SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended March 31, 1997.
Commission file number 1-11834
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PROVIDENT COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 62-1598430
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 Fountain Square, Chattanooga, Tennessee 37402
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(Address of principal executive offices)
(Zip Code)
(423)755-1011
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(Registrant's telephone number, including area code)
None
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Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate the number of shares outstanding for each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT March 31, 1997
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Common Stock, $1.00 Par Value 66,884,726
Total number of pages included are 32
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PROVIDENT COMPANIES, INC.
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial
Condition at March 31, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income for
the Three Months Ended March 31, 1997 and 1996 5
Condensed Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 1997 and 1996 6
Notes to Condensed Consolidated Financial Statements 7
Independent Accountants' Review Report 12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 27
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
March 31 December 31
1997 1996
(in millions of dollars)
---------------------------
(Unaudited)
ASSETS
Investments
Fixed Maturity Securities
Available-for-Sale $15,270.9 $10,880.1
Held-to-Maturity 269.3 264.5
Equity Securities 66.0 4.9
Mortgage Loans 280.4 -
Real Estate 132.8 151.1
Policy Loans 1,831.5 1,749.0
Other Long-term Investments 44.2 15.5
Short-term Investments 299.9 252.3
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Total Investments 18,195.0 13,317.4
Cash and Bank Deposits 29.1 19.3
Accounts and Premiums Receivable 282.4 112.4
Reinsurance Receivable 1,053.5 468.3
Accrued Investment Income 381.6 268.3
Deferred Policy Acquisition Costs 582.9 421.8
Value of Business Acquired--Note 5 677.9 5.9
Goodwill--Note 5 599.2 -
Deferred Federal Income Tax Asset 121.1 -
Property and Equipment 80.8 59.0
Miscellaneous 21.0 19.6
Separate Account Assets 300.7 300.5
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TOTAL ASSETS $22,325.2 $14,992.5
========= =========
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
March 31 December 31
1997 1996
(in millions of dollars)
---------------------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy and Contract Benefits $ 500.3 $ 411.7
Reserves for Future Policy and
Contract Benefits
and Unearned Premiums 12,393.7 8,110.1
Policyholders' Funds and Experience
Rating Refunds 5,458.7 3,881.1
Federal Income Tax Liability 50.3 49.1
Long-term Debt 725.0 200.0
Other Liabilities 446.2 301.4
Separate Account Liabilities 300.7 300.5
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TOTAL LIABILITIES 19,874.9 13,253.9
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COMMITMENTS AND CONTINGENT LIABILITIES
- NOTE 4
STOCKHOLDERS' EQUITY
Preferred Stock 156.2 156.2
Common Stock, $1 par 66.9 45.6
Additional Paid-in Capital 732.0 11.4
Net Unrealized Gain on Securities 23.5 90.9
Foreign Currency Translation
Adjustment (5.6) (5.2)
Retained Earnings 1,477.3 1,439.7
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TOTAL STOCKHOLDERS' EQUITY 2,450.3 1,738.6
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TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $22,325.2 $14,992.5
========= =========
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Three Months Ended March 31
1997 1996
(in millions of dollars, except share data)
---------------------------------------------
REVENUE
Premium Income $ 287.5 $ 304.6
Net Investment Income 262.5 278.5
Net Realized Investment Gains
(Losses) 4.7 (0.6)
Other Income 16.6 9.2
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TOTAL REVENUE 571.3 591.7
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BENEFITS AND EXPENSES
Policy and Contract Benefits 291.7 299.4
Change in Reserves for Future Policy
and Contract Benefits
and Policyholders' Funds 110.1 140.8
Amortization of Deferred Policy
Acquisition Costs 17.3 16.9
Other Operating Expenses 89.4 81.2
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TOTAL BENEFITS AND EXPENSES 508.5 538.3
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INCOME BEFORE FEDERAL INCOME TAXES 62.8 53.4
FEDERAL INCOME TAXES 22.0 19.0
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NET INCOME $ 40.8 $ 34.4
=========== ===========
NET INCOME PER COMMON SHARE - NOTE 2 $ 0.81 $ 0.69
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 46,605,854 45,434,964
DIVIDENDS PER COMMON SHARE $ 0.18 $ 0.18
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Three Months Ended March 31
1997 1996
(in millions of dollars)
-----------------------------
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 108.2 $ 142.2
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sales of Investments 233.7 438.7
Proceeds from Maturities of
Investments 385.2 427.5
Purchase of Investments (297.1) (503.7)
Net Sales of Short-term Investments 150.6 107.1
Acquisition of Business--Note 5 (857.8) -
Other (3.4) (47.5)
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NET CASH PROVIDED (USED) BY INVESTING
ACTIVITIES (388.8) 422.1
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CASH FLOWS FROM FINANCING ACTIVITIES
Deposits to Policyholder Accounts 86.1 97.4
Maturities and Benefit Payments from
Policyholder Accounts (511.5) (685.9)
Net Short-term Borrowings - 44.2
Net Long-term Borrowings 425.9 -
Issuance of Common Stock 301.9 1.3
Dividends Paid to Stockholders (11.4) (11.4)
Other 0.1 -
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NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES 291.1 (554.4)
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Effect of Foreign Exchange Rate Changes
on Cash (0.7) -
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NET INCREASE IN CASH AND BANK DEPOSITS 9.8 9.9
CASH AND BANK DEPOSITS AT BEGINNING OF
PERIOD 19.3 24.8
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CASH AND BANK DEPOSITS AT END OF PERIOD $ 29.1 $ 34.7
======= =======
See notes to condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
MARCH 31, 1997
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three month period ended March 31,
1997, are not necessarily indicative of the results that may be expected for the
year ended December 31, 1997. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1996.
NOTE 2--EARNINGS PER SHARE
The Company applies Accounting Principles Board Opinion No. 15 (Opinion 15),
"Earnings per Share," and related interpretations in calculating earnings per
common share. Earnings per common share are computed using net income less
preferred stock dividends ($3.2 million for the three month periods ended March
31, 1997 and 1996) 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 under Opinion 15.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS 128), "Earnings per Share," which
requires dual presentation of basic and diluted earnings per share on the face
of the income statement for all entities with complex capital structures. Basic
earnings per share excludes dilution and is computed using net income less
preferred stock dividends divided by the weighted average number of common
shares outstanding. Diluted earnings per share reflects the potential dilution
that would occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock. The Company has issued stock options under its management incentive
compensation plan and to certain non-employee brokers and producers which may
result in the issuance of common stock.
SFAS 128 is effective for financial statements issued for periods ending after
December 15, 1997. Earnings per share as defined under Opinion 15 and as
reported in the accompanying financial statements equals basic earnings per
share as defined under SFAS 128. Pro forma earnings per common share assuming
dilution under SFAS 128 for the three month periods ended March 31, 1997 and
1996, are $0.79 and $0.68, respectively.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
MARCH 31, 1997
NOTE 3--SEGMENT INFORMATION
A summary by segment of the Company's revenue and income before federal income
taxes, excluding and including net realized investment gains and losses,
follows:
Three Months Ended March 31
1997 1996
(in millions of dollars)
-----------------------------
Revenue (Excluding Net Realized
Investment Gains and Losses)
Individual Life and Disability $267.9 $257.7
Employee Benefits 156.4 161.9
Other Operations 142.3 172.7
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Total $566.6 $592.3
====== ======
Income Before Net Realized Investment
Gains and Losses and Federal Income
Taxes
Individual Life and Disability $ 26.2 $ 22.8
Employee Benefits 16.6 14.6
Other Operations 15.3 16.6
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Total $ 58.1 $ 54.0
====== ======
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
MARCH 31, 1997
NOTE 3--SEGMENT INFORMATION - CONTINUED
Three Months Ended March 31
1997 1996
(in millions of dollars)
----------------------------
Revenue (Including Net Realized
Investment Gains and Losses)
Individual Life and Disability $273.0 $262.2
Employee Benefits 156.2 161.5
Other Operations 142.1 168.0
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Total $571.3 $591.7
====== ======
Income Before Federal Income Taxes
Individual Life and Disability $ 31.3 $ 27.3
Employee Benefits 16.4 14.2
Other Operations 15.1 11.9
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Total $ 62.8 $ 53.4
====== ======
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.
NOTE 4--COMMITMENTS AND 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.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
MARCH 31, 1997
NOTE 5--ACQUISITION OF BUSINESS
GENEX SERVICES, INC.
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 $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. The fair value of the assets acquired and
liabilities assumed were $16.0 million and $6.5 million, respectively. The
consolidated financial statements include the operating results from the date of
acquisition. Pro forma results of operations have not been presented because the
effects of this acquisition were not material.
THE PAUL REVERE CORPORATION
On March 27, 1997, the Company acquired The Paul Revere Corporation (Paul
Revere), a provider of life and disability insurance products, at a price of
approximately $1.2 billion. The transaction was financed through common equity
issued to Zurich Insurance Company, a Swiss insurer, and its affiliates in the
amount of $300.0 million, common equity issued to Paul Revere shareholders in
the amount of $440.0 million, internally generated funds of $145.0 million, and
borrowings on the Company's revolving credit facility of $305.0 million. The
acquisition was accounted for by the purchase method. The fair value of the
assets acquired and liabilities assumed were $6,584.8 million and $6,494.5
million, respectively. The condensed consolidated statements of financial
condition reflect the accounts of Paul Revere at March 31, 1997. The purchase
price has been allocated principally to the value of business acquired with the
remainder being allocated to goodwill. The value of business acquired will be
amortized with interest based on premium income for the traditional individual
life and disability income products and on the estimates of future gross profits
for interest-sensitive individual life and individual annuity products. The
Company will periodically review the carrying amount of the value of business
acquired using the same methods used to evaluate deferred policy acquisition
costs.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
MARCH 31, 1997
NOTE 5--ACQUISITION OF BUSINESS - CONTINUED
The following pro forma results of operations for the three months ended March
31, 1997 and 1996, give effect to the acquisition and the related financing
arrangements, including the acquisition of debt and issuance of common stock
equity. The pro forma results of operations, prepared from historical financial
results of operations of the Company and Paul Revere with such adjustments as
are necessary to present the results of operations as if the acquisition had
occurred as of the beginning of each period presented, are as follows:
Three Months Ended March 31
1997 1996
(in millions of dollars)
-----------------------------
Revenue $1,014.0 $973.7
Income Before Federal Income Taxes 116.6 78.1
Net Income 73.6 49.0
Net Income per Common Share 1.05 0.68
Revenue and income before federal income taxes include $36.4 million and $4.2
million of pre-tax net realized investment gains for Paul Revere for the three
months ended March 31, 1997 and 1996, respectively. Net income includes $23.0
million ($0.34 per share) and $2.6 million ($0.04 per share) of after-tax net
realized investment gains for the three months ended March 31, 1997 and 1996,
respectively.
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INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors and Shareholders
Provident Companies, Inc.
We have reviewed the accompanying condensed consolidated statement of financial
condition of Provident Companies, Inc. and Subsidiaries as of March 31, 1997,
the related condensed consolidated statements of income for the three month
periods ended March 31, 1997 and 1996, and the condensed consolidated statements
of cash flows for the three month periods ended March 31, 1997 and 1996. These
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, which will be
performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial condition of Provident
Companies, Inc. and Subsidiaries as of December 31, 1996, and the related
consolidated statements of income, stockholders' equity and cash flows for the
year then ended, not presented herein, and in our report dated February 10,
1997, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated statement of financial condition as of December 31, 1996,
is fairly stated in all material respects in relation to the consolidated
statement of financial condition from which it has been derived.
ERNST & YOUNG LLP
Chattanooga, Tennessee
May 12, 1997
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Operating Results
- -----------------
Revenue excluding net realized investment gains and losses ("revenue")
declined $25.7 million, or 4.3 percent, to $566.6 million in the first quarter
of 1997 from $592.3 million in the first quarter of 1996. The decline was the
result of lower revenue in the other operations segment ($30.4 million) and
employee benefits segment ($5.5 million), which was partly offset by increased
revenue in the individual life and disability segment ($10.2 million).
Income before net realized investment gains and losses and federal income
taxes ("income") increased $4.1 million, or 7.6 percent, to $58.1 million in the
first quarter of 1997, from $54.0 million in the first quarter of 1996. The
increase was the result of increased income in the individual life and
disability segment ($3.4 million) and employee benefits segment ($2.0 million)
which was partly offset by lower income in the other operations segment ($1.3
million).
Net income increased $6.4 million, or 18.6 percent, to $40.8 million in the
first quarter of 1997, from $34.4 million in the first quarter of 1996. Net
realized investment gains after taxes were $3.1 million in the first quarter of
1997, compared to after-tax losses of $0.4 million in the first quarter of 1996.
Individual Life and Disability
- ------------------------------
Revenue in the individual life and disability segment increased $10.2
million, or 4.0 percent, to $267.9 million in the first quarter of 1997, from
$257.7 million in the first quarter of 1996. The increase was primarily the
result of higher net investment income. Net investment income in this segment
increased $8.7 million, or 9.1 percent, to $103.8 million in the first quarter
of 1997, from $95.1 million in the first quarter of 1996. The increase was due
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to an increased allocation of capital to the individual disability income line
of business and the growth in reserves in this line. Premium income in this
segment increased $0.4 million, or 0.2 percent, to $161.4 million in the first
quarter of 1997, from $161.0 million in the first quarter of 1996. The increase
was primarily the result of improvements in persistency in the individual
disability income line of business.
In November 1994, the Company announced its intention to discontinue
selling individual noncancelable disability contracts with own-occupation
provisions (other than conversion policies available under existing contractual
arrangements). The Company is focusing on replacing the traditional
noncancelable 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 the first quarter of 1997, annualized new premiums for
individual disability income increased to $10.5 million, from $8.8 million in
the first quarter of 1996, indicating improving market acceptance of the new
products.
Income in the individual life and disability segment increased $3.4
million, or 14.9 percent, to $26.2 million in the first quarter of 1997, from
$22.8 million in the first quarter of 1996. The increase is primarily due to
improved results in the individual disability income line of business. In this
line, income increased $7.0 million, or 48.3 percent, to $21.5 million in the
first quarter of 1997, from $14.5 million in the first quarter of 1996. This
improvement is primarily due to a lower level of new claims in the first quarter
of 1997 compared to the first quarter of 1996 and an improvement in the loss
ratio. Management believes substantial investments in the individual disability
claims management process since the first quarter of 1995 helped produce the
improvement that has occurred in this line over the past two years. 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
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specialized nature of disability claims, and an increased level of staffing with
experienced claim adjusters. The individual life line of business produced
income of $4.3 million in the first quarter of 1997, compared to $8.1 million in
the first quarter of 1996, primarily due to an adjustment to reserves in the
year ago quarter and to slightly higher mortality rates in the current quarter.
Deposits on deferred annuities totaled $9.4 million in the first quarter of
1997, compared to $3.3 million in the first quarter of 1996.
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 ("GAAP") 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 incorporated 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
-15-
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
- -----------------
Accidental death and dismemberment and accident and sickness are now
reported in the group life and group disability lines of business, respectively;
both were previously included with affinity groups in the packaged products
line. Prior year results have been reclassified to conform to current period
reporting. The reclassification did not change total revenue or total income for
the employee benefits segment.
Revenue in the employee benefits segment declined $5.5 million, or 3.4
percent, to $156.4 million in the first quarter of 1997, from $161.9 million in
the first quarter of 1996. The decline was primarily the result of a decline in
premium income in this segment of $15.2 million, or 11.1 percent, to $121.7
million in the first quarter of 1997, from $136.9 million in the first quarter
of 1996. The decline was primarily the result of the impact of refunds on
experience rated business, reduced premiums in the medical stop-loss line
of business, and the termination of the Medicare supplement coverage in the
affinity groups line. Premiums in the core voluntary benefits, pooled group
disability, and group life lines of business grew 13.3 percent in the first
quarter of 1997 to $58.7 million, from $51.8 million in the first quarter of
1996. Revenue was positively impacted $7.2 million by the acquisition of GENEX
Services, Inc. ("GENEX") during the first quarter of 1997. 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. In 1996, GENEX's revenues totaled $85.9 million.
-16-
Income in the employee benefits segment increased $2.0 million, or 13.7
percent, to $16.6 million in the first quarter of 1997, from $14.6 million in
the first quarter of 1996. The increase is primarily the result of increased
income in the group disability and affinity groups lines of business. The group
disability line of business produced income of $3.7 million in the first quarter
of 1997 compared to $0.2 million in the first quarter of 1996. The increase was
primarily due to improved loss ratios in the long-term and short-term disability
product lines. The affinity groups line of business produced income of $3.6
million in the first quarter of 1997 compared to $1.1 million in the first
quarter of 1996. The increase was primarily due to higher deficit recoveries.
Partly offsetting these results was a decline in income in the group life line
of business. This line produced income of $1.0 million in the first quarter of
1997 compared to $4.7 million in the first quarter of 1996. The decline is
primarily the result of a higher loss ratio in this line and lower deficit
recoveries on experience rated business.
Other Operations
- ----------------
The other operations segment includes the Company's group pension products,
its corporate-owned life insurance ("COLI") product, corporate (unallocated)
capital and assets, and a reinsurance agreement in connection with the medical
services business sold in 1995. 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 $30.4 million, or 17.6
percent, to $142.3 million in the first quarter of 1997, from $172.7 million in
the first quarter of 1996. The decline is primarily the result of a decrease in
funds under management resulting from the strategic decision to discontinue the
-17-
sale of products in the group pension line of business. Revenue in this line
declined to $85.5 million in the first quarter of 1997, from $112.7 million in
the first quarter of 1996.
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 and funds under management acquired from
The Paul Revere Corporation, totaled $4.31 billion at March 31, 1997, compared
to $5.88 billion at March 31, 1996, a decrease of 26.7 percent.
Also, 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 is selling this block of business through an assumptive
reinsurance transaction which is subject to the approval of the contract holders
and respective state regulators. This sale is expected to be completed by
December 31, 1997. Accumulated funds from the Company's synthetic GICs totaled
$2.16 billion at March 31, 1997, and $2.18 billion at December 31, 1996.
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 the first quarter of 1997 declined $1.3 million to $15.3 million
from $16.6 million in the first quarter of 1996. The decline in this segment was
due to lower income in the group pension line of business, which declined $1.9
million, or 15.0 percent, to $10.8 million in the first quarter of 1997 from
$12.7 million in the first quarter of 1996. 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 COLI line of
business increased slightly to $4.7 million in the first quarter of 1997,
compared to $4.5 million in the first quarter of 1996.
-18-
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.
Liquidity and Capital Resources
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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 the
Agreement had been amended and restated and that, in connection with that
amendment and restatement, 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 GAAP.
The financial terms of the acquisition were unchanged to Paul Revere's
public stockholders from those of the original Agreement. Under the terms of the
Amended and Restated Agreement and Plan of Merger (the "Amended Agreement"),
Textron committed to make a capital contribution to Paul Revere of between
$100.0 million and $180.0 million. The amount of the contribution, determined by
the amount of statutory reserve strengthening required by the Massachusetts
Division of Insurance as a condition to approving 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 used in computing the number of shares of the Company's common
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stock that constituted the stock portion of the merger consideration Textron
received 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 .0295,
compared to a minimum Textron exchange ratio of .0263 under the Amended
Agreement. This change reduced the number of shares of the Company's common
stock that Textron was entitled to receive. Additional consideration totaling
approximately $40 million was also contributed to Paul Revere by Textron. The
Amended Agreement contains certain limited purpose hold harmless provisions
pursuant to which Textron agreed to indemnify the Company from specified
damages. Subsequently, pursuant to the Textron Voting Agreement and an Agreement
dated as of March 27, 1997 between the Company and Textron ("Textron
Agreement"), Textron agreed, among other things, to pay to the Company a portion
of the net proceeds received by Textron from the sale of the shares of the
Company's common stock offered through a public secondary offering. The Paul
Revere Merger was consummated on March 27, 1997. The public secondary offering
of the Company's stock received by Textron was completed on May 5, 1997.
The foregoing discussion of the Amended Agreement and the Textron Agreement
is a summary of the terms of the Amended Agreement and Textron 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, and the Textron
Agreement, respectively, which have been previously filed with the Securities
and Exchange Commission, together with a more complete description of the terms
of the merger.
The Paul Revere Merger was financed through common equity issuance to
Zurich Insurance Company, a Swiss insurer, and its affiliates, common equity
issuance to Paul Revere stockholders, debt, and internally generated funds. The
debt financing was provided through an $800.0 million five-year revolving credit
facility with various domestic and international banks. The revolving credit
facility was established in 1996 to provide partial financing for the purchase
of Paul Revere, to refinance the existing bank term notes of $200.0 million, and
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for general corporate uses. At March 31, 1997 and December 31, 1996, outstanding
borrowings under the revolving credit facility were $725.0 million and $200.0
million, respectively. The credit facility has a current interest rate of 5.965
percent and contains certain restrictive covenants governing the Company's
ability to pay dividends and requirements that the Company satisfy certain
financial covenants, including requirements as to minimum adjusted statutory
surplus and risk-based capital levels. The Company believes the cash flow from
the combined operations will be sufficient to meet its operating and financing
cash flow requirements.
As a holding company, the Company is dependent upon payments from its
wholly-owned insurance subsidiaries and GENEX to pay dividends to its
stockholders and to pay its expenses. These payments by the Company's
subsidiaries may take the form of either dividends or interest payments on
amounts loaned to such subsidiaries 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, the state of domicile for
Provident Life and Accident Insurance Company, Provident Life and Casualty
Insurance Company, and Provident National Assurance Company, 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 any 12-month period 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. The Paul Revere
Life Insurance Company is domiciled in the Commonwealth of Massachusetts. The
maximum annual dividend which a Massachusetts insurance company is permitted to
pay without the prior approval of the Massachusetts Commissioner of Insurance is
greater of (a) ten percent of the insurance company's surplus to policyholders
as of the thirty-
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first day of December next preceding or (b) the insurance company's statutory
net gain from operations for the 12-month period ending the thirty-first day of
December next preceding. Legislation enacted in Massachusetts further provides
that any dividend not paid out of earned surplus be made only with prior
approval of the Massachusetts Commissioner of Insurance. In November 1996,
Provident National Assurance Company made an extraordinary cash distribution in
the amount of $100.0 million to the Company. An aggregate of $141.5 million
would be available in 1997 for the payment of dividends or other distributions
by the Company's top-tier insurance subsidiaries without regulatory approval.
The Company's requirements are met primarily by cash flow provided from
operations, principally in its insurance subsidiaries. Premium and investment
income as well as maturities and sales of invested assets provide the primary
sources of cash. Cash flow from operations was sufficient in the first quarter
of 1997. 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.
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. 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. 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
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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 a limited-time GIC surrender offer in 1995.
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.
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 acquisitions of Paul Revere and GENEX. Management
continues to analyze potential opportunities to utilize the capital to further
enhance stockholder value, including exploring options that would support the
Company's growth initiatives.
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.
For the past three years, the Company's exposure to non-current investments
has improved significantly from prior years. Non-current
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investments totaled $8.9 million at March 31, 1997, or 0.05 percent of invested
assets. Non-current investments excluding Paul Revere totaled $5.5 million at
March 31, 1997, or 0.04 percent of invested assets, and $7.3 million at December
31, 1996, or 0.05 percent of invested assets.
As previously discussed under Liquidity and Capital Resources, the Company
sold a substantial portion of its commercial mortgage loan portfolio in 1995 and
the remainder during 1996. Mortgage loans acquired through the merger with Paul
Revere were $280.4 million.
The Company's investment in mortgage-backed securities totaled $2.9 billion
at March 31, 1997. Investments in mortgage-backed securities excluding Paul
Revere totaled $2.3 billion at March 31, 1997, and $2.4 billion on an amortized
cost basis at December 31, 1996. At March 31, 1997, the mortgage-backed
securities for the combined companies had an average life of 8.7 years and
effective duration of 6.6 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
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be highly illiquid. Management does not anticipate any liquidity problem caused
by the investment in below-investment-grade securities, nor does it expect these
investments to adversely affect its ability to hold its other investments to
maturity.
The Company's exposure to below-investment-grade fixed maturity securities
at March 31, 1997, was $961.4 million, representing 5.3 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
excluding Paul Revere totaled $880.6 million, or 7.1 percent of invested assets,
at March 31, 1997, and at December 31, 1996, was $891.1 million, representing
6.7 percent of invested assets.
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.
During the first quarter of 1997, the Company executed a series of cash
flow hedges in its individual disability income portfolio, hedging $205.0
million of expected cash flows in the years 2001 and 2002 using forward interest
rate swaps and $85.0 million of expected future cash flows in the years 2000 and
2001 using options on forward interest rate swaps. The purpose of this action
was to hedge the reinvestment of future cash flows and protect the Company from
the potential adverse impact of declining interest rates over the next five
years. Management estimates that the yields on cash flows in the 2000 to 2002
time period for the individual disability income portfolio will range between
8.05 percent and 8.14 percent when the hedges terminate and long-term assets are
purchased.
During the first quarter of 1997, $100.0 million notional amount of forward
interest rate swaps related to the group pension cash match hedge settled,
producing a realized investment loss of $1.4 million. This was offset by a $1.6
million realized gain on the sale of the hedged assets. In addition, $150.0
million of options on forward interest rate swaps were added to hedge
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expected future cash flows for the single premium annuity portfolio in the years
2002 and 2003. The purpose of this action was to hedge the reinvestment of
future cash flows and protect the Company from the potential adverse impact of
declining interest rates. Management estimates the hedge-adjusted yield on the
long-term assets purchased when the hedges terminate will be approximately
8.52 percent.
REVIEW BY INDEPENDENT ACCOUNTANTS
The condensed consolidated financial statements at March 31, 1997, and for
the three month period then ended have been reviewed, prior to filing, by Ernst
& Young LLP, the Company's independent accountants, and their report is included
herein.
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PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 10.1 Agreement between the Company and Textron Inc., dated
March 27, 1997 (incorporated by reference to the Form
8-K filed by the Company on March 28, 1997).
Exhibit 10.2 Registration Rights Agreement between the Company and
Maclellan interests (incorporated by reference to
Exhibit 5 of Amendment No. 2 of Schedule 13D filed by
Charlotte M. Heffner with respect to her beneficial
ownership of Provident Companies, Inc. stock).
Exhibit 15 Letter re: unaudited interim financial information
Exhibit 27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K
Form 8-K filed on March 27, 1997 relating to financial statements of The
Paul Revere Corporation and pro forma financial information for the
Company.
Form 8-K filed on March 28, 1997 announcing consummation of the
acquisition of The Paul Revere Corporation.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Provident Companies, Inc.
Date: May 14, 1997 /s/ J. Harold Chandler
----------------------------------
J. Harold Chandler
Chairman, President and
Chief Executive Officer
Date: May 14, 1997 /s/ Thomas R. Watjen
----------------------------------
Thomas R. Watjen
Vice Chairman and
Chief Financial Officer
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
to
FORM 10-Q
PROVIDENT COMPANIES, INC.
-29-
INDEX OF EXHIBITS
EXHIBIT PAGE
Exhibit 15 Letter re: unaudited interim financial information 31
Exhibit 27 Financial Data Schedule (for SEC use only) 32
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