Back to issue home page

Though the Chattanooga-based insurer’s case management is the best in the business, its shares have sunk from $55 four years ago to about $15 today, an abject lesson in the consequences of Wall Street losing confidence in a company.

“Unum has to demonstrate that having the biggest market share gives it superior pricing ability,” the Fortune magazine All-Star analyst adds. So far it hasn’t proved that, nor has it made good on the promise of the 1999 merger that created UnumProvident from the country’s largest group disability insurer (Unum) and the country’s largest individual disability insurer (Provident).

How did things come to this pass?

Ten years ago, the word “venerable” was an apt description of Provident Life & Accident of Chattanooga. It had been around for a century; it was highly reputable and its sales force highly compensated; the founding family—the Maclellans—held more than 50% of the company, and their conservative Christian foundation was highly influential in Chattanooga.

In fact, like Nashville’s Life & Casualty and NLT, Provident was one of Tennessee’s insurance giants that formed some of the state’s great fortunes during the first half of the 20th century. Of the three, it was the last one standing, the other two long since absorbed by American General of Houston and their local employment ranks decimated as tasks migrated to Texas. The Maclellans’ overwhelming stake was likely the only factor that prevented a similar fate from befalling Provident.

But “venerable” also carries a negative connotation, implying that perhaps the company was at least slightly out-of-date, a little more dinosaur than mammal, not entirely competitive.

Harold Chandler, the CEO from 1993 to 2003 took these negatives as a challenge. As the first CEO who did not come through the Provident ranks (and the second non-Maclellan), he wasn’t beholden to tradition. Following the contemporary business mantra, he remade the company with the aim of being focused and dominant in one area—disability insurance. Over six years, he wheeled and dealed, shedding divisions like health and life, leaving a core individual disability company, with a sizeable life adjunct hung on its side. Then, he merged with Paul Revere out of New England to give his disability business greater gravitas. This company was merged into Unum’s group business to make UnumProvident, a company that writes about 33% of the disability insurance in the country.

So, join the country’s largest group disability insurer with the country’s largest issuer of individual disability—what’s not to like? It was a lay-up for investment bankers.

Except it didn’t work. Where one and one were supposed to make three, instead it has slipped back to one in terms of market capitalization and business. UnumProvident now concentrates on group disability, having almost completely given up the individual side of the business.

Moreover, since the merger, UnumProvident has made a practice of overpromising, then underdelivering on its quarterly earnings. And last year, after losing several spectacular lawsuits for not paying claims to clients, UnumProvident suffered the ultimate corporate insult: it was featured—in a very unflattering way—on CBS’s 60 Minutes. It was an enormous black eye for a company that once was a pillar of trust in the community.

So the board of directors did the inevitable: they fired Chandler (even though the board had, presumably, seconded his moves along the way). And then they did something unexpected: they hired his second-in-command, Thomas Watjen, an underwhelming gesture from a company wanting to convey a sense of starting afresh.

Furthering the impression of business as usual, Watjen hasn’t announced any new directions. Looking back over his first nine months as CEO, he cites as accomplishments a much-needed recapitalization, which brought in $1 billion in new cash (but had been planned long before Chandler’s termination), some unspecified operations issues, and a new “openness” as personal style and corporate culture. But little else.

No one doubts Watjen’s smarts or his competence. Some even praise his openness, saying that, unlike Chandler, “he doesn’t think he knows all the answers.” Watjen’s résumé includes stints at Aetna in corporate finance and at Morgan Stanley as an investment banker specializing in insurance companies. The man knows how to finance the company, and he seems to have a feel for the distribution side of the business as well.

Still, given UnumProvident’s long stock slide and the impression among some investors and analysts that it has lost its way, it seems unusual that he hasn’t articulated major changes in the plan of action. As Watjen himself says, Chandler had to go when “the company lost credibility with one of its major constituencies, Wall Street.” But it seems that Chandler’s departure was more show than a change in direction.

In part, UnumProvident’s problems stem from its emphasis on disability, which is inherently less predictable than other forms of insurance. The actuarial tables for life insurance are well known and provide few surprises. Property and casualty are less certain because a big event—terrorism, hurricanes—can cause dislocations. But disability, for no particularly known reason, is more variable than any other form of insurance.

For example, back in the 1990s, a popular disability product was charmingly called “non-can, own-occ” (non-cancelable, own occupation insurance), a policy geared toward doctors and lawyers who owned their own practice. But it was priced too low. As David Lewis of SunTrust Robinson Humphrey points out, everyone in the industry was selling the same product, so it wasn’t some bear trap that only Provident created for itself. Watjen admits that the product “never made money and it never will.” Instead, once the problems were known, Chandler split the business off into its own sector, the dead business division, where it remains. Because it was such a good deal for the consumer, the “persistence” of the business is high—insurance jargon for the fact that policyholders keep renewing their policies. And so the business stays on the books, diverting capital from other areas where it might be used more profitably.

Similarly, in the first quarter of 2003, UnumProvident had to increase its reserves by $450 million, partly because the ratio of claims to premiums jumped unexpectedly from 85% to 91%—another example of the unpredictability of the disability sector. David Lewis projects a return to the historic norm of 85%, putting the stock on his “outperform” list.

But Watjen is more cautious, explaining that the capital increase resulted in part “from more conservative assumptions,” making a quick return to former levels seem less likely.

For his part, when asked about the long list of problems facing UnumProvident, Watjen resolutely refuses to do any corporate soul-searching. Instead, he looks outward and gives an answer that’s the corporate equivalent of “It’s the economy, stupid.”

Which is partially true. One does not ordinarily think of disability insurance as being dependent on the economy, but Watjen cites the oft-used metaphor of the Perfect Storm to describe what happened to UnumProvident. At a critical juncture for the company—in 1999, when Provident merged with Unum—management needed a little slack time to get its act together because the combined entity faced some very large integration issues. Instead, the economy fell apart, and the Federal Reserve lowered interest rates to historical lows. All of this had implications for the disability industry.

The first front of the storm was low interest rates. UnumProvident has $30 billion in investable assets. The price of new policies includes an investment return factor—Unum plans to make money on your premiums between the time it receives them and the time you make a claim. If they make a lot, they can afford to sell the policy for less. Of course, the interest rate environment is the same for all companies, and all companies presumably face the same problem. When a policy is put in force, bonds are secured whose maturity approximates the projected need for cash. And, companies reprice their policies every year, so Unum had ample opportunity to compensate for the decline in yield.

Second, a poor employment environment affects claims—people who face unemployment may find it better to be disabled. This doesn’t pertain to many people, but a small difference makes itself felt. It’s hard to put a statistic on this number.

And third, the company has had a large number of bonds default. “UnumProvident has $30 billion in invested assets,” Watjen says, “so when a WorldCom or Adelphia goes bankrupt, chances are we own some of the paper.” That’s true, but it’s also true that Unum had prided itself in its ability to discriminate among lower grades of investment debt. As a result, it carried about 7% to 9% in sub-A-grade bonds in its portfolio, and it has had to write off $600 million in bonds that won’t be paid back.

These write-downs, the company’s meager earnings, and the increased policy reserves caused Standard & Poor and A.M. Best to lower their ratings on UnumProvident. The ratings companies don’t see any signs of Unum turning the situation around.

Last spring, Unum floated a new issue to put $1 billion of new capital back on its books. Watjen claims this as one of his accomplishments. It certainly needed to be done, but it had been on the shelf for some time. Before Unum was given the green light to proceed, Watjen needed to come to terms with the SEC about an earnings restatement for 2000-2002. Once that was settled, the issue went off without a hitch, though existing investors found their stock accordingly diluted.

The low point for Unum was Christmastime in 2002, when the rising tide of complaints about canceled claims earned the company a spot on 60 Minutes and its wall of shame.

On the show, discharged company employees charged that the company established daily quotas for finding recoverable claims and preventing people from receiving disability checks. Some of them—a doctor in the underwriting department who spoke of pressure to disallow new claims—were very credible. It was a large blow.

The 44-state investigation into the company’s payment practices is being led by three states, including Tennessee and Georgia. Their verdict has not yet been heard.

Watjen blames the notoriety on a few large settlements that drew attention to the company. Plus, the infamous “non-can, own-occ” policies had ambiguous language that invited lawsuits, he claims. Although Watjen sees litigation as an inevitable part of the business, “Lawsuits in the third quarter of 2003 were very low,” he says, “and new complaints, which are a leading indicator of lawsuits, were the lowest they have been in 23 years.”

He notes further that the board undertook an independent investigation of claims last February when the negative publicity was high and found no evidence of wrongdoing.

Roger Wall, the Nashville-based regional practice leader of supplemental benefits for UnumProvident, says the notoriety hasn’t hurt continuing business, though it has made new sales more difficult. UnumProvident doesn’t sell directly to its clients. Instead, it markets to insurance brokers, financial planners, and benefit consultants, people who are less affected by the news. More important to them is that the business, once written, gets put in place, and oftentimes the underwriting process at UnumProvident would last three or four months. Faced with this, brokers would switch to other insurers.

So the company is filthy rich in terms of problems, and it doesn’t have an aggressive plan for working them out. On the other hand, the company is priced very cheap—a book value of $26 per share versus a stock price of $15—and the stock trades hands at less than one-half times sales.

Because the stock was cheap, Bruce Wilcox of Cumberland Associates was proud to announce in a Barron’s interview a few months ago that his firm owned some Unum shares, even though the company had “made every mistake in the book.” Similarly, Dodge & Cox, a value-oriented, long-term holding mutual fund family—a company which overlooks present bad news to concentrate on underlying value—owns the biggest block of stock, with 8.4% of shares outstanding.

By comparison, AFLAC, Unum- Provident’s nearest competitor, sports a price-to-sales multiple of 1.6. In terms of earnings, AFLAC has an estimated (next twelve months) P/E ratio of 16 while UnumProvident remains at about half that: 8.3.

Of course, AFLAC is growing faster than Unum, and Unum may have some more nasty surprises in terms of write-offs in its bond portfolio. Nonetheless, the recapitalization means the company’s internal ratios—important to insurance company regulators—are healthy.

For his part, Watjen continues to sell off divisions that aren’t core or profitable. He has sold units in Japan and Canada recently (both of them concentrated on individual disability), raising cash. Meanwhile, in December he arranged for his U.K. unit to manage Swiss Life’s group life operations there after plans to acquire them were disrupted by anti-competitive concerns.

According to Smith Barney’s Devine, the disability business is basically a cost-plus industry, not spectacular, but steady, with a growth rate of 6% to 8%. Return on equity could easily be 12%. “Investors expect an insurance stock to be like its policies—solid, not surprising,” he says.

UnumProvident must decide to write less business, he continues, emphasizing quality over quantity. Top-line growth doesn’t always mean bottom-line profits. Warren Buffett, the stupendously successful chairman of insurer Geico’s parent company and a man long used to the swings in underwriting, has always advised against seeking new business when profits get down to zero. He knows they will swing the other way in good times.

As for Watjen, Devine believes the CEO has about twelve months to prove to investors that his top priority is building the bottom line. To do so, he must reject marginal new business even at the risk of offending the sales force. Believing that the sales force long has held too much sway at UnumProvident, the analyst urges Watjen to wrest control.

“Either he will get that done in the next year, or somebody will do it for him,” says Devine, not-so-subtly hinting at a potential takeover of UnumProvident’s valuable franchise.

In other words, simply battening down the hatches might not be enough to secure the future autonomy of Tennessee’s last great insurance giant.

Back to issue home page

Email to a Friend Print-Friendly Format