Description

Unum Group (UNM) $29.33

06/26/21

Summary

Unum Group (UNM) is an insurance company offering disability and supplemental and voluntary insurance products. It primarily provides its services to employers for the benefit of employees. Sales are through field sales and independent brokers. brook1001 wrote it up in 2010 and provided great detail on the business, which I will skip over here and focus on the opportunity at hand.

Unum’s stock has been depressed for the last several years due to concerns relating to reserves for long-term care insurance (last written in 2009) and the adverse impact of a persistent low-interest-rate environment.

Unum’s current attractiveness for investment rests upon improving operational performance and the optionality of earnings on their substantial reserves rising with interest rates and greater clarity regarding the long-term care book. Currently trading at $29, with a valuation of 0.6x book and 5.6x cash earnings, UNM could  repriced towards $40 - $50 in 2022 using modest assumptions. With 30% - 70% upside and moderate risk of long-term capital impairment, Unum offers a compelling reward-to-risk opportunity.

Background

Unum has a stable, if unexciting, business in providing group disability insurance and benefits. It has significant market share in the lines it offers, earns decent ROE’s in the 10-12% range, has a decent balance sheet (levered 6.5x), and is conservatively managed. The stock has been unloved for the last several years for three primary reasons:

·       Unum has exposure to long-term care insurance that, in hindsight, was mispriced by the entire industry given that the costs and duration of long-term care have experienced higher costs than initially projected. Unum stopped writing these policies in 2009 – the year that the current CEO joined UNM as CFO and has been managing the book in runoff.

·       Unum has a $42B fixed-income investment portfolio consisting primarily of investment grade corporate bonds. The ability of insurance companies – and other investors - to earn decent returns on their bond portfolio has been significantly constrained by the low-interest-rate environment that began in 2008.

·       Unum is a relatively small company, with a $6B market capitalization that operates in a dull and complicated industry.

Historically, Unum traded at 7x – 11x Cash EPS and 0.8x – 1.1x tangible book value. However, as the long-term care reserves became an issue in 2018, Unum fell towards a valuation range of 5x – 6x Cash EPS and 0.5x – 0.6x tangible book value.

What is Changing?

In May 2020, the Maine Bureau of Insurance reached an agreement with Unum to address the reserves in the long-term care runoff book. Maine determined that the book was under-reserved by $2.1B ($11B estimated vs. $9B current). Unum agreed to plug the gap and was allowed to do so over 7 years, commencing in 2020, by contributing approximately $250MM to the reserve pool. The remaining, $1.8B, to be paid over the next 6 years, has an estimated present value of $1.6B or $7.65/share.

This settlement would have been expected to have resulted in an upward repricing of UNM, given that the terms are manageable, and that the settlement provides a sense of both quantifying and resolving the issue. However, with the world reeling from the COVID pandemic, little attention was given to this.

In late 2020, Unum reached an agreement to reinsure most of its individual disability business ($7.1B in reserves) which was in runoff. This freed up around $600MM in capital. In these two transactions, UNM provided much greater certainty surrounding its closed book business.

The stock has been rebounding since October 2020 primarily relating to the impact of COVID subsiding and investors turning their attention to companies that benefit from the economy reopening as well as the impact of inflation/rising interest rates.

Valuation

Although Unum has almost doubled from the pandemic low of $15, it is trading flat with its depressed valuation at the beginning of 2020 despite a much-improved outlook and is trading at 0.6x book value and 6x cash earnings.

My conservative working assumptions are that UNM can grow book value by 4% per annum, resulting in an estimated $56 in 2022E book value. Assuming that the stock gets re-rated at 0.8x – 1.0x price/book, and adjusting for a 2022 present value of ($6.50) for the LTC reserve settlement, the resulting stock price in 2022 would be in the range of $38 - $50, an increase of 30% - 70% from current levels.

I assume that 2022 cash earnings could approximate $6.00 vs. $5.44 in 2019. Applying a p/e range of 6.5x – 8.0x, yields a 2022 valuation of $39 - $48, an increase of 33% - 64%.

I believe that these estimates are conservative in both growth rates and multiple expansion. However, determining the timing of a re-rating is challenging. One possible catalyst would be the resumption of share repurchases. Unum suspended repurchases in 2020 due to COVID and has yet to reinstate them, despite having excess capital. They did recently increase the dividend to $1.20 per annum, representing a 4.1% yield at the current price. Resuming repurchases would be a notable indicator that management is confident about their reserve position.

Unum doesn’t have the most exciting story, but it offers a very asymmetric reward-to-risk opportunity with impressive upside and limited downside at current prices.

Catalyst

share repurchases, rising interest rates and inflation, performance of long-term care book in line with reserve adjustment.