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, 2001.
Commission file number 1-11834
UnumProvident Corporation
(Exact name of registrant as specified in its charter)
Delaware 62-1598430
(State of other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
1 FOUNTAIN SQUARE 2211 CONGRESS STREET
CHATTANOOGA, TENNESSEE 37402 PORTLAND, MAINE 04122
(Address of principal executive offices)
423.755.1011
(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, 2001
----- -----------------------------
Common stock, $0.10 par value 241,379,755
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, 2001 and
December 31, 2000................................................................ 2
Condensed Consolidated Statements of Income for the three months ended
March 31, 2001 and 2000......................................................... 4
Condensed Consolidated Statements of Stockholders' Equity for the three months
ended March 31, 2001 and 2000................................................... 5
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2001 and 2000......................................................... 6
Notes to Condensed Consolidated Financial Statements.............................. 7
Independent Auditors' Review Report............................................... 15
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... 16
3. Quantitative and Qualitative Disclosure about Market Risk........................ 28
PART II
6. Exhibits and Reports on Form 8-K................................................. 29
Signatures....................................................................... 30
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, and reserves and related
assumptions. 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:
. 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 revenue and higher than expected amortization of deferred
policy acquisition costs.
. 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.
. Field force effectiveness in supporting new product offerings and providing
customer service may not meet expectations.
. Sales growth may be less than planned, which will impact revenue and
profitability.
. 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 revenue, and the Company could experience higher than expected
claims or claims with longer duration than expected.
. Legislative or regulatory changes may adversely affect the businesses in
which the Company is engaged.
. 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.
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, 2000.
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
2001 2000
(in millions of dollars)
--------------------------------------------
(Unaudited)
Assets
Investments
Fixed Maturity Securities
Available-for-Sale $23,405.4 $22,242.3
Held-to-Maturity - 346.6
Mortgage Loans 1,093.9 1,135.6
Real Estate 99.2 116.7
Policy Loans 2,412.3 2,426.7
Short-term Investments 267.6 279.4
Other Investments 59.1 56.8
--------- ---------
Total Investments 27,337.5 26,604.1
Cash and Bank Deposits 130.4 107.1
Accounts and Premiums Receivable 1,939.0 1,851.3
Reinsurance Receivable 5,824.8 6,046.5
Accrued Investment Income 565.8 532.2
Deferred Policy Acquisition Costs 2,479.9 2,424.0
Value of Business Acquired 574.5 591.6
Goodwill 688.8 683.3
Other Assets 1,462.3 1,456.2
Separate Account Assets 49.7 67.6
--------- ---------
Total Assets $41,052.7 $40,363.9
========= =========
See notes to condensed consolidated financial statements.
2
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
March 31 December 31
2001 2000
-------------------------------------------
(in millions of dollars)
(Unaudited)
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,824.7 $ 1,796.8
Reserves for Future Policy and Contract Benefits and
Unearned Premiums 26,397.2 25,966.7
Other Policyholders' Funds 2,552.1 2,645.1
Federal Income Tax 534.2 499.2
Short-term Debt 200.0 402.2
Long-term Debt 1,861.0 1,615.5
Other Liabilities 1,519.8 1,495.3
Separate Account Liabilities 49.7 67.6
--------- ---------
Total Liabilities 34,938.7 34,488.4
--------- ---------
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: 241,556,050 and 241,310,917 shares 24.2 24.1
Additional Paid-in Capital 1,049.7 1,040.2
Accumulated Other Comprehensive Income 227.4 140.7
Retained Earnings 4,526.2 4,379.7
Treasury Stock at Cost: 176,295 shares (9.2) (9.2)
Deferred Compensation (4.3) -
--------- ---------
Total Stockholders' Equity 5,814.0 5,575.5
--------- ---------
Total Liabilities and Stockholders' Equity $41,052.7 $40,363.9
========= =========
See notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Three Months Ended March 31
2001 2000
-------------------------------------------
(in millions of dollars, except share data)
Revenue
Premium Income $1,746.9 $1,780.8
Net Investment Income 494.5 552.1
Net Realized Investment Losses (1.2) (0.2)
Other Income 100.7 61.4
-------- --------
Total Revenue 2,340.9 2,394.1
-------- --------
Benefits and Expenses
Policyholder Benefits 1,518.1 1,579.5
Commissions 198.9 195.6
Interest and Debt Expense 42.8 43.9
Deferral of Policy Acquisition Costs (179.0) (147.2)
Amortization of Deferred Policy Acquisition Costs 115.1 143.6
Amortization of Value of Business Acquired and Goodwill 17.7 16.7
Other Operating Expenses 401.8 355.6
-------- --------
Total Benefits and Expenses 2,115.4 2,187.7
-------- --------
Income Before Federal Income Taxes 225.5 206.4
Federal Income Taxes 43.5 71.9
-------- --------
Net Income $ 182.0 $ 134.5
======== ========
Net Income Per Common Share
Basic $ 0.75 $ 0.56
Assuming Dilution $ 0.75 $ 0.56
Dividends Paid Per Common Share $ 0.1475 $ 0.1475
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, 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
===== ======== ====== ======== ===== ====== ========
Balance at December 31, 2000 $24.1 $1,040.2 $140.7 $4,379.7 $(9.2) $ - $5,575.5
Comprehensive Income, Net of Tax
Net Income 182.0 182.0
Change in Net Unrealized Gain
on Securities 79.4 79.4
Change in Net Gain on Cash
Flow Hedges 11.1 11.1
Change in Foreign Currency
Translation Adjustment (3.8) (3.8)
--------
Total Comprehensive Income 268.7
--------
Common Stock Activity 0.1 9.5 (4.3) 5.3
Dividends to Stockholders (35.5) (35.5)
----- -------- ------ -------- ----- ------ --------
Balance at March 31, 2001 $24.2 $1,049.7 $227.4 $4,526.2 $(9.2) $ (4.3) $5,814.0
===== ======== ====== ======== ===== ======== ========
See notes to condensed consolidated financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Three Months Ended March 31
2001 2000
------------------------------
(in millions of dollars)
Net Cash Provided by Operating Activities $ 345.1 $ 254.7
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments 713.4 619.7
Proceeds from Maturities of Investments 251.8 290.6
Purchase of Investments (1,279.5) (1,352.0)
Net Sales of Short-term Investments 10.7 147.5
Acquisition of Business (10.2) (88.0)
Disposition of Business - (78.2)
Other (12.9) (25.1)
--------- ---------
Net Cash Used by Investing Activities (326.7) (485.5)
--------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts 2.6 12.7
Maturities and Benefit Payments from Policyholder Accounts (9.0) (45.5)
Net Short-term Debt and Commercial Paper Borrowings (Repayments) (531.7) 136.5
Issuance of Long-term Debt 575.0 -
Dividends Paid to Stockholders (35.5) (35.7)
Other 5.3 4.5
--------- ---------
Net Cash Provided by Financing Activities 6.7 72.5
--------- ---------
Effect of Foreign Exchange Rate on Cash (1.8) -
--------- ---------
Net Increase (Decrease) in Cash and Bank Deposits 23.3 (158.3)
Cash and Bank Deposits at Beginning of Period 107.1 292.4
--------- ---------
Cash and Bank Deposits at End of Period $ 130.4 $ 134.1
========= =========
See notes to condensed consolidated financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 1 - Basis of Presentation
The accompanying condensed consolidated financial statements of UnumProvident
Corporation and subsidiaries (the Company) have been prepared in accordance with
accounting principles generally accepted in the United States 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 accounting principles generally accepted in the United
States 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, 2001, are not necessarily indicative of the results that
may be expected for the year ended December 31, 2001. Certain prior period
amounts in the condensed consolidated financial statements have been
reclassified to conform with the current period presentation. 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, 2000.
Note 2 - Change in Accounting Principle
Effective January 1, 2001, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative
Instruments and Hedging Activities, and Statement of Financial Accounting
Standards No. 138 (SFAS 138), Accounting for Certain Derivative Instruments and
Certain Hedging Activities - an Amendment of FASB Statement No. 133. SFAS 133
and SFAS 138 establish accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging activities.
They require that an entity recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. SFAS 133 and SFAS 138 specify a special method of
accounting for certain hedging transactions, prescribe the type of items and
transactions that may be hedged, and provide the criteria which must be met in
order to qualify for hedge accounting.
At the adoption date of SFAS 133, the Company designated anew all of its hedging
relationships and formally documented these relationships. The Company
reclassified all of its held-to-maturity fixed maturity securities to available-
for-sale fixed maturity securities. These held-to-maturity securities had an
amortized cost of $346.6 million and a fair value of $369.8 million on the date
of reclassification. The resulting before-tax unrealized gain of $23.2 million
was reported as a component of accumulated other comprehensive income in
stockholders' equity as a cumulative effect transition adjustment. No
transition adjustment was reported in net income as a result of the adoption of
SFAS 133 and 138.
The accounting for changes in the fair value (i.e., gains or losses) of a
derivative depends on whether it has been designated and qualifies as part of a
hedging relationship, and further, on the type of hedging relationship. For
those derivatives that are designated and qualify as hedging instruments, the
derivative is designated, based upon the exposure being hedged, as one of the
following:
Fair value hedge. Changes in the fair value of the derivative as well as
the offsetting change in fair value on the hedged item attributable to the
risk being hedged are recognized in current operating earnings during the
period of change in fair value.
Cash flow hedge. To the extent it is effective, changes in the fair value
of the derivative are reported in other comprehensive income and
reclassified into earnings in the same period or periods during which the
hedged item affects earnings. The ineffective portion of the hedge, if any,
is recognized in current operating earnings during the period of change in
fair value.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 2 - Change in Accounting Principle - Continued
Foreign currency exposure hedge. To the extent it is effective, changes in
the fair value of the derivative are reported in other comprehensive income
as part of the foreign currency translation adjustment and reclassified
into earnings in the same period or periods during which remeasurement of
the hedged foreign currency asset affects earnings. The ineffective portion
of the hedge, if any, is recognized in current operating earnings during
the period of change in fair value.
For a derivative not designated as a hedging instrument, the change in fair
value is recognized in current operating earnings during the period of change.
The Company's derivatives all qualify as hedges and have been designated as cash
flow hedges. The cash flow hedging programs are described as follows.
The Company has executed a series of cash flow hedges in the group disability,
individual disability, and group single premium annuities portfolios using
forward starting interest rate swaps. The purpose of these hedges is to lock in
the reinvestment rates on future anticipated cash flows through the year 2003
and protect the Company from the potential adverse impact of declining interest
rates on the associated policy reserves. The Company plans on terminating these
forward interest rate swaps at the time the projected cash flows are used to
purchase fixed income securities.
The Company has entered into an interest rate swap whereby it receives a fixed
rate and pays a variable rate of interest. The purpose of this swap is to hedge
the variable cash flows associated with a floating rate security owned by the
Company. The variable rate the Company pays on the swap is offset by the amount
the Company receives on the variable rate security.
The Company has entered into several foreign currency interest rate swaps
whereby it receives a fixed rate of interest denominated in U.S. dollars
(functional currency) and pays a fixed rate of interest denominated in a foreign
currency. The purpose of these derivatives is to eliminate the variability of
functional currency cash flows associated with certain foreign currency
denominated securities owned by the Company. The fixed rate the Company pays on
the swap is offset by the fixed rate it receives on the foreign currency
denominated security.
The Company also used forward starting swaps to hedge the interest rate on its
anticipated issuance of debt. This hedge was initiated in the first quarter of
2001 and was terminated in March 2001 when the debt was issued as disclosed in
Note 7. The deferred gain will be amortized into earnings as a component of
interest expense over the expected remaining life of the hedged debt instrument.
During the three months ended March 31, 2001, the Company recognized a net gain
of $19.3 million upon the termination of cash flow hedges and reported the gain
in other comprehensive income. The Company amortized $1.6 million of the net
deferred gain into earnings during the three months ended March 31, 2001. The
estimated amount of net deferred gain that will be amortized into operating
earnings during the next 12 months is $5.9 million. The notional amount
outstanding under the hedge programs was $1,023.1 million at March 31, 2001, and
the fair value of the derivatives was $130.0 million. The fair value of the
Company's open derivatives, all of which hedge available-for-sale securities,
are reported in the condensed consolidated statements of financial condition as
a component of fixed maturity securities.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 2 - Change in Accounting Principle - Continued
During the three months period ended March 31, 2001, there was no material
ineffectiveness related to the Company's derivative holdings, and there was no
component of the derivative instruments' gain or loss excluded from the
assessment of hedge effectiveness. Additionally, the Company did not
discontinue any hedges due to the probability of the original forecasted
transactions not occurring. In the event that the forecasted cash flows are no
longer likely to occur, the Company will terminate the derivative, and all
related amounts accumulated in other comprehensive income will be reclassified
into operating earnings.
Note 3 - Stockholders' Equity and Earnings Per Common Share
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
2001 2000
(in millions, except share data)
-----------------------------------
Numerator
Net Income $ 182.0 $ 134.5
========== ==========
Denominator (000s)
Weighted Average Common Shares - Basic 241,410.9 240,594.0
Dilutive Securities 1,790.3 791.4
---------- ----------
Weighted Average Common Shares -
Assuming Dilution 243,201.2 241,385.4
========== ==========
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 12.0 million and 12.3 million options for the three
month periods ended March 31, 2001 and 2000, respectively, were not considered
dilutive due to the options being out-of-the-money.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 4 - Comprehensive Income
The components of accumulated other comprehensive income, net of deferred tax,
are as follows:
March 31 December 31
2001 2000
(in millions of dollars)
----------------------------------------------
Net Unrealized Gain on Securities $206.4 $212.8
Net Gain on Cash Flow Hedges 96.9 -
Foreign Currency Translation Adjustment (75.9) (72.1)
------ ------
Accumulated Other Comprehensive Income $227.4 $140.7
====== ======
In accordance with the adoption of SFAS 133, the Company reclassified within
accumulated other comprehensive income the beginning of the year balance of
$85.8 million of after-tax unrealized gains on derivatives from the net
unrealized gain on securities to the net gain on cash flow hedges.
The components of comprehensive income and the related deferred tax are as
follows:
Three Months Ended March 31
2001 2000
(in millions of dollars)
---------------------------------------------
Net Income $182.0 $134.5
------ ------
Change in Net Unrealized Gain on Securities:
Change Before Reclassification Adjustment 99.5 97.5
Reclassification Adjustment for Net Realized Investment
Losses Included in Net Income 1.2 0.2
Cumulative Effect Transition Adjustment for the Adoption of
SFAS 133 and SFAS 138 - Note 2 23.2 -
Change in Net Gain on Cash Flow Hedges 17.1 -
Change in Foreign Currency Translation Adjustment (13.3) (5.7)
------ ------
127.7 92.0
Change in Deferred Tax 41.0 34.8
------ ------
Other Comprehensive Income 86.7 57.2
------ ------
Comprehensive Income $268.7 $191.7
====== ======
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 5 - Segment Information
Selected data by segment is as follows:
Three Months Ended March 31
2001 2000
(in millions of dollars)
---------------------------------------------
Premium Income
Employee Benefits $1,053.0 $1,005.9
Individual 461.7 447.4
Voluntary Benefits 195.5 181.8
Other 36.7 145.7
-------- --------
1,746.9 1,780.8
Net Investment Income and Other Income
Employee Benefits 226.1 206.5
Individual 249.5 221.5
Voluntary Benefits 35.9 29.4
Other 71.9 145.1
Corporate 11.8 11.0
-------- --------
595.2 613.5
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Employee Benefits 1,279.1 1,212.4
Individual 711.2 668.9
Voluntary Benefits 231.4 211.2
Other 108.6 290.8
Corporate 11.8 11.0
-------- --------
2,342.1 2,394.3
Benefits and Expenses
Employee Benefits 1,143.3 1,104.3
Individual 626.3 594.1
Voluntary Benefits 191.0 171.6
Other 98.0 267.3
Corporate 56.8 50.4
-------- --------
2,115.4 2,187.7
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Employee Benefits 135.8 108.1
Individual 84.9 74.8
Voluntary Benefits 40.4 39.6
Other 10.6 23.5
Corporate (45.0) (39.4)
-------- --------
226.7 206.6
Net Realized Investment Losses (1.2) (0.2)
-------- --------
Income Before Federal Income Taxes 225.5 206.4
Federal Income Taxes 43.5 71.9
-------- --------
Net Income $ 182.0 $ 134.5
======== ========
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 6 - Commitments and Contingent Liabilities
In 1997 two alleged class action lawsuits were filed in Superior Court in
Worcester, Massachusetts (Superior Court) against UnumProvident and several of
its subsidiaries, The Paul Revere Corporation, The Paul Revere Life Insurance
Company, The Paul Revere Variable Annuity Insurance Company, and The Paul Revere
Protective Life Insurance Company. One purported to represent independent
brokers who sold certain Paul Revere individual disability income policies with
benefit riders. Motions filed by UnumProvident and affiliates to dismiss most
of the counts in the complaint, which alleged various breach of contract and
statutory claims, were denied. A hearing to determine class certification was
heard on December 20, 1999 in Superior Court and the class was certified.
UnumProvident and affiliates appealed the class certification for the
independent brokers, but the appeal was denied. Summary judgment motions were
heard on November 10, 2000, and all motions from plaintiffs and defendants were
denied. A trial date for the brokers class action was set for March 26, 2001.
UnumProvident and affiliates filed a conditional counterclaim which requested a
substantial return of commissions should the Superior Court have agreed with the
plaintiffs' interpretation of the contracts.
The trial for the independent broker class action commenced on March 26, 2001,
at which time the Company dropped its conditional counterclaim. On April 13,
2001, the jury returned a complete defense verdict. The plaintiffs have not
given an indication as to whether or not they will appeal the jury verdict. The
plaintiffs are also contending that notwithstanding the jury verdict, the judge
is still permitted to rule separately on the claim that UnumProvident and its
affiliates violated the Massachusetts Consumer Protection Act.
The career agent class action purports 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. At the hearing to determine class
certification heard on December 20, 1999 in Superior Court, class certification
was denied for the career agents. Summary judgment motions were heard on
November 10, 2000 and all motions from plaintiffs and defendants were denied
pertaining to the two class representatives whose cases survived. The career
agent plaintiffs have re-filed, but not served, their complaint seeking class
action status by limiting the issues to those in the certified broker class
action.
In addition, the same plaintiffs' attorney who had initially filed the class
action lawsuits has filed 50 individual lawsuits on behalf of current and former
Paul Revere sales managers and career class action representatives alleging
various breach of contract claims. UnumProvident and affiliates filed a motion
in federal court to compel arbitration for 17 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 denied 15 of those motions and granted two. UnumProvident
and affiliates appealed the denial of the 15 motions before the First Circuit
Court of Appeals, but the District Court decision was affirmed. The two cases
were set for arbitration in 2001 - the first being scheduled for June 26, 2001.
However, plaintiffs appealed these two cases to the First Circuit Court of
Appeals, but the District Court decision was affirmed on May 3, 2001. Eight of
the other cases are tentatively set to begin trials in 2002. UnumProvident and
affiliates believe that they have strong defenses and plan to vigorously defend
their position in these cases. Although the 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.
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 6 - Commitments and Contingent Liabilities - Continued
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, and that action was voluntarily dismissed
by the plaintiff on June 12, 2000. 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
Corporation (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
Companies, Inc. (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. On
January 8, 2001, the district court affirmed a Recommended Decision by the
Magistrate Judge, entered November 8, 2000, that granted in part, and denied in
part, the motion. The district court granted the motion to dismiss plaintiff's
claims (i) under Section 10(b) of the Securities Exchange Act of 1934, (ii)
under Section 14(a) of the Securities Exchange Act of 1934 on behalf of the
former shareholders of Unum, and (iii) under Section 12(a) of the Securities Act
of 1933 on behalf of purchasers of the Company stock after the merger. The
district court also dismissed plaintiff's claims relating to disclosures
regarding the costs associated with Unum's exit from its reinsurance business,
but otherwise denied defendants' motion to dismiss plaintiff's claims under
Sections 11 and 12(a) (2) of the Securities Act of 1933 and the claim under
Section 14(a) of the Securities Exchange Act of 1934.
On February 16, 2001, each defendant answered the complaint by denying generally
the material allegations of the complaint. On January 30, 2001, the district
court issued an Amended Scheduling Order that, among other things, ordered all
discovery to be complete by July 10, 2001, and directed that the case be
prepared for trial in November 2001. Pre-trial discovery is now underway. The
Company disputes the claims alleged in the complaint and plans to vigorously
contest them.
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. See the reinsurance pools and management section
contained in the segment results discussion in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contained herein in
Item 2.
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.
13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
March 31, 2001
Note 7 - Other Events
In March 2001, the Company completed a long-term debt offering, issuing $575.0
million of 7.625% senior notes due March 1, 2011. The proceeds were used to
refinance short-term debt on a long-term basis and to fund other corporate
needs.
During the first quarter of 2001, the Company recognized a tax benefit of
approximately $35.2 million ($0.14 per common share assuming dilution) related
to its investment in the foreign reinsurance operations.
The National Association of Insurance Commissioners and the Company's insurance
subsidiaries' states of domicile approved a codification of statutory accounting
practices effective January 1, 2001, which serves as a comprehensive and
standardized guide to statutory accounting principles. The codification
changed, to some extent, the accounting practices that the Company's insurance
subsidiaries used to prepare their statutory financial statements. The
cumulative effect of the changes in accounting principles adopted to conform to
the codification of statutory accounting principles for the Company's insurance
subsidiaries was approximately $96.4 million and was recognized as an increase
to statutory surplus as of January 1, 2001.
14
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, 2001,
and the related condensed consolidated statements of income, stockholders'
equity, and cash flows for the three month periods ended March 31, 2001 and
2000. These financial statements are the responsibility of the Company's
management.
We conducted our reviews in accordance with auditing standards generally
accepted in the United States. 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
auditing standards generally accepted in the United States, 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, 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 accounting principles generally
accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated statement of financial condition
of UnumProvident Corporation as of December 31, 2000, 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 12,
2001, except for Notes 13 and 15, for which the date is February 27, 2001, 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, 2000, 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 7, 2001
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
UnumProvident Corporation (the Company) is the parent holding company for a
group of insurance and non-insurance companies that collectively operate
throughout North America and in the United Kingdom, Japan, and elsewhere around
the world. The Company's principal operating subsidiaries are Unum Life
Insurance Company of America, Provident Life and Accident Insurance Company, The
Paul Revere Life Insurance Company, and Colonial Life & Accident Insurance
Company. The Company, through its subsidiaries, is the largest provider of
group and individual disability insurance in North America and the United
Kingdom. It also provides a complementary portfolio of other insurance
products, including long-term care insurance, life insurance, employer- and
employee-paid group benefits, and related services.
The Company is organized around its customers, with reporting segments that
reflect its major market segments: Employee Benefits, Individual, and Voluntary
Benefits. The Other segment includes products that the Company no longer
actively markets. The Corporate segment includes investment income 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.
This discussion of consolidated operating results and operating results by
segment excludes net realized investment gains and losses from revenue and
income 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.
The trends in new annualized sales in the Employee Benefits, Individual, and
Voluntary Benefits segments 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.
The following should be read in conjunction with the condensed consolidated
financial statements and notes thereto in Part I, Item 1 contained herein and
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, 2000.
16
Consolidated Operating Results
(in millions of dollars)
Three Months Ended
-----------------------------
2001 % Change 2000
-------- --------
Revenue
Premium Income $1,746.9 (1.9)% $1,780.8
Net Investment Income 494.5 (10.4) 552.1
Other Income 100.7 64.0 61.4
-------- --------
Total Revenue 2,342.1 (2.2) 2,394.3
-------- --------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 1,518.1 (3.9) 1,579.5
Commissions 198.9 1.7 195.6
Interest and Debt Expense 42.8 (2.5) 43.9
Deferral of Policy Acquisition Costs (179.0) 21.6 (147.2)
Amortization of Deferred Policy
Acquisition Costs 115.1 (19.8) 143.6
Amortization of Value of Business
Acquired and Goodwill 17.7 6.0 16.7
Operating Expenses 401.8 13.0 355.6
-------- -------
Total Benefits and Expenses 2,115.4 (3.3) 2,187.7
-------- -------
Income Before Federal Income Taxes
and Net Realized Investment Loss 226.7 9.7 206.6
Federal Income Taxes 43.9 (39.0) 72.0
-------- -------
Income Before Net Realized Investment Loss 182.8 35.8 134.6
Net Realized Investment Loss (0.8) N.M. (0.1)
-------- -------
Net Income $ 182.0 35.3 $ 134.5
======== =======
N.M. = not a meaningful percentage
During the first quarter of 2001, the Company recognized a tax benefit of
approximately $35.2 million related to its investment in the foreign reinsurance
operations, resulting in a 2001 tax rate less than the U.S. federal statutory
rate of 35 percent.
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.
17
Employee Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
------------------------------
2001 % Change 2000
-------- ---------
Revenue
Premium Income
Group Long-term Disability $ 526.5 1.6 % $ 518.0
Group Short-term Disability 136.9 10.0 124.4
Group Life 319.0 5.3 302.9
Accidental Death & Dismemberment 52.0 10.9 46.9
Group Long-term Care 18.6 35.8 13.7
-------- ---------
Total Premium Income 1,053.0 4.7 1,005.9
Net Investment Income 184.2 8.1 170.4
Other Income 41.9 16.1 36.1
-------- ---------
Total Revenue 1,279.1 5.5 1,212.4
-------- ---------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 853.7 2.7 831.4
Commissions 84.8 (4.4) 88.7
Deferral of Policy Acquisition Costs (78.0) 21.1 (64.4)
Amortization of Deferred Policy
Acquisition Costs 51.2 6.0 48.3
Amortization of Value of Business Acquired 0.5 (16.7) 0.6
Operating Expenses 231.1 15.7 199.7
-------- --------
Total Benefits and Expenses 1,143.3 3.5 1,104.3
-------- --------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 135.8 25.6 $ 108.1
======== ========
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.
Employee Benefits new annualized sales, on a submitted date basis, increased
16.5 percent to $156.1 million in the first quarter of 2001 from $134.0 million
in the first quarter of 2000. On an effective date basis, sales increased 40.3
percent to $477.3 million in the first quarter of 2001 from $340.3 million in
the first quarter of 2000. Sales that combine long-term disability, short-term
disability, and group life products also increased from the prior year first
quarter, showing continued strong integrated sales and collaboration in the
field. During the first quarter of 2001, 27 percent of all new sales were with
long-term disability, short-term disability, and group life combined coverage,
compared to 25 percent for the first quarter of 2000 and 32 percent and 26
percent for the twelve months of 2000 and 1999.
Sales related to employee benefits can fluctuate significantly due to large case
size and timing of sales submissions. The Company implemented a number of
initiatives during 2000 to help maintain the sales momentum achieved during the
last half of 2000 and continuing into the first quarter of 2001, 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
national practice groups that focus on large employers, executive benefits, and
voluntary benefits. These national practice groups partner with the Company's
sales force and representatives from claims, customer service, and underwriting
to present coverage solutions to potential customers and to manage existing
customer accounts. The Company expects that these actions will continue to
favorably impact sales growth, but management intends to maintain pricing
discipline to balance sales growth and profitability, which may slow the rate of
long-term sales growth.
18
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 2001 for group disability,
group life, and accidental death and dismemberment products compared unfavorably
to the persistency expected at the time the business was written, resulting in
additional amortization of $20.3 million during the first quarter of 2001
compared to $18.6 million during the first quarter of 2000. It is expected that
persistency for the foreseeable future will continue to be lower than historical
levels for group disability as well as group life. The Company's renewal
program has generally been successful at retaining business that is relatively
more profitable than business that terminated. It is expected that the
additional premium and related profits associated with renewal activity will
emerge throughout 2001. The Company intends to maintain a disciplined approach
in the re-pricing of renewal business, while balancing the need to maximize
persistency and retain producer relationships. This approach may lead to lower
profit margins on affected cases than originally planned.
Revenue from the managed disability line of business, which includes GENEX
Services, Inc. and Options and Choices, Inc., totaled $35.7 million in the first
quarter of 2001 compared to $30.1 million in the first quarter of 2000.
Group Disability
Group disability revenue was $815.5 million in the first quarter of 2001
compared to $790.0 million in the first quarter of 2000. First quarter new
annualized sales for group long-term disability on a submitted date basis were
$69.8 million in 2001 and $63.5 million in 2000. New annualized sales for group
short-term disability on a submitted basis were $28.0 million in the first
quarter of 2001 as compared to $22.3 million in the first quarter of 2000. On
an effective date basis, new annualized sales for long-term disability and
short-term disability were $162.6 million and $88.0 million in the first quarter
of 2001 and $134.8 million and $61.4 million in the first quarter of 2000. A
critical part of the Company's strategy for group disability 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 higher terminations and slower sales have decreased the rate of
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.
Group disability reported income of $86.6 million for the first quarter of 2001
compared to $56.3 million for the first quarter of 2000. Positive impacts on
income were a $25.5 million revenue increase and an improvement in the benefit
ratio. The commission ratio also improved relative to the first quarter of
2000. Negatively impacting income was an increase in the operating expense
ratio in the first quarter of 2001 compared to the first quarter of 2000 and the
full year 2000. Additionally, the increase in the amortization of deferred
policy acquisition costs due to adverse changes in persistency had a negative
impact on 2001 income. The first quarter 2001 results included $12.0 million of
additional amortization necessitated by the higher level of group long-term and
short-term disability terminations experienced during the first quarter of 2001
relative to that which was expected. The additional amortization during the
first quarter of 2000 was $13.8 million. For both 2001 and 2000, the disability
business retained is relatively more profitable than the business that
terminated.
The fundamentals underlying risk results in the group disability line continue
to exhibit improvements, as demonstrated by the benefit ratio. Submitted claim
incidence for long-term disability has moved upward to a higher level than
experienced during recent quarters, but the paid claim incidence for long-term
disability is lower than the fourth quarter of 2000 due to claim management
effectiveness and is up only slightly from the first quarter of 2000. Claim
recovery rates for long-term disability continue to show an improving trend. In
short-term disability, the average weekly indemnity and submitted claim
incidence have increased over the first quarter of 2000. The average claim
duration for short-term disability is below the average for 2000, with a
marginal increase over the first quarter of 2000.
19
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 be worse than expected. Management monitors 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. Given the competitive market conditions for
the Company's disability products, it is uncertain whether pricing actions can
entirely mitigate the effect.
The Company, similar to all financial institutions, has some exposure if a
severe and prolonged recession occurs, but management believes that the Company
is well positioned if a weaker economy were to occur. Many of the Company's
products can be re-priced, which would allow the Company to reflect in its
pricing any fundamental change which might occur in the risk associated with a
particular industry or company within an industry. The Company has a well
diversified book of insurance exposure, with no unusual concentrations of risk
in any one industry. Because of improvements made in the claims organization in
recent years, the Company believes it can respond to increased levels of
submitted claims which might result from a slowing economy.
Group Life, Accidental Death and Dismemberment, and Long-term Care
Group life, accidental death and dismemberment, and long-term care reported
income of $45.9 million in the first quarter of 2001 compared to $50.0 million
in the first quarter of 2000. New annualized sales on a submitted date basis
increased to $58.3 million in the first quarter of 2001 as compared to the $48.2
million reported in the first quarter of 2000. On an effective date basis, new
annualized sales were $226.7 million in the first quarter of 2001 compared to
$144.1 million for the same period last year.
Group life, accidental death and dismemberment, and long-term care reported a
9.1 percent increase in revenue for the first quarter of 2001 compared to the
same period last year due to increases in premium income and net investment
income. Offsetting the revenue increase was an increase in the benefit ratio
when compared to the first quarter of 2000 and the fourth quarter of 2000.
Group life reported an increase in the benefit ratio in 2001 compared to the
prior year first quarter due to an increase in paid claim incidence as well as
the average paid claim size. Waiver incidence improved over the fourth quarter
of 2000, but is still high relative to the first quarter of 2000. The 2001
benefit ratio for accidental death and dismemberment is higher than the first
quarter of 2000, primarily as a result of an increase in paid incidence. Group
long-term care reported a decrease in the benefit ratio for the first quarter of
2001 compared to the first quarter of 2000. The incidence rates for both
submitted and paid claims decreased over the prior year first quarter, but are
above the fourth quarter 2000 rates. The long-term care claim recovery rate is
below the average rate for 2000.
The amortization of deferred policy acquisition costs for the first quarter of
2001 includes $8.3 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 2001 than expected at the time the
policies were written. The unfavorable variance of actual to expected
terminations occurred primarily in the group life product line. The additional
amortization during the first quarter of 2000 was $4.8 million.
During 2000, the Company reinsured on a 100 percent indemnity coinsurance basis
substantially all of the individual life insurance and corporate-owned life
insurance policies written by the Company's insurance subsidiaries, as well as a
small block of individually underwritten group life insurance. The reinsurance
agreements were effective as of July 1, 2000. This reinsurance transaction
reduced first quarter 2001 group life and accidental death and dismemberment
premium income and benefits approximately $13.2 million and $11.0 million,
respectively.
20
Individual Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
------------------------------
2001 % Change 2000
-------- ---------
Revenue
Premium Income
Individual Disability $422.0 0.9% $418.2
Individual Long-term Care 39.7 36.0 29.2
------ ------
Total Premium Income 461.7 3.2 447.4
Net Investment Income 223.9 8.3 206.7
Other Income 25.6 73.0 14.8
------ ------
Total Revenue 711.2 6.3 668.9
------ ------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 469.3 5.6 444.4
Commissions 65.9 0.5 65.6
Deferral of Policy Acquisition Costs (55.6) 9.4 (50.8)
Amortization of Deferred Policy
Acquisition Costs 25.4 12.4 22.6
Amortization of Value of Business Acquired 11.3 20.2 9.4
Operating Expenses 110.0 6.9 102.9
------ ------
Total Benefits and Expenses 626.3 5.4 594.1
------ ------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 84.9 13.5 $ 74.8
====== ======
The Individual segment includes results from the individual disability and
individual long-term care lines of business.
Individual Disability
New annualized sales in the individual disability line of business were $28.7
million in the first quarter of 2001 compared to $26.5 million in the first
quarter of 2000. The Company has developed a new individual disability product
portfolio which was released for sale in approved states early in the fourth
quarter of 2000. This product line consolidates the current offerings of the
Company's insurance subsidiaries into one new simplified product portfolio. The
new portfolio utilizes a modular approach offering customers a range of product
options and features. This portfolio was designed to combine the best features
from prior Company offerings and includes 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 line will grow on a year-over-year basis, contingent on further state
approvals of the new product portfolio, as the portfolio transition produces
increasing levels of new sales of individual disability products and as a result
of an increased focus on integrated disability sales in group and individual, as
well as other sales initiatives discussed under "Employee Benefits Segment
Operating Results." The persistency of existing individual disability income
business continued to be favorable during 2000 and the first quarter of 2001.
Revenue was $664.2 million for the first quarter of 2001 compared to $635.6
million in the same period of 2000, with increases reported in all components of
revenue. Income in the individual disability line of business was $84.0
million in the first quarter of 2001, an increase of 16.0 percent over the prior
year first quarter. This line reported an increase in the benefit ratio for the
first quarter of 2001 compared to the first quarter of 2000, but the ratio was
lower than the ratios for the fourth quarter of 2000 and the full year 2000.
The interest adjusted loss ratio was 61.8 percent and 63.2 percent for the first
quarter of 2001 and 2000, respectively. Submitted claim incidence increased
21
from the fourth quarter of 2000, as seasonally expected, but is flat with the
first two quarters of 2000. Paid incidence is also higher than the fourth
quarter of 2000, but has improved relative to the first quarter of 2000. The
claim recovery rate improved for the first quarter of 2001 relative to the same
period last year.
Individual disability benefited from a slightly improved commission ratio for
first quarter 2001 as compared to first quarter 2000, but the operating expense
ratio increased.
Individual Long-term Care
The individual long-term care line of business reported increased premium income
for the first quarter of 2001 compared to the same period of 2000, primarily due
to new sales growth for individual long-term care. New annualized sales for
long-term care were $11.8 million for the first quarter of 2001. For the
comparable period of 2000, new sales were $10.8 million. The Company expects
the strong sales momentum in individual long-term care to continue.
Income in the individual long-term care lines of business was $0.9 million for
the first quarter of 2001 compared to $2.4 million for the same period of 2000,
primarily due to an increase in the benefit ratio. The increase in the benefit
ratio was driven by an increase in the new claim rate, offset somewhat by an
improvement in the claim recovery rate. The operating expense ratio also
increased relative to the 2000 first quarter ratio, but the commission ratio
improved.
22
Voluntary Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
------------------------------
2001 % Change 2000
-------- ---------
Revenue
Premium Income $195.5 7.5 % $181.8
Net Investment Income 31.2 11.8 27.9
Other Income 4.7 213.3 1.5
------ ------
Total Revenue 231.4 9.6 211.2
------ ------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 118.4 10.0 107.6
Commissions 44.9 46.3 30.7
Deferral of Policy Acquisition Costs (45.4) 51.3 (30.0)
Amortization of Deferred Policy
Acquisition Costs 33.0 29.9 25.4
Amortization of Value of Business Acquired 0.6 (33.3) 0.9
Operating Expenses 39.5 6.8 37.0
------ ------
Total Benefits and Expenses 191.0 11.3 171.6
------ ------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 40.4 2.0 $ 39.6
====== ======
The Voluntary Benefits segment includes the results of products sold to
employees through payroll deduction at the workplace. These products include
life insurance and health products, primarily disability, accident and sickness,
and cancer.
Revenue in the Voluntary Benefits segment increased to $231.4 million in the
first quarter of 2001 from $211.2 million in the first quarter of 2000 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 2001 were
$66.0 million, an increase of 4.3 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."
Income for the first quarter of 2001 was $40.4 million compared to $39.6 million
in the first quarter of 2000. All of the product lines reported an increase in
premium income and net investment income. The life product line reported an
improvement in the benefit ratio, and the disability product line benefit ratio
was essentially flat with the first quarter of 2000 as well as the fourth
quarter of 2000. However, the overall benefit ratio for the segment was
slightly higher than the first quarter of 2000 and the fourth quarter of 2000,
primarily due to an increase in claims in the cancer product line.
23
Other Segment Operating Results
(in millions of dollars)
Three Months Ended March 31
------------------------------
2001 % Change 2000
-------- ---------
Revenue
Premium Income $ 36.7 (74.8)% $ 145.7
Net Investment Income 53.1 (61.9) 139.2
Other Income 18.8 218.6 5.9
------ -------
Total Revenue 108.6 (62.7) 290.8
------ -------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 76.7 (60.9) 196.1
Other Expenses 21.3 (70.1) 71.2
------ -------
Total Benefits and Expenses 98.0 (63.3) 267.3
------ -------
Income Before Federal Income Taxes and
Net Realized Investment Gains and Losses $ 10.6 (54.9) $ 23.5
====== ======
The Other operating segment includes results from products no longer actively
marketed, including individual life and corporate-owned life insurance,
reinsurance pools and management operations, group pension, health insurance,
and individual annuities. It is expected that revenue and income in this
segment will decline over time as these business lines wind down. 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.
Individual Life and Corporate-Owned Life
As previously discussed, during 2000 the Company reinsured substantially all of
the individual life and corporate-owned life insurance blocks of business
effective July 1, 2000. This reinsurance transaction resulted in a decrease in
revenue and income in the first quarter 2001 as compared to the first quarter of
2000. Total revenue and income for individual life and corporate-owned life
insurance was $10.7 million and $6.4 million, respectively, in the first quarter
of 2001 compared to $110.1 million in revenue and $14.0 million in income for
the same period of 2000.
Reinsurance Pools and Management
The Company's reinsurance 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. During
1999, the Company concluded that these operations were not solidly aligned with
the Company's strength in the disability insurance market and decided to exit
these operations through a combination of a sale, reinsurance, and/or placing
certain components in run-off. In 1999, the Company sold the reinsurance
management operations of its A&H and LTC reinsurance facilities and reinsured
the Company's risk participation in these facilities. The Company also decided
to discontinue its London accident reinsurance pool participation beginning in
year 2000. With respect to Lloyd's, the Company implemented a strategy which
limited participation in year 2000 underwriting risks, ceased participation in
Lloyd's underwriting risks after year 2000, and managed the run-off of its risk
participation in open years of account of Lloyd's reinsurance syndicates.
During the first quarter of 2001, the Company entered into an agreement with
Lloyd's to limit its liabilities pertaining to the Lloyd's syndicate
participations.
The reinsurance pools and management operations reported a loss of $1.0 million
in the first quarter of 2001 compared to income of $0.1 million for the
comparable period of 2000. Premium income was $25.8 million compared to $101.1
million in the first quarter of 2000.
24
Corporate Segment Operating Results
Revenue in the Corporate segment was $11.8 million in the first quarter of 2001
and $11.0 million in the first quarter of 2000. The Corporate segment reported a
loss of $45.0 million in the first quarter compared to a loss of $39.4 million
in the first quarter of 2000. Interest and debt expense was $42.8 million in the
first quarter of 2001 compared to $43.9 million for the first quarter of 2000.
The amortization of goodwill was $5.3 million in the first quarter of 2001 and
$5.2 million in the comparable period of 2000.
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.
Subsequent to the June 30, 1999 merger of Unum Corporation and Provident
Companies, Inc. and continuing through the first half 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 in
order to reduce vulnerability to interest rate risk in the future and increase
investment income. Excluding net investment income attributable to the
individual life and corporate-owned life insurance blocks of business ceded
effective as of July 1, 2000, net investment income for the first quarter of
2001 increased 4.2 percent over the same period of 2000 due to increased yields
and growth in the asset base.
The following table provides the distribution of invested assets for the periods
indicated. Policy loans are reported on a gross basis in the statements of
financial condition contained herein in Item 1 and in the table below. Policy
loans of $2.2 billion were ceded as of March 31, 2001 and December 31, 2000, and
the investment income thereon is no longer included in income.
March 31 December 31
2001 2000
----- -----
Investment-Grade Fixed Maturity Securities 78.3% 78.3%
Below-Investment-Grade Fixed Maturity Securities 7.3 6.6
Equity Securities 0.1 0.1
Mortgage Loans 4.0 4.3
Real Estate 0.4 0.4
Policy Loans 8.8 9.1
Other Invested Assets 1.1 1.2
----- -----
Total 100.0% 100.0%
===== =====
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately $3.5
billion on an amortized cost basis at March 31, 2001 and December 31, 2000. At
March 31, 2001, the mortgage-backed securities had an average life of 11.1 years
and effective duration of 9.1 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.
25
The Company's exposure to below-investment-grade fixed maturity securities at
March 31, 2001, was $1,988.5 million, representing 7.9 percent of invested
assets excluding ceded policy loans, 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 $1,760.8 million at December
31, 2000, representing 7.2 percent of invested assets excluding ceded policy
loans.
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.
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $1,093.9 million and $1,135.6 million
at March 31, 2001, and December 31, 2000, respectively. 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, 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. No new mortgage loans were added to the Company's investment
portfolio during the first quarter of 2001 or the year 2000 other than two new
purchase money mortgage loans for $12.3 million and $14.8 million, respectively,
associated with the sale of real estate.
At March 31, 2001, and December 31, 2000, impaired loans totaled $17.6 million
and $17.7 million, respectively. Included in the impaired loans at March 31,
2001 were $6.5 million of loans which had a related, specific investment
valuation allowance of $2.4 million and $11.1 million of loans which had no
related, specific allowance. Impaired mortgage loans are not expected to have a
material impact on the Company's liquidity, financial position, or results of
operations.
Restructured mortgage loans totaled $6.1 million and $8.5 million at March 31,
2001 and December 31, 2000, respectively, 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, 2001, and December 31, 2000.
Real estate was $99.2 million and $116.7 million at March 31, 2001, and December
31, 2000. 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 $8.4 million at March 31, 2001, and
$18.3 million at December 31, 2000.
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 an investment valuation
allowance for mortgage loans based on a review of individual loans and the
overall loan portfolio, considering the value of the underlying collateral.
Investment valuation allowances for real estate held for sale are established
based on a review of specific assets. If a decline in value of a mortgage loan
or real estate investment 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.
Management monitors the risk associated with these invested asset portfolios and
regularly reviews and adjusts the investment valuation allowance. As a result
of management's most recent review of the overall mortgage loan portfolio and
based on management's expectation that delinquencies and problem loans will
remain low, the valuation allowance on mortgage loans was reduced $5.0 million
during the first quarter of 2001. The real estate valuation allowance was
reduced $5.7 million during the first quarter of 2001 in conjunction with the
sale of the associated property. At March 31, 2001, the balance in the
valuation allowance for mortgage loans and real estate was $7.9 million and
$19.9 million, respectively.
26
Other
The Company's exposure to non-current investments totaled $65.5 million at March
31, 2001, or 0.2 percent of invested assets. These non-current investments are
foreclosed real estate held for sale and fixed income securities that became
more than thirty days past due in principal and interest payments.
Historically, the Company has utilized 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. Positions under the Company's hedging programs for derivative
activity that were open during the first quarter of 2001 involved current and
forward interest rate swaps, as well as currency swaps which are used to hedge
the currency risk of certain foreign currency denominated fixed income
securities. 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 $345.1 million for the
three months ended March 31, 2001, as compared to $254.7 million in the
comparable period in 2000. The Company believes the cash flows from its
operations will be sufficient to meet its operating and financial cash flow
requirements.
At March 31, 2001, the Company had short-term and long-term debt totaling $200.0
million and $1,861.0 million, respectively. At March 31, 2001, approximately
$880.5 million was available for additional financing under the Company's
revolving credit facilities.
During the fourth quarter of 2000, the Company entered into $1.0 billion senior
revolving credit facilities with a group of banks. The facilities, which are
split into five-year revolver and 364-day portions, replaced a 364-day revolver
which expired in October 2000 and a five-year revolver which has been canceled.
The new facilities are available for general corporate purposes, including
support of the Company's $1.0 billion commercial paper program, and contain
certain covenants that, among other provisions, include a minimum tangible net
worth requirement, a maximum leverage ratio restriction, and a limitation on
debt relative to the consolidated statutory earnings of the Company's insurance
subsidiaries.
During the third quarter of 2000, the Company filed with the Securities and
Exchange Commission a shelf registration on Form S-3 covering the issuance of up
to $1.0 billion of securities in order to provide funding alternatives for its
maturing debt. The shelf registration became effective in September 2000. In
March 2001, the Company completed a long-term debt offering, issuing $575.0
million of 7.625% senior notes due March 1, 2011. Contingent upon market
conditions and corporate needs, remaining funding under the shelf registration
will be used to refinance short-term debt on a long-term basis and to fund other
corporate needs.
During the second quarter of 2000, the Company issued $200.0 million of variable
rate notes in a privately negotiated transaction. The notes were used to
refinance other short-term debt and had a weighted average interest rate of 7.52
percent during the first quarter of 2001. The notes matured in April 2001.
27
Ratings
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's), Fitch,
Inc. (Fitch), 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.
In March 2001, in connection with the Company's issuance of $575.0 million of
7.625% senior notes due March 1, 2011, S&P, Moody's, and Fitch affirmed the
senior debt and financial strength ratings at the existing levels.
The table below reflects the current debt ratings for the Company and the
financial strength ratings for the U.S. domiciled insurance company
subsidiaries.
S&P Moody's Fitch AM Best
--- ------- ----- -------
- -----------------------------------------------------------------------------------------------------------------------------
UnumProvident Corporation
- -----------------------------------------------------------------------------------------------------------------------------
Senior Debt A- (Strong) Baa1 (Medium Grade) A- (High Not Rated
Credit Quality)
- -----------------------------------------------------------------------------------------------------------------------------
Junior Subordinated Debt BBB (Good) Baa2 (Medium Grade) BBB+ (Good Not Rated
Credit Quality)
- -----------------------------------------------------------------------------------------------------------------------------
Commercial Paper A-2 (Good) Prime-2 (Strong F2 (Good Not Rated
Ability) Credit Quality)
- -----------------------------------------------------------------------------------------------------------------------------
U.S. Insurance Subsidiaries
- -----------------------------------------------------------------------------------------------------------------------------
Provident Life & Accident AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Provident Life & Casualty Not Rated Not Rated Not Rated A+ (Superior)
- -----------------------------------------------------------------------------------------------------------------------------
Unum Life of America AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
First Unum Life AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Colonial Life & Accident AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Life AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Variable AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Protective AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A+ (Superior)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
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, 2000. During the first three months of 2001, there was
no substantive change to the Company's market risk or the management of such
risk.
28
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
Exhibit 12.1 Statement Regarding Computation of Ratio of Earnings to Fixed
Charges
Exhibit 12.2 Statement Regarding Computation of Ratio of Earnings to
Combined Fixed Charges and Preferred Stock Dividends
Exhibit 15 Letter re: Unaudited interim financial information
(b) Reports on Form 8-K
Form 8-K filed on January 3, 2001, reporting changing role for Elaine D.
Rosen.
Form 8-K filed on February 12, 2001, reporting fourth quarter 2000
financial results.
Form 8-Ks filed on March 2 and March 15, 2001, related to the issuance of
7.625% senior notes.
29
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 11, 2001 /s/ J. Harold Chandler
----------------------------
J. Harold Chandler
Chairman, President, and Chief Executive
Officer
Date: May 11, 2001 /s/ Thomas R. Watjen
------------------------------------------
Thomas R. Watjen
Executive Vice President, Finance and Risk
Management
30