Exhibit (13)
Portions of the Annual Report to Stockholders for year ended December 31,
1996
(attached)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(in millions of dollars, except share data) 1996 1995 1994 1993 1992
- -------------------------------------------- ------------ ------------ ------------ ------------ ------------
STATEMENT OF OPERATIONS DATA
Premium Income $ 1,175.7 $ 1,251.9 $ 1,382.6 $ 1,400.2 $ 1,490.7
Net Investment Income 1,090.1 1,221.3 1,238.6 1,318.7 1,241.8
Net Realized Investment Gains (Losses) (8.6) (31.7) (30.1) 43.6 (30.8)
Other Income 34.7 113.8 171.1 175.5 165.0
----------- ----------- ----------- ----------- -----------
Total Revenue 2,291.9 2,555.3 2,762.2 2,938.0 2,866.7
Benefits and Changes in Reserves 1,661.2 1,904.6 1,981.2 2,502.8 2,102.6
Operating Expenses 404.5 474.7 580.1 575.3 584.3
----------- ----------- ----------- ----------- -----------
Income (Loss) Before Federal Income Taxes 226.2 176.0 200.9 (140.1) 179.8
Federal Income Taxes (Credit) 80.6 60.4 65.6 (58.9) 67.2
----------- ----------- ----------- ----------- -----------
Net Income (Loss) $ 145.6 $ 115.6 $ 135.3 $ (81.2) $ 112.6
=========== =========== =========== =========== ===========
Net Income (Loss) Per Common Share $ 2.92 $ 2.27 $ 2.71 $ (2.03) $ 2.49
=========== =========== =========== =========== ===========
Weighted Average Common Shares Outstanding 45,522,417 45,381,373 45,311,053 45,200,914 45,175,980
=========== =========== =========== =========== ===========
Assets $ 14,992.5 $ 16,301.3 $ 17,149.9 $ 16,891.9 $ 15,925.1
Long-term Debt Including Capital Lease Obligations $ 200.0 $ 200.0 $ 202.5 $ 247.6 $ 206.2
Stockholders' Equity $ 1,738.6 $ 1,652.3 $ 1,169.1 $ 1,401.6 $ 1,387.5
Stockholders' Equity Per Common Share $ 34.68 $ 32.95 $ 22.33 $ 27.51 $ 30.74
Stockholders' Equity Per Common Share Excluding SFAS
115 Adjustment(1) $ 32.69 $ 30.65 $ 28.91 $ 27.51 $ 30.74
Dividends Per Common Share $ .72 $ .72 $ 1.04 $ 1.04 $ 1.00
Life Insurance Sales (Amount of Insurance) $ 14,777.4 $ 10,204.7 $ 8,332.5 $ 7,819.3 $ 5,964.0
Life Insurance in Force (Amount of Insurance) $ 102,664.5 $ 98,952.6 $ 86,785.6 $ 83,293.9 $ 80,893.3
(1) Adoption of Statement of Financial Accounting Standards No. 115
effective January 1, 1994.
CONSOLIDATED STATEMENTS OF INCOME BY SEGMENT
Year Ended December 31 1996 1995 1994
--------- -------- --------
(in millions of dollars)
Premium Income
Individual Life and Disability $646.3 $647.4 $644.9
Employee Benefits 501.4 485.9 465.6
Other Operations 28.0 118.6 272.1
------- ------- -------
1,175.7 1,251.9 1,382.6
Net Investment Income and Other Income
Individual Life and Disability 401.3 371.9 311.7
Employee Benefits 104.7 96.8 89.7
Other Operations 618.8 866.4 1,008.3
------- ------- -------
1,124.8 1,335.1 1,409.7
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Individual Life and Disability 1,047.6 1,019.3 956.6
Employee Benefits 606.1 582.7 555.3
Other Operations 646.8 985.0 1,280.4
------- ------- -------
2,300.5 2,587.0 2,792.3
Benefits and Expenses
Individual Life and Disability 930.3 982.8 903.4
Employee Benefits 549.8 534.1 483.5
Other Operations 585.6 862.4 1,174.4
------- ------- -------
2,065.7 2,379.3 2,561.3
Income Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Individual Life and Disability 117.3 36.5 53.2
Employee Benefits 56.3 48.6 71.8
Other Operations 61.2 122.6 106.0
------- ------- -------
234.8 207.7 231.0
Net Realized Investment Losses (8.6) (31.7) (30.1)
------- ------- -------
Income Before Federal Income Taxes 226.2 176.0 200.9
Federal Income Taxes 80.6 60.4 65.6
------- ------- -------
Net Income $145.6 $115.6 $135.3
======= ======= =======
OPERATING RESULTS
Revenue excluding net realized investment gains and losses (hereinafter
"revenue") declined $286.5 million in 1996, or 11.1 percent, to $2.30 billion in
1996 from $2.59 billion in 1995. Revenue includes premium income, net
investment income, and other income. This decline resulted from decreased
revenue in the Other Operations segment ($338.2 million). This decline was
partly offset by increased revenue in the Individual Life and Disability segment
($28.3 million) and Employee Benefits segment ($23.4 million).
In 1995, revenue declined $205.3 million, or 7.4 percent, to $2.59 billion
from $2.79 billion in 1994. This decline resulted from decreased revenue in the
Other Operations segment ($295.4 million). This decline was partly offset by
increased revenue in the Individual Life and Disability segment ($62.7 million)
and Employee Benefits segment ($27.4 million).
Income before net realized investment gains and losses and federal income
taxes (hereinafter "income") increased $27.1 million, or 13.0 percent, to $234.8
million in 1996 from $207.7 million in 1995. The increase resulted from higher
income in the Individual Life and Disability segment ($80.8 million) and
Employee Benefits segment ($7.7 million). These increases were partly offset by
decreased income in the Other Operations segment ($61.4 million).
In 1995, income was $207.7 million, compared to $231.0 million in 1994.
The decline resulted from decreased income in the Employee Benefits segment
($23.2 million) and Individual Life and Disability segment ($16.7 million).
These declines were only partly offset by increased income in the Other
Operations segment ($16.6 million).
Net income totaled $145.6 million in 1996, compared to $115.6 million in
1995 and $135.3 million in 1994. Net realized investment losses after federal
income taxes were $5.4 million in 1996, $20.7 million in 1995, and $22.5 million
in 1994.
INDIVIDUAL LIFE AND DISABILITY OPERATING RESULTS
Revenue in the Individual Life and Disability segment increased $28.3
million, or 2.8 percent, to $1,047.6 million in 1996 from $1,019.3 million in
1995. Net investment income increased $32.3 million, or 8.9 percent, to $393.6
million in 1996 from $361.3 million in 1995. This increase was primarily the
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INDIVIDUAL LIFE AND DISABILITY OPERATING RESULTS
Year Ended December 31 1996 1995 1994
---------- ----------- ---------
(in millions of dollars)
REVENUE EXCLUDING NET REALIZED INVESTMENT GAINS
Premium Income
Individual Disability Income $582.8 $584.5 $578.7
Individual Life and Annuities 63.5 62.9 66.2
------- -------- ------
Total Premium Income 646.3 647.4 644.9
Net Investment Income 393.6 361.3 302.4
Other Income 7.7 10.6 9.3
------- -------- ------
TOTAL 1,047.6 1,019.3 956.6
------- -------- ------
BENEFITS AND EXPENSES
Policy and Contract Benefits 477.1 443.7 381.3
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 220.5 303.6 297.6
Amortization of Deferred Policy Acquisition Costs 55.6 59.0 53.0
Other Expenses 177.1 176.5 171.5
------- -------- ------
TOTAL 930.3 982.8 903.4
------- -------- ------
INCOME BEFORE NET REALIZED INVESTMENT
GAINS AND FIT 117.3 36.5 53.2
NET REALIZED INVESTMENT GAINS 8.5 4.7 5.8
------- -------- ------
INCOME BEFORE FIT $125.8 $41.2 $59.0
======= ======== ======
SALES - ANNUALIZED NEW PREMIUMS
Individual Disability Income $45.1 $55.2 $65.0
Individual Life $6.7 $7.1 $9.2
DEPOSITS - DEFERRED ANNUITIES $21.2 $82.4 $141.8
LIFE INSURANCE IN FORCE $12,585.2 $12,709.1 $12,683.6
result of an increased allocation of capital to the individual disability income
line of business. Premium income in this segment declined $1.1 million or 0.2
percent, to $646.3 million in 1996 from $647.4 million in 1995. In the
individual disability income line of business, premium income declined $1.7
million, or 0.3 percent, to $582.8 million in 1996 from $584.5 million in 1995.
In the individual life line of business, premium income increased $0.4 million,
or 0.6 percent, to $63.3 million in 1996 from $62.9 million in 1995.
In 1995, revenue in the Individual Life and Disability segment increased
$62.7 million, or 6.6 percent, to $1,019.3 million from $956.6 million in 1994.
This increase was primarily the result of higher net investment income. Net
investment income in this segment increased $58.9 million, or 19.5 percent, due
to an increased allocation of capital to the individual disability income line
of business and higher investment income from the individual annuity line of
business. Premium income in this segment increased $2.5 million to $647.4
million in 1995 from $644.9 million in 1994. In the individual disability
income line, premium income was $584.5 million in 1995, compared to $578.7
million in 1994, while the individual life line of business experienced a
decline in premium income from $66.2 million in 1994 to $62.9 million in 1995.
In November 1994, the Company announced its intention to discontinue
selling individual noncancelable disability contracts with long-term own-
occupation provisions (other than conversion policies available under existing
contractual arrangements). The Company is focusing on replacing the traditional
noncancelable long-term own-occupation contracts with "loss of earnings"
contracts which insure income rather than occupation. During the transition to
the new products, revenue in this line was expected to decline as a result of a
period of lower premiums associated with the new products. The magnitude and
duration of the expected decline are dependent on the response of customers and
competitors in the industry. In 1996, annualized new premiums for individual
disability income declined $10.1 million, or 18.3 percent, to $45.1 million,
from $55.2 million in 1995. In the second half of 1996, annualized new premiums
totaled $24.6 million compared to $20.5 million in the first half of 1996 and
$21.5 million in the second half of 1995, indicating improving market acceptance
of the new products.
Income in the Individual Life and Disability segment increased $80.8
million to $117.3 million in 1996 from $36.5 million in 1995. The improvement
is primarily due to improved results in the individual disability income and the
individual life lines of business. In the individual disability income line,
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income increased $78.2 million to $91.3 million in 1996, from $13.1 million in
1995. This significant improvement is primarily due to a lower level of new
claims in the third and fourth quarters of 1996 along with higher levels of
claim resolutions. Management believes substantial investments in the
individual disability claims management process since the first quarter of 1995
helped produce the significant improvement in results in this line. The major
elements of this investment include an emphasis on early intervention to better
respond to the specific nature of the claims, increased specialization to
properly adjudicate the increasingly specialized nature of disability claims,
and an increased level of staffing with experienced claim adjusters. In
addition, net investment income in this line increased due to a higher
allocation of capital to this line of business. Income in the individual life
line of business increased $3.2 million, or 15.3 percent, to $24.1 million in
1996 from $20.9 million in 1995, while the individual annuities line of business
produced income of $1.9 million in 1996 compared to $2.5 million in 1995.
In 1995, income in the Individual Life and Disability segment declined
$16.7 million, or 31.4 percent, to $36.5 million, compared to $53.2 million in
1994. The decline was primarily due to the individual disability income line
which produced income of $13.1 million in 1995, compared to $27.1 million in
1994. Poor results in the first quarter of 1995 from adverse claim experience on
individual noncancelable disability income contracts with long-term own-
occupation provisions which were issued between 1983 and 1989 were the primary
reason for the decline. Specifically, the average size of new claims in the
first quarter of 1995 was higher than the average level experienced for all of
1994, and the level of claim resolutions was lower relative to 1994. During the
last three quarters of 1995, claim resolutions were higher relative to the first
quarter of 1995 and all of 1994. Management believes that the improvement in the
final three quarters of 1995 was primarily the result of the allocation of
significant resources to the Company's disability claims management unit. Lower
income from the individual life and individual annuities lines of business also
contributed to the decreased income in this segment. Income in the individual
life line declined to $20.9 million in 1995, compared to $22.9 million in 1994,
while income from the individual annuities line declined to $2.5 million in 1995
from $3.2 million in 1994.
Deposits on deferred annuities sold through financial institutions totaled
$8.1 million in 1996, compared to $78.2 million in 1995 and $131.8 million in
1994. This decline was primarily the result of the termination of certain
marketing relationships. Deposits on annuities sold through other distribution
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channels were $13.1 million in 1996, compared to $4.2 million in 1995 and $10.0
million in 1994.
The Company performed a loss recognition study on its individual disability
income business as of September 30, 1993. The study resulted in a $423.0
million pre-tax or $275.0 million after-tax charge to operating earnings. The
charge was required under generally accepted accounting principles due to the
significant decline in interest rates in 1993 and the increased level of
morbidity experienced by the Company. Since 1993, the Company has performed
annual loss recognition studies to determine the continued adequacy of the
reserves that were established. Based upon the December 1996 loss recognition
study, which incorporates management's best estimate for the assumptions used,
reserves were adequate at December 31, 1996.
The Company has engaged outside consultants to work with its personnel in
refining its methodology for analyzing frequency and severity rates, as well as
other factors that may affect reserve adequacy. Management intends to continue
to work to provide the Company with a better methodology for anticipating
changes in morbidity rates and a better methodology for reflecting those changes
in the management of its business. Significant testing of any methodology must
be undertaken. Early indicators suggest a sufficiency in the Company's
reserves.
It is not possible to predict with certainty whether morbidity, interest
rates, and expenses will continue at a level consistent with the assumptions
used in the loss recognition study, improve, or deteriorate; however, the
current assumptions as to these factors represent management's best estimates in
light of present circumstances. Additional increases to reserves would be
required if there is material deterioration in morbidity, interest rates, and/or
expenses. As part of its ongoing management of this line of business, the
Company will conduct a loss recognition study annually to validate the continued
adequacy of current reserves.
EMPLOYEE BENEFITS OPERATING RESULTS
Revenue in the Employee Benefits segment increased $23.4 million, or 4.0
percent, to $606.1 million in 1996 from $582.7 million in 1995. The increase is
primarily due to higher premium income which increased $15.5 million, or 3.2
percent, to $501.4 million in 1996 from $485.9 million in 1995. The increase was
primarily the result of higher premium income in the voluntary benefits, group
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EMPLOYEE BENEFITS OPERATING RESULTS
Year Ended December 31 1996 1995 1994
--------- --------- ----------
(in millions of dollars)
REVENUE EXCLUDING NET REALIZED INVESTMENT GAINS
Premium Income
Voluntary Benefits $70.6 $66.3 $58.7
Group Life 177.8 167.0 167.6
Medical Stop-Loss 49.4 62.2 66.9
Group Disability 69.4 59.5 53.6
Packaged Products 134.2 130.9 118.8
-------- -------- ---------
Total Premium Income 501.4 485.9 465.6
Net Investment Income 97.9 90.6 85.5
Other Income 6.8 6.2 4.2
-------- -------- ---------
TOTAL 606.1 582.7 555.3
-------- -------- ---------
BENEFITS AND EXPENSES
Policy and Contract Benefits 362.9 382.2 334.2
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 73.7 48.1 54.1
Amortization of Deferred Policy Acquisition 8.4 12.0 6.4
Other Expenses 104.8 91.8 88.8
-------- -------- ---------
TOTAL 549.8 534.1 483.5
-------- -------- ---------
INCOME BEFORE NET REALIZED INVESTMENT
GAINS AND FIT 56.3 48.6 71.8
NET REALIZED INVESTMENT GAINS 0.1 3.9 1.6
-------- -------- ---------
INCOME BEFORE FIT $56.4 $52.5 $73.4
======== ======== =========
SALES - ANNUALIZED NEW PREMIUMS
Voluntary Benefits $23.0 $20.2 $20.6
Group Life $37.8 $24.2 $16.7
Group LTD $16.5 $10.7 $14.4
LIFE INSURANCE IN FORCE $87,079.7 $83,276.3 $71,460.5
life, group disability, and packaged products lines of business, which more than
offset lower premium income in the medical stop-loss line of business. Net
investment income in this segment increased $7.3 million, or 8.1 percent, to
$97.9 million in 1996 from $90.6 million in 1995.
In 1995, revenue in the Employee Benefits segment increased $27.4 million,
or 4.9 percent, to $582.7 million from $555.3 million in 1994. Premium income
increased $20.3 million, or 4.4 percent, to $485.9 million in 1995 from $465.6
million in 1994. The increase in premium income in this segment was primarily
the result of higher premium income in the voluntary benefits, group disability,
and packaged products lines of business, which more than offset lower premium
income in the group life and medical stop-loss lines of business. Net
investment income in this segment increased $5.1 million, or 6.0 percent, to
$90.6 million in 1995, compared to $85.5 million in 1994.
Income in the Employee Benefits segment increased $7.7 million, or 15.8
percent, to $56.3 million in 1996 from $48.6 million in 1995. The increase is
primarily due to improved results in the voluntary benefits and group disability
lines of business. Income in the voluntary benefits line was $14.7 million in
1996 compared to $7.9 million in 1995. Income in the group disability line was
$2.9 million in 1996 compared to a loss of $12.8 million in 1995. Both lines
benefited from improved profitability following repricing actions in 1995. The
improvement in income in these lines of business was partly offset by lower
income in the group life, medical stop-loss, and packaged products lines of
business.
In 1995, income in the Employee Benefits segment declined to $48.6 million,
compared to $71.8 million in 1994. This decline was primarily the result of
lower income in the medical stop-loss and group disability lines of business.
Income in the medical stop-loss line declined to $16.4 million in 1995, compared
to $26.6 million in 1994, primarily as a result of lower premium income and
higher loss ratios. Income in the group disability line declined to a loss of
$12.8 million in 1995 from a loss of $4.5 million in 1994, primarily due to
higher claim incidence and severity. These losses were primarily attributable
to business associated with the medical and legal occupations. During the first
quarter of 1995, the Company notified the existing group disability customers in
the medical and legal occupational categories that coverages would be terminated
under the terms of the existing contracts during 1995, and the Company would no
longer accept proposals for group disability coverage of new medical or legal
groups. This action impacted approximately 15 percent of the group disability
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block of business. The group life and voluntary benefits lines of business also
produced lower income in 1995 compared to 1994, while the packaged products line
reported an increase in income.
-6-
OTHER OPERATIONS OPERATING RESULTS
Year Ended December 31 1996 1995 1994
--------- --------- ---------
(in millions of dollars)
REVENUE EXCLUDING NET REALIZED INVESTMENT LOSSES
Premium Income
Corporate-Owned Life $23.6 $24.8 $26.1
Group Single Premium Annuities 1.9 0.5 4.7
Other 2.5 93.3 241.3
-------- -------- ---------
Total Premium Income 28.0 118.6 272.1
Net Investment Income 598.6 769.4 850.7
ASO Fees -- 37.2 110.9
Gain on Sale of Group Medical Business -- 21.8 --
Other Income 20.2 38.0 46.7
-------- -------- ---------
TOTAL 646.8 985.0 1,280.4
-------- -------- ---------
BENEFITS AND EXPENSES
Policy and Contract Benefits 376.5 593.8 791.3
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 150.5 133.2 122.7
Other Expenses 58.6 135.4 260.4
-------- -------- ---------
TOTAL 585.6 862.4 1,174.4
-------- -------- ---------
INCOME BEFORE NET REALIZED INVESTMENT
LOSSES AND FIT 61.2 122.6 106.0
NET REALIZED INVESTMENT LOSSES (17.2) (40.3) (37.5)
-------- -------- ---------
INCOME BEFORE FIT $44.0 $82.3 $68.5
======== ======== =========
FUNDS UNDER MANAGEMENT AND
EQUIVALENTS AT END OF YEAR
Group Single Premium Annuities $1,188.1 $1,197.8 $1,209.5
Traditional GICs 3,204.3 4,838.0 7,042.6
Separate Account GICs 68.3 146.1 138.9
Synthetic GICs 2,176.6 2,571.9 1,626.8
Other 304.7 301.1 275.5
-------- -------- ---------
Total $6,942.0 $9,054.9 $10,293.3
======== ======== =========
LIFE INSURANCE IN FORCE - CORPORATE-OWNED LIFE $2,999.6 $2,967.2 $2,641.5
OTHER OPERATIONS OPERATING RESULTS
The Other Operations segment includes the Company's group pension products,
its corporate-owned life insurance ("COLI") products, corporate (unallocated)
capital and assets, and the medical services business sold in 1995 (see Note 13
of the Notes to Consolidated Financial Statements). The group pension and COLI
blocks of business are essentially closed blocks of business which have been
segregated for reporting and monitoring purposes. The group pension products
include the Company's traditional guaranteed investment contracts ("GICs"),
group single premium annuities ("SPAs"), and synthetic GICs.
Revenue in the Other Operations segment declined $338.2 million, or 34.3
percent, to $646.8 million in 1996 from $985.0 million in 1995. The decline was
partially due to the sale of the medical services line of business, which, prior
to its sale on April 30, 1995, contributed operating revenue of $146.1 million
and a gain from the sale of the business of $21.8 million. In addition, revenue
in the group pension line of business declined $177.2 million, or 30.3 percent,
to $408.4 million in 1996 from $585.6 million in 1995 due to a decrease in funds
under management resulting from the strategic decision to discontinue the sale
of traditional GICs. Premium income in this segment declined $90.6 million, or
76.4 percent, to $28.0 million in 1996 from $118.6 million in 1995. This
decline is due to the sale of the medical services line of business, which
produced $90.9 million of premium income prior to its sale in the second quarter
of 1995.
In 1995, revenue in the Other Operations segment declined $295.4 million, or
23.1 percent, to $985.0 million, compared to $1,280.4 million in 1994. Premium
income in this segment declined $153.5 million to $118.6 million in 1995
compared to $272.1 million in 1994. The primary reason for this decline was the
sale of the medical services business which produced premium income of $241.3
million in 1994 and $90.9 million in 1995 prior to its sale effective April 30,
1995. Net investment income declined $81.3 million to $769.4 million in 1995
from $850.7 million in 1994. The primary reason for this decline was the
decrease in funds under management in the group pension line of business. Net
investment income in the group pension line declined $80.0 million to $574.2
million in 1995, compared to $654.2 million in 1994. In addition, net
investment income from corporate (unallocated) capital and assets declined due
to additional capital being allocated to the individual disability income line
of business. Administrative services only fees associated with the medical
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services business declined due to the sale of the medical services business in
1995. These fees totaled $110.9 million in 1994 and $37.2 million in 1995.
The Company announced in December 1994, that it would discontinue the sale
of traditional GICs. Funds under management for the group pension line
excluding deposits for synthetic GICs totaled $4.77 billion at December 31,
1996, compared to $6.48 billion at December 31, 1995, a decrease of 26.5
percent. In 1995, funds under management decreased 25.2 percent, from $8.67
billion at December 31, 1994.
In 1995, the Company extended an offer to GIC contract holders to surrender
their contracts on a more favorable basis than would otherwise be available to
them. Contracts with a book value of $291.7 million were surrendered under the
offer. The Company has no plans for another offer of this kind. Early
surrenders of traditional GICs totaled $40.8 million in 1996 and $662.1 million
in 1995. The Company does not anticipate significant early withdrawals on its
remaining GICs as virtually all of the contracts are subject to a market value
adjustment for early withdrawal.
In keeping with management's strategic desire to focus its resources in the
other two segments, the Company decided to discontinue the sale of synthetic
GICs and in January 1997, signed a letter of understanding to sell the block of
business through an assumptive reinsurance transaction. Accumulated funds from
the sale of the Company's synthetic GICs totaled $2.18 billion at December 31,
1996, $2.57 billion at December 31, 1995, and $1.63 billion at December 31,
1994.
Revenue in this segment is expected to continue to decline as a result of
the discontinuance of the sales of traditional GICs and group SPAs and the run-
off of the funds under management. As the traditional GICs mature, capital will
be available for use by the Company as amounts allocated to this line are
released.
Income in 1996 declined $61.4 million to $61.2 million in 1996 from $122.6
million in 1995. This decline is partially due to the 1995 sale of the medical
services line of business, which produced operating income of $3.2 million and a
gain from the sale of $21.8 million during 1995. In addition, the decline in
this segment was due to lower income in the group pension line of business,
which declined $26.1 million, or 35.4 percent, to $47.6 million in 1996 from
$73.7 million in 1995. The decline in this line was primarily the result of
lower funds under management and lower income from a reduced amount of capital
allocated to this line. Income from the corporate-owned life insurance line of
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business declined slightly to $19.7 million in 1996, compared to $20.5 million
in 1995.
Income in this segment increased $16.6 million to $122.6 million in 1995
from $106.0 million in 1994. Higher income in the group pension line of
business and the gain from the sale of the medical services line were the
primary reasons for the increase in income. The group pension line produced
income of $73.7 million in 1995, compared to $48.8 million in 1994. This line
of business benefited from an improvement in the spread between interest
credited on contracts and the interest earned on the invested assets, as well as
income from bond call premiums, early surrender penalties, and lower expenses.
Income from the block of corporate-owned life insurance declined slightly to
$20.5 million in 1995 from $21.1 million in 1994. This decline in income was
primarily attributable to a decline in premium income in this line of business.
Income from the medical services line of business declined to $3.2 million for
the four months of 1995 from $16.9 million for the year 1994. In addition, the
Other Operations segment in 1995 included an unusually high level of corporate
expenses related to several initiatives underway within the Company.
Management expects that income in 1997 from the group pension line will
decline from the levels recorded in 1996 as the funds under management decline.
Management also expects that the level of corporate expenses related to this
segment will be lower in 1997 than in 1996.
-9-
LIQUIDITY AND CAPITAL RESOURCES
As a holding company, the Company is dependent upon payments from its
wholly-owned insurance subsidiaries, Provident Life and Accident Insurance
Company ("Accident"), Provident Life and Casualty Insurance Company
("Casualty"), and Provident National Assurance Company ("National")
(collectively "Provident") and its recently acquired wholly-owned subsidiaries
GENEX Services, Inc. and GENEX Services of Canada, Inc. (collectively "GENEX")
to pay dividends to its shareholders and to pay its expenses. These payments by
Provident and GENEX may take the form of either dividends or interest payments
on amounts loaned to Provident or GENEX by the Company.
State insurance laws generally restrict the ability of insurance companies
to pay cash dividends or make other payments to their affiliates in excess of
certain prescribed limitations. In Tennessee, Provident's state of domicile,
regulatory approval is required if an insurance company seeks to make loans to
affiliates in amounts equal to or in excess of three percent of the insurer's
admitted assets, or to pay cash dividends in excess of the greater of such
company's net gain from operations of the preceding year or ten percent of its
surplus as regards policyholders, as determined at the end of the preceding year
in accordance with prescribed or permitted accounting practices. In November
1996, National made an extraordinary cash distribution in the amount of $100.0
million to the Company. An aggregate of $107.0 million would be available in
1997 for the payment of dividends or other distributions by Accident, National,
and Casualty without regulatory approval.
The Company's requirements are met primarily by cash flow provided from
operations, principally in Provident. Premium and investment income as well as
maturities and sales of invested assets provide the primary sources of cash.
Cash flow from operations was sufficient in 1996. 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 flow from operations.
The Company expects no material adverse effect on its liquidity as a result
of the discontinuance of sales of traditional GICs. While traditionally the
investment strategy for this product line has been to match the effective asset
durations with the related expected liability durations, the Company has moved
to a cash flow matching strategy.
-10-
In May 1995, the Company sold 26 restructured mortgage loans with a
principal amount of $147.5 million and a book value of $122.6 million. The
transaction resulted in a before-tax realized investment loss of $23.1 million.
In October 1995, the Company completed the sale of commercial mortgage loans
with a principal amount and a book value of $962.4 million through a
securitization collateralized by 366 loans. The transaction resulted in a
before-tax realized investment gain of $8.9 million. In February 1996, the
Company sold 24 mortgage loans with a principal amount of $81.6 million and a
book value of $75.9 million, realizing a before-tax investment loss of $5.7
million. These transactions increased the liquidity of the investment portfolio
and facilitated the move to a cash flow matching strategy for the GIC
portfolios. The proceeds from the mortgage sales were reinvested in fixed
maturity securities and were also used to fund the limited-time GIC surrender
offer in 1995 described in Other Operations.
The sale of the mortgage loans is expected to result in lower investment
income in the future, as well as lower net realized investment losses and lower
investment expenses. Overall, the Company expects these transactions to have a
positive effect on net income in future years. Management also expects the
transactions to improve asset quality, liquidity, asset/liability management,
and the capital adequacy ratios.
On April 29, 1996, the Company announced that it had entered into an
Agreement and Plan of Merger ("Agreement") with The Paul Revere Corporation
("Paul Revere") pursuant to which the Company would acquire Paul Revere at a
price of approximately $1.2 billion.
The Company and Paul Revere's 83 percent shareholder, Textron Inc.
("Textron"), announced on November 6, 1996, that Textron had agreed to provide
additional capital to Paul Revere and that the parties would make certain other
adjustments relating to the Company's acquisition of Paul Revere. This followed
the announcement by Paul Revere of a $244.3 million after-tax reserve
strengthening in its individual disability insurance segment in the third
quarter of 1996. The strengthening reflected the results of a previously
announced comprehensive reserve study prepared in accordance with generally
accepted accounting principles which was completed in early November 1996.
The financial terms of the acquisition are unchanged to Paul Revere's public
shareholders from those of the original Agreement. Under the terms of the
Amended and Restated Agreement and Plan of Merger (the "Amended Agreement"),
-11-
Textron was committed to make a capital contribution to Paul Revere of between
$100 million and $180 million. The amount of the contribution, determined by
the amount of statutory reserve strengthening required by the Commonwealth of
Massachusetts Division of Insurance as a condition to consenting to the
acquisition of Paul Revere by the Company, was $121.0 million on an after-tax
basis, of which $83.5 million was contributed to Paul Revere as of December 31,
1996, and $37.5 million was contributed on February 18, 1997. Textron also
agreed to the resetting of the Exchange Ratio to be used in computing the number
of shares of Company stock that will constitute the stock portion of the merger
consideration Textron will receive for its 37.5 million shares of Paul Revere
stock. The Exchange Ratio for Textron as defined in the original Agreement was
to be no lower than 0.0295, compared to a minimum Textron Exchange Ratio of
0.0263 under the Amended Agreement. This change may reduce the number of shares
of the Company's stock that Textron will receive. Additional consideration
totaling approximately $35 million will also be paid to the Company or
contributed to Paul Revere by Textron. The Amended Agreement contains certain
limited purpose hold harmless provisions pursuant to which Textron has agreed to
indemnify the Company from specified damages. The transaction was approved by
the required vote of the shareholders of the Company and Paul Revere on December
31, 1996. It remains subject to the approval of the Commonwealth of
Massachusetts Division of Insurance. A hearing was held by the Division on
March 6, 1997, to consider the Company's application to acquire Paul Revere, and
a decision by the Commissioner is expected shortly.
The foregoing discussion of the Amended Agreement is a summary of the terms
of the Amended Agreement and is qualified in its entirety by reference to the
Amended Agreement and the joint press release of the Company and Textron dated
November 6, 1996, which have been previously filed with the Securities and
Exchange Commission, together with a more complete description of the terms of
the merger.
The acquisition will be financed through common equity issuance to Zurich
Insurance Company, a Swiss insurer, or one or more of its affiliates, common
equity issuance to Paul Revere shareholders, debt, and internally generated
funds. Contractual commitments are in place for the debt issuance. For
additional information, see Note 6 of the Notes to Consolidated Financial
Statements. The Company believes the cash flows from the combined operations
will be sufficient to meet its operating and financing cash flow requirements.
-12-
On February 28, 1997, the Company acquired GENEX Services, Inc. and GENEX
Services of Canada, Inc., subsidiaries of First Data Corporation, at a price of
approximately $70.0 million. GENEX is a leading provider of case management,
vocational rehabilitation, and related services to corporations, third party
administrators, and insurance companies. These services are utilized in the
management of disability and worker's compensation claims.
As a result of the release of capital generated by the run-off of the GIC
portfolio, the sale of the commercial mortgage loans, the sale of the medical
services line, and other corporate actions, the Company has increased its
available capital to support the growth of its businesses, including assisting
in the financing of the two acquisitions discussed above. Management continues
to analyze potential opportunities to utilize the capital to further enhance
shareholder value, including exploring options that would support the Company's
growth initiatives.
-13-
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. This discussion should be read
in connection with Note 3 of the Notes to Consolidated Financial Statements.
The following table provides the distribution of invested assets for the years
indicated.
- -----------------------------------------------------------------------------------
December 31 1996 1995 1994
- -----------------------------------------------------------------------------------
Investment-Grade Fixed Maturity Securites 77.0% 79.3% 72.6%
Below-Investment-Grade Fixed Maturity Securities 6.7 6.2 4.6
Equity Securities 0.1 --- 0.1
Mortgage Loans --- 0.7 10.0
Real Estate 1.1 1.4 1.6
Policy Loans 13.1 10.7 9.1
Other 2.0 1.7 2.0
- -----------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0%
- -----------------------------------------------------------------------------------
The following table provides certain investment information and results for
the years indicated.
- -----------------------------------------------------------------------------------
Year Ended December 31 1996 1995 1994
- -----------------------------------------------------------------------------------
(in millions of dollars)
- -----------------------------------------------------------------------------------
Average Cash and Invested Assets $14,056.3 $14,914.4 $15,047.3
Net Investment Income $ 1,090.1 $ 1,221.3 $ 1,238.6
Average Yield* 7.8% 8.2% 8.2%
Net Realized Investment Losses $ (8.6) $ (31.7) $ (30.1)
- -----------------------------------------------------------------------------------
*Average yield is determined by dividing net investment income by the average
cash and invested assets for the year. Excluding net unrealized gains and
losses on securities, the yield is 8.1%, 8.3%, and 8.3% for 1996, 1995, and
1994, respectively. See Notes 1 and 3 of the Notes to Consolidated Financial
Statements.
-14-
For the past three years, the Company's exposure to non-current investments
has improved significantly from prior years. These non-current investments are
primarily foreclosed real estate and mortgage loans which became more than
thirty days past due in their principal and interest payments. Non-current
investments, comprised of foreclosed real estate, totaled $7.3 million at
December 31, 1996, or 0.05 percent of invested assets. Non-current investments
at year-end 1995 were $31.9 million, or 0.22 percent of invested assets,
compared to $88.5 million, or 0.59 percent of invested assets at year-end 1994.
As previously discussed under Liquidity and Capital Resources, the Company
sold a substantial portion of its commercial mortgage loan portfolio in 1995.
The remaining exposure of $104.8 million of mortgage loans was liquidated during
1996.
During 1996, the Company sold four foreclosed properties with a book value
of $11.8 million. During 1995, the Company sold twelve foreclosed properties
with a book value of $39.6 million at the date of sale.
The Company's investment in mortgage-backed securities totaled $2.4 billion
on an amortized cost basis at December 31, 1996, and $2.9 billion at December
31, 1995. At December 31, 1996, the mortgage-backed securities had an average
life of 8.3 years and effective duration of 6.0 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.
As with most other fixed income investments, below-investment-grade bonds
are subject to the effects of changes in the overall level of interest rates,
which can affect both capital and reinvestment return. Below-investment-grade
bonds are inherently more risky than investment-grade bonds since the risk of
default by the issuer, by definition and as exhibited by bond rating, is higher.
Also, the secondary market for certain below-investment-grade issues can be
highly illiquid. Management does not anticipate any liquidity problem being
caused by the investments in below-investment-grade securities, nor does it
-15-
expect these investments to adversely affect its ability to hold its other
investments to maturity.
The Company's exposure to below-investment-grade fixed maturity securities
at December 31, 1996, was $891.1 million, representing 6.7 percent of invested
assets, below the internal limit of 7.5 percent of invested assets for this type
of investment. The Company's exposure to below-investment-grade fixed
maturities at December 31, 1995, was $911.8 million, representing 6.2 percent of
invested assets. Included in the below-investment-grade portfolio was the
Company's holding of $100.0 million of Healthsource 6.25% preferred stock,
received as part of the consideration for the sale of the group medical services
business. The preferred stock was redeemed in cash at par by Healthsource
during 1996.
Changes in interest rates and individuals' behavior affect the amount and
timing of asset and liability cash flows. Management has added resources in the
investment area to address modeling and testing of all asset and liability
portfolios to improve interest rate risk management and net yields. Testing the
asset and liability portfolios under various interest rate and economic
scenarios allows management to choose the most appropriate investment strategy
as well as to prepare for the most disadvantageous outcomes. This analysis is
the precursor to the Company's activities in derivative financial instruments
(see Note 4 of the Notes to Consolidated Financial Statements).
-16-
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Provident Companies, Inc.
We have audited the accompanying consolidated statements of financial condition
of Provident Companies, Inc. and Subsidiaries as of December 31, 1996 and 1995,
and the related consolidated statements of income, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Provident Companies, Inc. and Subsidiaries at December 31, 1996 and 1995, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, during 1994 the
Company changed its method of accounting for certain debt and equity securities.
ERNST & YOUNG LLP
Chattanooga, Tennessee
February 10, 1997, except for Note 16,
as to which the date is February 28, 1997
-1-
CONSOLIDATED STATEMENTS OF INCOME
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Year Ended December 31
1996 1995 1994
(in millions of dollars, except share data)
----------------------------------------------
REVENUE
Premium Income $ 1,175.7 $ 1,251.9 $ 1,382.6
Net Investment Income 1,090.1 1,221.3 1,238.6
Net Realized Investment Losses (8.6) (31.7) (30.1)
Other Income 34.7 113.8 171.1
----------- ----------- -----------
TOTAL REVENUE 2,291.9 2,555.3 2,762.2
----------- ----------- -----------
BENEFITS AND EXPENSES
Policy and Contract Benefits 1,216.5 1,419.7 1,506.8
Change in Reserves for Future Policy and Contract Benefits
and Policyholders' Funds 444.7 484.9 474.4
Amortization of Deferred Policy Acquisition Costs 64.0 71.0 59.4
Salaries 77.3 99.8 160.2
Commissions 124.0 131.9 121.8
Other Operating Expenses 139.2 172.0 238.7
----------- ----------- -----------
TOTAL BENEFITS AND EXPENSES 2,065.7 2,379.3 2,561.3
----------- ----------- -----------
INCOME BEFORE FEDERAL INCOME TAXES 226.2 176.0 200.9
FEDERAL INCOME TAXES 80.6 60.4 65.6
----------- ----------- -----------
NET INCOME $ 145.6 $ 115.6 $ 135.3
=========== =========== ===========
NET INCOME PER COMMON SHARE $ 2.92 $ 2.27 $ 2.71
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 45,522,417 45,381,373 45,311,053
=========== =========== ===========
See notes to consolidated financial statements.
-2-
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
December 31
1996 1995
(in millions of dollars)
---------------------------
ASSETS
INVESTMENTS
Fixed Maturity Securities
Available-for-Sale - at fair value (amortized cost: $10,384.3; $11,458.3) $10,880.1 $12,318.6
Held-to-Maturity - at amortized cost (fair value: $263.1; $321.1) 264.5 299.0
Equity Securities - at fair value (cost: $7.2; $9.2) 4.9 5.3
Mortgage Loans - 104.8
Real Estate 151.1 203.7
Policy Loans 1,749.0 1,574.6
Other Long-term Investments 15.5 14.0
Short-term Investments 252.3 231.0
--------- ---------
TOTAL INVESTMENTS 13,317.4 14,751.0
OTHER ASSETS
Cash and Bank Deposits 19.3 24.8
Accounts Receivable 40.1 41.3
Premiums Receivable 72.3 75.5
Reinsurance Receivable 468.3 435.3
Accrued Investment Income 268.3 277.4
Deferred Policy Acquisition Costs 421.8 271.8
Property and Equipment - at cost less accumulated depreciation 59.0 49.2
Miscellaneous 25.5 17.2
Separate Account Assets 300.5 357.8
--------- ---------
TOTAL ASSETS $14,992.5 $16,301.3
========= =========
See notes to consolidated financial statements.
-3-
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
December 31
1996 1995
(in millions of dollars)
---------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy and Contract Benefits $ 411.7 $ 383.7
Reserves for Future Policy and Contract Benefits 8,051.3 7,756.2
Unearned Premiums 58.8 58.4
Experience Rating Refunds 164.0 157.8
Policyholders' Funds 3,717.1 5,334.6
Federal Income Tax Liability
Current 34.6 29.9
Deferred 14.5 37.2
Long-term Debt 200.0 200.0
Other Liabilities 301.4 333.4
Separate Account Liabilities 300.5 357.8
--------- ---------
TOTAL LIABILITIES 13,253.9 14,649.0
--------- ---------
COMMITMENTS AND CONTINGENT LIABILITIES--NOTE 14
STOCKHOLDERS' EQUITY--NOTE 7
Preferred Stock 156.2 156.2
Common Stock, $1 par
Authorized: 150,000,000 shares
Issued: 45,627,629 and 45,397,886 shares 45.6 45.4
Additional Paid-in Capital 11.4 5.8
Net Unrealized Gain on Securities 90.9 101.9
Foreign Currency Translation Adjustment (5.2) (4.8)
Retained Earnings 1,439.7 1,347.8
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 1,738.6 1,652.3
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $14,992.5 $16,301.3
========= =========
See notes to consolidated financial statements.
-4-
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Year Ended December 31
1996 1995 1994
(in millions of dollars)
--------------------------------
PREFERRED STOCK
Balance at Beginning and End of Year $ 156.2 $ 156.2 $ 156.2
-------- -------- --------
COMMON STOCK
Balance at Beginning of Year 45.4 45.4 45.2
Issued During Year 0.2 - 0.2
-------- -------- --------
Balance at End of Year 45.6 45.4 45.4
-------- -------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at Beginning of Year 5.8 4.8 3.1
Contributions During Year 5.6 1.0 1.7
-------- -------- --------
Balance at End of Year 11.4 5.8 4.8
-------- -------- --------
NET UNREALIZED GAIN (LOSS) ON SECURITIES
Balance at Beginning of Year 101.9 (302.3) (2.1)
Adjustment for the Initial Application of SFAS 115 - - 244.9
Change During Year (11.0) 404.2 (545.1)
-------- -------- --------
Balance at End of Year 90.9 101.9 (302.3)
-------- -------- --------
FOREIGN CURRENCY TRANSLATION ADJUSTMENT
Balance at Beginning of Year (4.8) (5.4) (3.9)
Change During Year (0.4) 0.6 (1.5)
-------- -------- --------
Balance at End of Year (5.2) (4.8) (5.4)
-------- -------- --------
RETAINED EARNINGS
Balance at Beginning of Year 1,347.8 1,270.4 1,203.1
Net Income 145.6 115.6 135.3
Dividends to Stockholders
(Paid Per Common Share: $0.72; $0.72; $1.04) (53.7) (38.2) (68.0)
-------- -------- --------
Balance at End of Year 1,439.7 1,347.8 1,270.4
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY $1,738.6 $1,652.3 $1,169.1
======== ======== ========
See notes to consolidated financial statements.
-5-
CONSOLIDATED STATEMENTS OF CASH FLOWS
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Year Ended December 31
1996 1995 1994
(in millions of dollars)
-----------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 145.6 $ 115.6 $ 135.3
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities
Policy Acquisition Costs Capitalized (71.4) (88.1) (95.1)
Amortization of Policy Acquisition Costs 64.0 71.0 59.4
Depreciation and Amortization 11.1 24.3 42.2
Net Realized Investment Losses 8.6 31.7 30.1
Premiums Receivable 3.2 (13.2) 2.4
Reinsurance Receivable (33.0) 2.0 (56.4)
Accrued Investment Income 9.1 4.1 (17.4)
Insurance Reserves and Liabilities 546.8 581.8 563.6
Federal Income Taxes (11.9) (11.4) (25.7)
Other (11.5) (42.9) 8.0
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 660.6 674.9 646.4
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sales of Investments
Available-for-Sale Securities 1,592.6 1,359.9 693.7
Other Investments 141.8 1,172.5 50.2
Proceeds from Maturities of Investments
Available-for-Sale Securities 1,115.7 880.8 2,023.6
Held-to-Maturity Securities 100.5 0.7 2.2
Other Investments 13.0 248.7 382.9
Purchase of Investments
Available-for-Sale Securities (1,630.7) (1,680.1) (3,453.4)
Held-to-Maturity Securities (48.6) (183.9) (0.2)
Other Investments (177.5) (236.6) (266.9)
Net (Purchases) Sales of Short-term Investments (21.5) 58.7 66.4
Disposition of Group Medical Business - (48.9) -
Other (75.5) (67.0) 63.5
--------- --------- ---------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES $ 1,009.8 $ 1,504.8 $ (438.0)
--------- --------- ---------
See notes to consolidated financial statements.
-6-
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Year Ended December 31
1996 1995 1994
(in millions of dollars)
-----------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits to Policyholder Accounts $ 392.5 $ 530.6 $ 1,691.0
Maturities and Benefit Payments from
Policyholder Accounts (2,023.8) (2,663.5) (1,779.7)
Net Short-term Debt Repayments (1.4) (13.0) (14.6)
Issuance of Common Stock 5.8 1.0 1.9
Dividends Paid to Stockholders (45.5) (45.3) (59.8)
Other (3.5) - (43.9)
--------- --------- ---------
NET CASH USED BY FINANCING ACTIVITIES (1,675.9) (2,190.2) (205.1)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND BANK DEPOSITS (5.5) (10.5) 3.3
CASH AND BANK DEPOSITS AT BEGINNING OF YEAR 24.8 35.3 32.0
--------- --------- ---------
CASH AND BANK DEPOSITS AT END OF YEAR $ 19.3 $ 24.8 $ 35.3
========= ========= =========
See notes to consolidated financial statements.
-7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The accompanying financial statements have been prepared
on the basis of generally accepted accounting principles. Such accounting
principles differ from statutory accounting practices prescribed or permitted by
state regulatory authorities (see Note 15). The consolidated financial
statements include the accounts of Provident Companies, Inc. and its wholly-
owned subsidiaries (the Company), including Provident Life and Accident
Insurance Company, Provident Life and Casualty Insurance Company, and Provident
National Assurance Company (see Note 7). Material intercompany transactions
have been eliminated.
OPERATIONS: The Company does business in the fifty states, the District of
Columbia, Puerto Rico, and ten provinces and two territories of Canada. The
Company operates principally in the life and health insurance business.
Individual life products, individual disability income products, and individual
annuities are reported in the Individual Life and Disability segment and are
marketed primarily through personal producing general agents, brokerage offices,
and corporate marketing arrangements. Individual annuities are also marketed
through financial institutions. The Employee Benefits segment contains products
that are sold to or through corporate customers and certain affinity groups,
including permanent and term life insurance, disability, medical stop-loss,
cancer, accident and sickness, and accidental death and dismemberment
protection. The Other Operations segment reports corporate results, primarily
investment earnings not specifically allocated to a line of business, and also
includes results from products no longer actively marketed, including guaranteed
investment contracts (GICs), group single premium annuities, and corporate-
owned life insurance. This segment also includes the results of the group
medical business which was sold effective April 30, 1995 (see Note 13).
USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect amounts reported in the financial statements and
accompanying notes. Such estimates and assumptions could change in the future
as more information becomes known, which could impact the amounts reported and
disclosed herein.
INVESTMENTS: Investments are reported in the consolidated statements of
financial condition as follows:
Available-for-Sale Fixed Maturity Securities are reported at fair value.
Held-to-Maturity Fixed Maturity Securities are generally reported at amortized
cost.
Equity Securities are reported at fair value.
Mortgage Loans are generally carried at the unpaid balance. Mortgage loans that
are considered impaired are carried at the lower of the unpaid balance or the
fair value of the collateral.
Real Estate that the Company expects to hold and use is carried at cost less
accumulated depreciation which is calculated using principally the straight-line
method. Real estate to be disposed of is carried at the lower of cost less
accumulated depreciation or fair value less cost to sell.
Policy Loans are presented at unpaid balances.
Other Long-term Investments are carried at cost plus the Company's equity in
undistributed net earnings since acquisition.
Short-term Investments are carried at cost.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Fixed maturity securities include bonds and redeemable preferred stocks. Equity
securities include common stocks and nonredeemable preferred stocks. Fixed
maturity and equity securities not bought and held for the purpose of selling in
the near term but for which the Company does not have the positive intent and
ability to hold to maturity are classified as available-for-sale. Fixed
maturity securities that the Company has the positive intent and ability to hold
to maturity are classified as held-to-maturity. The Company determines the
appropriate classification of fixed maturity securities at the time of purchase.
Realized investment gains and losses, which are reported as a component of
revenue in the consolidated statements of income, are based upon specific
identification of the investments sold and do not include amounts allocable to
separate accounts. At the time a decline in the value of an investment is
determined to be other than temporary, a loss is recorded which is included in
realized investment gains and losses.
DERIVATIVE FINANCIAL INSTRUMENTS:
Interest Rate Swap Agreements are agreements in which two parties agree to
exchange, at specified intervals, interest payment streams calculated on an
agreed-upon notional principal amount with at least one stream based on a
specified variable rate. The underlying notional principal is not exchanged
between the parties. The Company has certain forward interest rate swap
agreements where the exchange of interest payments does not begin until a
specified future date. The Company intends to settle the forward interest rate
swap agreements prior to the commencement of the exchange of interest payment
streams.
The fair values of interest rate swap agreements which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of interest rate swap
agreements which hedge liabilities are not reported in the consolidated
statements of financial condition. Amounts to be paid or received pursuant to
interest rate swap agreements are accrued and recognized in the consolidated
statements of income as an adjustment to net investment income for asset hedges
or as an adjustment to policy and contract benefits for liability hedges.
The Company accounts for all of its interest rate swap agreements as hedges.
Accordingly, any gains or losses realized on closed or terminated interest rate
swap agreements are deferred and amortized to net investment income for asset
hedges or policy and contract benefits for liability hedges over the expected
remaining life of the hedged item. If the hedged item matures or terminates
earlier than anticipated, the remaining unamortized gain or loss is amortized to
net investment income or policy and contract benefits in the current period.
Gains or losses realized on interest rate swap agreements which are terminated
when the hedged assets are sold or which are terminated because the hedged
anticipated transaction is no longer likely to occur are reported in the
consolidated statements of income as a component of net realized investment
gains and losses. The Company regularly monitors the effectiveness of its
hedging programs. In the event a hedge becomes ineffective, it is
marked-to-market, resulting in a charge or credit to net investment income or
policy and contract benefits.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Futures and Forwards contracts are commitments to either purchase or sell a
financial instrument at a specific future date for a specified price. The
Company invests only in futures and forwards contracts which have U.S. Treasury
securities as the underlying investments. Changes in the market value of
contracts are generally settled on a daily basis. The notional amount of
futures and forwards contracts represent the extent of the Company's involvement
but not the future cash requirements, as the Company intends to close out open
positions prior to settlement. All of the Company's futures and forwards
contracts are accounted for as hedges.
The fair values of futures and forwards which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of futures and
forwards which hedge liabilities are not reported in the consolidated statements
of financial condition. Gains or losses realized on the termination of futures
and forwards contracts are accounted for in the same manner as interest rate
swap agreements.
Options contracts give the owner the right, but not the obligation, to buy or
sell a financial instrument at an agreed-upon price on or before a specific
date. The purchasing counterparty pays a premium to the selling counterparty
for this right. The notional amounts of contracts represent the Company's
involvement but not the future cash requirements, as the Company intends to
close out contracts prior to the expiration date when the market price of the
underlying financial instrument exceeds the option price or allow contracts to
expire if the option price exceeds the market price. All of the Company's
options contracts are accounted for as hedges. The book and fair values of
options contracts are reported in the statements of financial condition in a
manner similar to the underlying hedged item. Gains or losses on the
termination of options contracts are accounted for in the same manner as
interest rate swap agreements.
DEFERRED POLICY ACQUISITION COSTS: Certain costs of acquiring new business
which vary with and are primarily related to the production of new business have
been deferred. Such costs include commissions, other agency compensation,
certain selection and policy issue expenses, and certain field expenses.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing subsequent to the year of
issue.
Deferred policy acquisition costs related to traditional individual life and
individual disability income are amortized over the premium paying period of the
related policies in proportion to the ratio of the present value of annual
expected premium income to the present value of total expected premium income.
Adjustments are made each year to recognize actual persistency experience as
compared to assumed experience.
Deferred policy acquisition costs related to interest-sensitive individual life
and individual annuity policies are amortized over the lives of the policies in
relation to the present value of estimated gross profits from surrender charges
and mortality, investment, and expense margins. Adjustments are made each year
to reflect actual experience for assumptions which deviate significantly
compared to assumed experience.
The amortization periods do not exceed 25 years for traditional and interest-
sensitive individual life policies, 20 years for individual disability income
policies, and 15 years for individual annuity policies. Loss recognition is
performed when, in the judgment of management, adverse deviations from original
assumptions have occurred and may be likely to continue such that
recoverability of deferred policy acquisition costs on a line of business is
questionable. Insurance contracts are grouped on a basis consistent with the
Company's manner of acquiring, servicing, and measuring profitability of the
contracts. If loss recognition testing indicates that deferred policy
acquisition costs are not recoverable, the deficiency is charged to expense.
Once a loss recognition adjustment is required, loss recognition testing is
generally performed on an annual basis using then current assumptions until the
line of business becomes immaterial or results improve significantly. The
assumptions used in loss recognition testing represent management's best
estimates of future experience.
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
PROPERTY AND EQUIPMENT: Property and equipment is depreciated on the straight-
line method over its estimated useful life. The accumulated depreciation for
property and equipment was $84.4 million and $87.6 million as of December 31,
1996 and 1995, respectively.
REVENUE RECOGNITION: For traditional life and accident and health products, the
amounts collected from policyholders are recognized as premium income over the
premium paying period and are reported net of experience rating refunds and
unearned premiums. For interest-sensitive products, the amounts collected from
policyholders are considered deposits, and only the deductions during the period
for cost of insurance, policy administration, and surrenders are included in
revenue. Policyholders' funds represent funds deposited by contract holders and
are not included in revenue.
POLICY AND CONTRACT BENEFITS: Policy and contract benefits, principally related
to accident and health insurance policies, are based on reported losses and
estimates of incurred but not reported losses for traditional life and accident
and health products. For interest-sensitive products, benefits are the amounts
paid and expected to be paid on insured claims in excess of the policyholders'
policy fund balances.
RESERVES FOR FUTURE POLICY AND CONTRACT BENEFITS: Active life reserves for
future policy and contract benefits on traditional life and accident and health
products have been provided on the net level premium method. The reserves are
calculated based upon assumptions as to interest, withdrawal, morbidity, and
mortality that were appropriate at the date of issue. Withdrawal assumptions
are based on actual Company experience. Morbidity and mortality assumptions are
based upon industry standards adjusted as appropriate to reflect actual Company
experience. The assumptions vary by plan, year of issue, and policy duration
and include a provision for adverse deviation.
Disabled lives reserves for future policy and contract benefits on disability
income policies are calculated based upon assumptions as to interest and claim
termination rates that are currently appropriate. Termination rate assumptions
are based upon industry standards adjusted as appropriate to reflect actual
Company experience. The assumptions vary by year of claim incurral.
Reserves for future policy and contract benefits on group single premium
annuities have been provided on a net single premium method. The reserves are
calculated based upon assumptions as to interest, mortality, and retirement that
were appropriate at the date of issue. Mortality assumptions are based upon
industry standards adjusted as appropriate to reflect actual Company experience.
The assumptions vary by year of issue and include a provision for adverse
deviation.
The interest rate assumptions used to calculate reserves for future policy and
contract benefits are as follows:
December 31
1996 1995
---------------------------------
ACTIVE LIFE RESERVES - CURRENT YEAR ISSUES
Traditional Life 7.25% to 10.00% 7.25% to 10.00%
Individual Disability Income 7.00% to 7.75% 7.50% to 7.75%
DISABLED LIVES RESERVES - CURRENT YEAR CLAIMS
Individual Disability Income 8.00% 8.25%
Group Disability Income 7.00% 6.75%
DISABLED LIVES RESERVES - PRIOR YEAR CLAIMS
Individual Disability Income 8.00% 8.25%
Group Disability Income 6.00% to 7.00% 6.00% to 7.00%
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Interest assumptions for active life reserves are generally graded downward over
a period of years. Reserves for future policy and contract benefits on
interest-sensitive products are principally policyholder account values
determined on the retrospective deposit method.
The Company performed a loss recognition study as of December 31, 1996, for the
individual disability income business. In a loss recognition study, the Company
uses its best estimates as to future experience with regard to interest rates,
morbidity rates, lapse rates, expenses, and other factors to determine if
reserves currently held plus the present value of future cash inflows (primarily
from premiums and investment income) are projected to be sufficient to meet the
present value of future cash outflows (primarily for benefits and expenses) and
the amortization of deferred policy acquisition costs. If they are not
sufficient, an additional provision must be recorded either as a reduction of
deferred policy acquisition costs or as an increase in reserve liabilities.
Based upon current assumptions which represent management's best estimates,
reserves were adequate at December 31, 1996.
POLICYHOLDERS' FUNDS: Policyholders' funds represent customer deposits plus
interest credited at contract rates. The Company controls its interest rate
risk by investing in quality assets which have an aggregate duration that
closely matches the expected duration of the liabilities. For GICs, the Company
has changed its investment strategy from a duration matching approach to a cash
flow matching approach. The change was necessitated by the Company's
announcement in 1994 that it had discontinued the sale of new traditional GIC
business. The Company will continue to service all of its existing GICs.
The liability for GICs comprises over 85 percent of the liability balance shown
on the consolidated statements of financial condition. The interest rate
credited on a contract is dependent upon the time to maturity with most
contracts issued having a three to five year maturity. Generally, if a
policyholder terminates a GIC prior to maturity, there is a surrender charge
imposed which is based on the length of the remaining life of the GIC and the
change in interest rates from the date the GIC was issued to the date of
termination. In 1995, the Company extended an offer to GIC policyholders to
surrender their contracts on a more favorable basis than would otherwise be
available to them. Contracts with a book value of $291.7 million were
surrendered under the offer.
Interest credited on GICs is reported as a part of policy and contract benefits
in the consolidated statements of income. The interest credited on GICs and the
average interest crediting rates are presented below.
Interest Credited Average Interest
(in millions of dollars) Crediting Rate
--------------------------------------------
Year Ended December 31
1996 $249.4 6.40%
1995 393.5 6.65
1994 499.2 6.94
-12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
SYNTHETIC GICS: In May 1996, the Company discontinued accepting new synthetic
GIC deposits. Prior to this time, the Company issued synthetic GICs to trustees
of employee benefit plans pursuant to the terms of which the trustees own and
retain the assets related to these contracts. Such assets are not included in
the Company's consolidated statements of financial condition. The Company
guarantees to provide benefit payments in the event of plan benefit requests
and, in return for this guarantee, receives a premium based on such elements as
benefit payment exposure and contract size. The trustees may either reimburse
the Company for such benefit payments with interest, either at a fixed or
floating rate, from future plan and asset cash flows or from the sale of
securities. In certain circumstances, the Company may realize a gain or loss
upon the sale of the securities by the trustees. The Company underwrote the
plans for the possibility of having to make benefit payments and must agree to
investment guidelines to ensure appropriate asset quality and the matching of
asset and liability durations. Accumulated funds from the sale of synthetic GICs
were $2,176.6 million and $2,571.9 million at December 31, 1996 and 1995,
respectively.
FEDERAL INCOME TAXES: Deferred taxes have been recorded for significant
temporary differences between financial statement income and taxable income.
SEPARATE ACCOUNTS: The separate account amounts shown in the accompanying
financial statements represent contributions by contract holders to variable-
benefits and fixed-benefits pension plans. The contract purchase payments and
the assets of the separate accounts are segregated from other Company funds for
both investment and administrative purposes. Contract purchase payments
received under variable annuity contracts are subject to deductions for sales
and administrative fees. Also, the sponsoring company of the separate accounts
receives management fees which are based on the net asset values of the separate
accounts.
TRANSLATION OF FOREIGN CURRENCY: Revenues and expenses of the Company's
Canadian operations are translated at average exchange rates. Assets and
liabilities are translated at the rates of exchange on the balance sheet date.
The translation gain or loss is generally reported in stockholders' equity, net
of deferred tax credits of $2.8 million and $2.7 million at December 31, 1996
and 1995, respectively.
EARNINGS PER SHARE: Earnings per common share are computed using net income
less preferred stock dividends divided by the weighted average number of common
shares outstanding. There is no significant difference between earnings per
share on a primary or fully diluted basis.
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
CHANGES IN ACCOUNTING PRINCIPLES:
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
In 1996, the Company adopted the provisions of SFAS 121 which require that long-
lived assets and certain identifiable intangibles to be held and used by an
entity be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Measurement of an impairment loss for long-lived assets and identifiable
intangibles that an entity expects to hold and use should be based on the fair
value of the asset. SFAS 121 also requires that long-lived assets and certain
intangibles to be disposed of generally be reported at the lower of the carrying
amount or fair value less cost to sell.
The primary assets of the Company which are subject to SFAS 121 are investment
real estate and property and equipment used in the Company's daily operations.
The effect of the adoption of SFAS 121 on the Company's financial position and
results of operations was immaterial.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 (SFAS 123), ACCOUNTING FOR
STOCK-BASED COMPENSATION
SFAS 123 defines a fair value based method of accounting for stock-based
employee compensation plans. Under this method, compensation cost is measured
at the grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. SFAS 123 also allows an
entity to continue to measure compensation cost using the intrinsic value based
method of accounting prescribed by Accounting Principles Board Opinion No. 25
(Opinion 25), Accounting for Stock Issued to Employees. Under this method,
compensation cost is the excess, if any, of the quoted market price of the stock
at grant date or other measurement date over the amount an employee must pay to
acquire the stock. SFAS 123 requires entities electing to continue accounting
for stock-based employee compensation plans under Opinion 25 to make pro forma
disclosures of net income and earnings per share as if the fair value based
method of accounting defined under SFAS 123 had been applied. The Company
adopted the disclosure provisions of SFAS 123 in 1996 (see Note 9), but elected
to continue to measure compensation cost for stock-based compensation under the
expense recognition provisions of Opinion 25. The adoption of SFAS 123,
therefore, did not have an effect on the Company's financial position or results
of operations.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 114 (SFAS 114), ACCOUNTING BY
CREDITORS FOR IMPAIRMENT OF A LOAN AND STATEMENT OF FINANCIAL ACCOUNTING
STANDARDS NO. 118 (SFAS 118), ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN -
INCOME RECOGNITION AND DISCLOSURES
In 1995, the Company adopted the provisions of SFAS 114 and SFAS 118. SFAS 114
requires that certain impaired loans of creditors be measured based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, at the loan's observable market price, or at the fair value of
the collateral if the loan is collateral dependent. SFAS 118 amends SFAS 114
and eliminates its provisions regarding how a creditor should report income on
an impaired loan. SFAS 118 allows the Company to continue to use its existing
method for recognizing income on impaired loans. The adoptions of SFAS 114 and
SFAS 118 did not affect the Company's financial position or results of
operations.
-14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 1--SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 115 (SFAS 115), ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES
SFAS 115 addresses the accounting and reporting for investments in fixed
maturity securities and for equity securities with readily determinable fair
values. SFAS 115 requires these investments to be classified into three
categories and accounted for as follows:
(1) Fixed maturity securities that the Company has the positive intent and
ability to hold to maturity are classified as held-to-maturity
securities and reported at amortized cost.
(2) Fixed maturity and equity securities that are bought and held
principally for the purpose of selling in the near term are classified
as trading securities and reported at fair value, with changes in
unrealized holding gains and losses included in results of operations.
(3) Fixed maturity and equity securities classified neither as held-to-
maturity securities nor as trading securities are classified as
available-for-sale securities and reported at fair value, with
unrealized holding gains and losses reported as a separate component
of stockholders' equity.
The issuance of SFAS 115 changed the previous definition of what constituted a
security being held-to-maturity. Due to the significant restrictions placed on
securities classified as held-to-maturity, the Company believes that prudent
asset management requires a major portion of debt securities to be classified as
available-for-sale.
The Company adopted the provisions of SFAS 115 as of January 1, 1994, and
classified over 99 percent of its fixed maturity securities as available-for-
sale with the remainder reported as held-to-maturity. In addition to reporting
available-for-sale securities at fair value, the Securities and Exchange
Commission expressed its belief and requirement that registrants also adjust
deferred policy acquisition costs and certain policyholder liabilities to
reflect the changes that would have been necessary if the unrealized investment
gains and losses related to the available-for-sale securities had been realized.
Therefore, where applicable, the Company has reflected those adjustments in the
asset and liability balances with the offset as a direct adjustment to
stockholders' equity. In accordance with SFAS 115, prior period financial
statements were not restated to reflect the change in accounting principle.
The changes required by SFAS 115 and the Securities and Exchange Commission did
not result in any changes to the net income of the Company. The Company has not
changed its investment policies or strategies as a result of the implementation
of the new accounting requirements.
ACCOUNTING PRONOUNCEMENTS OUTSTANDING:
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 125 (SFAS 125), ACCOUNTING FOR
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES
AND STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 127 (SFAS 127), DEFERRAL OF
THE EFFECTIVE DATE OF CERTAIN PROVISIONS OF FASB STATEMENT NO. 125
In 1996, the Financial Accounting Standards Board (FASB) issued SFAS 125 which
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. Those standards are based
on consistent application of a financial-components approach that focuses on
control. SFAS 125 also establishes new rules for determining whether a
transfer of financial assets constitutes a sale and, if so, the determination of
any resulting gain or loss. The provisions of SFAS 125 were to be applied to
transactions occurring after December 31, 1996. However, SFAS 127 was issued
which defers the effective date one year for those provisions of SFAS 125 that
deal with securities lending, repurchase and dollar repurchase agreements, and
the recognition of collateral. The Company does not expect the adoptions of
SFAS 125 and SFAS 127 to have a material effect on its financial position or
results of operations.
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
PROVIDENT COMPANIES, INC AND SUBSIDIARIES
NOTE 2--FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts and fair values of the Company's financial instruments are
as follows:
December 31
(in millions of dollars)
---------------------------------------------
1996 1995
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------------------------------------------
ASSETS
Fixed Maturity Securities
Available-for-Sale $10,859.9 $10,859.9 $12,337.4 $12,337.4
Derivatives Hedging Available-for-Sale 20.2 20.2 (18.8) (18.8)
Held-to-Maturity 264.5 263.1 299.0 321.1
Equity Securities 4.9 4.9 5.3 5.3
Mortgage Loans - - 104.8 104.8
Policy Loans 1,749.0 2,080.5 1,574.6 2,005.7
Short-term Investments 252.3 252.3 231.0 231.0
Cash and Bank Deposits 19.3 19.3 24.8 24.8
LIABILITIES
Policyholders' Funds
GICs 3,204.3 3,230.9 4,838.0 4,980.7
Deferred Annuity Products 281.4 266.0 263.1 247.7
Supplementary Contracts without
Life Contingencies 61.1 61.1 44.7 44.7
Long-term Debt 200.0 200 0 200.0 200.0
Derivatives Hedging Liabilities - 3.0 - 0.6
The following methods and assumptions were used by the Company in estimating the
fair values of its financial instruments:
Fixed Maturity Securities: Fair values for fixed maturity securities are based
on quoted market prices, where available. For fixed maturity securities not
actively traded, fair values are estimated using values obtained from
independent pricing services or, in the case of private placements, are
estimated by discounting expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments. See
Note 3 for the amortized cost and fair values of securities by security type and
by maturity date.
Equity Securities: Fair values for equity securities are based on quoted market
prices.
Mortgage Loans: At December 31, 1995, the fair value for mortgage loans to be
sold was based on the expected sales price as of that date. For mortgage loans
which were in the process of foreclosure, the fair value was the appraised value
of collateral for the loan.
Policy Loans: Fair values for policy loans are estimated using discounted cash
flow analyses, using interest rates currently being offered.
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 2--FAIR VALUES OF FINANCIAL INSTRUMENTS - CONTINUED
Short-term Investments and Cash and Bank Deposits: Carrying amounts for short-
term investments and cash and bank deposits approximate fair value.
Policyholders' Funds: Fair values of the Company's liability for GICs are
estimated using discounted cash flow calculations, based on current market
interest rates available for similar contracts with maturities consistent with
those remaining for the contracts being valued. Fair values of the Company's
liability for deferred annuity products are estimated using the cash surrender
values of the annuity contracts. The carrying amounts for supplementary
contracts without life contingencies approximate fair value.
Fair values for the Company's insurance contracts other than investment
contracts are not required to be disclosed. However, the fair values of
liabilities under all insurance contracts are taken into consideration in the
Company's overall management of interest rate risk, which minimizes exposure to
changing interest rates through the matching of investment maturities with
amounts due under insurance contracts.
Long-term Debt: The carrying amounts for long-term debt approximate fair value.
Derivatives: Fair values of the Company's derivative financial instruments are
based on market quotes, pricing models, or formulas using current interest rates
and assumptions and represent the net amount of cash the Company would have
received or paid if the contracts had been settled or closed on December 31.
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 3--INVESTMENTS
SECURITIES
The amortized cost and fair values of securities by security type are as
follows:
December 31, 1996
(in millions of dollars)
--------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------
AVAILABLE-FOR-SALE SECURITIES
United States Government and
Government Agencies and Authorities $ 6.4 $ 0.8 $ - $ 7.2
Foreign Governments 156.5 19.9 - 176.4
Public Utilities 2,421.5 206.4 7.4 2,620.5
Mortgage-backed Securities 2,156.9 28.4 33.3 2,152.0
All Other Corporate Bonds 5,595.6 306.2 26.8 5,875.0
Redeemable Preferred Stocks 47.4 2.1 0.5 49.0
--------- ------ ----- ---------
Total Fixed Maturity Securities 10,384.3 563.8 68.0 10,880.1
Equity Securities 7.2 - 2.3 4.9
--------- ------ ----- ---------
$10,391.5 $563.8 $70.3 $10,885.0
========= ====== ===== =========
HELD-TO-MATURITY SECURITIES
United States Government and
Government Agencies and Authorities $ 13.5 $ 1.5 $ - $ 15.0
States, Municipalities, and Political
Subdivisions 3.2 0.2 - 3.4
Mortgage-backed Securities 234.9 3.3 8.1 230.1
All Other Corporate Bonds 12.9 1.7 - 14.6
--------- ------ ----- ---------
$ 264.5 $ 6.7 $ 8.1 $ 263.1
========= ====== ===== =========
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 3--INVESTMENTS - CONTINUED
December 31, 1995
(in millions of dollars)
--------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------
AVAILABLE-FOR-SALE SECURITIES
United States Government and
Government Agencies and Authorities $ 5.4 $ 9.5 $ - $ 14.9
Foreign Governments 159.2 17.1 0.5 175.8
Public Utilities 2,679.8 345.9 2.0 3,023.7
Mortgage-backed Securities 2,738.5 48.4 15.4 2,771.5
All Other Corporate Bonds 5,805.5 530.8 76.9 6,259.4
Redeemable Preferred Stocks 69.9 3.7 0.3 73.3
--------- ------ ----- ---------
Total Fixed Maturity Securities 11,458.3 955.4 95.1 12,318.6
Equity Securities 9.2 0.1 4.0 5.3
--------- ------ ----- ---------
$11,467.5 $955.5 $99.1 $12,323.9
========= ====== ===== =========
HELD-TO-MATURITY SECURITIES
United States Government and
Government Agencies and Authorities $ 13.3 $ 2.8 $ - $ 16.1
States, Municipalities, and Political
Subdivisions 3.4 0.3 - 3.7
Mortgage-backed Securities 170.3 16.7 - 187.0
All Other Corporate Bonds 12.0 2.3 - 14.3
Redeemable Preferred Stocks 100.0 - - 100.0
--------- ------ ----- ---------
$ 299.0 $ 22.1 $ - $ 321.1
========= ====== ===== =========
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 3--INVESTMENTS - CONTINUED
The amortized cost and fair values of fixed maturity securities by maturity date
are shown below. The maturity dates have not been adjusted for possible calls
or prepayments.
December 31, 1996
(in millions of dollars)
--------------------------
Amortized Fair
Cost Value
--------------------------
AVAILABLE-FOR-SALE SECURITIES
1 year or less $ 668.4 $ 706.5
Over 1 year through 5 years 1,610.5 1,693.2
Over 5 years through 10 years 2,308.7 2,419.5
Over 10 years 3,639.8 3,908.9
--------- ---------
8,227.4 8,728.1
Mortgage-backed Securities 2,156.9 2,152.0
--------- ---------
$10,384.3 $10,880.1
========= =========
HELD-TO-MATURITY SECURITIES
1 year or less $ 1.2 $ 1.3
Over 1 year through 5 years 2.0 2.1
Over 5 years through 10 years 0.9 1.0
Over 10 years 25.5 28.6
--------- ---------
29.6 33.0
Mortgage-backed Securities 234.9 230.1
--------- ---------
$ 264.5 $ 263.1
========= =========
The adjustments related to SFAS 115 are as follows:
December 31
1996 1995
(in millions of dollars)
---------------------------
ASSETS
Fixed Maturity Securities $ 495.8 $ 860.3
Equity Securities (2.3) (3.9)
Deferred Policy Acquisition Costs (240.9) (383.5)
LIABILITIES
Reserve for Future Policy and 112.8 316.1
Contract Benefits
Deferred Federal Income Taxes 48.9 54.9
STOCKHOLDERS' EQUITY
Net Unrealized Gain on Securities 90.9 101.9
-20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 3--INVESTMENTS - CONTINUED
At December 31, 1996, the total investment in below-investment-grade fixed
maturity securities (securities rated below Baa3 by Moody's Investors Services
or an equivalent internal rating) was $891.1 million or 6.7 percent of invested
assets. The amortized cost of these securities was $869.2 million.
MORTGAGE LOANS
As of December 31, 1996, the recorded investment in mortgage loans was $1.0
million with a related loss reserve of $1.0 million. Changes in the mortgage
loan loss reserve are as follows:
1996 1995 1994
(in millions of dollars)
----------------------------
BALANCE AT JANUARY 1 $ 12.0 $ 49.0 $ 55.3
Additions Charged to Realized
Investment Losses - 3.0 11.2
Release Due to Sale or Direct
Write-Down of Loans (11.0) (40.0) (17.5)
------ ------ ------
BALANCE AT DECEMBER 31 $ 1.0 $ 12.0 $ 49.0
====== ====== ======
In February 1996, the Company sold 24 mortgage loans with a principal amount of
$81.6 million and a book value of $75.9 million. In October 1995, the Company
sold commercial mortgage loans with a principal amount and a book value of
$962.4 million through a securitization collateralized by 366 loans. In May
1995, the Company sold 26 restructured mortgage loans with a principal amount of
$147.5 million and a book value of $122.6 million. The transactions resulted in
before-tax realized investment gains (losses) of $(5.7) million, $8.9 million,
and $(23.1) million, respectively.
REAL ESTATE
Accumulated depreciation on real estate was $28.5 million and $33.6 million as
of December 31, 1996 and 1995, respectively.
-21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 3--INVESTMENTS - CONTINUED
NET INVESTMENT INCOME
Sources for net investment income are as follows:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
------------------------------
Fixed Maturity Securities $ 900.2 $ 961.4 $ 946.2
Equity Securities 0.4 0.4 0.6
Mortgage Loans 2.6 100.7 159.0
Real Estate 25.8 29.6 38.0
Policy Loans 182.8 163.9 137.9
Other Long-term Investments 3.9 4.3 3.6
Short-term Investments 7.4 6.9 8.4
-------- -------- --------
Gross Investment Income 1,123.1 1,267.2 1,293.7
Investment Expenses 33.0 45.9 55.1
-------- -------- --------
Net Investment Income $1,090.1 $1,221.3 $1,238.6
======== ======== ========
REALIZED INVESTMENT GAINS AND LOSSES
Realized investment gains (losses) are as follows:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
----------------------------
Fixed Maturity Securities $ 37.1 $ 14.9 $ (1.3)
Equity Securities (1.3) 0.2 2.0
Mortgage Loans and Real Estate (3.7) (26.9) (30.2)
Real Estate Partnerships and Other
Invested Assets 0.1 - (0.4)
Derivatives (40.8) (19.9) (0.2)
------ ------ ------
$ (8.6) $(31.7) $(30.1)
====== ====== ======
Net realized investment losses include writedowns and changes in the reserve for
losses on mortgage loans and foreclosed real estate of $(5.0) million, $(29.0)
million, and $16.8 million for 1996, 1995, and 1994, respectively.
-22-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 3--INVESTMENTS - CONTINUED
Proceeds from sales of fixed maturity and equity securities and the related
gross gains and losses realized on those sales are as follows:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
----------------------------
PROCEEDS FROM SALES
Available-for-Sale Fixed Maturity
Securities $1,592.0 $1,353.1 $686.3
Equity Securities 0.6 6.8 7.4
GROSS GAINS
Available-for-Sale Fixed Maturity
Securities 50.1 35.3 19.0
Equity Securities - 1.3 2.4
GROSS LOSSES
Available-for-Sale Fixed Maturity
Securities 13.0 20.4 20.3
Equity Securities 1.3 1.1 0.4
NOTE 4--DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses interest rate swaps and exchange-traded interest rate futures
contracts to hedge interest rate risks and to match assets with its insurance
liabilities. Other derivatives, such as options and interest rate forward
contracts, are also used to some extent in the hedging process.
DERIVATIVE RISKS
The basic types of risks associated with derivatives are market risk (that the
value of the derivative will be adversely impacted by changes in the market,
primarily the change in interest rates) and credit risk (that the counterparty
will not perform according to the terms of the contract). The market risk of
the derivatives should generally offset the market risk associated with the
hedged financial instrument or liability.
To help limit the credit exposure of the derivatives, the Company has entered
into master netting agreements with its counterparties whereby contracts in a
gain position can be offset against contracts in a loss position. The Company
also typically enters into bilateral, cross-collateralization agreements with
its counterparties to help limit the credit exposure of the derivatives. These
agreements require the counterparty in a loss position to submit acceptable
collateral with the other counterparty in the event the net loss position meets
or exceeds an agreed upon amount. The Company's current credit exposure on
derivatives, which is limited to the value of those contracts in a net gain
position, was $3.0 million at December 31, 1996.
-23-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 4--DERIVATIVE FINANCIAL INSTRUMENTS - CONTINUED
HEDGING ACTIVITY
The table below summarizes by notional amounts the activity for each category of
derivatives.
Interest Rate Swaps
-----------------------------
Receive Receive
Variable/ Fixed/
Pay Fixed Pay Variable Forwards Futures Options Total
(in millions of dollars)
------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1993 $ - $525.0 $ 22.0 $ 21.0 $ - $ 568.0
Additions 800.0 201.0 178.5 1,464.5 - 2,644.0
Terminations - - 200.5 1,280.5 - 1,481.0
------ ------ -------- -------- ------- --------
BALANCE AT DECEMBER 31, 1994 800.0 726.0 - 205.0 - 1,731.0
Additions 300.0 495.0 - 947.5 820.0 2,562.5
Terminations 200.0 359.8 - 1,137.5 820.0 2,517.3
------ ------ -------- -------- ------- --------
BALANCE AT DECEMBER 31, 1995 900.0 861.2 - 15.0 - 1,776.2
Additions - 400.0 - 477.0 - 877.0
Terminations 600.0 463.6 - 482.0 - 1,545.6
------ ------ -------- -------- ------- --------
BALANCE AT DECEMBER 31, 1996 $300.0 $797.6 $ - $ 10.0 $ - $1,107.6
====== ====== ======== ======== ======= ========
Additions and terminations reported above for futures include roll activity,
which is the closing out of an old contract and initiation of a new one when the
futures contract is about to mature but the need for it still exists.
The following table summarizes the timing of anticipated settlements of interest
rate swaps outstanding at December 31, 1996, and the related weighted average
interest receive rate or pay rate assuming current market conditions.
1997 1998 1999 2000 2001 2002 Total
(in millions of dollars)
------------------------------------------------------------
RECEIVE VARIABLE/PAY FIXED
Notional value $300.0 - - - - - $ 300.0
Weighted average receive rate 5.56% - - - - - 5.56%
Weighted average pay rate 6.99 - - - - - 6.99
RECEIVE FIXED/PAY VARIABLE
Notional value $113.9 - $333.7 $170.0 $160.0 $20.0 $ 797.6
Weighted average receive rate 6.16% - 7.12% 7.79% 7.81% 7.44% 7.27%
Weighted average pay rate 5.50 - 5.54 5.56 5.56 5.50 5.54
TOTAL INTEREST RATE SWAPS $413.9 - $333.7 $170.0 $160.0 $20.0 $1,097.6
TOTAL WEIGHTED AVERAGE RECEIVE RATE 5.73% - 7.12% 7.79 7.81% 7.44% 6.81%
TOTAL WEIGHTED AVERAGE PAY RATE 6.58 - 5.54 5.56 5.56 5.50 5.94
-24-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 4--DERIVATIVE FINANCIAL INSTRUMENTS - CONTINUED
Derivative activity falls under five hedging programs as follows:
PROGRAM 1
The Company routinely uses forwards and futures to protect margins by reducing
the risk of changes in interest rates between the time of asset purchase and the
associated sale of an asset or sale of new business. Prior to 1995, this
activity was primarily associated with new GIC sales. The majority of the 1995
activity ($500.0 million) was a hedge of the reinvestment of the proceeds from
the securitization of the Company's commercial mortgage loan portfolio (see Note
3).
Gains or losses on termination of these forwards and futures are deferred and
reported as an adjustment of the carrying amount of the hedged asset or
liability and amortized into earnings over the lives of the hedged items. The
net deferred gain associated with this activity was $29.3 million and $31.8
million at December 31, 1996 and 1995, respectively.
The deferred gain from this program was amortized into income in the
consolidated statements of income as follows:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
-----------------------------------------
Net Investment Income $ 1.0 $ 0.2 $ 0.1
Policy and Contract Benefits 1.2 3.8 1.9
----- ----- -----
$ 2.2 $ 4.0 $ 2.0
===== ===== =====
At December 31, 1996, the Company had no open futures contracts under this
program.
PROGRAM 2
In 1994 and 1993 the Company created $101.0 million of synthetic fixed rate
assets consisting of variable rate mortgage-backed securities combined with
index amortizing swaps (receive fixed/pay variable). These synthetic fixed rate
assets back fixed rate GICs. During this time, the Company also created $625.0
million of synthetic variable rate GICs consisting of fixed rate GICs combined
with index amortizing swaps (receive fixed/pay variable), which were then backed
by variable rate mortgage-backed securities. The notional amount of index
amortizing swaps associated with this program was $197.6 million and $366.2
million at December 31, 1996 and 1995, respectively. The notional amount of
these swaps reduces based on an amortization schedule indexed to a constant
maturity treasury rate. Under market conditions at December 31, 1996, the
remaining swaps are expected to amortize fully over the next three years.
-25-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 4--DERIVATIVE FINANCIAL INSTRUMENTS - CONTINUED
Income (expense) from settlements of payment streams on these interest rate swap
agreements as reported in the consolidated statements of income were as follows:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
--------------------------------
Net Investment Income $ - $ 0.9 $ 0.4
Policy and Contract Benefits 0.3 (4.7) 3.9
----- ------ -----
$ 0.3 $(3.8) $ 4.3
===== ====== =====
PROGRAM 3
In December 1994, the Company announced that it would discontinue the sale of
traditional GICs. At that time, the Company decided to convert from a duration
matching investment approach to a cash flow matching investment approach for its
GIC business. The Company hedged the risk that a rise in interest rates would
reduce the price on future sales of assets which would be necessary to fund
maturing liabilities by entering into $1.1 billion notional amount of forward
interest rate swaps (receive variable/pay fixed) and $205.0 million notional
amount of short interest rate futures contracts. The majority of this hedge was
initiated in 1994, with the last $300.0 million of swaps initiated in 1995.
The $205.0 million futures position was terminated in 1995 as planned when
$208.7 million of fixed maturity securities were sold to fund maturing GICs. The
Company realized a $0.1 million before-tax investment gain on the futures and a
$5.6 million before-tax investment loss on the fixed maturity securities, a net
result which was consistent with the original hedge expectations. The first
$200.0 million swap position was terminated in 1995; however, fixed maturity
securities sales did not occur as originally anticipated because the Company had
adequate cash flow from other sources to fund the maturing GICs. The primary
source of this other cash flow was the securitization of the commercial mortgage
loan portfolio which had not been anticipated at the time this hedge was
initiated (see Note 3). The Company realized a $20.0 million before-tax
investment loss on termination of this swap position in 1995.
During 1996, the Company terminated $600.0 million of these forward swaps as
scheduled, realizing a $36.1 million before-tax investment loss. In addition,
the Company used offsetting futures contracts to partially remove the hedge as
fixed maturities were sold prior to the termination date of the interest rate
swaps. The Company realized a $5.3 million before-tax investment loss on the
termination of these futures contracts. The Company sold $423.0 million of fixed
maturity securities associated with this hedge, realizing a $19.6 million
before-tax investment gain. The remaining fixed maturity sales did not occur as
originally anticipated because the Company had adequate cash flow from other
sources to fund the maturing GICs. The last $300.0 million of these swaps will
be terminated as scheduled in 1997.
At December 31, 1996, the Company had an unrealized loss of $4.5 million on
these outstanding interest rate swaps and an unrealized gain of $5.1 million on
the associated fixed maturity securities.
PROGRAM 4
In 1995, the Company purchased $820.0 million in put options on treasury
securities to hedge the risk that a rise in interest rates would reduce the
price realized on the securitization of the commercial mortgage loan portfolio.
The options expired without value, and the $7.6 million price of the option was
reported as an adjustment to the net realized investment gain from the mortgage
loan sale.
-26-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 4--DERIVATIVE FINANCIAL INSTRUMENTS - CONTINUED
PROGRAM 5
During 1995, the Company executed a series of cash flow hedges in the individual
disability income portfolio, hedging $495.0 million of expected cash flows in
the years 1996 through 2000 using forward interest rate swaps (receive fixed/pay
variable). During 1996, the Company added $200.0 million of forward interest
rate swaps to the individual disability income portfolio and initiated a $200.0
million forward interest rate swap position in the group single premium annuity
portfolio. The purpose of these actions was to lock in the reinvestment rates
on future cash flows and protect the Company from the potential adverse impact
of declining interest rates on the associated policy reserves.
During 1996, the Company terminated $295.0 million of these interest rate swaps,
$160.0 million of which were terminated in conjunction with the purchase of
$160.0 million of fixed maturity securities. The $3.6 million before-tax
investment gain realized on the termination of the swaps was deferred as an
adjustment to the book value of the purchased fixed maturity securities. In
addition, the Company used offsetting futures contracts to partially remove the
hedge as fixed maturities were purchased prior to the termination date of the
interest rate swaps. The $3.6 million before-tax investment gain realized on the
termination of these futures contracts was deferred as an adjustment to the book
value of the purchased fixed maturity securities. Interest rate swaps of $120.0
million were terminated when it was determined that the hedged anticipated cash
flows were no longer likely to occur. The resulting $0.5 million before-tax gain
on this termination is reported as a component of realized investment gains and
losses. The remaining $15.0 million of interest rate swaps were replaced with
$15.0 million of interest rate futures contracts to maintain the hedge until the
fixed maturity securities are purchased. In 1996, the Company amortized into net
investment income $0.1 million of the deferred gain from this program.
At December 31, 1996, the Company had an unrealized gain of $24.7 million on the
open forward interest rate swaps and interest rate futures. These derivatives
are scheduled to be terminated in the years 1997 through 2002 as assets are
purchased with the future anticipated cash flows.
NOTE 5--FEDERAL INCOME TAXES
A reconciliation of the income tax attributable to continuing operations
computed at U.S. federal statutory tax rates to the income tax expense as
included in the consolidated statements of income follows:
Year Ended December 31
1996 1995 1994
----------------------------------
Statutory Federal Income Tax Rate 35.0% 35.0% 35.0%
Tax-preferred Investment Income (1.1) (2.1) (2.4)
Net Prior Years Tax Refunds (0.1) (0.8) (2.4)
Other Items, Net 1.8 2.2 2.5
---- ---- ----
Effective Tax Rate 35.6% 34.3% 32.7%
==== ==== ====
-27-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 5--FEDERAL INCOME TAXES - CONTINUED
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial statement
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred federal income tax liability are as follows:
December 31
1996 1995
(in millions of dollars)
----------------------------------
DEFERRED TAX LIABILITY
Deferred Policy Acquisition Costs $133.6 $140.5
Bond Market Discount 11.2 10.7
Net Unrealized Investment Gains 48.9 54.9
Cost of Business Acquired 2.3 2.3
Property and Equipment 9.8 6.7
Other 13.4 11.3
------ ------
Total Deferred Tax Liability 219.2 226.4
------ ------
DEFERRED TAX ASSET
Reserves 105.5 106.1
Realized Investment Gains and Losses 44.7 32.5
Postretirement Benefits 20.9 23.8
Other Employee Benefits 24.4 21.1
Other 9.2 5.7
------ ------
Total Deferred Tax Asset 204.7 189.2
------ ------
NET DEFERRED TAX LIABILITY $ 14.5 $ 37.2
====== ======
The Company is required to establish a valuation allowance for any portion of
the deferred tax asset that management believes will not be realized. In the
opinion of management, it is more likely than not that the Company will realize
the benefit of the deferred tax asset and, therefore, no such valuation
allowance has been established.
-28-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 5--FEDERAL INCOME TAXES - CONTINUED
Under the Life Insurance Company Tax Act of 1959, life companies were required
to maintain a policyholders' surplus account containing the accumulated portion
of current income which had not been subjected to income tax in the year earned.
The Deficit Reduction Act of 1984 requires that no future amounts be added after
1983 to the policyholders' surplus account. Further, any future distributions
from the account would become subject to federal income taxes at the general
corporate federal income tax rate then in effect. The amount of the
policyholders' surplus account at December 31, 1996, is approximately $125.0
million. Future distributions from the policyholders' surplus account are
deemed to occur if a statutorily prescribed maximum for the account is less than
the value of the account or if dividend distributions exceed the total amount
accumulated as currently taxable income in the year earned. If the entire
policyholders' surplus account were deemed distributed in 1997, this would
result in a tax of approximately $43.8 million. No current or deferred federal
income taxes have been provided on these amounts because management considers
the conditions under which such taxes would be paid to be remote.
In 1996, the Company received a refund that had been accrued in 1995 relating to
the final settlement of litigation for tax years 1980 through 1983. The refund
of taxes was $1.5 million and interest on the refund was $4.2 million. The
Company also received a refund that had been accrued in 1994 relating to a final
settlement of the remaining issues in dispute for the 1984 and 1985 tax years.
The refund of taxes was $3.1 million and related interest was $5.9 million.
During 1996, the Internal Revenue Service concluded its examination of the
Company's federal income tax returns for tax years 1990 through 1992 and issued
a Revenue Agents' Report proposing a tax deficiency of $26.0 million for these
years. Although this proposed deficiency has been appealed, the Company made an
additional payment for these years of $13.0 million tax and $5.2 million
interest to preclude the accrual of interest at punitive rates on any portion of
the proposed deficiency that the Company could possibly lose. Net income for
1996 was increased by $0.9 million as a result of these tax refunds and
payments.
In 1995, the Company received a refund that was previously accrued in 1994
relating to a final settlement of the remaining issues in litigation for the
1966 through 1979 tax years. The refund of taxes was $1.1 million and interest
on the refund was $4.8 million. The Company also accrued refunds of federal
income tax of $1.5 million and related interest of $3.5 million attributable to
a final settlement of the remaining issues in litigation for tax years 1980
through 1983. Overall, including interest received, net income in 1995 was
increased by $4.0 million as a result of the receipt and accrual of these
refunds.
In 1994, the Company accrued refunds of federal income tax of $4.3 million and
related interest of $9.6 million. The refunds related to the 1984 and 1985 tax
years and to a final settlement of court proceedings for the remaining issues in
dispute for tax years 1966 through 1979. Also, during 1994, the Internal
Revenue Service concluded its examination of the Company's federal income tax
returns for tax years 1988 and 1989 and issued a Revenue Agent's Report
reflecting a proposed deficiency of $17.5 million for these years. The Company
paid $6.6 million of tax and interest in response to this proposed deficiency to
preclude the possible accrual of interest at punitive rates. Net income for
1994 was increased by $10.5 million as a result of these items.
During the year, the Internal Revenue Service began its examination of the
Company's federal income tax returns for tax years 1993 through 1995.
Management believes this examination will have no material impact on the
Company's financial statements.
Federal income taxes paid during 1996, 1995, and 1994 were $92.5 million, $71.8
million, and $91.3 million, respectively.
-29-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 6--DEBT
During 1996, the Company entered into an $800.0 million five-year revolving
credit facility with various domestic and international banks. The purpose of
this arrangement was to provide partial financing for the purchase of The Paul
Revere Corporation (see Note 14), to refinance the existing bank term notes of
$200.0 million, and for general corporate uses. Interest is variable based upon
a London Interbank Offered Rate (LIBOR) plus a margin. At December 31, 1996,
the outstanding borrowing under the revolving credit facility was $200.0
million.
During 1996, the Company repaid the $200.0 million bank term notes which were
due on or before December 1, 1996.
There was no short-term debt outstanding at December 31, 1996. Short-term debt
outstanding at December 31, 1995 was $1.4 million.
Interest paid on short- and long-term debt during 1996, 1995, and 1994 was $17.1
million, $22.4 million, and $27.3 million, respectively. Interest expense
during 1996, 1995, and 1994 was $17.8 million, $22.3 million, and $25.9 million,
respectively.
NOTE 7--STOCKHOLDERS' EQUITY
CORPORATE REORGANIZATION
Effective December 27, 1995, Provident Life and Accident Insurance Company of
America completed a step in a corporate reorganization which created a new
parent holding company, Provident Companies, Inc., a non-insurance holding
company incorporated in Delaware. In accordance with the Plan of Share Exchange
approved by shareholders at the 1995 annual meeting, each share of Class A and
Class B common stock of Provident Life and Accident Insurance Company of America
was exchanged for a single class of common stock of Provident Companies, Inc.,
with each share entitled to one vote. Each depositary share of cumulative
preferred stock of Provident Life and Accident Insurance Company of America was
also exchanged for an equivalent depositary share of cumulative preferred stock
of Provident Companies, Inc.
In March 1996, Provident Life and Accident Insurance Company of America and
Provident Life Capital Corporation were dissolved and their respective assets
and liabilities were distributed to and assumed by Provident Companies, Inc.
Provident Life and Accident Insurance Company, Provident National Assurance
Company, and Provident Life and Casualty Insurance Company are now direct
subsidiaries of Provident Companies, Inc.
-30-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 7--STOCKHOLDERS' EQUITY - CONTINUED
PREFERRED AND COMMON STOCK
In 1996, the Company's shareholders approved an amendment to the Company's
Amended and Restated Certificate of Incorporation to increase from 65,000,000 to
150,000,000 the number of shares of common stock which the Company is authorized
to issue.
In 1993, the Company issued 1,041,667 shares of 8.10% cumulative preferred
stock, liquidation preference $150 per share evidenced by depositary receipts
for 6,250,002 depositary shares each representing a one-sixth interest of a
preferred share, of which 6,249,202 and 6,250,002 were issued and outstanding as
of December 31, 1996 and 1995, respectively. The preferred stock is redeemable
at a redemption price of $150 per share (equivalent to $25 per depositary share)
at the option of the Company in 1998.
NOTE 8--RETIREMENT BENEFITS
PENSION PLAN
The Company provides a self-administered, defined benefit pension plan for
eligible salaried employees. The benefits are based on years of service and the
employee's highest consecutive five years of compensation. The Company's
funding policy is to contribute amounts to the plan sufficient to meet the
minimum funding requirements set forth in the Employee Retirement Income
Security Act of 1974, plus such additional amounts as the Company may determine
to be appropriate. Plan assets are invested in two separate accounts of a
subsidiary of the Company, one of which invests in listed equity securities and
the other in corporate obligations and U.S. bonds.
The pension plan's funded status and the amount recognized in the Company's
consolidated statements of financial condition are as follows:
December 31
1996 1995
(in millions of dollars)
----------------------------------
Actuarial present value of benefit
obligation - vested $160.8 $147.9
====== ======
Accumulated benefit obligation $161.6 $149.0
====== ======
Projected benefit obligation $189.8 $177.6
Plan assets at fair value 220.2 200.5
------ ------
Plan assets in excess of projected
benefit obligation 30.4 22.9
Unrecognized net actuarial gains (29.9) (26.3)
Unrecognized prior service cost 2.4 2.6
Unrecognized net transition obligation 0.6 0.7
------ ------
Accrued pension asset (liability) $ 3.5 $ (0.1)
====== ======
Weighted-average discount rate used in
determining the projected benefit obligation 7.25% 7.75%
Weighted-average rate of compensation
increase 4.50% 5.00%
-31-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 8--RETIREMENT BENEFITS - CONTINUED
Net periodic pension cost (benefit) included the following components:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
-----------------------------
Service cost $ 4.0 $ 5.7 $ 7.8
Interest cost 12.6 12.6 10.0
Actual return on plan assets (28.1) (43.1) (9.8)
Net amortization and deferral 7.5 26.5 (4.1)
Curtailment cost - 1.0 -
------ ------ -----
$ (4.0) $ 2.7 $ 3.9
====== ====== =====
Expected long-term rate of return on plan assets 8.50% 7.75% 7.75%
POSTRETIREMENT PLANS
The Company sponsors two defined benefit postretirement plans other than
pensions for full-time employees who have ten years of credited service with the
Company and have reached age 55. One plan provides medical and dental benefits,
and the other provides life insurance benefits. The postretirement health care
plan is contributory, with retiree contributions adjusted annually, and contains
other cost-sharing features such as deductibles and coinsurance. It is the
Company's expressed intent to increase the health care plan's retiree
contribution rate annually as the cost of health care increases. The life
insurance plan is noncontributory and is fully funded through a life insurance
contract issued by the Company. The health care plan is unfunded.
The following tables show the accumulated postretirement benefit obligation, the
amount recognized in the Company's consolidated statements of financial
condition, and the net periodic postretirement benefit cost.
December 31
1996 1995
(in millions of dollars)
----------------------------
Accumulated postretirement benefit obligation:
Retirees $43.2 $42.9
Fully eligible active plan participants 1.7 2.4
Other active plan participants 14.3 15.4
----- -----
59.2 60.7
Plan assets at fair value 8.5 7.7
----- -----
Accumulated postretirement benefit obligation in excess of plan assets 50.7 53.0
Unrecognized net gain 7.6 7.3
----- -----
Accrued postretirement benefit liability $58.3 $60.3
===== =====
Weighted-average discount rate used in determining the
accumulated postretirement benefit obligation 7.25% 8.50%
-32-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 8--RETIREMENT BENEFITS - CONTINUED
Net periodic postretirement benefit cost included the following components:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
-----------------------------------
Service cost $ 1.5 $ 1.9 $ 4.1
Interest cost 4.0 4.6 5.0
Actual return on plan assets (0.5) (0.5) (0.6)
Net amortization and deferral (3.0) (3.4) (1.2)
----- ----- -----
$ 2.0 $ 2.6 $ 7.3
===== ===== =====
Expected long-term rate of return on plan assets 8.50% 8.50% 8.50%
The postretirement benefit costs for 1996, 1995, and 1994 assume a weighted-
average annual rate of increase in the per capita cost of covered health care
benefits of 9 percent, 12 percent, and 12 percent, respectively, decreasing
gradually to 5 percent for 2004 and thereafter. The health care cost trend rate
assumption has a significant effect on the amounts reported. Increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation as of December 31,
1996, by $7.1 million and the aggregate of net periodic postretirement benefit
cost for 1996 by $0.8 million.
CURTAILMENT GAINS
During 1995, the Company recognized curtailment gains of $16.6 million and $7.7
million in its pension plan and postretirement plans, respectively. The gains
resulted from the sale of the group medical business (see Note 13) and the
consequent termination of participation in the Company's benefit plans of
certain employees. The gains were included in the determination of the total
gain recognized on the sale.
NOTE 9--INCENTIVE COMPENSATION AND STOCK PURCHASE PLANS
MANAGEMENT INCENTIVE COMPENSATION PLAN
The Company has in effect a two-part management incentive compensation plan, the
first part of which is cash-based and is designed to encourage achievement of
specific annual goals in which key employees participate. The compensation cost
recognized in the consolidated statements of income for this part of the plan is
$3.6 million, $2.9 million, and $2.5 million for 1996, 1995, and 1994,
respectively. The second part of this plan is a stock option plan. The Company
applies Opinion 25 and related interpretations in accounting for the stock
option plan. For those stock options subject to stock price performance, the
compensation cost recognized in the consolidated statements of income is $2.0
million and $2.4 million for 1996 and 1995, respectively. No cost was
recognized for 1994.
Under the 1994 stock plan, the Company may grant options of up to 3,500,000
shares of common stock. The exercise price of each option equals the market
price of the Company's stock on the date of grant. The options cannot be
exercised until at least one year after the date of grant and have a maximum
term of ten years after the date of grant. A portion of the options are also
subject to stock price performance requirements being met prior to exercise. In
January 1997, the Compensation Committee of the Company's Board of Directors
amended the number of options which may be granted under the 1994 plan to
5,000,000 shares, subject to approval by the Company's shareholders.
-33-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 9--INCENTIVE COMPENSATION AND STOCK PURCHASE PLANS - CONTINUED
Options granted prior to 1994 were granted under the 1989 stock option plan.
Under that plan, the Company could grant options of up to 700,000 shares of
common stock over the five year term of the plan which ended effective December
31, 1993.
The exercise price of each option equaled the market price of the Company's
stock on the date of grant. The options outstanding under this plan are
currently exercisable and have a maximum term of ten years after the date of
grant.
Summaries of the Company's stock options are as follows:
1996 1995 1994
------------------------- ------------------------- -------------------------
Shares Weighted-Average Shares Weighted-Average Shares Weighted-Average
(000) Exercise Price (000) Exercise Price (000) Exercise Price
------- ---------------- ------- ---------------- ------- ----------------
Outstanding at January 1 1,648 $24.82 885 $27.35 564 $25.11
Granted 674 31.13 1,003 22.70 481 29.13
Exercised (161) 24.17 (49) 20.72 (88) 20.74
Forfeited (31) 30.81 (103) 26.05 (51) 30.75
Expired (10) 29.30 (88) 26.89 (21) 27.57
----- ----- ----
Outstanding at December 31 2,120 26.77 1,648 24.82 885 27.35
===== ===== ====
December 31
1996 1995 1994
(shares in thousands)
-----------------------------------------------------------
Exercisable 1,477 476 265
Exercisable based on
additional service 643 975 460
Exercisable based on
stock price performance 0 197 160
----- ----- ----
Outstanding 2,120 1,648 885
===== ===== ====
December 31, 1996
-------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------- ----------------------------
Weighted-Average
Range of Shares Remaining Weighted-Average Shares Weighted-Average
Exercise Prices (000) Contractual Life Exercise Price (000) Exercise Price
- ------------------ ------- ---------------- ---------------- ------- ------------------
$18.00 to 24.99 931 5.0 years $22.52 931 $22.52
25.00 to 31.99 1,145 5.8 29.91 546 28.85
32.00 to 51.99 44 8.1 34.75 - -
----- -----
18.00 to 51.99 2,120 5.5 26.77 1,477 24.86
===== =====
-34-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 9--INCENTIVE COMPENSATION AND STOCK PURCHASE PLANS - CONTINUED
EMPLOYEE STOCK PURCHASE PLAN
In 1995, the Company established an employee stock purchase plan to promote and
maintain widespread employee stock ownership. The plan became effective in the
fourth quarter of 1995 and conforms to Internal Revenue Code Section 423. Under
the plan, the Company is authorized to issue up to 1,000,000 shares of common
stock to its employees, nearly all of whom are eligible to participate. Under
the terms of the plan, eligible employees may purchase common stock of the
Company at the end of each three-month financial quarter. The purchase price of
the stock is 85 percent of the lower of its beginning of the quarter or end of
the quarter market price. The maximum amount of stock a participating employee
may purchase under the plan in any one calendar year is limited to $25,000 in
fair market value of the stock as determined at the beginning of each purchase
period. The Company sold 34,311 and 31,935 shares to employees with a weighted-
average exercise price of $29.36 and $23.06 per share in 1996 and 1995,
respectively. The Company applies Opinion 25 and related interpretations in
accounting for the stock purchase plan. Accordingly, no compensation cost has
been recognized.
COMPENSATION COST UNDER THE FAIR VALUE APPROACH (SFAS 123)
Compensation cost for the Company's management incentive compensation plan and
employee stock purchase plan under the fair value approach was estimated as of
the grant date using the Black-Scholes option pricing model with the following
weighted-average assumptions:
Year Ended December 31
1996 1995
----------------------------
Volatility 18.2% 19.1%
Risk-free rate of return 5.7% 7.6%
Dividend payout rate per share $0.72 $0.72
Time of exercise
Management Incentive Compensation Plan
Executives 7 years 5 years
Non-executives 6 years 4 years
Employee Stock Purchase Plan 3 months 3 months
Weighted-average fair value of options granted during the year
Management Incentive Compensation Plan $7.36 $4.92
Employee Stock Purchase Plan $6.77 $5.26
Had compensation cost for the two plans been determined in accordance with the
provisions of SFAS 123, the Company's pro forma net income for the years ended
December 31, 1996 and 1995 would have been $143.6 million and $114.2 million,
respectively. There are no significant differences between earnings per common
share as reported and pro forma earnings per common share on a primary or fully
diluted basis for the years ended December 31, 1996 and 1995.
-35-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 10--REINSURANCE
The Company routinely assumes and cedes reinsurance with other insurance
companies. The primary purpose of ceded reinsurance is to limit losses from
large exposures; however, if the reinsurer is unable to meet its obligations,
the originating issuer of the insurance coverage retains the liability. Premium
income, policy and contract benefits, and change in reserves for future policy
and contract benefits and policyholders' funds are presented in the consolidated
statements of income net of reinsurance ceded.
On May 1, 1995, the Company entered into an indemnity and assumption reinsurance
agreement with Healthsource Insurance Company in connection with the sale of the
group medical business (see Note 13). Under the terms of the reinsurance
agreement, the Company cedes to Healthsource Insurance Company premium income
and associated obligations and liabilities arising with respect to medical
indemnity and dental and vision insurance issued by the Company in certain
states where Healthsource Insurance Company is not currently licensed and
approved to transact this type of business. Total premium income and policy and
contract benefits ceded under this reinsurance agreement were $224.6 million and
$188.5 million, respectively, for the year ended December 31, 1996, and $170.6
million and $137.5 million, respectively, for the year ended December 31, 1995.
Once Healthsource Insurance Company obtains the necessary licenses and approvals
to transact this business in all states, the group medical reinsurance agreement
will be terminated.
The total amounts deducted for reinsurance ceded are as follows:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
--------------------------
Premium Income $305.5 $249.2 $61.3
Policy and Contract Benefits 265.5 202.7 49.2
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 26.4 44.7 53.2
-36-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 10--REINSURANCE - Continued
Reinsurance ceded and assumed consists of the following:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
------------------------------
CEDED
Life Insurance in Force (Amount of Insurance) $4,347.9 $4,258.5 $4,202.6
Premium Income
Individual Life and Disability 48.2 47.8 41.0
Employee Benefits 31.9 29.9 18.9
Other Operations 225.4 171.5 1.4
ASSUMED
Life Insurance in Force (Amount of Insurance) $ 437.0 $ 460.2 $ 499.2
Premium Income
Individual Life and Disability 35.3 36.9 39.1
Employee Benefits 16.2 15.4 0.4
-37-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 11-- LIABILITY FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES
Changes in the liability for unpaid claims and claim adjustment expenses were as
follows:
1996 1995 1994
(in millions of dollars)
---------------------------------
BALANCE AT JANUARY 1 $2,824.7 $2,472.9 $2,143.9
Less Reinsurance Recoverables 343.2 237.6 180.9
-------- -------- --------
Net Balance at January 1 2,481.5 2,235.3 1,963.0
-------- -------- --------
Incurred Related to:
Current Year 910.6 960.0 1,062.4
Prior Years 107.8 123.9 115.9
-------- -------- --------
Total Incurred 1,018.4 1,083.9 1,178.3
-------- -------- --------
Paid Related to:
Current Year 322.4 359.0 456.3
Prior Years 502.1 478.7 449.7
-------- -------- --------
Total Paid 824.5 837.7 906.0
-------- -------- --------
Net Balance at December 31 2,675.4 2,481.5 2,235.3
Plus Reinsurance Recoverables 372.1 343.2 237.6
-------- -------- --------
BALANCE AT DECEMBER 31 $3,047.5 $2,824.7 $2,472.9
======== ======== ========
The majority of the net balances are related to disabled lives claims with long-
tail payouts on which interest earned on assets backing liabilities is an
integral part of pricing and reserving. The incurred amounts shown above have
not been adjusted for interest.
Prior year claim reserves include strengthening (reserve releases) of $(2.0)
million, $(33.5) million, and $35.1 million for 1996, 1995, and 1994,
respectively.
-38-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 12--SEGMENT INFORMATION
Selected data by segment is as follows:
Year Ended December 31
1996 1995 1994
(in millions of dollars)
--------------------------------------
REVENUE (EXCLUDING NET REALIZED INVESTMENT
GAINS AND LOSSES)
Individual Life and Disability $ 1,047.6 $ 1,019.3 $ 956.6
Employee Benefits 606.1 582.7 555.3
Other Operations 646.8 985.0 1,280.4
--------- --------- ---------
Total $ 2,300.5 $ 2,587.0 $ 2,792.3
========= ========= =========
INCOME BEFORE NET REALIZED INVESTMENT
GAINS AND LOSSES AND FEDERAL INCOME TAXES
Individual Life and Disability $ 117.3 $ 36.5 $ 53.2
Employee Benefits 56.3 48.6 71.8
Other Operations 61.2 122.6 106.0
--------- --------- ---------
Total $ 234.8 $ 207.7 $ 231.0
========= ========= =========
REVENUE (INCLUDING NET REALIZED INVESTMENT
GAINS AND LOSSES)
Individual Life and Disability $ 1,056.1 $ 1,024.0 $ 962.4
Employee Benefits 606.2 586.6 556.9
Other Operations 629.6 944.7 1,242.9
--------- --------- ---------
Total $ 2,291.9 $ 2,555.3 $ 2,762.2
========= ========= =========
INCOME BEFORE FEDERAL INCOME TAXES
Individual Life and Disability $ 125.8 $ 41.2 $ 59.0
Employee Benefits 56.4 52.5 73.4
Other Operations 44.0 82.3 68.5
--------- --------- ---------
Total $ 226.2 $ 176.0 $ 200.9
========= ========= =========
ASSETS
Individual Life and Disability $ 6,051.3 $ 5,746.1 $ 4,597.1
Employee Benefits 1,505.8 1,426.5 1,238.3
Other Operations 7,435.4 9,128.7 11,314.5
--------- --------- ---------
Total $14,992.5 $16,301.3 $17,149.9
========= ========= =========
Total revenue (excluding net realized investment gains and losses) includes
premium income, net investment income, and other income. Total revenue
(including net realized investment gains and losses) includes premium income,
net investment income, net realized investment gains and losses, and other
income. Assets have been allocated to the segments based upon identifiable
liabilities and allocated stockholders' equity.
-39-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 13--SALE OF A PORTION OF A LINE OF BUSINESS
In December 1994, the Company entered into an Asset and Stock Purchase Agreement
with Healthsource, Inc. (Healthsource) whereby Healthsource agreed to acquire
certain assets and assume certain liabilities of the Company's group medical
business. The sale was completed on May 31, 1995, effective April 30, 1995. The
Company received $131.0 million in cash and $100.0 million of a new issue of
Healthsource 6.25% preferred stock which was redeemed at par in the first
quarter of 1996. Pursuant to the Asset and Stock Purchase Agreement, assets were
transferred to Healthsource which had a carrying value of approximately $297.5
million. Liabilities assumed by Healthsource in connection with the transferred
business totaled $221.5 million. Total revenue and income before federal income
taxes for the group medical business were $146.2 million and $3.3 million,
respectively, for the four month period ended April 30, 1995. The gain on sale
of the Company's group medical business increased 1995 operating earnings by
$21.8 million ($0.48 per common share) before taxes and $14.2 million ($0.31 per
common share) after taxes.
NOTE 14--COMMITMENTS AND CONTINGENT LIABILITIES
COMMITMENT TO ACQUIRE THE PAUL REVERE CORPORATION
On April 29, 1996, the Company entered into a definitive agreement (the
Agreement) to acquire The Paul Revere Corporation (Paul Revere), a provider of
life and disability insurance products, at a price of approximately $1.2
billion. The public shareholders of Paul Revere may elect to receive per share
$26 in cash; a combination of $20 cash and a number of shares of the Company's
common stock equal to the product of 6 and the Exchange Ratio; or a number of
shares of the Company's common stock equal to the product of 26 and the Exchange
Ratio. The public shareholders' Exchange Ratio (as defined in the Agreement) is
based on the Company's common stock price during a defined period prior to
closing and is subject to certain maximum and minimum share amounts.
On November 4, 1996, the Company entered into an amended definitive agreement
(Amended Agreement). The Amended Agreement affected only the terms related to
the acquisition of Textron Inc.'s 83 percent ownership interest in Paul Revere.
Under the terms of the Amended Agreement, the Company has agreed to pay to
Textron Inc. $20 per share in cash and a number of shares of newly issued common
stock equal to the product of 6 and the Textron Inc. Exchange Ratio.
The transaction will be financed through common equity issued to Zurich
Insurance Company, a Swiss insurer, or one or more of its affiliates, common
equity issued to Paul Revere shareholders, debt, and internally generated funds.
The transaction is subject to regulatory approval and is expected to close
during the first quarter of 1997. The acquisition will be accounted for by the
purchase method.
CONTINGENT LIABILITIES
Various lawsuits against the Company have arisen in the normal course of
business. Contingent liabilities that might arise from litigation are not
deemed likely to materially affect the financial position or results of
operations of the Company.
-40-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 15--STATUTORY FINANCIAL INFORMATION
STATUTORY NET INCOME, STOCKHOLDER'S EQUITY, AND DIVIDENDS
The Company's insurance subsidiaries' statutory net income, as reported in
conformity with statutory accounting practices prescribed by state regulatory
authorities, for the years ended December 31, 1996, 1995, and 1994, was $104.9
million, $67.1 million, and $33.8 million, respectively. Statutory
stockholder's equity at December 31, 1996 and 1995, was $674.2 million and
$570.4 million, respectively.
Regulatory restrictions limit the amount of dividends available for distribution
to the Company from its insurance subsidiaries, without prior approval by
regulatory authorities, to the greater of ten percent of an insurer's statutory
surplus as regards policyholders as of the preceding year end or the statutory
net gain from operations, excluding realized investment gains and losses, of the
preceding year. The payment of dividends is further limited to the amount of
statutory unassigned surplus. Based on these restrictions, $107.0 million will
be available for the payment of dividends to the Company from its insurance
subsidiaries during 1997.
PERMITTED STATUTORY ACCOUNTING PRACTICES
The Company's insurance subsidiaries prepare their statutory-basis financial
statements in accordance with accounting practices prescribed or permitted by
the National Association of Insurance Commissioners (NAIC) and the Tennessee
Department of Commerce and Insurance. Prescribed statutory accounting practices
include state laws, regulations, and general administrative rules, as well as a
variety of publications of the NAIC. Permitted statutory accounting practices
encompass all accounting practices that are not prescribed; such practices may
differ from state to state, may differ from company to company within a state,
and may change in the future. At December 31, 1996, the Company has not applied
any permitted accounting practices that differ from prescribed statutory
accounting practices.
The NAIC currently is in the process of recodifying statutory accounting
practices, the result of which is expected to standardize prescribed statutory
accounting practices. Accordingly, that project, which is expected to be
completed in 1997, will likely change, to some extent, prescribed statutory
accounting practices and may result in changes to the accounting practices that
the Company's insurance subsidiaries use to prepare their statutory financial
statements.
DEPOSITS
At December 31, 1996, the Company's insurance subsidiaries had on deposit with
regulatory authorities securities with a book value of $173.9 million held for
the protection of policyholders.
NOTE 16--SUBSEQUENT EVENTS
On February 28, 1997, the Company acquired GENEX Services, Inc. and GENEX
Services of Canada, Inc. (GENEX), subsidiaries of First Data Corporation, at a
price of approximately $70.0 million. GENEX is a provider of case management,
vocational rehabilitation, and related services to corporations, third party
administrators, and insurance companies. These services are utilized in the
management of disability and worker's compensation cases. The acquisition,
financed through borrowings on the Company's revolving credit facility, was
accounted for by the purchase method.
-41-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTE 17--SUPPLEMENTAL DATA ON QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for 1996
and 1995:
1996
-----------------------------------------------
4th 3rd 2nd 1st
(in millions of dollars, except per share data)
-----------------------------------------------
Premium Income $292.4 $287.4 $291.3 $304.6
Net Investment Income 268.0 269.5 274.1 278.5
Net Realized Investment Gains (Losses) 1.4 (4.1) (5.3) (0.6)
Total Revenue 568.5 562.7 569.0 591.7
Income Before Federal Income Taxes 67.8 51.8 53.2 53.4
Net Income 43.9 33.2 34.1 34.4
Net Income Per Common Share .89 .66 .68 .69
1995
-----------------------------------------------
4th 3rd 2nd 1st
(in millions of dollars, except per share data)
-----------------------------------------------
Premium Income $285.8 $292.0 $313.1 $361.0
Net Investment Income 296.9 301.6 309.8 313.0
Net Realized Investment Losses (2.3) (0.9) (24.6) (3.9)
Total Revenue 594.7 602.7 644.1 713.8
Income Before Federal Income Taxes 53.4 51.1 51.9 19.6
Net Income 35.4 32.9 35.0 12.3
Net Income Per Common Share .71 .66 .70 .20
-42-