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 June 30, 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 (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
(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 June 30, 2001
----- ----------------------------
Common stock, $0.10 par value 241,982,062
TABLE OF CONTENTS
PART I
Cautionary Statement Regarding Forward-Looking Statements................................................ 1
1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial Condition at June 30, 2001 and December 31, 2000..... 2
Condensed Consolidated Statements of Income for the three and six months ended
June 30, 2001 and 2000............................................................................ 4
Condensed Consolidated Statements of Stockholders' Equity for the six months ended
June 30, 2001 and 2000............................................................................ 5
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 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.............................................. 29
PART II
6. Exhibits and Reports on Form 8-K....................................................................... 30
Signatures............................................................................................. 31
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.
. Actual experiences may deviate from that assumed in pricing and
underwriting.
. 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
June 30 December 31
2001 2000
(in millions of dollars)
-----------------------------------
(Unaudited)
Assets
Investments
Fixed Maturity Securities
Available-for-Sale $23,592.5 $22,242.3
Held-to-Maturity - 346.6
Equity Securities 15.6 24.5
Mortgage Loans 1,025.3 1,135.6
Real Estate 99.4 116.7
Policy Loans 2,452.3 2,426.7
Short-term Investments 201.5 279.4
Other Long-term Investments 21.3 32.3
--------- ---------
Total Investments 27,407.9 26,604.1
Cash and Bank Deposits 94.6 107.1
Accounts and Premiums Receivable 1,896.3 1,851.3
Reinsurance Receivable 5,611.3 6,046.5
Accrued Investment Income 569.0 532.2
Deferred Policy Acquisition Costs 2,552.9 2,424.0
Value of Business Acquired 566.9 591.6
Goodwill 683.5 683.3
Other Assets 1,454.9 1,456.2
Separate Account Assets 49.8 67.6
--------- ---------
Total Assets $40,887.1 $40,363.9
========= =========
See notes to condensed consolidated financial statements.
2
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
June 30 December 31
2001 2000
(in millions of dollars)
------------------------------------------
(Unaudited)
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,923.6 $ 1,796.8
Reserves for Future Policy and Contract Benefits and
Unearned Premiums 26,444.8 25,966.7
Other Policyholders' Funds 2,540.7 2,645.1
Federal Income Tax 396.4 499.2
Short-term Debt - 402.2
Long-term Debt 2,039.2 1,615.5
Other Liabilities 1,440.4 1,495.3
Separate Account Liabilities 49.8 67.6
--------- ---------
Total Liabilities 34,834.9 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: 242,158,357 and 241,310,917 shares 24.2 24.1
Additional Paid-in Capital 1,056.8 1,040.2
Accumulated Other Comprehensive Income 47.7 140.7
Retained Earnings 4,636.7 4,379.7
Treasury Stock at Cost: 176,295 shares (9.2) (9.2)
Deferred Compensation (4.0) -
--------- ---------
Total Stockholders' Equity 5,752.2 5,575.5
--------- ---------
Total Liabilities and Stockholders' Equity $40,887.1 $40,363.9
========= =========
See notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Three Months Ended Six Months Ended
June 30 June 30
2001 2000 2001 2000
(in millions of dollars, except share data)
-------------------------------------------------------------------
Revenue
Premium Income $1,769.8 $1,789.9 $3,516.7 $3,570.7
Net Investment Income 500.0 543.0 994.5 1,095.1
Net Realized Investment Gains (Losses) (1.5) 1.8 (2.7) 1.6
Other Income 94.7 89.0 195.4 150.4
-------- -------- -------- --------
Total Revenue 2,363.0 2,423.7 4,703.9 4,817.8
-------- -------- -------- --------
Benefits and Expenses
Policyholder Benefits 1,571.2 1,631.1 3,089.3 3,210.6
Commissions 196.4 188.9 395.3 384.5
Interest and Debt Expense 44.2 45.1 87.0 89.0
Deferral of Policy Acquisition Costs (164.7) (148.5) (343.7) (295.7)
Amortization of Deferred Policy Acquisition Costs 95.6 124.6 210.7 268.2
Amortization of Value of Business Acquired and Goodwill 18.1 17.8 35.8 34.5
Other Operating Expenses 391.3 345.1 793.1 700.7
-------- -------- -------- --------
Total Benefits and Expenses 2,152.1 2,204.1 4,267.5 4,391.8
-------- -------- -------- --------
Income Before Federal Income Taxes 210.9 219.6 436.4 426.0
Federal Income Taxes 64.8 76.5 108.3 148.4
-------- -------- -------- --------
Net Income $ 146.1 $ 143.1 $ 328.1 $ 277.6
======== ======== ======== ========
Net Income Per Common Share
Basic $ 0.60 $ 0.59 $ 1.36 $ 1.15
Assuming Dilution $ 0.60 $ 0.59 $ 1.35 $ 1.15
Dividends Paid Per Common Share $ 0.1475 $ 0.1475 $ 0.2950 $ 0.2950
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 277.6 277.6
Change in Net Unrealized Gain
(Loss) on Securities (57.1) (57.1)
Change in Foreign Currency
Translation Adjustment (17.5) (17.5)
---------
Total Comprehensive Income 203.0
---------
Common Stock Activity 5.0 5.0
Dividends to Stockholders (106.4) (106.4)
------ -------- ------ -------- ----- ------ ---------
Balance at June 30, 2000 $ 24.1 $1,033.6 $(93.5) $4,128.8 $(9.2) $ - $ 5,083.8
====== ======== ====== ======== ===== ====== =========
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 328.1 328.1
Change in Net Unrealized
Gain on Securities (91.2) (91.2)
Change in Net Gain on Cash
Flow Hedges (15.2) (15.2)
Change in Foreign Currency
Translation Adjustment 13.4 13.4
---------
Total Comprehensive Income 235.1
---------
Common Stock Activity 0.1 16.6 (4.0) 12.7
Dividends to Stockholders (71.1) (71.1)
------ -------- ------ -------- ----- ------ ---------
Balance at June 30, 2001 $ 24.2 $1,056.8 $ 47.7 $4,636.7 $(9.2) $ (4.0) $ 5,752.2
====== ======== ====== ======== ===== ====== =========
See notes to condensed consolidated financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Six Months Ended June 30
2001 2000
(in millions of dollars)
-------------------------
Net Cash Provided by Operating Activities $ 817.9 $ 533.0
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments 1,361.0 1,010.2
Proceeds from Maturities of Investments 576.7 551.5
Purchase of Investments (2,766.9) (2,050.7)
Net Sales of Short-term Investments 76.7 159.9
Acquisition of Business (10.2) (94.2)
Disposition of Business - (78.2)
Other (24.5) (34.9)
--------- ---------
Net Cash Used by Investing Activities (787.2) (536.4)
--------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts 6.1 22.3
Maturities and Benefit Payments from Policyholder Accounts (12.1) (99.9)
Net Short-term Debt and Commercial Paper Repayments (553.5) (34.5)
Issuance of Long-term Debt 575.0 -
Dividends Paid to Stockholders (71.1) (70.9)
Other 12.7 5.0
--------- ---------
Net Cash Used by Financing Activities (42.9) (178.0)
--------- ---------
Effect of Foreign Exchange Rate on Cash (0.3) (0.7)
--------- ---------
Net Decrease in Cash and Bank Deposits (12.5) (182.1)
Cash and Bank Deposits at Beginning of Period 107.1 292.4
--------- ---------
Cash and Bank Deposits at End of Period $ 94.6 $ 110.3
========= =========
See notes to condensed consolidated financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
June 30, 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 and
six month periods ended June 30, 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 to 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 - Changes in Accounting Principles
Effective April 1, 2001, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 140 (SFAS 140), Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities. SFAS 140
revises the standards for accounting and reporting for transfers and servicing
of financial assets and extinguishment of liabilities. The adoption of SFAS 140
did not have a material impact on the Company's financial position or results of
operations.
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.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2001
Note 2 - Changes in Accounting Principles - Continued
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.
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, group and individual long-term care, 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 2004 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 is being amortized into earnings as a component of
interest expense over the expected remaining life of the hedged debt instrument.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2001
Note 2 - Change in Accounting Principle - Continued
During the three month and six month periods ended June 30, 2001, the Company
recognized net gains of $23.5 million and $42.8 million, respectively, upon the
termination of cash flow hedges and reported $22.1 million and $41.4 million of
these gains in other comprehensive income. The Company reported $1.4 million in
operating earnings as a realized investment gain in conjunction with a hedge
that was terminated due to the probability that the original forecasted
transactions would not occur.
The Company amortized $1.8 million and $3.4 million of net deferred gains into
earnings during the three and six month periods ended June 30, 2001, including
the amortization of deferred gains on derivative instruments that arose prior to
the initial application of SFAS 133 and that were previously added to the
carrying amount of recognized hedged assets. The estimated amount of net
deferred gains that will be amortized into operating earnings during the next 12
months is $7.4 million. The notional amount outstanding under the hedge programs
was $1,148.9 million at June 30, 2001, and the fair value of the derivatives was
$68.2 million. The fair values 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.
During the three month and six month periods ended June 30, 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.
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 June 30 Six Months Ended June 30
2001 2000 2001 2000
( in millions, except share data)
----------------------------------------------------------------
Numerator
Net Income $ 146.1 $ 143.1 $ 328.1 $ 277.6
========== ========== ========== ==========
Denominator (000s)
Weighted Average Common Shares - Basic 241,720.5 240,755.1 241,556.0 240,684.9
Dilutive Securities 2,288.5 890.4 2,026.4 844.6
---------- ---------- ---------- ----------
Weighted Average Common Shares -
Assuming Dilution 244,009.0 241,645.5 243,582.4 241,529.5
========== ========== ========== ==========
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.
Options out-of-the-money approximated 7.4 million and 9.7 million shares for the
three and six month periods ended June 30, 2001 and 11.6 million and 11.9
million shares for the three and six month periods ended June 30, 2000.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2001
Note 4 - Comprehensive Income
The components of accumulated other comprehensive income, net of deferred tax,
are as follows:
June 30 December 31
2001 2000
(in millions of dollars)
----------------------------------------------
Net Unrealized Gain on Securities $ 35.8 $212.8
Net Gain on Cash Flow Hedges 70.6 -
Foreign Currency Translation Adjustment (58.7) (72.1)
------ ------
Accumulated Other Comprehensive Income $ 47.7 $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 (loss) and the related deferred tax are
as follows:
Three Months Ended June 30 Six Months Ended June 30
2001 2000 2001 2000
(in millions of dollars)
---------------------------------------------------------------------
Net Income $ 146.1 $ 143.1 $ 328.1 $ 277.6
------- ------- ------- -------
Change in Net Unrealized Gain (Loss) on Securities:
Change Before Reclassification Adjustment (268.9) (186.6) (169.4) (89.1)
Reclassification Adjustment for Net Realized
Investment Gains and Losses Included in Net Income 1.5 (1.8) 2.7 (1.6)
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 (40.4) - (23.3) -
Change in Foreign Currency Translation Adjustment 24.1 (14.8) 10.8 (20.5)
------- ------- ------- -------
(283.7) (203.2) (156.0) (111.2)
Change in Deferred Tax (104.0) (71.4) (63.0) (36.6)
------- ------- ------- -------
Other Comprehensive Loss (179.7) (131.8) (93.0) (74.6)
------- ------- ------- -------
Comprehensive Income (Loss) $ (33.6) $ 11.3 $ 235.1 $ 203.0
======= ======= ======= =======
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2001
Note 5 - Segment Information
Selected data by segment is as follows:
Three Months Ended June 30 Six Months Ended June 30
2001 2000 2001 2000
(in millions of dollars)
----------------------------------------------------------------
Premium Income
Employee Benefits $1,080.9 $1,008.2 $2,133.9 $2,014.1
Individual 452.7 441.4 914.4 888.8
Voluntary Benefits 195.7 184.7 391.2 366.5
Other 40.5 155.6 77.2 301.3
-------- -------- -------- --------
1,769.8 1,789.9 3,516.7 3,570.7
Net Investment Income and Other Income
Employee Benefits 233.6 212.3 459.7 418.8
Individual 251.7 240.2 501.2 461.7
Voluntary Benefits 32.6 29.5 68.5 58.9
Other 67.3 138.4 139.2 283.5
Corporate 9.5 11.6 21.3 22.6
-------- -------- -------- --------
594.7 632.0 1,189.9 1,245.5
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Employee Benefits 1,314.5 1,220.5 2,593.6 2,432.9
Individual 704.4 681.6 1,415.6 1,350.5
Voluntary Benefits 228.3 214.2 459.7 425.4
Other 107.8 294.0 216.4 584.8
Corporate 9.5 11.6 21.3 22.6
-------- -------- -------- --------
2,364.5 2,421.9 4,706.6 4,816.2
Benefits and Expenses
Employee Benefits 1,194.3 1,099.1 2,337.6 2,203.4
Individual 627.2 609.7 1,253.5 1,203.8
Voluntary Benefits 188.0 174.8 379.0 346.4
Other 91.2 270.7 189.2 538.0
Corporate 51.4 49.8 108.2 100.2
-------- -------- -------- --------
2,152.1 2,204.1 4,267.5 4,391.8
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Employee Benefits 120.2 121.4 256.0 229.5
Individual 77.2 71.9 162.1 146.7
Voluntary Benefits 40.3 39.4 80.7 79.0
Other 16.6 23.3 27.2 46.8
Corporate (41.9) (38.2) (86.9) (77.6)
-------- -------- -------- --------
212.4 217.8 439.1 424.4
Net Realized Investment Gains (Losses) (1.5) 1.8 (2.7) 1.6
-------- -------- -------- --------
Income Before Federal Income Taxes 210.9 219.6 436.4 426.0
Federal Income Taxes 64.8 76.5 108.3 148.4
-------- -------- -------- --------
Net Income $ 146.1 $ 143.1 $ 328.1 $ 277.6
======== ======== ======== ========
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 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 Corporation
(UnumProvident) and several of its subsidiaries, The Paul Revere Corporation
(Paul Revere), The Paul Revere Life Insurance Company, The Paul Revere Variable
Annuity Insurance Company, The Paul Revere Protective Life Insurance Company,
and Provident Life and Accident Insurance Company. One purported to represent
independent brokers who sold certain individual disability income policies with
benefit riders that were issued by subsidiaries of Paul Revere. 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. 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 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 (NASD) 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. Plaintiffs appealed these two
cases to the First Circuit Court of Appeals, but the District Court decision was
affirmed on May 3, 2001. The first arbitration was heard before a NASD panel the
week of June 25, 2001. The second arbitration will be held before a NASD panel
the week of September 25, 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. On January 27, 2000, a sixth complaint against
the same defendants was filed in the Southern District of New York.
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2001
Note 6 - Commitments and Contingent Liabilities - Continued
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 May 15, 2001, the district court
issued an Amended Scheduling Order that, among other things, ordered all
discovery to be complete by September 10, 2001, and directed that the case be
prepared for trial in December 2001. The Company disputes the claims alleged in
the complaint and plans to vigorously contest them.
On May 24, 2001, in an individual disability benefits case pending in federal
court in Tampa, Florida, a jury returned a verdict of $36.7 million against The
Paul Revere Life Insurance Company. There was no compensatory award because all
outstanding benefits had been paid in advance of the trial. The Company has
identified a number of legal issues and factual errors to challenge the award,
all of which have been presented to the trial court in a series of post trial
motions. The Company has requested that judgment be entered in its favor based
on the evidence presented at trial or, in the alternative, that the court order
that a new trial be held. Depending on the rulings in the trial court, the
Company may be required to seek relief on appeal.
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.
13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2001
Note 6 - Commitments and Contingent Liabilities - Continued
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 - 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 June 30, 2001, the
related condensed consolidated statements of income for the three and six month
periods ended June 30, 2001 and 2000, and the condensed consolidated statements
of stockholders' equity and cash flows for the six month periods ended June 30,
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
July 25, 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
life insurance, employer- and employee-paid group benefits, long-term care
insurance, 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 June 30 Six Months Ended June 30
-------------------------------------- --------------------------------------
2001 % Change 2000 2001 % Change 2000
------------- ------------ ------------- -------------
Revenue
Premium Income $ 1,769.8 (1.1)% $ 1,789.9 $ 3,516.7 (1.5)% $ 3,570.7
Net Investment Income 500.0 (7.9) 543.0 994.5 (9.2) 1,095.1
Other Income 94.7 6.4 89.0 195.4 29.9 150.4
------------- ------------ ------------- -------------
Total Revenue 2,364.5 (2.4) 2,421.9 4,706.6 (2.3) 4,816.2
------------- ------------ ------------- -------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 1,571.2 (3.7) 1,631.1 3,089.3 (3.8) 3,210.6
Commissions 196.4 4.0 188.9 395.3 2.8 384.5
Interest and Debt Expense 44.2 (2.0) 45.1 87.0 (2.2) 89.0
Deferral of Policy Acquisition Costs (164.7) 10.9 (148.5) (343.7) 16.2 (295.7)
Amortization of Deferred Policy
Acquisition Costs 95.6 (23.3) 124.6 210.7 (21.4) 268.2
Amortization of Value of
Business Acquired 12.8 3.2 12.4 25.2 5.4 23.9
Amortization of Goodwill 5.3 (1.9) 5.4 10.6 - 10.6
Operating Expenses 391.3 13.4 345.1 793.1 13.2 700.7
------------- ------------ ------------- -------------
Total Benefits and Expenses 2,152.1 (2.4) 2,204.1 4,267.5 (2.8) 4,391.8
------------- ------------ ------------- -------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) 212.4 (2.5) 217.8 439.1 3.5 424.4
Federal Income Taxes 66.1 (12.8) 75.8 110.0 (25.6) 147.8
------------- ------------ ------------- -------------
Income Before Net Realized
Investment Gain (Loss) 146.3 3.0 142.0 329.1 19.0 276.6
Net Realized Investment Gain (Loss) (0.2) N.M. 1.1 (1.0) N.M. 1.0
------------- ------------ ------------- -------------
Net Income $ 146.1 2.1 $ 143.1 $ 328.1 18.2 $ 277.6
============= ============ ============= =============
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, which lowers the 2001 tax rate below the U.S. federal statutory rate
of 35 percent. Additionally, as a result of tax legislation enacted in the
United Kingdom during 2000 that allows additional group tax relief among
companies with common ownership, the Company began recognizing foreign tax
benefits during 2001.
In the following discussion of operating results by segment, "revenue" includes
premium income, net investment income, and other income. "Income" or "loss"
excludes net realized investment gains and losses and federal income taxes.
17
Employee Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended June 30 Six Months Ended June 30
----------------------------------------- ------------------------------------------
2001 % Change 2000 2001 % Change 2000
-------------- ------------- -------------- --------------
Revenue
Premium Income
Group Long-term Disability $ 536.8 4.1 % $ 515.6 $ 1,063.3 2.9 % $ 1,033.6
Group Short-term Disability 145.2 13.0 128.5 282.1 11.5 252.9
Group Life 327.2 8.8 300.6 646.2 7.1 603.5
Accidental Death &
Dismemberment 51.1 6.0 48.2 103.1 8.4 95.1
Group Long-term Care 20.6 34.6 15.3 39.2 35.2 29.0
-------------- ------------- -------------- --------------
Total Premium Income 1,080.9 7.2 1,008.2 2,133.9 5.9 2,014.1
Net Investment Income 188.6 8.1 174.4 372.8 8.1 344.8
Other Income 45.0 18.7 37.9 86.9 17.4 74.0
-------------- ------------- -------------- --------------
Total Revenue 1,314.5 7.7 1,220.5 2,593.6 6.6 2,432.9
-------------- ------------- -------------- --------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 912.6 7.7 847.0 1,766.3 5.2 1,678.4
Commissions 87.5 11.0 78.8 172.3 2.9 167.5
Deferral of Policy Acquisition Costs (67.3) 21.9 (55.2) (145.3) 21.5 (119.6)
Amortization of Deferred Policy
Acquisition Costs 30.0 (18.0) 36.6 81.2 (4.4) 84.9
Amortization of Value of
Business Acquired 0.5 (16.7) 0.6 1.0 (16.7) 1.2
Operating Expenses 231.0 20.8 191.3 462.1 18.2 391.0
-------------- ------------- -------------- --------------
Total Benefits and Expenses 1,194.3 8.7 1,099.1 2,337.6 6.1 2,203.4
-------------- ------------- -------------- --------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 120.2 (1.0) $ 121.4 $ 256.0 11.5 $ 229.5
============== ============= ============== ==============
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
17.3 percent to $227.3 million in the second quarter of 2001 from $193.8 million
in the second quarter of 2000. On an effective date basis, sales increased 12.5
percent to $149.1 million in the second quarter of 2001 from $132.5 million in
the second quarter of 2000. Year-to-date sales for 2001 were $383.4 million on a
submitted date basis and $626.4 million on an effective date basis, compared to
year-to-date 2000 sales of $327.8 million on a submitted date basis and $472.8
million on an effective date basis. The Company has adjusted its focus to
integrated selling that combines long-term disability, short-term disability,
and group life products. During the first six months of 2001, 28 percent of all
new sales were with long-term disability, short-term disability, and group life
combined coverage. This compares to 31 percent for the first six months of 2000
and 32 percent and 26 percent for the twelve months of 2000 and 1999.
18
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 throughout 2000 which helped maintain the sales momentum achieved
during the last half of 2000 and continuing into 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.
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 second quarter of 2001 for group disability,
group life, and accidental death and dismemberment products improved over the
year ago quarter and compared favorably to the persistency expected at the time
the business was written. Persistency during the first quarter of 2001,
however, was unfavorable when compared to the expected persistency, resulting in
additional amortization of $20.3 million during the first quarter of 2001. The
additional amortization related to persistency in the second quarter and first
six months of 2000 was $7.3 million and $25.9 million, respectively. It is
expected that persistency for the foreseeable future may continue to be lower
than historical levels for group disability as well as group life. The
Company's 2001 renewal program has generally been successful at retaining
business that is relatively more profitable than business that terminated,
particularly in group disability. 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 $38.4 million in the
second quarter of 2001 compared to $31.6 million in the second quarter of 2000.
On a year-to-date basis, revenue was $74.1 million in 2001 and $61.7 million in
2000.
Group Disability
Group disability revenue was $837.5 million in the second quarter of 2001
compared to $796.0 million in the second quarter of 2000. Second quarter new
annualized sales for group long-term disability on a submitted date basis were
$73.0 million in 2001 and $68.2 million in 2000. New annualized sales for group
short-term disability on a submitted basis were $38.2 million in the second
quarter of 2001 as compared to $29.6 million in the second quarter of 2000. On
an effective date basis, new annualized sales for long-term disability and
short-term disability, respectively, were $64.7 million and $27.8 million in the
second quarter of 2001 and $63.2 million and $23.1 million in the second quarter
of 2000.
For the first six months, group disability revenue was $1,653.0 million in 2001
compared to $1,586.0 million in 2000. New annualized sales for group long-term
disability on a submitted date basis were $142.8 million in the first six months
of 2001 and $131.7 million in the same period of 2000. New annualized sales for
group short-term disability on a submitted basis were $66.2 million in 2001 as
compared to $51.9 million in 2000. On an effective date basis, new annualized
sales for the first six months for long-term disability and short-term
disability, respectively, were $227.3 million and $115.8 million in 2001 and
$198.0 million and $84.5 million in 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.
The Company has implemented pricing changes in the group disability line wherein
prices may increase or decrease by market segment, as appropriate, to respond to
current claim experience and other factors and assumptions.
19
Group disability reported income of $90.4 million for the second quarter of 2001
compared to $67.0 million for the second quarter of 2000. Positive impacts on
income were a $41.5 million revenue increase and an improvement in the benefit
ratio. The commission ratio also improved relative to the second quarter of
2000. Negatively impacting income was an increase in the operating expense
ratio in the second quarter of 2001 compared to the second quarter of 2000 and
the full year 2000.
Group disability reported income of $177.0 million for the six months of 2001
compared to $123.3 million for the same period of 2000. Positive impacts on
income were a $67.0 million revenue increase and an improvement in the benefit
ratio. The commission ratio also improved relative to the first six months of
2000. Negatively impacting income was an increase in the operating expense
ratio for 2001 compared to 2000. The first quarter and six month 2001 results
include $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.
Persistency during the second quarter of 2001 was favorable compared to
expected, resulting in no additional amortization. The additional amortization
during the second quarter and first six months of 2000 was $5.8 million and
$19.6 million, respectively. 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 in 2001, as demonstrated by the lower benefit ratios for
second quarter and year-to-date. Claim recovery rates for long-term disability
continue to show an improving trend. Submitted claim incidence for long-term
disability is down slightly from the first quarter of 2001, but continues to be
at a higher level than experienced during recent quarters. The paid claim
incidence for long-term disability, which has increased when compared to the
second quarter of last year, is consistent with the first quarter of 2001 and is
lower than the fourth quarter of 2000. For short-term disability, the average
weekly indemnity and submitted claim incidence have increased over the second
quarter of 2000. The average claim duration for short-term disability is at its
lowest level since the second quarter of 1999.
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 $26.2 million in the second quarter of 2001 compared to $51.6 million
in the second quarter of 2000. New annualized sales on a submitted date basis
increased to $116.1 million in the second quarter of 2001 as compared to the
$96.0 million reported in the second quarter of 2000. On an effective date
basis, new annualized sales were $56.6 million in the second quarter of 2001
compared to $46.2 million for the same period last year.
20
For the first six months, group life, accidental death and dismemberment, and
long-term care reported income of $72.1 million in 2001 compared to $101.6
million in 2000. New annualized sales on a submitted date basis were $174.4
million in 2001 compared to $144.2 million in 2000. On an effective date basis,
new annualized sales were $283.3 million in 2001 and $190.3 million for 2000.
Group life, accidental death and dismemberment, and long-term care reported an
increase in revenue for the second quarter and six months of 2001 compared to
the same periods last year due to increases in both premium income and net
investment income. Offsetting the revenue increase was an increase in the
benefit ratio and operating expense ratio when compared to the previous year
reporting periods. The amortization of deferred policy acquisition costs for
the first quarter and six months 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
first quarter variance of actual to expected terminations occurred primarily in
the group life product line. During the second quarter of 2001, actual
persistency was favorable compared to expected, and no additional amortization
was reported. The additional amortization during the second quarter and first
six months of 2000 was $1.5 million and $6.3 million, respectively.
Group life, which was the primary contributor to the decrease in income for the
second quarter of 2001, reported an increase in the benefit ratio for the second
quarter and six months of 2001 compared to the prior year periods. Paid
mortality incidence was above seasonal expectations and at its highest level in
recent periods. The average paid claim size has also increased. Waiver incidence
for the second quarter of 2001, which continues to be above historical levels
and increased significantly from the first quarter of 2001, is down from the
prior year second quarter. The claim recovery rate on waiver claims has
increased, somewhat mitigating the impact of the increase in waiver incidence.
Although persistency of the business has improved, group life is experiencing a
higher level of terminations in business that is relatively more profitable than
the retained business. The Company has implemented several actions which include
tighter underwriting guidelines and pricing changes and is developing case
specific remedial plans for poorly performing business. The Company believes
these actions will improve profitability in group life, but it is uncertain
whether these actions will restore the profitability that this line of business
has historically reported. As a result of the actions implemented, it is
expected that the sales growth rate in this business will slow from that
experienced in recent quarters.
The 2001 second quarter benefit ratio for accidental death and dismemberment is
lower than the first quarter of 2001 and second quarter of 2000, primarily as a
result of a decrease in paid incidence. For the six months of 2001, the benefit
ratio is higher than the previous year due to the high rate of claim incidence
that occurred during the first quarter of 2001. Group long-term care reported a
decrease in the benefit ratio for the second quarter and six months of 2001
compared to the comparable periods of 2000. The incidence rates for both
submitted and paid claims decreased over the prior year second quarter and first
six months, although the paid incidence has been increasing throughout the last
two quarters. The long-term care claim recovery rate for the second quarter is
above the rate for the second quarter of 2000, but the average for the first six
months of 2001 is slightly below the comparable prior year period.
21
Individual Segment Operating Results
(in millions of dollars)
Three Months Ended June 30 Six Months Ended June 30
--------------------------------------- ----------------------------------------
2001 % Change 2000 2001 % Change 2000
------------- ------------ -------------- ------------
Revenue
Premium Income
Individual Disability $ 409.2 - % $ 409.4 $ 831.2 0.4 % $ 827.6
Individual Long-term Care 43.5 35.9 32.0 83.2 35.9 61.2
------------- ------------ -------------- ------------
Total Premium Income 452.7 2.6 441.4 914.4 2.9 888.8
Net Investment Income 224.8 10.0 204.3 448.7 9.2 411.0
Other Income 26.9 (25.1) 35.9 52.5 3.6 50.7
------------- ------------ -------------- ------------
Total Revenue 704.4 3.3 681.6 1,415.6 4.8 1,350.5
------------- ------------ -------------- ------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 473.0 1.8 464.5 942.3 3.7 908.9
Commissions 62.3 (0.5) 62.6 128.2 - 128.2
Deferral of Policy Acquisition Costs (53.9) 9.1 (49.4) (109.5) 9.3 (100.2)
Amortization of Deferred Policy
Acquisition Costs 26.3 20.1 21.9 51.7 16.2 44.5
Amortization of Value of
Business Acquired 11.8 7.3 11.0 23.1 13.2 20.4
Operating Expenses 107.7 8.7 99.1 217.7 7.8 202.0
------------- ------------ -------------- ------------
Total Benefits and Expenses 627.2 2.9 609.7 1,253.5 4.1 1,203.8
------------- ------------ -------------- ------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 77.2 7.4 $ 71.9 $ 162.1 10.5 $ 146.7
============= ============ ============== ============
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 $39.0
million in the second quarter of 2001 compared to $29.7 million in the second
quarter of 2000. On a year-to-date basis, new annualized sales were $67.7
million in 2001 and $56.2 million in 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 continues to be stable.
22
Revenue was $653.6 million for the second quarter of 2001 compared to $645.2
million in the same period of 2000. Income in the individual disability line
of business was $73.1 million in the second quarter of 2001, an increase of 5.0
percent over the prior year second quarter. The benefit ratio for the second
quarter of 2001 was unchanged compared to the second quarter of 2000, but the
ratio increased over the first quarter of 2001 and the full year 2000. The
interest adjusted loss ratio was 61.7 percent and 61.8 percent for the second
quarter of 2001 and 2000, respectively. Submitted claim incidence increased
from the first quarter of 2001 and is higher than recent historical incidence.
Paid incidence, however, has improved relative to the first quarter of 2001 as
well as the second quarter of 2000, and the claim recovery rate improved for the
second quarter of 2001 relative to the same period last year, although it has
decreased from the previous two quarters. Individual disability benefited from
a slightly improved commission ratio for second quarter 2001 as compared to
second quarter 2000, but the operating expense ratio increased.
For the first six months, revenue was $1,317.8 million in 2001 and $1,280.8
million in 2000. Income was $157.1 million in 2001 compared to $142.0 million
in 2000. The benefit ratio increased from the prior year comparable period due
to an increase in submitted incidence. Paid incidence improved during the first
six months of 2001 compared to the first six months of 2000. The interest
adjusted loss ratio was 61.7 percent and 62.5 percent for the six months of 2001
and 2000, respectively.
Individual Long-term Care
The individual long-term care line of business reported increased premium income
for the second 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 $13.7 million for the second quarter of 2001 and $25.5
million for the first six months. For the comparable periods of 2000, new sales
were $10.7 million and $21.5 million. The Company expects the strong sales
momentum in individual long-term care to continue.
Income in the individual long-term care line of business was $4.1 million for
the second quarter of 2001 compared to $2.3 million for the same period of 2000,
primarily due to an increase in revenue and a decrease in both the benefit ratio
and the commission and operating expense ratios. The decrease in the benefit
ratio was driven by a decrease in the new claim rate compared to the second
quarter of 2000 and the first quarter of 2001 and an increase in the claim
recovery rate.
For the first six months, income in the individual long-term care lines of
business was $5.0 million in 2001 compared to $4.7 million for the same period
of 2000, primarily due to the increase in premium income resulting from the
sales growth of recent periods. The benefit ratio was higher for the 2001
period, driven primarily by the first quarter of 2001 new claim experience.
23
Voluntary Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended June 30 Six Months Ended June 30
------------------------------------------ ----------------------------------------
2001 % Change 2000 2001 % Change 2000
--------------- ------------ ------------- -------------
Revenue
Premium Income $ 195.7 6.0 % $ 184.7 $ 391.2 6.7 % $ 366.5
Net Investment Income 30.5 10.1 27.7 61.7 11.0 55.6
Other Income 2.1 16.7 1.8 6.8 106.1 3.3
--------------- ------------ ------------- -------------
Total Revenue 228.3 6.6 214.2 459.7 8.1 425.4
--------------- ------------ ------------- -------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 121.2 8.4 111.8 239.6 9.2 219.4
Commissions 43.3 11.3 38.9 88.2 26.7 69.6
Deferral of Policy Acquisition Costs (43.4) 3.1 (42.1) (88.8) 23.2 (72.1)
Amortization of Deferred Policy
Acquisition Costs 28.6 (4.3) 29.9 61.6 11.4 55.3
Amortization of Value of
Business Acquired 0.5 150.0 0.2 1.1 - 1.1
Operating Expenses 37.8 4.7 36.1 77.3 5.7 73.1
--------------- ------------ ------------- -------------
Total Benefits and Expenses 188.0 7.6 174.8 379.0 9.4 346.4
--------------- ------------ ------------- -------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 40.3 2.3 $ 39.4 $ 80.7 2.2 $ 79.0
=============== ============ ============= =============
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 $228.3 million in the
second quarter of 2001 from $214.2 million in the second 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 second quarter
of 2001 were $66.4 million, an increase of 13.9 percent over the comparable
prior year period. For the first six months, sales were $132.4 million in 2001
and $121.6 million in 2000. Management continues its efforts to increase sales
through the sales initiatives discussed under "Employee Benefits Segment
Operating Results."
For both the second quarter and six months of 2001, all of the product lines
reported an increase in premium income and net investment income over the
comparable periods of 2000. The life product line reported an improvement in
the benefit ratio, and the disability product line benefit ratio was essentially
flat with recent quarters. However, the overall benefit ratio for the segment
was slightly higher than the second quarter and six months of 2000, primarily
due to an increase in claims in the cancer product line. The Company is re-
pricing existing business in the cancer product line, at contract renewal dates,
in an attempt to mitigate the effect of the claim experience.
24
Other Segment Operating Results
(in millions of dollars)
Three Months Ended June 30 Six Months Ended June 30
------------------------------------------- -------------------------------------------
2001 % Change 2000 2001 % Change 2000
-------------- -------------- -------------- --------------
Revenue
Premium Income $ 40.5 (74.0)% $ 155.6 $ 77.2 (74.4)% $ 301.3
Net Investment Income 50.2 (61.5) 130.3 103.3 (61.7) 269.5
Other Income 17.1 111.1 8.1 35.9 156.4 14.0
-------------- -------------- -------------- --------------
Total Revenue 107.8 (63.3) 294.0 216.4 (63.0) 584.8
-------------- -------------- -------------- --------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 64.4 (69.0) 207.8 141.1 (65.1) 403.9
Other Expenses 26.8 (57.4) 62.9 48.1 (64.1) 134.1
-------------- -------------- -------------- --------------
Total Benefits and Expenses 91.2 (66.3) 270.7 189.2 (64.8) 538.0
-------------- -------------- -------------- --------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 16.6 (28.8) $ 23.3 $ 27.2 (41.9) $ 46.8
============== ============== ============== ==============
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
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. The
reinsurance agreements were effective as of July 1, 2000. This reinsurance
transaction resulted in a decrease in individual life and corporate-owned life
second quarter and six month revenue and income in 2001 relative to the
comparable periods of 2000. Total revenue and income were $13.2 million and $7.6
million, respectively, in the second quarter of 2001 compared to $106.6 million
in revenue and $16.1 million in income for the same period of 2000. Revenue and
income decreased $192.8 million and $16.1 million, respectively, in 2001 year-
to-date compared to the first six months of 2000.
Reinsurance Pools and Management
The Company's reinsurance operations include the reinsurance management
operations of Duncanson & Holt, Inc. 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.
25
The reinsurance pools and management operations reported income of $4.2 million
in the second quarter of 2001 and a loss of $0.5 million for the comparable
period of 2000. On a year-to-date basis, income was $3.2 million in 2001
compared to a loss of $0.4 million in 2000. Premium income for the second
quarter of 2001 was $25.8 million compared to $115.2 million in the second
quarter of 2000. Through June, premium income was $51.6 million in 2001 and
$216.3 million in 2000.
Corporate Segment Operating Results
Revenue in the Corporate segment was $9.5 million in the second quarter of 2001
and $11.6 million in the second quarter of 2000. Interest and debt expense was
$44.2 million in the second quarter of 2001 compared to $45.1 million for the
second quarter of 2000. The amortization of goodwill was $5.3 million in the
second quarter of 2001 and $5.4 million in the comparable period of 2000.
For the first six months, revenue was $21.3 million and $22.6 million in 2001
and in 2000. Interest and debt expense was $87.0 million in 2001 compared to
$89.0 million for 2000, and the amortization of goodwill was $10.6 million for
both periods.
The Corporate segment reported a loss of $41.9 million and $86.9 million for the
second quarter and six months of 2001 compared to a loss of $38.2 million and
$77.6 million for the same periods 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.
Excluding the net investment income reported in the Other segment, which
continues its expected decline as these product lines are sold, reinsured, or
wind down, second quarter 2001 net investment income increased 9.0 percent over
the previous year second quarter. The overall yield in the portfolio remains
relatively stable at 8.06 percent as of the end of the second quarter of 2001
compared to 8.04 percent at December 31, 2000. The Company is presently
evaluating the possible sale of all or a portion of the real estate and mortgage
loan portfolios for replacement with longer duration securities.
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 $2.3 billion and $2.2 billion were ceded as of June 30, 2001 and
December 31, 2000, respectively, and the investment income thereon is no longer
included in income.
June 30 December 31
2001 2000
---- ----
Investment-Grade Fixed Maturity Securities 78.8% 78.3%
Below-Investment-Grade Fixed Maturity Securities 7.3 6.6
Equity Securities 0.1 0.1
Mortgage Loans 3.7 4.3
Real Estate 0.4 0.4
Policy Loans 8.9 9.1
Other Invested Assets 0.8 1.2
----- -----
Total 100.0% 100.0%
===== =====
26
Fixed Maturity Securities
The Company's investment in mortgage-backed securities, on an amortized cost
basis, was approximately $3.6 billion and $3.5 billion at June 30, 2001 and
December 31, 2000, respectively. At June 30, 2001, the mortgage-backed
securities had an average life of 11.5 years and effective duration of 9.8
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.
The Company's exposure to below-investment-grade fixed maturity securities at
June 30, 2001, was $1,988.1 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 $1,025.3 million and $1,135.6 million
at June 30, 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 the 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 six months 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 June 30, 2001, and December 31, 2000, impaired loans totaled $13.3 million
and $17.7 million, respectively. Included in the impaired loans at June 30, 2001
were $6.5 million of loans which had a related, specific investment valuation
allowance of $2.4 million and $6.8 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 $6.0 million and $8.5 million at June 30,
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 six and twelve month periods ended
June 30, 2001, and December 31, 2000.
Real estate was $99.4 million and $116.7 million at June 30, 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 $8.0 million at June 30, 2001, and $18.3 million at December 31,
2000.
27
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 $5.5 million and $5.0
million, respectively, during the second and first quarters 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 June 30, 2001,
the balance in the valuation allowance for mortgage loans and real estate was
$2.4 million and $19.9 million, respectively.
Other
The Company's exposure to non-current investments totaled $93.5 million at June
30, 2001, or 0.3 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 half 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 long-term care and
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 $817.9 million for the
six months ended June 30, 2001, as compared to $533.0 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 June 30, 2001, the Company had long-term debt totaling $2,039.2 million and
no short-term debt. At June 30, 2001, approximately $702.3 million was available
for additional financing under the Company's revolving credit facilities. The
debt to total capital ratio declined to 29.3 percent at June 30, 2001 compared
to 30.2 percent at December 31, 2000.
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.
28
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 debt on a longer-term basis and/or 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.
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.
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)
- -----------------------------------------------------------------------------------------------------------------------------
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 six months of 2001, there was no
substantive change to the Company's market risk or the management of such risk.
29
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
None.
30
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: August 10, 2001 /s/ J. Harold Chandler
------------------------------------
J. Harold Chandler
Chairman, President, and Chief
Executive Officer
Date: August 10, 2001 /s/ Thomas R. Watjen
------------------------------------
Thomas R. Watjen
Executive Vice President, Finance
and Risk Management
31