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 September 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 September 30, 2001
----- ---------------------------------
Common stock, $0.10 par value 242,053,710
TABLE OF CONTENTS
PART I
Cautionary Statement Regarding Forward-Looking Statements...................................... 1
1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial Condition at September 30, 2001 and December
31, 2000..................................................................................... 2
Condensed Consolidated Statements of Income for the three and nine months ended
September 30, 2001 and 2000................................................................. 4
Condensed Consolidated Statements of Stockholders' Equity for the nine months ended
September 30, 2001 and 2000................................................................. 5
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2001 and 2000................................................................. 6
Notes to Condensed Consolidated Financial Statements.......................................... 7
Independent Auditors' Review Report........................................................... 17
2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 18
3. Quantitative and Qualitative Disclosure about Market Risk..................................... 33
PART II
6. Exhibits and Reports on Form 8-K............................................................. 34
Signatures................................................................................... 35
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 experience 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.
. Events or consequences relating to terrorism and acts of war, both
domestic and foreign, which are in many respects unpredictable, may
adversely affect the Company's business and may also affect the
availability and cost of reinsurance.
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
September 30 December 31
2001 2000
(in millions of dollars)
---------------------------------
(Unaudited)
Assets
Investments
Fixed Maturity Securities
Available-for-Sale $24,760.2 $22,242.3
Held-to-Maturity - 346.6
Equity Securities 10.6 24.5
Mortgage Loans 998.4 1,135.6
Real Estate 59.9 116.7
Policy Loans 2,483.9 2,426.7
Short-term Investments 82.9 279.4
Other Long-term Investments 22.0 32.3
--------- ---------
Total Investments 28,417.9 26,604.1
Cash and Bank Deposits 100.6 107.1
Accounts and Premiums Receivable 2,003.0 1,851.3
Reinsurance Receivable 5,780.4 6,046.5
Accrued Investment Income 604.0 532.2
Deferred Policy Acquisition Costs 2,610.7 2,424.0
Value of Business Acquired 553.7 591.6
Goodwill 678.3 683.3
Other Assets 1,462.1 1,456.2
Separate Account Assets 47.3 67.6
--------- ---------
Total Assets $42,258.0 $40,363.9
========= =========
See notes to condensed consolidated financial statements.
2
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
September 30 December 31
2001 2000
(in millions of dollars)
---------------------------------
(Unaudited)
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,912.2 $ 1,796.8
Reserves for Future Policy and Contract Benefits and
Unearned Premiums 27,228.5 25,966.7
Other Policyholders' Funds 2,505.6 2,645.1
Federal Income Tax 562.1 499.2
Short-term Debt 172.5 402.2
Long-term Debt 2,016.8 1,615.5
Other Liabilities 1,486.8 1,495.3
Separate Account Liabilities 47.3 67.6
--------- ---------
Total Liabilities 35,931.8 34,488.4
--------- ---------
Commitments and Contingent Liabilities - Note 7
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: 242,230,005 and 241,310,917 shares 24.2 24.1
Additional Paid-in Capital 1,059.1 1,040.2
Accumulated Other Comprehensive Income 227.1 140.7
Retained Earnings 4,728.8 4,379.7
Treasury Stock at Cost: 176,295 shares (9.2) (9.2)
Deferred Compensation (3.8) -
--------- ---------
Total Stockholders' Equity 6,026.2 5,575.5
--------- ---------
Total Liabilities and Stockholders' Equity $42,258.0 $40,363.9
========= =========
See notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Three Months Ended Nine Months Ended
September 30 September 30
2001 2000 2001 2000
(in millions of dollars, except share data)
-----------------------------------------------------------
Revenue
Premium Income $1,792.2 $1,754.6 $5,308.9 $5,325.3
Net Investment Income 515.5 482.4 1,510.0 1,577.5
Net Realized Investment Losses (9.1) (14.0) (11.8) (12.4)
Other Income 78.8 88.7 274.2 239.1
-------- -------- -------- --------
Total Revenue 2,377.4 2,311.7 7,081.3 7,129.5
-------- -------- -------- --------
Benefits and Expenses
Benefits and Change in Reserves for Future Benefits 1,611.0 1,556.7 4,700.3 4,767.3
Commissions 191.3 188.6 586.6 573.1
Interest and Debt Expense 41.1 47.2 128.1 136.2
Deferral of Policy Acquisition Costs (165.7) (138.1) (509.4) (433.8)
Amortization of Deferred Policy Acquisition Costs 105.3 95.2 316.0 363.4
Amortization of Value of Business Acquired and 17.9 18.8 53.7 53.3
Goodwill
Other Operating Expenses 383.3 334.8 1,176.4 1,035.5
-------- -------- -------- --------
Total Benefits and Expenses 2,184.2 2,103.2 6,451.7 6,495.0
-------- -------- -------- --------
Income Before Federal Income Taxes 193.2 208.5 629.6 634.5
Federal Income Taxes 66.1 71.5 174.4 219.9
-------- -------- -------- --------
Net Income $ 127.1 $ 137.0 $ 455.2 $ 414.6
======== ======== ======== ========
Net Income Per Common Share
Basic $ 0.53 $ 0.57 $ 1.88 $ 1.72
Assuming Dilution $ 0.52 $ 0.57 $ 1.87 $ 1.72
Dividends Paid Per Common Share $ 0.1475 $ 0.1475 $ 0.4425 $ 0.4425
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 414.6 414.6
Change in Net Unrealized Gain
(Loss) on Securities (57.2) (57.2)
Change in Foreign Currency
Translation Adjustment (28.6) (28.6)
---------
Total Comprehensive Income 328.8
---------
Common Stock Activity 7.7 7.7
Dividends to Stockholders (142.0) (142.0)
----- -------- --------- -------- ----- ------- ---------
Balance at September 30, 2000 $24.1 $1,036.3 $(104.7) $4,230.2 $(9.2) $ - $ 5,176.7
===== ======== ========= ======== ===== ======= =========
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 455.2 455.2
Change in Net Unrealized
Gain on Securities 37.7 37.7
Change in Net Gain on Cash
Flow Hedges 37.8 37.8
Change in Foreign Currency
Translation Adjustment 10.9 10.9
---------
Total Comprehensive Income 541.6
---------
Common Stock Activity 0.1 18.9 (3.8) 15.2
Dividends to Stockholders (106.1) (106.1)
----- -------- --------- -------- ----- ------- ---------
Balance at September 30, 2001 $24.2 $1,059.1 $ 227.1 $4,728.8 $(9.2) $ (3.8) $ 6,026.2
===== ======== ========= ======== ===== ======= =========
See notes to condensed consolidated financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
Nine Months Ended September 30
2001 2000
(in millions of dollars)
------------------------------
Net Cash Provided by Operating Activities $ 963.8 $ 897.3
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments 2,029.4 1,529.2
Proceeds from Maturities of Investments 811.8 801.4
Purchase of Investments (4,064.1) (2,977.0)
Net Sales of Short-term Investments 195.8 68.8
Acquisition of Business (10.2) (94.2)
Disposition of Business - (78.2)
Other 21.2 (45.7)
--------- ---------
Net Cash Used by Investing Activities (1,016.1) (795.7)
--------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts 8.1 30.8
Maturities and Benefit Payments from Policyholder Accounts (42.0) (170.4)
Net Short-term Debt and Commercial Paper Repayments (403.4) (53.7)
Issuance of Long-term Debt 575.0 -
Dividends Paid to Stockholders (106.1) (106.5)
Other 15.2 7.7
--------- ---------
Net Cash Provided (Used) by Financing Activities 46.8 (292.1)
--------- ---------
Effect of Foreign Exchange Rate on Cash (1.0) (1.5)
--------- ---------
Net Decrease in Cash and Bank Deposits (6.5) (192.0)
Cash and Bank Deposits at Beginning of Period 107.1 292.4
--------- ---------
Cash and Bank Deposits at End of Period $ 100.6 $ 100.4
========= =========
See notes to condensed consolidated financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 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 of America 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 of America 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 nine month periods ended September 30, 2001, are not necessarily
indicative of the results that may be expected for the year ended December 31,
2001. For further information, refer to the consolidated financial statements
and footnotes thereto included in the Company's annual report on Form 10-K for
the year ended December 31, 2000.
Note 2 - Change in Accounting 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
revised 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
September 30, 2001
Note 2 - Change 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 9. 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
September 30, 2001
Note 2 - Change in Accounting Principles - Continued
During the three month and nine month periods ended September 30, 2001, the
Company recognized net gains of $28.1 million and $70.9 million, respectively,
upon the termination of cash flow hedges and reported $27.5 million and $68.9
million of these gains in other comprehensive income. For the three month and
nine month periods ended September 30, 2001, the Company reported $0.6 million
and $2.0 million, respectively, in operating earnings as realized investment
gains in conjunction with hedges that were terminated.
The Company amortized $2.2 million and $5.6 million of net deferred gains into
earnings during the three and nine month periods ended September 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 $9.0 million. The notional amount outstanding under the hedge
programs was $924.2 million at September 30, 2001, and the fair value of the
derivatives was $123.3 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 nine month periods ended September 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 - Accounting Pronouncements Outstanding
In June 2001, the Financial Accounting Standards Board (FASB) issued Statements
of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and
No. 142 (SFAS 142), Goodwill and Other Intangible Assets. In accordance with
SFAS 142, goodwill will no longer be amortized but will be subject to annual
impairment tests. Other intangible assets will continue to be amortized over
their useful lives.
The Company will adopt the provisions of SFAS 141 and SFAS 142 effective January
1, 2002. Application of the non-amortization provision is expected to increase
2002 earnings $21.3 million before tax and $20.2 million after tax. At the
initial adoption of SFAS 142, the Company will perform the required transitional
goodwill impairment test. Any impairment loss resulting from the transitional
goodwill impairment test will be recognized as the effect of a change in
accounting principle and will be presented as a separate caption, net of tax, in
the consolidated statements of income. The impairment loss, if any, is not
expected to have a material impact on the Company's financial position or
results of operations.
Also in June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143 (SFAS 143), Accounting for Asset Retirement Obligations. SFAS 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. The Company will adopt the provisions of SFAS 143 effective January 1,
2003. The adoption of this pronouncement is not expected to have a material
impact on the Company's financial position or results of operations.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2001
Note 3 - Accounting Pronouncements Outstanding - Continued
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets.
SFAS 144 supercedes Statement of Financial Accounting Standards No. 121 (SFAS
121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30 (APB Opinion 30), Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. Two accounting models existed for long-lived assets to be
disposed of under SFAS 121 and APB Opinion 30. SFAS 144 represents a single
accounting model for long-lived assets to be disposed of by sale. The Company
will adopt the provisions of SFAS 144 effective January 1, 2002. The adoption
of this pronouncement is not expected to have a material impact on the Company's
financial position or results of operations.
Note 4 - 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.
Net income per common share is determined as follows:
Three Months Ended Nine Months Ended
September 30 September 30
2001 2000 2001 2000
( in millions, except share data)
------------------------------------------------------------------
Numerator
Net Income $ 127.1 $ 137.0 $ 455.2 $ 414.6
========== ========== ========== ==========
Denominator (000s)
Weighted Average Common Shares - Basic 242,020.8 240,929.5 241,718.5 240,766.3
Dilutive Securities 1,764.3 1,258.9 1,934.6 982.8
---------- ---------- ---------- ----------
Weighted Average Common Shares -
Assuming Dilution 243,785.1 242,188.4 243,653.1 241,749.1
========== ========== ========== ==========
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 8.3 million and 9.2 million
shares for the three and nine month periods ended September 30, 2001 and 10.3
million and 11.4 million shares for the three and nine month periods ended
September 30, 2000.
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2001
Note 5 - Comprehensive Income
The components of accumulated other comprehensive income, net of deferred tax,
are as follows:
September 30 December 31
2001 2000
(in millions of dollars)
-----------------------------------
Net Unrealized Gain on Securities $164.7 $212.8
Net Gain on Cash Flow Hedges 123.6 -
Foreign Currency Translation Adjustment (61.2) (72.1)
------ ------
Accumulated Other Comprehensive Income $227.1 $140.7
====== ======
In accordance with the adoption of SFAS 133, the Company reclassified within
accumulated other comprehensive income the beginning of the year balance of
$85.8 million of after-tax unrealized gains on derivatives from the net
unrealized gain on securities to the net gain on cash flow hedges.
The components of comprehensive income and the related deferred tax are as
follows:
Three Months Ended Nine Months Ended
September 30 September 30
2001 2000 2001 2000
(in millions of dollars)
---------------------------------------------------------
Net Income $127.1 $137.0 $455.2 $ 414.6
------ ------ ------ -------
Change in Net Unrealized Gain (Loss) on Securities:
Change Before Reclassification Adjustment 200.5 (10.8) 31.1 (99.9)
Reclassification Adjustment for Net Realized
Investment Losses Included in Net Income 9.1 14.0 11.8 12.4
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 81.5 - 58.2 -
Change in Foreign Currency Translation Adjustment (9.6) (15.8) 1.2 (36.3)
------ ------ ------ -------
281.5 (12.6) 125.5 (123.8)
Change in Deferred Tax 102.1 (1.4) 39.1 (38.0)
------ ------ ------ -------
Other Comprehensive Gain (Loss) 179.4 (11.2) 86.4 (85.8)
------ ------ ------ -------
Comprehensive Income $306.5 $125.8 $541.6 $ 328.8
====== ====== ====== =======
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2001
Note 6 - Segment Information
Selected data by segment is as follows:
Three Months Ended Nine Months Ended
September 30 September 30
2001 2000 2001 2000
(in millions of dollars)
---------------------------------------------------------------
Premium Income
Employee Benefits $1,102.9 $1,015.0 $3,236.8 $3,029.1
Individual 454.3 444.9 1,368.7 1,333.7
Voluntary Benefits 198.6 187.6 589.8 554.1
Other 36.4 107.1 113.6 408.4
-------- -------- -------- --------
1,792.2 1,754.6 5,308.9 5,325.3
Net Investment Income and Other Income
Employee Benefits 238.7 211.6 698.4 630.4
Individual 251.5 243.0 752.7 704.7
Voluntary Benefits 32.9 30.2 101.4 89.1
Other 60.1 70.3 199.3 353.8
Corporate 11.1 16.0 32.4 38.6
-------- -------- -------- --------
594.3 571.1 1,784.2 1,816.6
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Employee Benefits 1,341.6 1,226.6 3,935.2 3,659.5
Individual 705.8 687.9 2,121.4 2,038.4
Voluntary Benefits 231.5 217.8 691.2 643.2
Other 96.5 177.4 312.9 762.2
Corporate 11.1 16.0 32.4 38.6
-------- -------- -------- --------
2,386.5 2,325.7 7,093.1 7,141.9
Benefits and Expenses
Employee Benefits 1,215.2 1,103.2 3,552.8 3,306.6
Individual 644.5 615.9 1,898.0 1,819.7
Voluntary Benefits 194.1 182.2 573.1 528.6
Other 82.9 151.5 272.1 689.5
Corporate 47.5 50.4 155.7 150.6
-------- -------- -------- --------
2,184.2 2,103.2 6,451.7 6,495.0
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Employee Benefits 126.4 123.4 382.4 352.9
Individual 61.3 72.0 223.4 218.7
Voluntary Benefits 37.4 35.6 118.1 114.6
Other 13.6 25.9 40.8 72.7
Corporate (36.4) (34.4) (123.3) (112.0)
-------- -------- -------- --------
202.3 222.5 641.4 646.9
Net Realized Investment Losses (9.1) (14.0) (11.8) (12.4)
-------- -------- -------- --------
Income Before Federal Income Taxes 193.2 208.5 629.6 634.5
Federal Income Taxes 66.1 71.5 174.4 219.9
-------- -------- -------- --------
Net Income $ 127.1 $ 137.0 $ 455.2 $ 414.6
======== ======== ======== ========
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2001
Note 7 - 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 have a pending motion seeking a new trial. Notwithstanding the jury
verdict, the judge is obligated to rule separately on the claim that
UnumProvident and its affiliates violated the Massachusetts Consumer Protection
Act. The bench trial for the alleged violation commenced October 16, 2001 and
concluded November 5, 2001 with closing briefs to be submitted to the judge by
December 5, 2001.
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
their complaint seeking a 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 (including the 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, and the arbitration panel awarded the
plaintiffs approximately $0.2 million in compensatory damages with no award for
punitive damages, attorney's fees, or interest. The second arbitration is
tentatively scheduled to be heard before a NASD panel in January 2002. 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.
13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2001
Note 7 - Commitments and Contingent Liabilities - Continued
During September and October 1999, the Company and several of its officers were
named as defendants in five class action lawsuits filed in the United States
District Court for the District of Maine. On January 3, 2000, the Maine
district court appointed a lead class action plaintiff and ordered plaintiffs to
file a consolidated amended complaint. On January 27, 2000, a sixth complaint
against the same defendants was filed in the Southern District of New York. On
March 7, 2000, the sixth action was transferred to the District of Maine, 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. The Company disputes the claims
alleged in the complaint and denies any liability to plaintiffs.
In October 2001, the parties reached an agreement in principle to settle this
litigation. Under the terms of the settlement, which is subject to, among other
things, final documentation and approval by the court, the Company has agreed to
pay $45 million to settle all claims that were or could have been asserted by
the class in the litigation. The parties have agreed that, for purposes of the
settlement only, the litigation may be maintained as a class action on behalf of
all persons who exchanged the stock of Unum or Provident for the common stock of
the Company pursuant to the joint proxy/registration statement or otherwise
acquired Company common stock traceable to the joint proxy/registration
statement on or before August 3, 1999, other than the defendants and their
officers, directors, affiliates, and subsidiaries.
The Company has received confirmation from its insurance carriers that, apart
from a $1 million deductible, the entire amount to be paid under the proposed
settlement, as well as the attorneys' fees and expenses incurred by the Company
defending the litigation, will be covered under the Company's insurance
policies. Management is of the opinion that, if the settlement is finally
approved by the court, this matter will not have any material adverse affect on
the Company's financial position or results of operations.
14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2001
Note 7 - Commitments and Contingent Liabilities - Continued
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.
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 8 - September 11, 2001
The events of September 11, 2001 resulted in a third quarter 2001 before-tax
charge of $24.0 million, or $15.6 million after tax ($0.06 per common share
assuming dilution). This charge includes estimated gross ultimate losses from
reported and unreported claims of $71.0 million less an estimated $47.0 million
recoverable from the Company's reinsurers. The charge does not include any
indirect costs which the Company incurred in developing specialized procedures
for filing claims resulting from the attacks and in providing additional support
to impacted policyholders and group clients. The Company's reinsurance program
provides a significant layer of catastrophic coverage for its individual
disability and its group life, accidental death and dismemberment, travel
accident, long-term disability, and short-term disability lines of business
through a group of highly rated major national and international reinsurance
organizations. Because of the quality and level of the Company's various
reinsurance coverages, the Company does not anticipate that any of its
reinsurers will be unable to cover the claims incurred as a result of the
events. Should this occur, however, all of the Company's insurance subsidiaries
are sufficiently capitalized such that each insurance subsidiary will be able to
satisfy these claims and will face no liquidity or risk-based capital issues.
15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2001
Note 9 - Other
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.
Note 10 - Subsequent Event
On October 31, 2001 the Company redeemed its $172.5 million par value 8.8%
monthly income debt securities (junior subordinated debt), which were due in
2025 but callable at par in 2000 and thereafter. Short-term debt as reported in
the September 30, 2001 condensed consolidated statements of financial condition
reflects the reclassification of these securities from long-term debt. This
early extinguishment of debt will result in a write-off of the remaining
deferred debt costs of approximately $4.5 million associated with the issuance
of the securities. The write-off will be reported as an extraordinary item, net
of a $1.6 million tax benefit, in the fourth quarter of 2001.
16
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 September 30,
2001, the related condensed consolidated statements of income for the three and
nine month periods ended September 30, 2001 and 2000, and the condensed
consolidated statements of stockholders' equity and cash flows for the nine
month periods ended September 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 of America. 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 of
America, 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 of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, 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
November 6, 2001
17
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.
Results of Operations
The events of September 11, 2001 resulted in a third quarter 2001 before-tax
charge of $24.0 million, or $15.6 million after tax. This charge includes
estimated gross ultimate losses from reported and unreported claims of $71.0
million less an estimated $47.0 million recoverable from the Company's
reinsurers. The charge does not include any indirect costs which the Company
incurred in developing specialized procedures for filing claims resulting from
the attacks and in providing additional support to impacted policyholders and
group clients. The Company's reinsurance program provides a significant layer
of catastrophic coverage for its individual disability and its group life,
accidental death and dismemberment, travel accident, long-term disability, and
short-term disability lines of business through a group of highly rated major
national and international reinsurance organizations. Because of the quality
and level of the Company's various reinsurance coverages, the Company does not
anticipate that any of its reinsurers will be unable to cover the claims
incurred as a result of the events. Should this occur, however, all of the
Company's insurance subsidiaries are sufficiently capitalized such that each
insurance subsidiary will be able to satisfy these claims and will face no
liquidity or risk-based capital issues. The effects on each line of business
are disclosed in the following discussion of segment results.
18
During the first quarter of 2001, the Company recognized a tax benefit of $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 June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and
No. 142 (SFAS 142), Goodwill and Other Intangible Assets. In accordance with
SFAS 142, goodwill will no longer be amortized but will be subject to annual
impairment tests. Other intangible assets will continue to be amortized over
their useful lives.
The Company will adopt the provisions of SFAS 141 and SFAS 142 effective January
1, 2002. Application of the non-amortization provision is expected to increase
2002 earnings $21.3 million before tax and $20.2 million after tax. At the
initial adoption of SFAS 142, the Company will perform the required transitional
goodwill impairment test. Any impairment loss resulting from the transitional
goodwill impairment test will be recognized as the effect of a change in
accounting principle and will be presented as a separate caption, net of tax, in
the income statement. The impairment loss, if any, is not expected to have a
material impact on the Company's financial position or results of operations.
At September 30, 2001 the goodwill balance was $678.3 million, and the
amortization expense recorded for the nine months ended September 30, 2001 was
$15.9 million.
19
Consolidated Operating Results
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
--------------------------------------- ---------------------------------------
2001 % Change 2000 2001 % Change 2000
------------- -------------- -------------- -------------
Revenue
Premium Income $ 1,792.2 2.1 % $ 1,754.6 $ 5,308.9 (0.3) % $ 5,325.3
Net Investment Income 515.5 6.9 482.4 1,510.0 (4.3) 1,577.5
Other Income 78.8 (11.2) 88.7 274.2 14.7 239.1
------------- -------------- -------------- -------------
Total Revenue 2,386.5 2.6 2,325.7 7,093.1 (0.7) 7,141.9
------------- -------------- -------------- -------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 1,611.0 3.5 1,556.7 4,700.3 (1.4) 4,767.3
Commissions 191.3 1.4 188.6 586.6 2.4 573.1
Interest and Debt Expense 41.1 (12.9) 47.2 128.1 (5.9) 136.2
Deferral of Policy Acquisition Costs (165.7) 20.0 (138.1) (509.4) 17.4 (433.8)
Amortization of Deferred Policy
Acquisition Costs 105.3 10.6 95.2 316.0 (13.0) 363.4
Amortization of Value of
Business Acquired 12.6 (4.5) 13.2 37.8 1.9 37.1
Amortization of Goodwill 5.3 (5.4) 5.6 15.9 (1.9) 16.2
Operating Expenses 383.3 14.5 334.8 1,176.4 13.6 1,035.5
------------- -------------- -------------- -------------
Total Benefits and Expenses 2,184.2 3.9 2,103.2 6,451.7 (0.7) 6,495.0
------------- -------------- -------------- -------------
Income Before Federal Income
Taxes and Net Realized
Investment Loss 202.3 (9.1) 222.5 641.4 (0.9) 646.9
Federal Income Taxes 69.3 (10.0) 77.0 179.3 (20.2) 224.8
------------- -------------- -------------- -------------
Income Before Net Realized
Investment Loss 133.0 (8.6) 145.5 462.1 9.5 422.1
Net Realized Investment Loss (5.9) 30.6 (8.5) (6.9) 8.0 (7.5)
------------- -------------- -------------- -------------
Net Income $ 127.1 (7.2) $ 137.0 $ 455.2 9.8 $ 414.6
============= ============== ============== =============
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.
20
Employee Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
----------------------------------------- ------------------------------------------
2001 % Change 2000 2001 % Change 2000
-------------- ------------- --------------- --------------
Revenue
Premium Income
Group Long-term Disability $ 541.8 2.8 % $ 527.2 $ 1,605.1 2.8 % $ 1,560.8
Group Short-term Disability 141.4 10.8 127.6 423.5 11.3 380.5
Group Life 349.6 17.3 298.1 995.8 10.4 901.6
Accidental Death &
Dismemberment 49.8 9.9 45.3 152.9 8.9 140.4
Group Long-term Care 20.3 20.8 16.8 59.5 29.9 45.8
-------------- ------------- --------------- --------------
Total Premium Income 1,102.9 8.7 1,015.0 3,236.8 6.9 3,029.1
Net Investment Income 192.7 10.8 173.9 565.5 9.0 518.7
Other Income 46.0 22.0 37.7 132.9 19.0 111.7
-------------- ------------- --------------- --------------
Total Revenue 1,341.6 9.4 1,226.6 3,935.2 7.5 3,659.5
-------------- ------------- --------------- --------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 927.8 9.8 844.7 2,694.1 6.8 2,523.1
Commissions 85.2 5.8 80.5 257.5 3.8 248.0
Deferral of Policy Acquisition Costs (69.7) 33.8 (52.1) (215.0) 25.2 (171.7)
Amortization of Deferred Policy
Acquisition Costs 39.0 18.9 32.8 120.2 2.1 117.7
Amortization of Value of
Business Acquired 0.5 (16.7) 0.6 1.5 (16.7) 1.8
Operating Expenses 232.4 18.1 196.7 694.5 18.2 587.7
-------------- ------------- --------------- --------------
Total Benefits and Expenses 1,215.2 10.2 1,103.2 3,552.8 7.4 3,306.6
-------------- ------------- --------------- --------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 126.4 2.4 $ 123.4 $ 382.4 8.4 $ 352.9
============== ============= =============== ==============
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.
The Company implemented new internal guidelines in the first quarter of 2001 for
reporting its submitted date basis sales for the Employee Benefits segment lines
of business. The purpose was to better match its reported sales results with
reported premium growth and ensure consistency of quarterly sales reporting.
Under the new reporting guidelines, if a submitted sale is to be included in the
current quarter reporting period, the effective date of the submitted sale
cannot go beyond one month and one day after the last day of the current
quarter. This new guideline results in a shift in the historical quarterly
sales pattern but has no impact on reported premium income or reported effective
date basis sales. There were no material differences during the first and
second quarters of 2001 or 2000 in the old basis and new basis of reporting
submitted sales. However, third quarter of 2000 reported several large sales
that under the new basis would have been reported as submitted in the fourth
quarter of 2000. Sales reported on the following page reflect these new
guidelines and also show the 2000 submitted sales under the old basis for
comparative purposes.
21
Sales
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
----------------------------------------- ------------------------------------------
2001 % Change 2000 2001 % Change 2000
-------------- ------------- --------------- --------------
Sales - Submitted Date New Basis
Long-term Disability $ 53.9 (4.4)% $ 56.4 $ 196.7 10.0 % $ 178.8
Short-term Disability 25.1 32.8 18.9 91.3 38.5 65.9
Life 36.6 (5.7) 38.8 177.6 59.6 111.3
AD&D and Long-term Care 13.5 - 13.5 46.9 0.4 46.7
-------------- ------------- --------------- --------------
Total $ 129.1 1.2 $ 127.6 $ 512.5 27.3 $ 402.7
============== ============= =============== ==============
Sales - Submitted Date Old Basis
Long-term Disability N/A $ 100.7 N/A $ 232.4
Short-term Disability N/A 35.2 N/A 87.1
Life N/A 80.8 N/A 189.8
AD&D and Long-term Care N/A 16.0 N/A 51.2
------------- --------------
Total N/A $ 232.7 N/A $ 560.5
============= ==============
Sales - Effective Date Basis
Long-term Disability $ 68.9 6.3 % $ 64.8 $ 296.2 12.7 % $ 262.8
Short-term Disability 33.9 50.7 22.5 149.7 39.9 107.0
Life 99.2 121.4 44.8 336.4 81.6 185.2
AD&D and Long-term Care 20.7 21.1 17.1 66.8 (0.3) 67.0
-------------- ------------- --------------- --------------
Total $ 222.7 49.3 $ 149.2 $ 849.1 36.5 $ 622.0
============== ============= =============== ==============
N/A = not applicable
The Company has adjusted its focus to integrated selling that combines long-term
disability, short-term disability, and group life products. During the first
nine months of 2001, 28 percent of all new sales included long-term disability,
short-term disability, and group life combined coverage. This compares to 30
percent and 24 percent, as restated for the new reporting guidelines on
submitted date sales, for the first nine months of 2000 and 1999, respectively.
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 policy acquisition costs.
Persistency during the third and first quarters of 2001 for group disability,
group life, and accidental death and dismemberment products was unfavorable for
certain issue years when compared to the persistency expected at the time the
business was written, resulting in additional amortization of $8.5 million and
$20.3 million, respectively, or $28.8 million year-to-date. The majority of the
unfavorable persistency occurred in more recently issued business, which has
higher associated unamortized deferred policy acquisition costs. There was no
additional amortization for persistency during the second quarter of 2001. The
additional amortization related to persistency in the third, second, and first
quarters of 2000 was $5.7 million, $7.3 million, and $18.6 million,
respectively, for a year-to-date adjustment of $31.6 million. It is expected
that persistency for the foreseeable future may continue to be lower than
historical levels. The Company's 2001 renewal program has generally been
successful at retaining business that is relatively more profitable than
business that
22
terminated. It is expected that the additional premium and related profits
associated with renewal activity will emerge throughout 2001 and 2002. 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 $38.5 million in the third
quarter of 2001 compared to $31.9 million in the third quarter of 2000. On a
year-to-date basis, revenue was $112.6 million in 2001 and $93.6 million in
2000.
Group Disability
Group disability revenue was $844.0 million in the third quarter of 2001
compared to $803.5 million in the third quarter of 2000. For the first nine
months, group disability revenue was $2,497.0 million in 2001 compared to
$2,389.5 million in 2000.
Group disability reported income of $79.1 million for the third quarter of 2001
compared to $72.7 million for the third quarter of 2000. Positive impacts on
income were a $40.5 million revenue increase and an improvement in the benefit
ratio. The commission ratio also improved relative to the third quarter of
2000. Negatively impacting income was an increase in the operating expense
ratio in the third quarter of 2001 compared to the third quarter of 2000 and the
full year 2000. The third quarter 2001 results include $7.3 million of
additional amortization necessitated by the higher level of group long-term and
short-term disability terminations experienced during the third quarter relative
to that which was expected at the time the business was written. The additional
amortization during the third quarter of 2000 was $3.7 million.
Group disability third quarter and nine month results include $7.3 million for
losses related to the September 11, 2001 events. Estimated gross ultimate
losses from reported and unreported claims are $15.0 million less an estimated
$7.7 million recoverable from the Company's reinsurers.
Group disability reported income of $256.1 million for the nine months of 2001
compared to $196.0 million for the same period of 2000. Positive impacts on
income were a $107.5 million revenue increase and an improvement in the benefit
ratio. The commission ratio also decreased relative to the first nine months of
2000, but the operating expense ratio increased over the prior year nine months.
The nine month 2001 results include $19.3 million of additional amortization for
persistency compared to $23.3 million during the first nine months of 2000. For
both 2001 and 2000, the disability business retained is relatively more
profitable than the business that terminated.
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.
The fundamentals underlying risk results in the group disability line continue
to exhibit overall improvement in 2001, as demonstrated by the lower benefit
ratios for third quarter and year-to-date. Claim recovery rates continue to be
above historical levels. However, both submitted and paid claim incidence for
long-term disability have increased over recent quarters, with a portion of the
increase attributable to industries impacted by the weaker economy. For short-
term disability, the average claim duration has increased from the second
quarter of 2001, but is slightly lower than the third quarter of 2000.
Submitted incidence for short-term disability was down from both the second
quarter of 2001 and the prior year third quarter. Offsetting these positive
trends, the average weekly indemnity continues to increase.
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.
23
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 $44.1 million in the third quarter of 2001 compared to $48.1 million
in the third quarter of 2000. For the first nine months, these three lines of
business reported income of $116.2 million in 2001 compared to $149.7 million in
2000. Included in the 2001 third quarter and nine months income is additional
benefit expense of $6.7 million related to the September 11, 2001 events.
Group life, accidental death and dismemberment, and long-term care reported an
increase in revenue for the third quarter and nine 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 third quarter and nine months of 2001 includes $1.2 million and $9.5
million, respectively, of additional amortization due to the higher level of
terminations for group life and accidental death and dismemberment products
experienced than expected at the time the policies were written. The
unfavorable year-to-date variance of actual to expected terminations occurred
primarily in the group life product line. The additional amortization during
the third quarter and first nine months of 2000 was $2.0 million and $8.3
million, respectively.
Group life reported an increase in the benefit ratio for the third quarter and
nine months of 2001 compared to the prior year periods, but the ratio was lower
than the second quarter of 2001. The decrease from the second quarter of 2001
was due to lower paid claim incidence, although paid claim incidence was higher
than the third quarter of 2000 and continues to be above historical rates. The
average paid claim size has also increased compared to the second quarter of
2001 but is down slightly from the prior year third quarter. Waiver incidence
continues to be above historical levels and has increased from the second
quarter of 2001. The claim recovery rate on waiver claims has increased,
somewhat mitigating the impact of the increase in waiver incidence.
Group life third quarter benefits include estimated gross ultimate losses from
reported and unreported claims of $16.0 million less an estimated $13.0 million
recoverable from the Company's reinsurers, for a net increase in benefits of
$3.0 million related to the September 11, 2001 events.
The Company has implemented several actions in the group life line of business,
including tighter underwriting guidelines and pricing changes, and is developing
case specific remedial plans for under 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 third quarter benefit ratio for accidental death and dismemberment is
higher than the second quarter of 2001 and has also increased from the prior
year third quarter. For the nine 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 an increase in
the benefit ratio for the third quarter of 2001 compared to the second quarter
of 2001. The increase resulted from an increase in submitted claim incidence
and a decrease in the claim recovery rate. During the first nine months of
2001, the incidence rates for both submitted and paid claims decreased from that
experienced during the first nine months of 2000.
Third quarter and nine month results for accidental death and dismemberment
include estimated gross ultimate losses of $25.0 million less estimated
reinsurance recoverables of $21.3 million, for a net increase in benefits of
$3.7 million related to the September 11, 2001 events. These losses relate to
both accidental death and dismemberment and travel accident coverages.
Excluding these losses, the third quarter 2001 benefit ratio is slightly lower
than the second quarter of 2001 and the prior year third quarter.
24
Individual Segment Operating Results
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
--------------------------------------- ------------------------------------------
2001 % Change 2000 2001 % Change 2000
------------- ----------- -------------- --------------
Revenue
Premium Income
Individual Disability $ 407.4 (0.8)% $ 410.6 $ 1,238.6 - % $ 1,238.2
Individual Long-term Care 46.9 36.7 34.3 130.1 36.2 95.5
------------- ----------- -------------- --------------
Total Premium Income 454.3 2.1 444.9 1,368.7 2.6 1,333.7
Net Investment Income 235.3 12.0 210.0 684.0 10.1 621.0
Other Income 16.2 (50.9) 33.0 68.7 (17.9) 83.7
------------- ----------- -------------- --------------
Total Revenue 705.8 2.6 687.9 2,121.4 4.1 2,038.4
------------- ----------- -------------- --------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 492.6 5.4 467.4 1,434.9 4.3 1,376.3
Commissions 64.3 (0.3) 64.5 192.5 (0.1) 192.7
Deferral of Policy Acquisition Costs (52.3) 8.5 (48.2) (161.8) 9.0 (148.4)
Amortization of Deferred Policy
Acquisition Costs 26.8 22.4 21.9 78.5 18.2 66.4
Amortization of Value of
Business Acquired 11.5 (0.9) 11.6 34.6 8.1 32.0
Operating Expenses 101.6 2.9 98.7 319.3 6.2 300.7
------------- ----------- -------------- --------------
Total Benefits and Expenses 644.5 4.6 615.9 1,898.0 4.3 1,819.7
------------- ----------- -------------- --------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 61.3 (14.9) $ 72.0 $ 223.4 2.1 $ 218.7
============= =========== ============== ==============
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 $35.3
million in the third quarter of 2001 compared to $27.5 million in the third
quarter of 2000. On a year-to-date basis, new annualized sales were $103.0
million in 2001 and $83.7 million in 2000. The Company developed a new
individual disability product portfolio that was released for sale in approved
states early in the fourth quarter of 2000. 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 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 individual disability business continues to be stable.
Revenue was $651.4 million for the third quarter of 2001 compared to $649.0
million in the same period of 2000. Income in the individual disability line
of business was $56.7 million in the third quarter of 2001, a decrease of 18.1
percent over the prior year third quarter. Included in the third quarter
results was $15.0 million of estimated gross ultimate losses related to the
September 11, 2001 events, less an estimated recoverable from reinsurers of $5.0
million. Excluding these loss estimates, income in the second quarter of 2001
decreased 3.6 percent over the prior year comparable quarter.
25
The benefit ratio for the third quarter of 2001 was higher than the third
quarter of 2000 as well as the first and second quarters of 2001. The interest
adjusted loss ratio was 65.4 percent and 63.2 percent for the third quarter of
2001 and 2000, respectively. Submitted claim incidence increased from the first
and second quarters of 2001 and is higher than recent historical incidence.
Paid incidence has also increased relative to the first and second quarters of
2001 as well as the third quarter of 2000. The claim recovery rate for the
third quarter of 2001 is comparable 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 third quarter 2001 as compared to
third quarter 2000, but the operating expense ratio increased.
For the first nine months, revenue was $1,969.2 million in 2001 and $1,929.8
million in 2000. Income was $213.8 million in 2001 compared to $211.2 million
in 2000. The benefit ratio increased from the prior year comparable period due
to an increase in both submitted and paid incidence. The interest adjusted loss
ratio was 63.0 percent and 62.7 percent for the nine months of 2001 and 2000,
respectively.
Individual Long-term Care
The individual long-term care line of business reported increased premium income
for the third quarter of 2001 compared to the same period of 2000, primarily due
to new sales growth. New annualized sales for long-term care were $13.1 million
for the third quarter of 2001 and $38.6 million for the first nine months. For
the comparable periods of 2000, new sales were $11.8 million and $33.3 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 $4.6 million for
the third quarter of 2001 compared to $2.8 million for the same period of 2000,
primarily due to an increase in revenue and an improvement in the commission and
operating expense ratios. The benefit ratio increased when compared to the
second quarter of 2001 and the third quarter of 2000. The increase over the
prior year third quarter resulted from an increase in both submitted and paid
claim incidence and a decrease in the claim recovery rate. Incidence rates for
submitted and paid claims were lower than the second quarter of 2001, but the
claim recovery rate decreased.
For the first nine months, income in the individual long-term care line of
business was $9.6 million in 2001 compared to $7.5 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.
26
Voluntary Benefits Segment Operating Results
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
------------------------------------------ ----------------------------------------
2001 % Change 2000 2001 % Change 2000
--------------- ------------ ------------- -------------
Revenue
Premium Income $ 198.6 5.9 % $ 187.6 $ 589.8 6.4 % $ 554.1
Net Investment Income 31.5 10.1 28.6 93.2 10.7 84.2
Other Income 1.4 (12.5) 1.6 8.2 67.3 4.9
--------------- ------------ ------------- -------------
Total Revenue 231.5 6.3 217.8 691.2 7.5 643.2
--------------- ------------ ------------- -------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 124.1 6.9 116.1 363.7 8.4 335.5
Commissions 43.2 6.9 40.4 131.4 19.5 110.0
Deferral of Policy Acquisition Costs (43.6) 16.0 (37.6) (132.4) 20.7 (109.7)
Amortization of Deferred Policy
Acquisition Costs 31.6 8.6 29.1 93.2 10.4 84.4
Amortization of Value of
Business Acquired 0.6 - 0.6 1.7 - 1.7
Operating Expenses 38.2 13.7 33.6 115.5 8.2 106.7
--------------- ------------ ------------- -------------
Total Benefits and Expenses 194.1 6.5 182.2 573.1 8.4 528.6
--------------- ------------ ------------- -------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 37.4 5.1 $ 35.6 $ 118.1 3.1 $ 114.6
=============== ============ ============= =============
The Voluntary Benefits segment includes the results of products sold to
employees through payroll deduction at the workplace. These products include
life insurance and health products, primarily disability, accident and sickness,
and cancer.
Revenue in the Voluntary Benefits segment increased to $231.5 million in the
third quarter of 2001 from $217.8 million in the third 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 third quarter of 2001 were
$66.4 million, an increase of 15.9 percent over the comparable prior year
period. For the first nine months, sales were $198.8 million in 2001 and $178.9
million in 2000. Management continues its efforts to increase sales through the
sales initiatives discussed under "Employee Benefits Segment Operating Results."
For both the third quarter and nine 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 for both the third quarter and year-to-date relative to 2000,
with an improvement in overall claims experience. The disability product line
benefit ratio for the nine months of 2001 was essentially flat with the prior
year, but the third quarter increased slightly over the previous quarters of
2001. The average disability claim payment increased, but the incidence rate
was lower. The benefit ratio for the cancer line was higher than the third
quarter and nine months of 2000 due to an increase in claim incidence and the
average claim size. 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.
During the third quarter of 2001, the Company signed a letter of intent to
reinsure on a 100 percent indemnity coinsurance basis certain cancer policies
written by the Company's subsidiary, Colonial Life & Accident Insurance Company.
The transaction, which is subject to customary closing conditions, is expected
to close by year-end with an effective date of November 1, 2001.
27
Other Segment Operating Results
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
------------------------------------------- -----------------------------------------
2001 % Change 2000 2001 % Change 2000
--------------- ------------ -------------- ------------
Revenue
Premium Income $ 36.4 (66.0)% $ 107.1 $ 113.6 (72.2)% $ 408.4
Net Investment Income 50.8 (17.5) 61.6 154.1 (53.5) 331.1
Other Income 9.3 6.9 8.7 45.2 99.1 22.7
--------------- ------------ -------------- ------------
Total Revenue 96.5 (45.6) 177.4 312.9 (58.9) 762.2
--------------- ------------ -------------- ------------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 66.5 (48.2) 128.5 207.6 (61.0) 532.4
Other Expenses 16.4 (28.7) 23.0 64.5 (58.9) 157.1
--------------- ------------ -------------- ------------
Total Benefits and Expenses 82.9 (45.3) 151.5 272.1 (60.5) 689.5
--------------- ------------ -------------- ------------
Income Before Federal Income
Taxes and Net Realized
Investment Gain (Loss) $ 13.6 (47.5) $ 25.9 $ 40.8 (43.9) $ 72.7
=============== ============ ============== ============
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. Certain of the
Company's insurance subsidiaries received regulatory approval and closed the
approved transactions during the 2000 third quarter, with reserves of
approximately $3.0 billion ceded to the reinsurer. The Company recognized a
third quarter 2000 before-tax realized investment loss of $19.0 million on the
fixed maturity securities transferred to the reinsurer and retrospectively
adjusted deferred policy acquisition costs related to interest-sensitive
individual life policies with a $9.4 million credit to amortization to reflect
investment experience.
The reinsurance transaction resulted in a decrease in individual life and
corporate-owned life third quarter and nine month revenue and income in 2001
relative to the comparable periods of 2000. Total revenue and income were $9.0
million and $13.2 million, respectively, in the third quarter of 2001 compared
to $20.4 million in revenue and $17.3 million in income for the same period of
2000. Revenue and income decreased $204.2 million and $20.2 million,
respectively, in 2001 year-to-date compared to the first nine months of 2000.
Reinsurance Pools and Management
The Company's reinsurance operations include the reinsurance management
operations of Duncanson & Holt, Inc. and its subsidiaries 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
28
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.
During the third quarter of 2001, the Company signed a letter of intent with ACE
Tempest Life Reinsurance Ltd. (ACE), a Bermuda-based reinsurance subsidiary of
ACE Limited. ACE has agreed to reinsure 100 percent of the Company's group
disability reinsurance reserves and all future business underwritten and managed
by Duncanson and Holt Services, Inc., a subsidiary of Duncanson & Holt, Inc.
The transaction, which is subject to customary closing conditions, is expected
to close by year-end with an effective date of January 1, 2001. The Company
also intends to sell the reinsurance management operations of Duncanson and Holt
Services, Inc. and divest the remaining assets of that facility in a transaction
expected to be completed during the fourth quarter of 2001.
The reinsurance pools and management operations reported a loss of $1.3 million
in the third quarter of 2001 and income of $3.0 million for the comparable
period of 2000. On a year-to-date basis, income was $1.9 million in 2001
compared to $2.6 million in 2000. Premium income for the third quarter of 2001
was $24.0 million compared to $91.2 million in the third quarter of 2000.
Through September, premium income was $75.6 million in 2001 and $307.5 million
in 2000.
Corporate Segment Operating Results
Revenue in the Corporate segment was $11.1 million in the third quarter of 2001
and $16.0 million in the third quarter of 2000. Interest and debt expense was
$41.1 million in the third quarter of 2001 compared to $47.2 million for the
third quarter of 2000. The amortization of goodwill was $5.3 million in the
third quarter of 2001 and $5.6 million in the comparable period of 2000.
For the first nine months, revenue was $32.4 million and $38.6 million in 2001.
Interest and debt expense was $128.1 million in 2001 compared to $136.2 million
for 2000, and the amortization of goodwill was $15.9 million and $16.2 million.
The Corporate segment reported a loss of $36.4 million and $123.3 million for
the third quarter and nine months of 2001 compared to a loss of $34.4 million
and $112.0 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, third quarter 2001 net investment income increased 10.4 percent over
the previous year third quarter. The overall yield in the portfolio remains
relatively stable at 8.05 percent as of the end of the third quarter of 2001.
The Company is actively marketing its real estate investments and presently
evaluating the possible sale of all or a portion of the mortgage loan portfolio
for replacement with longer duration securities.
29
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 reinsured with third party
reinsurers as of September 30, 2001 and December 31, 2000, respectively, and the
investment income thereon is no longer included in income.
September 30 December 31
2001 2000
------------ -----------
Investment-Grade Fixed Maturity Securities 80.2% 78.3%
Below-Investment-Grade Fixed Maturity Securities 6.9 6.6
Equity Securities - 0.1
Mortgage Loans 3.5 4.3
Real Estate 0.2 0.4
Policy Loans 8.8 9.1
Other Invested Assets 0.4 1.2
----- -----
Total 100.0% 100.0%
===== =====
Fixed Maturity Securities
The Company's investment in mortgage-backed securities, on an amortized cost
basis, was approximately $3.8 billion and $3.5 billion at September 30, 2001 and
December 31, 2000, respectively. At September 30, 2001, the mortgage-backed
securities had an average life of 10.8 years and effective duration of 9.2
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
September 30, 2001, was $1,965.3 million, representing 7.5 percent of invested
assets excluding policy loans ceded to reinsurers, 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. The secondary market for certain below-investment-grade
issues can also 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 $998.4 million and $1,135.6 million at
September 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 nine 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 September 30, 2001, and December 31, 2000, impaired loans totaled $13.2
million and $17.7 million, respectively. Included in the impaired loans at
September 30, 2001 were $6.5 million of loans which had a related, specific
investment valuation allowance of $2.4 million and $6.7 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.
30
Restructured mortgage loans totaled $5.8 million and $8.5 million at September
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 nine and twelve month periods ended
September 30, 2001, and December 31, 2000.
Real estate was $59.9 million and $116.7 million at September 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 $7.6 million at September 30, 2001, and
$18.3 million at December 31, 2000.
The Company uses a comprehensive rating system to evaluate the investment and
credit risk of each mortgage loan and to identify specific properties for
inspection and reevaluation. The Company establishes an investment valuation
allowance for mortgage loans based on a review of individual loans and the
overall loan portfolio, considering the value of the underlying collateral.
Investment valuation allowances for real estate held for sale are established
based on a review of specific assets. If a decline in value of a mortgage loan
or real estate investment is considered to be other than temporary or if the
asset is deemed permanently impaired, the investment is reduced to estimated net
realizable value, and the reduction is recorded as a realized investment loss.
Management monitors the risk associated with these invested asset portfolios and
regularly reviews and adjusts the investment valuation allowance. As a result
of management's most recent review of the overall mortgage loan portfolio and
based on management's expectation that delinquencies and problem loans will
remain low, the valuation allowance on mortgage loans was reduced $5.5 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
September 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 $145.9 million at
September 30, 2001, or 0.6 percent of invested assets excluding policy loans
ceded to reinsurers. These non-current investments are foreclosed real estate
held for sale and fixed income securities and mortgage loans 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.
31
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 $963.8 million for the
nine months ended September 30, 2001, as compared to $897.3 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 September 30, 2001, the Company had short-term and long-term debt totaling
$172.5 million and $2,016.8 million, respectively. At September 30, 2001,
approximately $550.2 million was available for additional financing under the
Company's revolving credit facilities. The debt to total capital ratio was 30.3
percent at September 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. The 364-day portion of the credit facilities was renewed as of
October 30, 2001.
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.
On October 31, 2001 the Company redeemed its $172.5 million par value 8.8%
monthly income debt securities (junior subordinated debt), which were due in
2025 but callable at par in 2000 and thereafter. Short-term debt reported as of
September 30, 2001 reflects the reclassification of these securities from long-
term debt.
32
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 a- (Strong)
Credit Quality)
- -----------------------------------------------------------------------------------------------------------------------------
Junior Subordinated Debt BBB (Good) Baa2 (Medium Grade) BBB+ (Good bbb+ (Adequate)
Credit Quality)
- -----------------------------------------------------------------------------------------------------------------------------
Commercial Paper A-2 (Good) Prime-2 (Strong F2 (Good AMB-2
Ability) Credit Quality) (Acceptable)
- -----------------------------------------------------------------------------------------------------------------------------
U.S. Insurance Subsidiaries
- -----------------------------------------------------------------------------------------------------------------------------
Provident Life & Accident AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Provident Life & Casualty Not Rated Not Rated Not Rated A (Excellent)
- -----------------------------------------------------------------------------------------------------------------------------
Unum Life of America AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
First Unum Life AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Colonial Life & Accident AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Life AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- -----------------------------------------------------------------------------------------------------------------------------
Paul Revere Variable AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
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 nine months of 2001, there was
no substantive change to the Company's market risk or the management of such
risk.
33
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
Exhibit 12.1 Statement Regarding Computation of Ratio of Earnings to Fixed
Charges
Exhibit 12.2 Statement Regarding Computation of Ratio of Earnings to
Combined Fixed Charges and Preferred Stock Dividends
Exhibit 15 Letter re: Unaudited interim financial information
(b) Reports on Form 8-K
Form 8-K filed on August 7, 2001, reporting second quarter 2001 financial
results.
34
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: November 13, 2001 /s/ J. Harold Chandler
-----------------------------------------
J. Harold Chandler
Chairman, President, and Chief Executive
Officer
Date: November 13, 2001 /s/ Thomas R. Watjen
-----------------------------------------
Thomas R. Watjen
Executive Vice President, Finance and
Risk Management
35