, no assurances can be given that such litigation would not materially and adversely affect our business, financial position, results of operations or cash flows.

•

We may be exposed to environmental liability from our commercial mortgage loan and real estate investments—As a commercial mortgage lender, we customarily conduct environmental assessments prior to originating commercial mortgage loans secured by real estate and before taking title through foreclosure or deeds in lieu of foreclosure to real estate collateralizing delinquent commercial mortgage loans held by us. Compliance costs associated with environmental laws and regulations or any remediation of affected properties could have a material adverse effect on our results of operations or financial condition.

•

Certain concentrations in our commercial mortgage loan portfolio may subject us to losses—Concentration of borrowers and tenants in our commercial mortgage loan portfolio may expose us to potential losses resulting from a downturn in the economy, business performance of tenants, or adverse changes in a borrower’s financial condition. Although we diversify our commercial mortgage loan portfolio by location, type of property, borrower and tenants, such diversification may not eliminate the risk of such losses, which could have a material adverse effect on our business, financial position, results of operations or cash flows.

•

The concentration of our investments in California may subject us to losses resulting from an economic downturn—Our commercial mortgage loans are concentrated in the western region of the U.S., particularly in California. Currently, our California exposure is primarily in Los Angeles County, Orange County, San Diego County and the Bay Area Counties. We have a smaller concentration of commercial mortgage loans in the Inland Empire and the San Joaquin Valley where there has historically been greater economic decline. A decline in economic conditions in California could have a material adverse effect on our business, financial position, results of operations or cash flows.

•

The concentration of our investments in the western region of the U.S. may subject us to losses resulting from certain natural catastrophes in this area—Due to our commercial mortgage loan concentration in the western region of the U.S., particularly in California, we are exposed to potential losses resulting from certain natural catastrophes, such as earthquakes and fires, which may affect the region. Although we require borrowers to maintain fire insurance, consider the potential for earthquake loss based upon specific information to each property and diversify our commercial mortgage loan portfolio within the western region by both location and type of property in an effort to reduce earthquake exposure, such diversification may not eliminate the risk of such losses, which could have a material adverse effect on our business, financial position, results of operations or cash flows.

 

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•

Catastrophe losses from a disease pandemic could have an adverse effect on us—Our life insurance operations are exposed to the risk of loss from an occurrence of catastrophic mortality caused by a disease pandemic, which could have a material adverse effect on our business, financial position, results of operations or cash flows.

•

Catastrophe losses from terrorism or other factors could have an adverse effect on us—An occurrence of a significant catastrophic event, including terrorism, natural or other disasters, or a change in the nature and availability of or continuation of existing reinsurance and catastrophe reinsurance, could have a material adverse effect on our business, financial position, results of operations, cash flows or capital levels. In February 2015, we were notified of the termination of the catastrophe reinsurance pool effective June 2015. We continue to explore our options in the market for catastrophe reinsurance coverage.

•

As a holding company, we depend on the ability of our subsidiaries to transfer funds to us in sufficient amounts to pay dividends to shareholders, make payments on debt securities and meet our other obligations—We are a holding company for our insurance and asset management subsidiaries as well as for the subsidiaries that comprise our Other category and do not have any significant operations of our own. Dividends and permitted payments from our subsidiaries are our principal source of cash to pay dividends to shareholders, make payments on debt securities and meet our other obligations. As a result, our ability to pay dividends to shareholders and interest payments on debt securities will primarily depend upon the receipt of dividends and other distributions from our subsidiaries.

    Many of our subsidiaries are non-insurance businesses and have no regulatory restrictions on dividends. Our insurance subsidiaries, however, are regulated by insurance laws and regulations that limit the maximum amount of dividends, distributions and other payments that they could declare and pay to us without prior approval of the states in which the subsidiaries are domiciled. Under Oregon law, Standard Insurance Company may pay dividends only from the earned surplus arising from its business. Oregon law gives the Director of the Oregon Department of Consumer and Business Services—Insurance Division (“Oregon Insurance Division”) broad discretion regarding the approval of dividends in excess of certain statutory limitations. Oregon law requires us to receive the prior approval of the Oregon Insurance Division to pay such a dividend. See Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Management—Dividends from Standard.”

•

Our ability to refinance debt and raise capital in future years depends not only on contributions from our subsidiaries but also on market conditions and availability of credit in the market—We do not have any significant debt maturities in the near term. Our 10-year senior notes of $250 million will mature in August 2022, and our junior subordinated debentures (“Subordinated Debt”) of $252.9 million will mature in 2067 with a call option in 2017. We maintain a $250 million senior unsecured revolving credit facility (“Facility”) for general corporate purposes. Upon our request and with consent of the lenders under the Facility, the Facility can be increased to $350 million. The termination date of the Facility is June 22, 2018. We had no outstanding balance on the Facility at March 31, 2015. The Facility is composed of a syndication of seven banks. Commitments from the banks toward the available line of credit range from $15.0 million to $60.0 million per bank. Should a bank from this syndication default, the available line of credit would be reduced by that bank’s commitment toward the line.

•

Our portfolio of investments, including U.S. government and agency bonds and U.S. state and political subdivision bonds could be negatively impacted by U.S. credit and financial market conditions—A potential ratings downgrade of U.S. government securities could lead to future deterioration in the U.S. and global credit and financial markets. As a result, these events may materially adversely affect our business, financial condition and results of operations.

•

Our profitability may be adversely affected by a decline in equity and debt markets—U.S. and global equity markets heavily influence the value of our retirement plan assets under administration, which are a significant component from which our administrative fee revenues are derived. A decline in equity and debt markets could result in decreases in the value of the assets under administration in our retirement plans, which could reduce our ability to earn administrative fee revenues derived from the value of those assets.

•

A decline in equity and debt markets and low interest rates could affect the funding status of Company sponsored pension plans—Our estimates of liabilities and expenses for pension and other postretirement benefits incorporate significant assumptions including the rate used to discount the estimated future liability, the long-term rate of return on plan assets, inflation rates, mortality rates, and the employee workforce. Changes in the discount rate, inflation rates, mortality rates, or the rate of return on plan assets resulting from economic downturns could increase our required cash contributions or pension-related expenses in future periods. The funding status of the Company’s pension plans is evaluated annually during the fourth quarter.

•

Our ability to conduct business may be compromised if we are unable to maintain the availability of our systems and safeguard the security of our data in the event of a disaster or other unanticipated events—We use computer systems to store, retrieve, evaluate and utilize customer and company data and information. Our business is highly dependent on our ability to access these systems to perform necessary business functions. System failures, system outages, outsourcing risk or the failure or unwillingness of a service provider to perform could compromise our ability to perform these functions in a timely manner and could hurt our relationships with our business partners and customers. In the event of a disaster such as a natural catastrophe, fire, a blackout, a computer virus, a terrorist attack or war, these systems may be inaccessible to our employees, customers or business partners for an extended period of time. These systems could also be subject to physical and electronic break-ins and subject to similar disruptions from unauthorized tampering. This may impede or interrupt our business operations and could have a material adverse effect on our business, financial position, results of operations or cash flows.

 

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•

Ongoing weakness and financial market uncertainty could continue to adversely affect us in the near term—Economic downturns and disruptions in the global financial market present risks and uncertainties. During an economic downturn, we face the following risks:

•

Declines in revenues or profitability as a result of lost wages or lower levels of insured employees by our customers due to reductions in workforce. Additionally, revenues and profitability could decline as a result of lower levels of assets under administration.

•

Increases in pricing pressure and competition resulting in a loss of customers or new business as customers seek to reduce benefit costs and competitors seek to protect market share.

•

A declining or a continued low interest rate environment and its effect on product pricing and the reserves we must carry.

•

Increases in commercial mortgage loan foreclosures.

•

Increases in holdings of Real Estate Owned properties due to a decline in demand for these properties and the decline in value of these properties during our holding period.

•

Continued pressure on budgets for public institutions could impact the employment and wage levels of our customer groups in this sector, which represents a significant customer group for our employee benefits business, which may have an adverse effect on our premium levels for our group businesses and revenues for our retirement plans business.

•

Increases in corporate tax rates to finance government-spending programs.

•

Reductions in the number of our potential lenders or to our committed credit availability due to combinations or failures of financial institutions.

•

Loss of employer groups due to business acquisitions, bankruptcy or failure.

•

Declines in the financial health of reinsurers.

•

Reduction in the value of our general account investment portfolio.

•

Declines in revenues and profitability as a result of lower levels of assets under administration.

 

ITEM 2:

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth share repurchase information for the periods indicated:

 

		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs				Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
Period:
January 1-31, 2015			---			$	---				---				1,972,337
February 1-28, 2015			---				---				---				1,972,337
March 1-31, 2015			---				---				---				1,972,337
Total first quarter			---			$	---				---				1,972,337

On February 11, 2014, our Board of Directors authorized the repurchase of up to 3.0 million shares of StanCorp common stock through December 31, 2015 (“February 2014 Authorization”). The February 2014 Authorization took effect upon completion of a prior repurchase authorization during the second quarter of 2014. Share repurchases are made in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Exchange Act. Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock, capital levels, our assessment of the overall economy and other potential growth opportunities or priorities for capital use.

The following table sets forth share repurchase activity:

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in millions —except per share data)
Share repurchases:
Shares repurchased			---				553,200
Cost of share repurchases		$	---			$	34.6
Weighted-average price per common share			---				62.63
Shares remaining under repurchase authorizations			1,972,337				3,802,312

 

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The declaration and payment of dividends would be restricted if we elect to defer interest payments on our Subordinated Debt. If we elect to defer interest payments, the dividend restriction would be in place during the interest deferral period, which cannot exceed five years. See Part I, Item 2, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations—Capital Management—Dividends to Shareholders.”

 

ITEM 3:

DEFAULTS UPON SENIOR SECURITIES

None

 

ITEM 4:

MINE SAFETY DISCLOSURES

Not applicable.

 

ITEM 5:

OTHER INFORMATION

On February 23, 2015, the Organization & Compensation Committee of the Board of Directors approved a revised form of long-term incentive award agreement for senior executives to be effective for the performance years 2015-2017. A copy of the form of agreement was filed as Exhibit 10.19 in Form 10-K filed on February 26, 2015 and is incorporated herein by this reference.

On May 6, 2015, StanCorp Financial Group, Inc. announced a strategic reorganization and effective May 31, 2015, the executive leadership position held by James B. Harbolt, Vice President Asset Management, will be eliminated. Other members of the executive leadership team will assume responsibility of businesses in the Asset Management segment. The terms of the separation and release agreement are under consideration.

 

ITEM 6:

EXHIBITS

The list of exhibits in the Exhibit Index to this quarterly report is incorporated herein by reference.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: May 6, 2015				By:		/S/    FLOYD F. CHADEE
						Floyd F. Chadee Senior Vice President and Chief Financial Officer (Principal Financial Officer)

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EXHIBITS INDEX

 

Number		Name		Method of Filing
3.1		Articles of Incorporation of StanCorp Financial Group, Inc., As Amended		Filed as Exhibit 3.1 to Registrant’s Form 10-Q filed on August 6, 2014 and incorporated herein by this reference
3.2		Bylaws of StanCorp Financial Group, Inc., As Amended		Filed as Exhibit 3.2 to Registrant’s Form 10-Q filed on November 5, 2014 and incorporated herein by this reference
10.1*		Form of StanCorp Financial Group, Inc. Long-Term Incentive Award Agreement (2015-2017 Performance Period)		Filed as Exhibit 10.19 to Registrant’s Form 10-K filed on February 26, 2015 and incorporated herein by this reference
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002		Filed herewith
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002		Filed herewith
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		Filed herewith
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		Filed herewith
101.INS		XBRL Instance Document		Filed herewith
101.SCH		XBRL Taxonomy Extension Schema Document		Filed herewith
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document		Filed herewith
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document		Filed herewith
101.LAB		XBRL Taxonomy Extension Label Linkbase Document		Filed herewith
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document		Filed herewith

 

*

Indicates management contract or compensatory plan or arrangement