SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended March 31, 2000.
Commission file number 1-11834
UnumProvident Corporation
(Exact name of registrant as specified in its charter)
Delaware 62-1598430
(State of other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1 FOUNTAIN SQUARE 2211 CONGRESS STREET
CHATTANOOGA, TENNESSEE 37402 PORTLAND, MAINE 04122
(Address of principal executive offices)
423.755.1011 207.770.2211
(Registrant's telephone number, including area code)
Not Applicable
(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 the number of shares outstanding for each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at March 31, 2000
----- -----------------------------
Common stock, $0.10 par value 240,492,136
TABLE OF CONTENTS
PART I
Cautionary Statement Regarding Forward-Looking Statements............................................... 1
1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial Condition at March 31, 2000 and
December 31, 1999................................................................................... 2
Condensed Consolidated Statements of Income for the three months ended March 31, 2000 and 1999........ 4
Condensed Consolidated Statements of Stockholders' Equity for the three months ended
March 31, 2000 and 1999............................................................................. 5
Condensed Consolidated Statements of Cash Flows for the three months ended March 31,
2000 and 1999....................................................................................... 6
Notes to Condensed Consolidated Financial Statements.................................................. 7
Independent Auditors' Review Report................................................................... 13
2. Management's Discussion and Analysis of Financial Condition and Results of Operations................... 14
3. Quantitative and Qualitative Disclosure about Market Risk.............................................. 25
PART II
6. Exhibits and Reports on Form 8-K........................................................................ 26
Signatures.............................................................................................. 27
PART I
Cautionary Statement Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the Act) provides a "safe-
harbor" for forward-looking statements which are identified as such and are
accompanied by the identification of important factors which could cause actual
results to differ materially from the forward-looking statements. UnumProvident
Corporation (the Company) claims the protection afforded by the safe harbor in
the Act. Certain information contained in this discussion, or in any other
written or oral statements made by the Company, is or may be considered as
forward-looking. Examples of disclosures that contain such information include,
among others, sales estimates, income projections, reserves and related
assumptions, and the year 2000 date conversion. Forward-looking statements are
those not based on historical information, but rather relate to future
operations, strategies, financial results, or other developments. These
statements may be made directly in this document or may be made part of this
document by reference to other documents filed with the Securities and Exchange
Commission by the Company, which is known as "incorporation by reference." You
can find many of these statements by looking for words such as "may," "should,"
"believes," "expects," "anticipates," "estimates," "intends," "projects,"
"goals," "objectives," or similar expressions in this document or in documents
incorporated herein.
These forward-looking statements are subject to numerous assumptions, risks, and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by the forward-looking statements include, among others, the
following possibilities:
. Competitive pressures in the insurance industry may increase
significantly through industry consolidation, competitor
demutualization, or otherwise.
. General economic or business conditions, both domestic and foreign,
whether relating to the economy as a whole or to particular sectors,
may be less favorable than expected, resulting in, among other things,
lower than expected revenues, and the Company could experience higher
than expected claims or claims with longer duration than expected.
. Insurance reserve liabilities can fluctuate as a result of changes in
numerous factors, and such fluctuations can have material positive or
negative effects on net income.
. Actual persistency may be lower than projected persistency, resulting
in lower than expected revenues and higher than expected amortization
of deferred policy acquisition costs.
. Reorganization of the Company's field sales force and integrated
product offerings may initially adversely impact new sales and
renewals.
. Costs or difficulties related to the integration of the business of
the Company following the merger may be greater than expected,
including costs or difficulties related to the management of claims.
. Legislative or regulatory changes may adversely affect the businesses
in which the Company is engaged.
. Necessary technological changes may be more difficult or expensive to
make than anticipated, and subsequent non-compliance resulting from
year 2000 data systems issues may occur.
. Adverse changes may occur in the securities market.
. Changes in the interest rate environment may adversely affect profit
margins and the Company's investment portfolio.
. The rate of customer bankruptcies may increase.
. Incidence and recovery rates may be influenced by, among other
factors, the emergence of new diseases, new trends and developments in
medical treatments, and the effectiveness of risk management programs.
. Retained risks in the Company's reinsurance operations are influenced
by many factors and can fluctuate as a result of changes in these
factors, and such fluctuations can have material positive or negative
effects on net income.
For further discussion of risks and uncertainties which could cause actual
results to differ from those contained in the forward-looking statements, see
"Risk Factors" in Part I of the Company's Form 10-K for the fiscal year ended
December 31, 1999.
All subsequent written and oral forward-looking statements attributable to the
Company or any person acting on its behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to in this section.
The Company does not undertake any obligation to release publicly any revisions
to such forward-looking statements to reflect events or circumstances after the
date of this document or to reflect the occurrence of unanticipated events.
1
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UnumProvident Corporation and Subsidiaries
March 31 December 31
2000 1999
(in millions of dollars)
--------------------------------------------
(Unaudited)
Assets
Investments
Fixed Maturity Securities
Available-for-Sale $22,408.4 $22,033.2
Held-to-Maturity 329.6 323.5
Mortgage Loans 1,241.4 1,278.1
Real Estate 191.6 211.2
Policy Loans 2,308.5 2,316.9
Short-term Investments 174.0 321.5
Other Investments 73.8 64.9
--------- ---------
Total Investments 26,727.3 26,549.3
Cash and Bank Deposits 134.1 292.4
Accounts and Premiums Receivable 1,903.9 1,144.3
Reinsurance Receivable 5,447.2 4,741.2
Accrued Investment Income 590.1 543.6
Deferred Policy Acquisition Costs 2,393.8 2,391.2
Value of Business Acquired 610.0 534.1
Goodwill 701.0 706.4
Other Assets 1,331.3 1,085.9
Separate Account Assets 469.9 459.1
--------- ---------
Total Assets $40,308.6 $38,447.5
========= =========
See notes to condensed consolidated financial statements.
2
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
March 31 December 31
2000 1999
(in millions of dollars)
-------------------------------------------
(Unaudited)
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,737.2 $ 1,722.1
Reserves for Future Policy and Contract Benefits and
Unearned Premiums 25,572.7 23,719.7
Other Policyholders' Funds 3,165.4 3,521.8
Federal Income Tax 360.3 271.6
Short-term Debt 1,211.5 1,075.0
Long-term Debt 1,166.5 1,166.5
Other Liabilities 1,217.9 1,229.5
Separate Account Liabilities 469.9 459.1
--------- ---------
Total Liabilities 34,901.4 33,165.3
--------- ---------
Commitments and Contingent Liabilities - Note 6
Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debt Securities of the Company 300.0 300.0
--------- ---------
Stockholders' Equity
Common Stock, $0.10 par
Authorized: 725,000,000 shares
Issued: 240,668,431 and 240,515,180 shares 24.1 24.1
Additional Paid-in Capital 1,033.1 1,028.6
Accumulated Other Comprehensive Income (Loss) 38.3 (18.9)
Retained Earnings 4,020.9 3,957.6
Treasury Stock at Cost: 176,295 shares (9.2) (9.2)
--------- ---------
Total Stockholders' Equity 5,107.2 4,982.2
--------- ---------
Total Liabilities and Stockholders' Equity $40,308.6 $38,447.5
========= =========
See notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Three Months Ended March 31
2000 1999
(in millions of dollars, except share data)
-----------------------------------------
Revenue
Premium Income $1,780.8 $1,681.5
Net Investment Income 552.1 499.6
Net Realized Investment Gains (Losses) (0.2) 7.2
Other Income 61.4 80.8
-------- --------
Total Revenue 2,394.1 2,269.1
-------- --------
Benefits and Expenses
Policyholder Benefits 1,579.5 1,502.1
Commissions 195.6 242.5
Interest and Debt Expense 43.9 32.9
Deferral of Policy Acquisition Costs (147.2) (231.2)
Amortization of Deferred Policy Acquisition Costs 143.6 113.2
Amortization of Value of Business Acquired and Goodwill 16.7 42.7
Other Operating Expenses 355.6 403.7
-------- --------
Total Benefits and Expenses 2,187.7 2,105.9
-------- --------
Income Before Federal Income Taxes 206.4 163.2
Federal Income Taxes 71.9 73.9
-------- --------
Net Income $ 134.5 $ 89.3
======== ========
Net Income Per Common Share
Basic $ 0.56 $ 0.38
Assuming Dilution $ 0.56 $ 0.37
Dividends Paid Per Common Share $ 0.15 $ 0.14
See notes to condensed consolidated financial statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Accumulated
Additional Other
Common Paid-in Comprehensive Retained Treasury Deferred
Stock Capital Income (Loss) Earnings Stock Compensation Total
(in millions of dollars)
-------------------------------------------------------------------------------------
Balance at December 31, 1998 $23.8 $ 959.2 $ 914.7 $4,279.2 $(9.2) $(21.5) $ 6,146.2
Comprehensive Loss, Net of Tax
Net Income 89.3 89.3
Change in Net Unrealized Gain
on Securities (325.6) (325.6)
Change in Foreign Currency
Translation Adjustment (0.3) (0.3)
---------
Total Comprehensive Loss (236.6)
---------
Common Stock Activity 10.3 4.4 14.7
Dividends to Stockholders (34.0) (34.0)
------ -------- ------- -------- ------ ------ ---------
Balance at March 31, 1999 $23.8 $ 969.5 $ 588.8 $4,334.5 $(9.2) $(17.1) $ 5,890.3
====== ======== ======= ======== ===== ====== =========
Balance at December 31, 1999 $24.1 $1,028.6 $ (18.9) $3,957.6 $(9.2) $ - $ 4,982.2
Comprehensive Income, Net of Tax
Net Income 134.5 134.5
Change in Net Unrealized Gain
on Securities 62.6 62.6
Change in Foreign Currency
Translation Adjustment (5.4) (5.4)
---------
Total Comprehensive Income 191.7
---------
Common Stock Activity 4.5 4.5
Dividends to Stockholders (71.2) (71.2)
------ -------- ------- -------- ------ ------ ---------
Balance at March 31, 2000 $24.1 $1,033.1 $ 38.3 $4,020.9 $(9.2) $ - $ 5,107.2
====== ======== ======= ======== ===== ====== =========
See notes to condensed consolidated financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Three Months Ended March 31
2000 1999
(in millions of dollars)
-------------------------------
Net Cash Provided by Operating Activities $ 254.7 $ 382.0
----------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments 619.7 797.3
Proceeds from Maturities of Investments 290.6 335.9
Purchase of Investments (1,352.0) (1,266.3)
Net Purchases of Short-term Investments 147.5 (58.3)
Acquisition of Business (88.0) ---
Disposition of Business (78.2) ---
Other (25.1) (19.4)
----------- ---------
Net Cash Used by Investing Activities (485.5) (210.8)
----------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts 12.7 48.4
Maturities and Benefit Payments from Policyholder Accounts (45.5) (284.3)
Net Short-term Borrowings 136.5 112.8
Dividends Paid to Stockholders (35.7) (34.0)
Other 4.5 9.0
------------ ---------
Net Cash Provided (Used) by Financing Activities 72.5 (148.1)
------------ ---------
Effect of Foreign Exchange Rate on Cash --- (0.4)
------------ ---------
Net Increase (Decrease) in Cash and Bank Deposits (158.3) 22.7
Cash and Bank Deposits at Beginning of Period 292.4 111.2
------------ ---------
Cash and Bank Deposits at End of Period $ 134.1 $ 133.9
============ =========
See notes to condensed consolidated financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
March 31, 2000
Note 1--Basis of Presentation
On June 30, 1999, Unum Corporation (Unum) merged with and into Provident
Companies, Inc. (Provident) under the name UnumProvident Corporation (the
Company). The merger was accounted for as a pooling of interests. The
historical financial results presented herein give effect to the merger as if it
had been completed at the beginning of the earliest period presented.
The condensed consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three month period ended March 31, 2000, are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2000. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on Form
10-K for the year ended December 31, 1999.
Note 2--Merger
During the second and third quarters of 1999, the Company recognized before-tax
expenses of $184.7 million related to the merger and $125.9 million for the
early retirement offer to employees.
Employee related expense consisted of employee severance costs, change in
control costs, restricted stock costs which fully vested upon stockholder
adoption of the merger agreement or upon completion of the merger, and
outplacement costs to assist involuntarily terminated employees. Severance
benefits and change in control costs were $60.2 million, and costs associated
with the vesting of restricted stock were $17.5 million. The Company estimated
that in total approximately 1,615 positions would be eliminated over a twelve
month period beginning June 30, 1999. As of March 31, 2000, approximately all
of these positions have been eliminated, and approximately $57.0 million of the
estimated $60.2 million has been paid for severance benefits and change in
control costs.
Exit activities related to duplicate facilities/asset abandonments consisted of
closing of duplicate offices and write-off of redundant computer hardware and
software. The cost associated with these office closures is approximately $25.6
million, which represents the cost of future minimum lease payments less any
estimated amounts recovered under subleases. As of March 31, 2000, $3.8 million
of this estimated liability has been paid. Also, certain physical assets,
primarily computer equipment, redundant systems, and systems incapable of
supporting the combined entity, have been abandoned as a result of the merger.
This abandonment resulted in a write-down of the assets' book values by
approximately $41.8 million during 1999. Approximately $40.9 million of the
$41.8 million of assets have been removed from service as of March 31, 2000. As
of March 31, 2000, the investment banking, legal, and accounting fees of $39.6
million have been paid.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2000
Note 2--Merger (Continued)
The results of operations for the separate companies and the combined amounts
for the periods prior to the merger were as follows:
Three Months Ended
March 31, 1999
( in millions of dollars)
--------------------------------
Revenue
Unum $1,280.7
Provident 988.4
--------
Combined Revenue $2,269.1
========
Net Income
Unum $ 15.5
Provident 73.8
--------
Combined Net Income $ 89.3
========
Unum's net income for the three months ended March 31, 1999 includes after tax
first quarter charges of $88.0 million related to its reinsurance operations.
See the Company's report on Form 10-K for the year ended December 31, 1999 for
further discussion.
Note 3--Stockholders' Equity and Earnings Per Common Share
In accordance with the restated certificate of incorporation, the Company has
25,000,000 shares of preferred stock authorized with a par value of $0.10 per
share. No preferred stock has been issued to date.
Net income per common share is determined as follows:
Three Months Ended March 31
2000 1999
( in millions, except share data)
-----------------------------------
Numerator
Net Income $ 134.5 $ 89.3
========== ==========
Denominator (000s)
Weighted Average Common Shares - Basic 240,594.0 237,785.4
Dilutive Securities 791.4 4,467.8
---------- ----------
Weighted Average Common Shares -
Assuming Dilution 241,385.4 242,253.2
========== ==========
In computing earnings per share assuming dilution, only potential common shares
that are dilutive (those that reduce earnings per share) are included.
Potential common shares are not used when computing earnings per share assuming
dilution if the result would be antidilutive, such as when options are out-of-
the-money. Approximately 12.3 million options for the three month period ended
March 31, 2000, were not considered dilutive due to the options being out-of-
the-money. Out-of-the-money options for the three months ended March 31, 1999
were immaterial.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2000
Note 4--Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss), net of deferred
tax, are as follows:
March 31 December 31
2000 1999
(in millions of dollars)
----------------------------------------------
Net Unrealized Gain on Securities $ 82.4 $ 19.8
Foreign Currency Translation Adjustment (44.1) (38.7)
------ ------
Accumulated Other Comprehensive Income (Loss) $ 38.3 $(18.9)
====== ======
The components of comprehensive income (loss) and the related deferred tax are
as follows:
Three Months Ended March 31
2000 1999
(in millions of dollars)
---------------------------------------------
Net Income $134.5 $ 89.3
------ -------
Change in Net Unrealized Gain on Securities:
Change Before Reclassification Adjustment 97.5 (496.3)
Reclassification Adjustment for Net Realized Investment
(Gains) Losses Included in Net Income 0.2 (7.2)
Change in Foreign Currency Translation Adjustment (5.7) 2.9
------ -------
92.0 (500.6)
Change in Deferred Tax 34.8 (174.7)
------ -------
Other Comprehensive Income (Loss) 57.2 (325.9)
------ -------
Comprehensive Income (Loss) $191.7 $(236.6)
====== =======
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2000
Note 5--Segment Information
Selected data by segment is as follows:
Three Months Ended March 31
2000 1999
(in millions of dollars)
---------------------------------------------
Premium Income
Employee Benefits $1,005.9 $ 953.3
Individual 469.1 433.1
Voluntary Benefits 181.8 171.2
Other 124.0 123.9
-------- --------
1,780.8 1,681.5
Net Investment Income and Other Income
Employee Benefits 206.5 176.8
Individual 247.2 227.5
Voluntary Benefits 29.4 26.6
Other 119.4 141.4
Corporate 11.0 8.1
-------- --------
613.5 580.4
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Employee Benefits 1,212.4 1,130.1
Individual 716.3 660.6
Voluntary Benefits 211.2 197.8
Other 243.4 265.3
Corporate 11.0 8.1
-------- --------
2,394.3 2,261.9
Benefits and Expenses
Employee Benefits 1,104.3 964.6
Individual 632.9 579.9
Voluntary Benefits 171.6 166.3
Other 228.5 326.4
Corporate 50.4 68.7
-------- --------
2,187.7 2,105.9
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Employee Benefits 108.1 165.5
Individual 83.4 80.7
Voluntary Benefits 39.6 31.5
Other 14.9 (61.1)
Corporate (39.4) (60.6)
-------- --------
206.6 156.0
Net Realized Investment Gains (Losses) (0.2) 7.2
-------- --------
Income Before Federal Income Taxes 206.4 163.2
Federal Income Taxes 71.9 73.9
-------- --------
Net Income $ 134.5 $ 89.3
======== ========
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2000
Note 6--Commitments and Contingent Liabilities
In 1997 two alleged class action lawsuits were filed in Superior Court in
Worcester, Massachusetts (Superior Court) against the Company--one purporting to
represent all career agents of subsidiaries of The Paul Revere Corporation (Paul
Revere) whose employment relationships ended on June 30, 1997 and were offered
contracts to sell insurance policies as independent producers and the other
purporting to represent independent brokers who sold certain Paul Revere
individual disability income policies with benefit riders. Motions filed by the
Company to dismiss most of the counts in the complaints, which allege various
breach of contract and statutory claims, have been denied, but the cases remain
at a preliminary stage. A hearing to determine class certification was heard on
December 20, 1999 in Massachusetts state court. The court certified a class for
the independent brokers and has denied class certification for the career
agents. The Company appealed the class certification for the independent
brokers, but the appeal was denied. A tentative trial date of January 2001 has
been set. The Company has filed a conditional counterclaim in each action which
requests a substantial return of commissions should the Superior Court agree
with the plaintiff's interpretation of the contracts. The Company believes that
it has strong defenses to both lawsuits and plans to vigorously defend its
position.
In addition, the same plaintiff's attorney who has filed the purported class
action lawsuits has filed 47 individual lawsuits on behalf of current and former
Paul Revere sales managers alleging various breach of contract claims. The
Company has filed a motion in federal court to compel arbitration for 16 of the
plaintiffs who are licensed by the National Association of Securities Dealers
and have executed the Uniform Application for Registration or Transfer in the
Securities Industry (Form U-4). The federal court has denied 14 of those
motions and granted two. The Company is appealing the denial of the 14. The
Company believes that it has strong defenses and plans to vigorously defend its
position in these cases. Although the alleged class action lawsuits and
individual lawsuits described above are in the early stages, management does not
currently expect these suits to materially affect the financial position or
results of operations of the Company.
During September and October 1999, the Company and several of its officers were
named as defendants in five class action lawsuits filed in the United States
District Court for the District of Maine. On January 3, 2000, the Maine
district court appointed a lead class action plaintiff and ordered plaintiffs to
file a consolidated amended complaint. On January 27, 2000, a sixth complaint
against the same defendants was filed in the Southern District of New York. On
March 7, 2000, the sixth action was transferred to the District of Maine. On
February 23, 2000, two consolidated amended class action complaints were filed
against the same defendants. The first amended class action complaint asserts a
variety of claims under the Securities Exchange Act of 1934, as amended, on
behalf of a putative class of shareholders who purchased or otherwise acquired
stock in the Company or Unum between February 4, 1998 and February 9, 2000. The
second amended complaint asserts a variety of claims under the Securities Act of
1933 and the Securities Exchange Act of 1934, as amended, on behalf of a
putative class of shareholders who exchanged the common stock of Unum or
Provident for the Company's stock pursuant to the joint proxy/registration
statement issued in connection with the merger between Unum and Provident. The
complaints allege that the defendants made false and misleading public
statements concerning, among other things, Unum's and the Company's reserves for
disability insurance and pricing policies, the Company's merger costs, and the
adequacy of the due diligence reviews performed in connection with the merger.
The complaints seek money damages on behalf of all persons who purchased or
otherwise acquired Company or Unum stock in the class period or who were issued
Company stock pursuant to the merger. On April 10, 2000, the defendants filed a
motion to dismiss the complaints. Plaintiff's response to the motion to dismiss
has not been filed. To date, no class has been certified, and no defendant has
answered any complaint. The Company disputes the claims alleged in the complaint
and plans to vigorously contest them.
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2000
Note 6--Commitments and Contingent Liabilities (Continued)
In certain reinsurance pools associated with the Company's reinsurance
businesses there are disputes among the pool members and reinsurance
participants concerning the scope of their obligations and liabilities within
the complex pool arrangements, including pools for which subsidiaries of the
Company acted either as pool managers or underwriting agents, as pool members or
as reinsurers. The Company or the Company's subsidiaries either have been or
may in the future be brought into disputes, arbitration proceedings, or
litigation with other pool members or reinsurers of the pools in the process of
resolving the various claims, but it is unclear what exposure the Company or its
subsidiaries may ultimately have to share in the losses of pool members or
reinsurers because of the subsidiaries' activities in placing insurance or
otherwise.
Various other lawsuits against the Company have arisen in the normal course of
its business. Contingent liabilities that might arise from such other
litigation are not deemed likely to materially affect the financial position or
results of operations of the Company.
Note 7--Change in Accounting Principle
Effective January 1, 2000, the Company adopted the provisions of Statement of
Position 98-7 (SOP 98-7), Deposit Accounting: Accounting for Insurance and
Reinsurance Contracts That Do Not Transfer Insurance Risk. SOP 98-7 provides
guidance on applying the deposit method of accounting to insurance and
reinsurance contracts that do not transfer insurance risk. The effect of the
adoption of SOP 98-7 on the Company's financial position and results of
operations was immaterial.
Note 8--Subsequent Events
On April 18, 2000, the Company issued $200.0 million of variable rate notes in a
privately negotiated transaction. The notes are due in April 2001 and were
issued to refinance other short-term debt. The notes had an initial interest
rate of 7.03 percent.
12
Independent Auditors' Review Report
Board of Directors and Shareholders
UnumProvident Corporation
We have reviewed the accompanying condensed consolidated statement of financial
condition of UnumProvident Corporation and Subsidiaries as of March 31, 2000,
and the related condensed consolidated statements of income, stockholders'
equity, and cash flows for the three month periods ended March 31, 2000 and
1999. The consolidated financial statements give retroactive effect to the
merger of Unum Corporation and Provident Companies, Inc. on June 30, 1999, which
has been accounted for using the pooling of interests method as described in the
notes to condensed consolidated financial statements. These financial statements
are the responsibility of the Company's management.
We were furnished with the report of other accountants on their review of the
interim information of the former Unum Corporation and Subsidiaries whose
revenues for the three month period ended March 31, 1999 constituted 56 percent
of the related consolidated totals.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, which will be
performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews and the report of other accountants, we are not aware of
any material modifications that should be made to the accompanying condensed
consolidated financial statements referred to above for them to be in conformity
with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial condition of UnumProvident
Corporation as of December 31, 1999, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the year then ended not
presented herein, and in our report dated February 9, 2000, except for Note 17,
for which the date is March 7, 2000, we expressed an unqualified opinion on
those consolidated financial statements. In our opinion, the information set
forth in the accompanying condensed consolidated statement of financial
condition as of December 31, 1999, is fairly stated, in all material respects,
in relation to the consolidated statement of financial condition from which it
has been derived.
/s/ ERNST & YOUNG LLP
---------------------
Chattanooga, Tennessee
May 3, 2000
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
On June 30, 1999, Unum Corporation (Unum) merged with and into Provident
Companies, Inc. (Provident) under the name UnumProvident Corporation. The
merger was accounted for as a pooling of interests. The historical financial
results discussed herein give effect to the merger as if it had been completed
at the beginning of the earliest period presented. See Notes 1 and 2 of the
"Notes to Condensed Consolidated Financial Statements" for further discussion.
The following should be read in conjunction with the condensed consolidated
financial statements and notes thereto in Part I, Item 1 contained herein and
the with the discussion, analysis, and consolidated financial statements and
notes thereto in Part I, Item I and Part II, Items 6, 7, 7A, and 8 of the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1999.
This discussion of consolidated operating results and operating results by
segment excludes net realized investment gains and losses from revenue and
income (loss) before taxes. The Company's investment focus has been on
investment income to support its insurance liabilities as opposed to the
generation of realized investment gains. Due to the nature of the Company's
business, a long-term focus is necessary to maintain profitability over the life
of the business. The realization of investment gains and losses will impact
future earnings levels as the underlying business is long-term in nature and
requires that the Company be able to sustain the assumed interest rates in its
liabilities. However, income excluding realized investment gains and losses
does not replace net income as a measure of the Company's profitability.
Management believes that the trends in new annualized sales in the Employee
Benefits, Individual, and Voluntary Benefits segments are important for
investors to assess in their analysis of the Company's operating results. The
trends in new sales are indicators of the Company's potential for growth in its
respective markets and the level of market acceptance of price changes and new
products. The Company has closely linked its various incentive compensation
programs to the achievement of its goals for new sales and renewals of existing
business. The Company's long-term financial objectives, which balance growth
and profitability, are to achieve sales growth of 10 to 12 percent per year,
earnings per share growth of 12 to 14 percent per year, and a return on equity
of 14 to 16 percent per year.
Consolidated Operating Results
(in millions of dollars)
Three Months Ended March 31
2000 1999 % Change
-------------------------------------------
Premium Income $1,780.8 $1,681.5 5.9 %
Net Investment Income 552.1 499.6 10.5
Other Income 61.4 80.8 (24.0)
-------- --------
Total Revenue 2,394.3 2,261.9 5.9
Benefits and Expenses 2,187.7 2,105.9 3.9
-------- --------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses 206.6 156.0 32.4
Federal Income Taxes 72.0 71.4 0.8
-------- --------
Income Before Net Realized Investment Gains and Losses 134.6 84.6 59.1
Net Realized Investment Gains (Losses) (0.1) 4.7 N.M.
-------- --------
Net Income $ 134.5 $ 89.3 50.6
======== ========
N.M. = not a meaningful percentage
14
During the first quarter of 1999, the Company began a comprehensive strategic
review of its reinsurance operations to determine the appropriateness of their
fit within the context of the merged entity. These operations include the
reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk
assumption, which includes reinsurance pool participation; direct reinsurance
which includes accident and health (A&H), long-term care (LTC), and long-term
disability coverages; and Lloyd's of London (Lloyd's) syndicate participations.
In April 1999, the strategic review was completed, and the Company concluded
that these operations were not solidly aligned with the Company's strength in
the disability insurance market. The Company decided to exit these operations
through a combination of a sale, reinsurance, and/or placing certain components
in run-off and recognized a before-tax charge of $101.1 million ($88.0 million
after tax) in the first quarter of 1999. The charge was recorded in the Other
segment as a $72.6 million increase in the reserve for future benefits and a
$1.5 million reduction in other income and in the Corporate segment as a $27.0
million increase in other operating expenses related to the write-off of
goodwill.
A portion of the losses recognized in 1999 relating to the Company's reinsurance
operations does not receive a tax benefit, which unfavorably impacted the 1999
effective tax rate.
In the following discussion of operating results by segment, "revenue" includes
premium income, net investment income, and other income. "Income" excludes net
realized investment gains and losses and federal income taxes.
Employee Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
2000 1999 % Change
---------------------------------------------
Premium Income
Group Long-term Disability $ 518.0 $ 498.1 4.0%
Group Short-term Disability 124.4 111.2 11.9
Group Life 302.9 287.0 5.5
Accidental Death & Dismemberment 46.9 47.7 (1.7)
Group Long-term Care 13.7 9.3 47.3
-------- --------
Total Premium Income 1,005.9 953.3 5.5
Net Investment Income 170.4 144.0 18.3
Other Income 36.1 32.8 10.1
-------- --------
Total Revenue 1,212.4 1,130.1 7.3
-------- --------
Benefits and Change in Reserves 831.4 732.0 13.6
Commissions 88.7 80.3 10.5
Deferral of Policy Acquisition Costs (64.4) (75.6) (14.8)
Amortization of Deferred Policy Acquisition Costs 48.3 25.1 92.4
Other Operating Expenses 200.3 202.8 (1.2)
-------- --------
Total Benefits and Expenses 1,104.3 964.6 14.5
-------- --------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 108.1 $ 165.5 (34.7)
======== ========
The Employee Benefits segment includes group long-term and short-term disability
insurance, group life insurance, accidental death and dismemberment coverages,
group long-term care, and the results of managed disability.
New sales declined in the fourth quarter of 1999 compared to the 1998 fourth
quarter and in the first quarter of 2000 compared to the first quarter of 1999.
Employee Benefits new annualized sales, on a submitted date basis, decreased
46.0 percent to $134.0 million in the first quarter of 2000 from $248.3 million
in the first quarter of 1999. On an effective date basis, sales decreased 37.3
percent to $340.3 million in the first quarter of 2000 from $542.5 million in
the first quarter of 1999. Sales related to employee benefits can fluctuate
significantly from quarter to quarter due to large case size and timing of sales
submissions. Several factors contributed to the decrease in sales, including
rate increases and turnover in the field sales force. The Company has a number
of initiatives underway to help restore sales momentum, including targeted
incentive plans, organizational changes to create a greater focus on the
customer, and enhanced communication with producers. In order to give the
appropriate focus to the Company's primary business markets, the Company has
established national practice groups to focus on large employers, executive
benefits, and voluntary benefits. These national practice groups work with the
Company's sales force to
15
present coverage solutions to potential customers and to manage existing
customer accounts. The Company expects that these actions will favorably impact
future sales growth, but management intends to maintain pricing discipline to
balance sales growth and profitability which will likely lead to lower long-term
sales growth than historically experienced by the Company.
The Company monitors persistency and reflects adverse changes in persistency in
the current period's amortization of deferred acquisition costs. Actual
persistency experienced during the first quarter of 2000 for group disability,
group life, and accidental death and dismemberment products compared unfavorably
to the persistency expected, resulting in additional amortization of $18.6
million during the first quarter of 2000. The adverse persistency was due to
large case terminations and an aggressive 2000 renewal program that is heavily
concentrated in the first quarter. It is expected that persistency in 2000 will
continue to be lower than historical levels for group disability as well as
group life. The Company's 2000 renewal program has been successful at renewing
profitable business, while less profitable business has been terminated. It is
expected that the additional premium and related profits associated with this
renewal activity will emerge over the next six quarters. The impact of the
renewal program in the first quarter of 2000 was a reduction in income due to
the additional amortization related to the resultant adverse persistency with
little recognition of the premium income that will occur over time from the
renewal program.
Revenue from the managed disability line of business, which includes GENEX
Services, Inc. and Options and Choices, Inc., totaled $30.1 million in the first
quarter of 2000 compared to $25.8 million in the first quarter of 1999.
Group Disability
Group disability revenue was $790.0 million in the first quarter of 2000
compared to $735.6 million in the first quarter of 1999. First quarter new
annualized sales for group long-term disability on a submitted date basis were
$63.5 million in 2000 and $105.6 million in 1999. New annualized sales for
group short-term disability were $22.3 million in the first quarter of 2000 as
compared to $44.6 million in the first quarter of 1999. On an effective date
basis, new annualized sales for long-term disability and short-term disability
were $134.8 million and $61.4 million in the first quarter of 2000 and $231.8
million and $97.7 million in the first quarter of 1999. A critical part of the
Company's strategy for group disability during 2000 involves executing its
renewal program and managing persistency, both of which management expects will
have a positive impact on future premium growth and profitability. However, the
high terminations and slow sales have decreased the earned premium growth
compared to that experienced during 1999. The Company is implementing pricing
changes in the group disability line. Prices will increase or decrease by
market segment, as appropriate, to respond to current claim experience and other
factors and assumptions. Net investment income is expected to continue to
increase due to the increase in the level of invested assets allocated to this
line of business, the increased duration on new investments, and the higher
interest rate environment.
Group disability reported income of $56.3 million for the first quarter of 2000
compared to $105.5 million for the first quarter of 1999. Positive impacts on
income were the revenue increase and an improvement in the operating expense
ratio due to cost savings resulting from the merger. Offsetting these increases
was a higher benefit ratio in the first quarter of 2000 as compared to 1999,
which has increased due to the higher reserve factors for new claims and due to
slower earned premium growth over the past few quarters. The fundamentals
underlying risk results in the group disability line continue to exhibit
improvements as the integration of the claims organization continues. The paid
claim incidence for long-term disability compares favorably to the first quarter
of 1999 due to lower claim acceptance rates, and submitted claim incidence has
moved upward only slightly. The benefit ratio for short-term disability is up
over the first quarter of 1999 due to an increase in the average weekly
indemnity and a slight increase in paid claim incidence. The submitted claim
incidence for short-term disability has improved from that experienced in the
first quarter of 1999.
Also contributing to the decline in income was the increase in the amortization
of deferred policy acquisition costs for the first quarter of 2000. This
increase resulted from $13.8 million of additional amortization necessitated by
the higher level of terminations for long-term and short-term disability
experienced during the first quarter of 2000 than expected at the time the
business was written.
16
In the fourth quarter of 1998, the Company recorded a $50.3 million before-tax
charge for the group long-term disability line of business in the Employee
Benefits segment for the expected increase in claims durations due to
management's expectation that productivity in the claims organization will be
impacted as a result of planning, consolidation, and integration efforts related
to the merger. Management expects the claims integration efforts to have some
benefits, primarily related to claims incurred in future periods, as well as the
potential for improved customer satisfaction and lower ultimate claim costs as
best practices in return-to-work and claims management are implemented. As
benefits related to the integration become known, reserve assumptions will be
revised, if appropriate. Insurance policies that are impacted by the temporary
change in claim resolution rates will not perform as anticipated when priced.
However, since the cause of the additional claim cost is of a temporary nature,
it is not anticipated to have an effect on future policy pricing.
During the first quarter of 1999, those claim operations integration activities
progressed as assumed. At December 31, 1998, management assumed the revised
claim resolution rates for the first quarter of 1999 to be 90 percent of
assumptions, before adjusting for the impact of the claim operations integration
activities. The actual experience was 89 percent for the first quarter of 1999.
If the impact of merger-related claim operations integration activities on claim
durations had not been anticipated at December 31, 1998, first quarter 1999
before-tax income for the group long-term disability line of business would have
been negatively impacted by $11.8 million. The effect of integration activities
on new claim resolution rates is not expected to be material during 2000. See
Notes 2 and 7 of the "Notes to Consolidated Financial Statements" of the
Company's Form 10-K for the fiscal year ended December 31, 1999 for further
discussion.
As discussed under "Cautionary Statement Regarding Forward-Looking Statements,"
certain risks and uncertainties are inherent in the Company's business.
Components of claims experience, including but not limited to, incidence levels
and claims duration, may continue for some period of time at or above the levels
experienced in 1999 and 1998. Therefore, management continues to monitor claims
experience in group disability and responds to changes by periodically adjusting
prices, refining underwriting guidelines, changing product features, and
strengthening risk management policies and procedures. The Company expects to
price new business and re-price existing business, at contract renewal dates, in
an attempt to mitigate the effect of these and other factors, including interest
rates, on new claim liabilities. However, given the competitive market
conditions for the Company's disability products, it is uncertain whether
pricing actions can mitigate the entire effect.
Group Life, Accidental Death and Dismemberment, and Long-term Care
Group life, accidental death and dismemberment, and long-term care reported
income of $50.0 million in the first quarter of 2000 compared to $58.5 million
in the first quarter of 1999. New annualized sales on a submitted date basis
decreased to $48.2 million in the first quarter of 2000 as compared to the $98.1
million reported in the first quarter of 1999. On an effective date basis, new
annualized sales were $144.1 million in the first quarter of 2000 compared to
$213.0 million for the same period last year.
Group life and long-term care reported increases in revenue due to the increase
in premium income and net investment income, while accidental death and
dismemberment reported a very slight decline in revenue. Group life and
accidental death and dismemberment reported a slightly unfavorable benefit ratio
compared to the prior year first quarter, due primarily to an increase in both
the mortality incidence and waiver incidence for group life. Group long-term
care reported an unfavorable benefit ratio for the first quarter of 2000
compared to the first quarter of 1999 due to an increase in submitted claim
incidence. Paid claim incidence compares favorably with the prior year first
quarter. The net claim resolution rate compares unfavorably to the resolution
rate for the first quarter of 1999, but has improved from the fourth quarter of
1999 and is also above the average rate for all of 1999.
The amortization of deferred policy acquisition costs for the first quarter of
2000 includes $4.8 million of additional amortization due to the higher level of
terminations for group life and accidental death and dismemberment products
experienced during the first quarter of 2000 than expected at the time the
policies were written. The operating expense ratio compared favorably to the
1999 first quarter ratio due to cost savings resulting from the merger.
17
Individual Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
2000 1999 % Change
--------------------------------------------
Premium Income
Individual Disability $418.2 $391.3 6.9 %
Individual Life 21.7 22.6 (4.0)
Individual Long-term Care 29.2 19.2 52.1
------ ------
Total Premium Income 469.1 433.1 8.3
Net Investment Income 232.6 209.3 11.1
Other Income 14.6 18.2 (19.8)
------ ------
Total Revenue 716.3 660.6 8.4
------ ------
Benefits and Change in Reserves 474.9 416.1 14.1
Commissions 67.0 69.6 (3.7)
Deferral of Policy Acquisition Costs (52.5) (50.6) 3.8
Amortization of Deferred Policy Acquisition Costs 25.6 23.0 11.3
Other Operating Expenses 117.9 121.8 (3.2)
------ ------
Total Benefits and Expenses 632.9 579.9 9.1
------ ------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 83.4 $ 80.7 3.3
====== ======
The Individual segment includes results from the individual disability,
individual life, and individual long-term care lines of business.
Individual Disability
New annualized sales in the individual disability line of business were $26.5
million in the first quarter of 2000 compared to $33.9 million in the first
quarter of 1999. As discussed in the "Employee Benefits Segment Operating
Results," several factors have contributed to the decrease in sales. However,
the persistency of existing individual disability income business continued to
be favorable during 1999 and the first quarter of 2000. The Company is
developing a new portfolio of individual disability products for release in the
second half of 2000. This product line will consolidate the current offerings
of the Company's insurance subsidiaries into one new simplified product
portfolio. The new portfolio will utilize a modular approach offering customers
a range of product options and features. This portfolio has been designed to
combine the best features from prior Company offerings and will include return-
to-work incentives and optional long-term care conversion benefits and/or
benefits for catastrophic disabilities. Management expects that premium income
in the individual disability income line will grow on a year-over-year basis as
the portfolio transition produces increasing levels of new sales of individual
disability products and as a result of the sales initiatives discussed under
"Employee Benefits Segment Operating Results."
Revenue was $635.6 million for the first quarter of 2000 compared to $588.6
million in the same period of 1999. The growth in 2000 revenue was driven
primarily by the growth in premium income as well as net investment income.
Premium income in the first quarter of 2000 included $24.7 million from an
inforce block of individual disability business reinsured effective January 1,
2000.
Income in the individual disability line of business was $72.4 million in the
first quarter of 2000, an increase of 1.1 percent over the prior year quarter.
This line reported an increase in the benefit ratio for the first quarter of
2000 compared to the first quarter of 1999 due to a high incidence of new claims
in the Canadian operations as well as a slightly increased average new claim
size in the U.S. operations. Both submitted and paid claim incidence for the
U.S. operations were down relative to the first quarter of 1999. The claim
resolution rate for the first quarter of 2000 compares favorably with the same
period of 1999 and with the fourth quarter of 1999. Individual disability
benefited from higher net investment income and an improved commission and
operating expense ratio for first quarter 2000 as compared to first quarter
1999.
18
As noted in the "Employee Benefits Segment Operating Results," claim resolution
rates were revised downward in the fourth quarter of 1998 for claim operations
integration activities related to the merger. The Company recorded a $100.3
million before-tax charge in the fourth quarter of 1998 in the Individual
segment related to the revised claim resolution rates for individual disability.
At December 31, 1998, management assumed the revised claim resolution rates for
the first quarter of 1999 to be 90 percent of assumptions, before adjusting for
the impact of the claim operations integration activities. The actual experience
for the Company in the first quarter of 1999 was 89 percent. If the impact of
merger-related claim operations integration activities on claim durations had
not been anticipated at December 31, 1998, first quarter 1999 before-tax
operating income for the individual disability line of business would have been
negatively impacted by $23.8 million. The effect of integration activities on
new claim resolution rates is not expected to be material during 2000. See
Notes 2 and 7 of the "Notes to Consolidated Financial Statements" of the
Company's Form 10-K for the fiscal year ended December 31, 1999 for further
discussion.
Individual Life and Long-term Care
The individual long-term care line of business reported increased premium income
for the first quarter of 2000 compared to the same period of 1999, primarily due
to new sales growth for individual long-term care. New annualized sales for
long-term care were $10.8 million for the first quarter of 2000. For the
comparable period of 1999, new sales were $7.6 million. The Company expects the
strong sales momentum in individual long-term care to continue. Individual life
reported both new sales and premium income slightly lower than the prior year
first quarter.
Income in the individual life and long-term care lines of business was $11.0
million for the first quarter of 2000 compared to $9.1 million for the same
period of 1999. Individual long-term care reported an improvement in the first
quarter 2000 benefit ratio as compared to the same quarter last year. The first
quarter 2000 benefit ratio for individual life compared unfavorably to the 1999
first quarter ratio, but the operating expense ratio for both lines of business
improved relative to the 1999 first quarter ratio.
Voluntary Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
2000 1999 % Change
--------------------------------------------
Premium Income $181.8 $171.2 6.2 %
Net Investment Income 27.9 24.9 12.0
Other Income 1.5 1.7 (11.8)
------ ------
Total Revenue 211.2 197.8 6.8
------ ------
Benefits and Change in Reserves 107.6 96.3 11.7
Commissions 30.7 34.9 (12.0)
Deferral of Policy Acquisition Costs (30.0) (37.0) (18.9)
Amortization of Deferred Policy Acquisition Costs 25.4 27.0 (5.9)
Other Operating Expenses 37.9 45.1 (16.0)
------ ------
Total Benefits and Expenses 171.6 166.3 3.2
------ ------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 39.6 $ 31.5 25.7
====== ======
The Voluntary Benefits segment includes the results of products sold to
employees through payroll deduction at the work site. These products include
life insurance and health products, primarily disability, accident and sickness,
and cancer.
Revenue in the Voluntary Benefits segment increased to $211.2 million in the
first quarter of 2000 from $197.8 million in the first quarter of 1999 primarily
due to the increase in premium income which was attributable to sales growth and
favorable persistency. New annualized sales for the first quarter of 2000 were
$63.3 million, an increase of 7.7 percent over the comparable prior year period.
Management continues its efforts to increase sales through the sales initiatives
discussed under "Employee Benefits Segment Operating Results." However, these
sales are not necessarily indicative of the levels that may be attained in the
future. The investment income growth was due to the repositioning of the
investment portfolio subsequent to the merger.
19
The $8.1 million increase in income for the first quarter of 2000 over the first
quarter of 1999 was primarily due to the increase in premium income in all of
the product lines, increased investment income, and favorable commission and
operating expense ratios. The improvement in the operating expense ratio is
attributable to costs savings resulting from the merger. The first quarter
benefit ratio was unfavorable compared with the first quarter of 1999. The
primary drivers were poor mortality results in the life product line and a
slightly higher loss ratio in the accident, sickness, and disability product
line.
Other Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
2000 1999 % Change
-------------------------------------------
Premium Income $124.0 $123.9 0.1%
Net Investment Income 113.3 113.5 (0.2)
Other Income 6.1 27.9 N.M.
------ ------
Total Revenue 243.4 265.3 (8.3)
Benefits and Expenses 228.5 326.4 (30.0)
------ ------
Income (Loss) Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 14.9 $(61.1) N.M.
====== ======
The Other operating segment includes results from reinsurance pools and
management and other products no longer actively marketed, including corporate-
owned life insurance, group pension, health insurance, and individual annuities.
It is expected that revenue and earnings in this segment will decline over time
as these business lines wind down. The run-off of the group pension line results
in a decline in assets under management and, in turn, a continued decline in the
net investment income produced by the assets. Management expects to reinvest
the capital supporting these lines of business in the future growth of the
Employee Benefits, Individual, and Voluntary Benefits segments. The closed
blocks of business have been segregated for reporting and monitoring purposes.
The reinsurance pools and management reported a gain of $0.1 million for the
first quarter of 2000 compared to a loss of $74.0 million in the first quarter
of 1999. The 1999 loss was the result of the $74.1 million charge related to
the decision to exit the reinsurance operations. Premium income was $101.1
million compared to $103.8 million in the first quarter of 1999. These results
are consistent with the strategy which the Company implemented during 1999 to
limit participation in Lloyd's year 2000 underwriting risks, manage the run-off
of the Company's risk participation in open years of account of Lloyd's
reinsurance syndicates, discontinue the accident reinsurance business in London
beginning in year 2000, sell the reinsurance management operations of the A&H
and LTC reinsurance facilities, and reinsure the Company's risk participation in
these facilities. See previous discussion under "Consolidated Operating
Results" and Note 13 of the "Notes to Consolidated Financial Statements" of the
Company's Form 10-K for the fiscal year ended December 31, 1999.
In the fourth quarter of 1998, the Company recorded a $2.4 million before-tax
charge related to the revised claim resolution rates for group long-term
disability reinsurance. If the impact of merger-related claim operations
integration activities on claim duration had not been anticipated at December
31, 1998, first quarter 1999 before-tax earnings for the reinsurance pools and
management line of business would have been negatively impacted by $0.6 million.
Corporate Segment Operating Results
The Corporate segment includes investment earnings on corporate assets not
specifically allocated to a line of business, corporate interest expense,
amortization of goodwill, and certain corporate expenses not allocated to a line
of business.
Revenue in the Corporate segment was $11.0 million in the first quarter of 2000
and $8.1 million in the first quarter of 1999. The Corporate segment reported
a loss of $39.4 million in the first quarter compared to a loss of $60.6 million
in the first quarter of 1999. Interest and debt expense was $43.9 million in
the first quarter of 2000 compared to $32.9 million for the first quarter of
1999 due to increased corporate borrowings. The Company recorded a before-tax
write-down of goodwill of $27.0 million in the 1999 first quarter related to its
decision to exit the reinsurance operations.
20
Investments
Investment activities are an integral part of the Company's business, and
profitability is significantly affected by investment results. Invested assets
are segmented into portfolios, which support the various product lines.
Generally, the investment strategy for the portfolios is to match the effective
asset durations with related expected liability durations and to maximize
investment returns, subject to constraints of quality, liquidity,
diversification, and regulatory considerations.
During 1999 and continuing into the first quarter of 2000, the Company actively
pursued its strategy of extending the duration of its investments and shifting
the mix of assets for approximately $2.1 billion of its investments. This
program was approximately 90 percent complete as of March 31, 2000, with total
completion expected by the end of the second quarter. Management believes this
strategy will reduce its vulnerability to interest rate risk in the future and
anticipates that, as a result, investment income may increase on an annualized
basis approximately $40 million.
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately $3.3
billion and $3.1 billion on an amortized cost basis at March 31, 2000, and at
December 31, 1999, respectively. At March 31, 2000, the mortgage-backed
securities had an average life of 12.5 years and effective duration of 10.3
years. The mortgage-backed securities are valued on a monthly basis using
valuations supplied by the brokerage firms that are dealers in these securities.
The primary risk involved in investing in mortgage-backed securities is the
uncertainty of the timing of cash flows from the underlying loans due to
prepayment of principal. The Company uses models which incorporate economic
variables and possible future interest rate scenarios to predict future
prepayment rates. The Company has not invested in mortgage-backed derivatives,
such as interest-only, principal-only or residuals, where market values can be
highly volatile relative to changes in interest rates.
Below-investment-grade bonds are inherently more risky than investment-grade
bonds since the risk of default by the issuer, by definition and as exhibited by
bond rating, is higher. Also, the secondary market for certain below-
investment-grade issues can be highly illiquid. Management does not anticipate
any liquidity problem caused by the investments in below-investment-grade
securities, nor does it expect these investments to adversely affect its ability
to hold its other investments to maturity.
The Company's exposure to below-investment-grade fixed maturity securities at
March 31, 2000, was $2,028.5 million, representing 7.6 percent of invested
assets, below the Company's internal limit of 10.0 percent of invested assets
for this type of investment. The Company's exposure to below-investment-grade
fixed maturities totaled $2,147.4 million at December 31, 1999, representing 8.1
percent of invested assets.
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $1,241.4 million and $1,278.1 million
at March 31, 2000, and December 31, 1999, respectively. The Company uses a
comprehensive rating system to evaluate the investment and credit risk of each
mortgage loan and to identify specific properties for inspection and
reevaluation. The Company establishes allowances for probable mortgage loan
losses based on a review of individual loans and the overall loan portfolio,
considering the value of the underlying collateral.
The mortgage loan portfolio is well diversified geographically and among
property types. The incidence of new problem mortgage loans and foreclosure
activity has remained low in 2000 and 1999, reflecting improvements in overall
economic activity and improving real estate markets in the geographic areas
where the Company has mortgage loans. Management expects the level of
delinquencies and problem loans to remain low in the future.
At March 31, 2000, and December 31, 1999, impaired loans totaled $18.0 million
and $18.1 million, respectively. Included in the impaired loans at March 31,
2000 were $6.6 million of loans which had a related, specific allowance for
probable losses of $2.4 million and $11.4 million of loans which had no related,
specific allowance for probable losses. Impaired mortgage loans are not
expected to have a material impact on the Company's liquidity, financial
position, or results of operations.
21
Restructured mortgage loans totaled $8.7 million at March 31, 2000 and December
31, 1999, and represent loans that have been refinanced with terms more
favorable to the borrower. Interest lost on restructured loans was immaterial
for the three and twelve month periods ended March 31, 2000, and December 31,
1999.
Real estate was $191.6 million and $211.2 million at March 31, 2000, and
December 31, 1999. Investment real estate is carried at cost less accumulated
depreciation. Real estate acquired through foreclosure is valued at fair value
at the date of foreclosure and may be classified as investment real estate if it
meets the Company's investment criteria. If investment real estate is
determined to be permanently impaired, the carrying amount of the asset is
reduced to fair value. Occasionally, investment real estate is reclassified to
real estate held for sale when it no longer meets the Company's investment
criteria. Real estate held for sale, which is valued net of a valuation
allowance that reduces the carrying value to the lower of cost or fair value
less estimated cost to sell, amounted to $63.4 million at March 31, 2000, and
$79.4 million at December 31, 1999.
Allowances for probable losses on mortgage loans and real estate held for sale
are established based on a review of specific assets as well as on an overall
portfolio basis, considering the value of the underlying assets and collateral.
If a decline in value is considered to be other than temporary or if the asset
is deemed permanently impaired, the investment is reduced to estimated net
realizable value, and the reduction is recorded as a realized investment loss.
The allowance for probable losses on mortgage loans and real estate was $32.9
million and $37.8 million, respectively, at March 31, 2000. Management monitors
the risk associated with the invested asset portfolio and regularly reviews and
adjusts the allowance for probable losses.
Other
The Company's exposure to non-current investments totaled $23.0 million at March
31, 2000, or 0.1 percent of invested assets. These non-current investments are
comprised of foreclosed real estate and mortgage loans that became more than
thirty days past due in principal and interest payments.
The Company utilizes interest rate futures contracts, current and forward
interest rate swaps, interest rate forward contracts, and options on forward
interest rate swaps, forward treasuries, or specific fixed income securities to
manage duration and increase yield on cash flows expected from current holdings.
All transactions are hedging in nature and not speculative. Almost all
transactions are associated with the individual and group disability product
portfolios. All other product portfolios are periodically reviewed to determine
if hedging strategies would be appropriate for risk management purposes.
Liquidity and Capital Resources
The Company's liquidity requirements are met primarily by cash flows provided
from operations, principally in its insurance subsidiaries. Premium and
investment income, as well as maturities and sales of invested assets, provide
the primary sources of cash. Cash is applied to the payment of policy benefits,
costs of acquiring new business (principally commissions) and operating expenses
as well as purchases of new investments. The Company has established an
investment strategy that management believes will provide for adequate cash
flows from operations. Cash flows from operations were $254.7 million for the
three months ended March 31, 2000, as compared to $382.0 million in the
comparable period in 1999.
The Company believes the cash flows from its operations will be sufficient to
meet its operating and financial cash flow requirements, excluding the strain
placed on capital as a result of the charges recorded in connection with the
merger. As a result of the effect on capital during 1999 of the merger related
charges, the Company raised approximately $500 million through the debt markets
during the fourth quarter of 1999 by securing $200 million of one-year bank debt
and by issuing commercial paper. The Company is exploring alternative financing
sources to further increase its financial flexibility. The Company intends to
file a shelf registration during the first half of 2000 in order to provide
funding flexibility through the issuance of debt and equity securities. Any
funding will be used to refinance short-term debt on a long-term basis and to
fund internal expansion, acquisitions, investment opportunities, and the
retirement of the Company's debt and equity. During 1999, the Company raised
approximately $700 million of capital in the debt markets.
22
In 1997, the Company borrowed $168.3 million through a private placement. Under
the terms of the agreement, the investor exercised the right to redeem the
private placement at par value during the second quarter of 1999. The Company
refinanced this debt by issuing $200.0 million of variable rate medium-term
notes in June 1999, due in June 2000. The notes had an interest rate of 6.12
percent at March 31, 2000.
At March 31, 2000, the Company had short-term and long-term debt totaling
$1,211.5 million and $1,166.5 million, respectively. At March 31, 2000,
approximately $346.8 million was available for additional financing under the
existing revolving credit facilities. Contingent upon market conditions and
corporate needs, management may refinance short-term notes payable for longer-
term securities.
In April 2000, the Company issued $200.0 million of variable rate notes, due in
April 2001, in a privately negotiated transaction. The notes were used to
refinance other short-term debt and had an initial interest rate of 7.03
percent.
Ratings
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's), Duff &
Phelps Credit Rating Company (Duff & Phelps), and A.M. Best Company (AM Best)
are among the third parties that provide the Company assessments of its overall
financial position. Ratings from these agencies for financial strength are
available for the individual U.S. domiciled insurance company subsidiaries.
Financial strength ratings are based primarily on U.S. statutory financial
information for the individual U.S. domiciled insurance companies. Debt ratings
for the Company are based primarily on consolidated financial information
prepared using generally accepted accounting principles. Both financial
strength ratings and debt ratings incorporate qualitative analyses by rating
agencies on an ongoing basis.
The rating agencies reviewed and, in some instances, revised their ratings to
reflect the completion of the merger. The table below reflects the most recent
debt ratings for the Company and the financial strength ratings for the U.S.
domiciled insurance company subsidiaries.
- -----------------------------------------------------------------------------------------------------------------------------
S&P Moody's Duff & Phelps AM Best
- -----------------------------------------------------------------------------------------------------------------------------
UnumProvident Corporation
- -----------------------------------------------------------------------------------------------------------------------------
Senior Debt A- (Strong) A3 (Upper Medium A- Not Rated
Grade) (Investment Grade)
- -----------------------------------------------------------------------------------------------------------------------------
Junior Subordinated Debt BBB (Good) Baa1 (Medium Grade) BBB+ Not Rated
(Investment Grade)
- -----------------------------------------------------------------------------------------------------------------------------
Commercial Paper A-2 (Good) Prime-2 (Strong Not Rated Not Rated
Ability)
- -----------------------------------------------------------------------------------------------------------------------------
U.S. Insurance Subsidiaries
- -----------------------------------------------------------------------------------------------------------------------------
Provident Life & Accident AA- (Very Strong) A1 (Good Financial AA-(Secure/ A+ (Superior)
Security) Investment Grade)
- -----------------------------------------------------------------------------------------------------------------------------
Provident Life & Casualty Not Rated Not Rated Not Rated A+ (Superior)
- -----------------------------------------------------------------------------------------------------------------------------
Provident National Assurance Not Rated A1 (Good Financial AA-(Secure/ A+ (Superior)
Security) Investment Grade)
- -----------------------------------------------------------------------------------------------------------------------------
Unum Life of America AA- (Very Strong) A1 (Good Financial Not Rated A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
First Unum Life AA- (Very Strong) A1 (Good Financial Not Rated A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Colonial Life & Accident AA- (Very Strong) A1 (Good Financial Not Rated A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Life AA- (Very Strong) A1 (Good Financial AA-(Secure/ A+ (Superior)
Security) Investment Grade)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Variable AA- (Very Strong) A1 (Good Financial Not Rated A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Protective AA- (Very Strong) A1 (Good Financial Not Rated A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
23
Year 2000 Date Conversion
As are many other businesses in this country and abroad, the Company is affected
in numerous ways, both by its own computer information systems and by third
parties with which it has business relationships, in the processing of date data
relating to the year 2000 and beyond. Failure to have adequately addressed and
substantially resolved year 2000 issues could have had, and as to mission
critical systems in certain circumstances would have had, a material adverse
effect on the Company's business, results of operations, or financial condition.
While there can be no assurance as to its long-term success, the Company
completed a project which was intended and designed to avoid and/or mitigate any
such material adverse effect from year 2000 issues. The Company's program for
the year 2000 was organized into a number of phases for rectifying its internal
computer systems, including assessment, code remediation, testing, and
deployment. The program continues to monitor systems for year 2000 issues,
including the ability to properly handle the dates of June 30, October 10, and
December 31, 2000 and February 28 and December 31, 2001. To date, no material
issues have been identified.
There are numerous instances in which third parties having a relationship with
the Company had and may continue to have year 2000 issues to address and
resolve. These include, among others, vendors of hardware and software, holders
of group insurance policies, issuers of investment securities, financial
institutions, governmental agencies, and suppliers. To date, no significant
issues from critical external dependencies have been identified; however, there
can be no guarantee that the computer systems of these third parties will
continue to be year 2000 trouble free. As a result, the Company will continue
to monitor these dependencies for year 2000 problems.
Although there was a broad range of possibilities that could have occurred in
connection with non-compliance with year 2000 that might have affected the
Company, particularly as a consequence of third parties, the Company experienced
no material problems before, on, or after January 2, 2000. Consequently, the
Company has not experienced any material adverse impact on its business, results
of operations, or financial condition from year 2000 issues. With regard to any
subsequent non-compliance resulting from the Company's systems, which the
Company believes to be less likely than that resulting from third parties, the
Company will provide adequate financial and personnel resources to remediate the
problem as soon as possible. With regard to non-compliance resulting from third
party failure, the Company has appropriate contingency arrangements that will
minimize such impact; however, given the range of possibilities, no assurance
can be given that the Company's efforts will be successful.
The foregoing discussion of the year 2000 issue contains forward-looking
statements relating to such matters as financial performance and the business of
the Company. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor for forward-looking statements. In order for the Company to comply
with the terms of the safe harbor, the Company notes that a variety of factors
could cause the Company's actual results and experience relating to compliance
with year 2000 to differ materially from the anticipated results or other
expectations expressed in the Company's forward-looking statements concerning
year 2000 issues, which involve certain risks and uncertainties. These factors
include (i) the unanticipated material impact of a system fault of the Company
relating to year 2000, (ii) the failure to successfully remediate, in spite of
testing, material systems of the Company, (iii) the time it may take to
successfully remediate a failure once it occurs, as well as the resulting costs
and loss of revenues, and (iv) the failure of third parties to properly
remediate material year 2000 problems.
Since inception of the project, the Company has expensed approximately $33.2
million through March 31, 2000, in connection with incremental cost of the year
2000 project and estimates an additional $0.8 million of expense during the
remainder of 2000.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is subject to various market risk exposures including interest rate
risk and foreign exchange rate risk. With respect to the Company's exposure to
market risk, see the discussion in Part II, Item 7A of Form 10-K for the fiscal
year ended December 31, 1999. During the first three months of 2000, there was
no substantive change to the Company's market risk or the management of such
risk.
25
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
Exhibit 15 Letter re: Unaudited interim financial information
Exhibit 27 Financial data schedules (for SEC use only)
(b) Reports on Form 8-K
None
26
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.
UnumProvident Corporation
(Registrant)
Date: May 12, 2000 /s/ J. Harold Chandler
-----------------------------------------------------
J. Harold Chandler
Chairman, President, and Chief Executive Officer
Date: May 12, 2000 /s/ Thomas R. Watjen
-----------------------------------------------------
Thomas R. Watjen
Executive Vice President, Finance and Risk Management
27