SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended June 30, 1997.
Commission file number 1-11834
--------
PROVIDENT COMPANIES, INC.
-------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 62-1598430
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 Fountain Square, Chattanooga, Tennessee 37402
------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(423)755-1011
---------------------------------------------------
(Registrant's telephone number, including area code)
None
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- ------
Indicate the number of shares outstanding for each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT June 30, 1997
- ------------------------------ -----------------------------
Common Stock, $1.00 Par Value 67,415,148
Total number of pages included are 39
PROVIDENT COMPANIES, INC.
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial
Condition at June 30, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income
for the Three Months and Six Months
Ended June 30, 1997 and 1996 5
Condensed Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 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 36
-2-
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
June 30 December 31
1997 1996
(in millions of dollars)
--------------------------------
(Unaudited)
ASSETS
Investments
Fixed Maturity Securities
Available-for-Sale $15,910.1 $10,880.1
Held-to-Maturity 274.2 264.5
Equity Securities 10.3 4.9
Mortgage Loans 277.7 -
Real Estate 116.9 151.1
Policy Loans 1,881.0 1,749.0
Other Long-term Investments 48.6 15.5
Short-term Investments 103.1 252.3
--------- ---------
Total Investments 18,621.9 13,317.4
Cash and Bank Deposits 43.9 19.3
Accounts and Premiums Receivable 158.3 112.4
Reinsurance Receivable 1,046.2 468.3
Accrued Investment Income 373.7 268.3
Deferred Policy Acquisition Costs 497.5 421.8
Value of Business Acquired--Note 4 657.0 5.9
Goodwill--Note 4 595.6 -
Deferred Federal Income Tax Asset 5.7 -
Property and Equipment 85.9 59.0
Miscellaneous 27.5 19.6
Separate Account Assets 288.1 300.5
--------- ---------
TOTAL ASSETS $22,401.3 $14,992.5
========= =========
See notes to condensed consolidated financial statements.
-3-
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
June 30 December 31
1997 1996
(in millions of dollars)
--------------------------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy and Contract Benefits $ 483.9 $ 411.7
Reserves for Future Policy and Contract Benefits
and Unearned Premiums 12,646.4 8,110.1
Policyholders' Funds and Experience Rating Refunds 4,977.1 3,881.1
Federal Income Tax Liability 54.9 49.1
Long-term Debt 725.0 200.0
Other Liabilities 431.9 301.4
Separate Account Liabilities 288.1 300.5
--------- ---------
TOTAL LIABILITIES 19,607.3 13,253.9
--------- ---------
COMMITMENTS AND CONTINGENT LIABILITIES - NOTE 5
STOCKHOLDERS' EQUITY
Preferred Stock 156.2 156.2
Common Stock, $1 par 67.4 45.6
Additional Paid-in Capital 815.3 11.4
Net Unrealized Gain on Securities 238.6 90.9
Foreign Currency Translation Adjustment (3.9) (5.2)
Retained Earnings 1,520.4 1,439.7
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 2,794.0 1,738.6
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $22,401.3 $14,992.5
========= =========
See notes to condensed consolidated financial statements.
-4-
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Three Months Ended June 30 Six Months Ended June 30
1997 1996 1997 1996
(in millions of dollars, except share data)
-------------------------------------------------------------
REVENUE
Premium Income $ 590.0 $ 291.3 $ 877.5 $ 595.9
Net Investment Income 364.7 274.1 627.2 552.6
Net Realized Investment Gains (Losses) 1.5 (5.3) 6.2 (5.9)
Other Income 37.6 8.9 54.2 18.1
----------- ----------- ----------- -----------
TOTAL REVENUE 993.8 569.0 1,565.1 1,160.7
----------- ----------- ----------- -----------
BENEFITS AND EXPENSES
Policy and Contract Benefits 468.7 309.2 760.4 608.6
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 200.3 106.1 310.4 246.9
Amortization
Deferred Policy Acquisition Costs 19.2 16.1 36.5 33.0
Value of Business Acquired 10.1 0.2 10.2 0.3
Goodwill 4.2 - 4.4 -
Salaries 53.5 19.8 77.0 36.9
Commissions 65.7 31.1 96.9 62.4
Other Operating Expenses 81.4 33.3 115.8 66.0
----------- ----------- ----------- -----------
TOTAL BENEFITS AND EXPENSES 903.1 515.8 1,411.6 1,054.1
----------- ----------- ----------- -----------
INCOME BEFORE FEDERAL INCOME TAXES 90.7 53.2 153.5 106.6
FEDERAL INCOME TAXES 31.0 19.1 53.0 38.1
----------- ----------- ----------- -----------
NET INCOME $ 59.7 $ 34.1 $ 100.5 $ 68.5
=========== =========== =========== ===========
NET INCOME PER COMMON SHARE - NOTE 2 $ 0.84 $ 0.68 $ 1.66 $ 1.37
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 67,073,736 45,507,537 56,896,336 45,472,124
DIVIDENDS PER COMMON SHARE $ 0.18 $ 0.18 $ 0.36 $ 0.36
See notes to condensed consolidated financial statements.
-5-
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Six Months Ended June 30
1997 1996
(in millions of dollars)
----------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 369.3 $ 317.0
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sales of Investments 724.7 740.4
Proceeds from Maturities of Investments 752.6 744.2
Purchase of Investments (1,172.6) (1,023.4)
Net Sales of Short-term Investments 347.7 79.4
Acquisition of Business--Note 4 (857.8) -
Other (15.0) (32.3)
--------- ---------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (220.4) 508.3
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits to Policyholder Accounts 287.0 203.9
Maturities and Benefit Payments from Policyholder Accounts (1,194.5) (1,126.4)
Net Short-term Borrowings - 101.7
Net Long-term Borrowings 425.9 -
Issuance of Common Stock 384.3 3.2
Dividends Paid to Stockholders (26.6) (23.3)
Other 0.3 -
--------- ---------
NET CASH USED BY FINANCING ACTIVITIES (123.6) (840.9)
--------- ---------
Effect of Foreign Exchange Rate Changes on Cash (0.7) -
--------- ---------
NET INCREASE (DECREASE) IN CASH AND BANK DEPOSITS 24.6 (15.6)
CASH AND BANK DEPOSITS AT BEGINNING OF PERIOD 19.3 24.8
--------- ---------
CASH AND BANK DEPOSITS AT END OF PERIOD $ 43.9 $ 9.2
========= =========
See notes to condensed consolidated financial statements.
-6-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
JUNE 30, 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 and six month periods ended June
30, 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 ($3.1 million for the three month periods and
$6.3 million for the six month periods ended June 30, 1997 and 1996,
respectively) 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 June 30, 1997 and
1996, are $0.83 and $0.67 and for the six month periods ended June 30, 1997 and
1996, are $1.62 and $1.35, respectively.
-7-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
JUNE 30, 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 Six Months Ended
June 30 June 30
1997 1996 1997 1996
(in millions of dollars)
------------------------------------------------------------
Revenue (Excluding Net Realized Investment
Gains and Losses)
Individual Life and Disability $571.1 $259.3 $ 839.0 $ 517.0
Employee Benefits 259.0 149.8 415.4 311.7
Other Operations 162.2 165.2 304.5 337.9
------ ------ -------- --------
Total $992.3 $574.3 $1,558.9 $1,166.6
====== ====== ======== ========
Income Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Individual Life and Disability $ 66.0 $ 23.6 $ 92.2 $ 46.4
Employee Benefits 14.3 17.0 30.9 31.6
Other Operations 8.9 17.9 24.2 34.5
------ ------ -------- --------
Total $ 89.2 $ 58.5 $ 147.3 $ 112.5
====== ====== ======== ========
-8-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
JUNE 30, 1997
NOTE 3--SEGMENT INFORMATION - CONTINUED
Three Months Ended Six Months Ended
June 30 June 30
1997 1996 1997 1996
(in millions of dollars)
------------------------------------------------------------
Revenue (Including Net Realized Investment
Gains and Losses)
Individual Life and Disability $572.8 $260.8 $ 845.8 $ 523.0
Employee Benefits 258.8 150.2 415.0 311.7
Other Operations 162.2 158.0 304.3 326.0
------ ------ -------- --------
Total $993.8 $569.0 $1,565.1 $1,160.7
====== ====== ======== ========
Income Before Federal Income Taxes
Individual Life and Disability $ 67.7 $ 25.1 $ 99.0 $ 52.4
Employee Benefits 14.1 17.4 30.5 31.6
Other Operations 8.9 10.7 24.0 22.6
------ ------ -------- --------
Total $ 90.7 $ 53.2 $ 153.5 $ 106.6
====== ====== ======== ========
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--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
purchase price has been allocated to goodwill and will be amortized on a
straight-line basis over a twenty-five year period. The consolidated financial
statements include the operating results of GENEX from March 1, 1997.
-9-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
JUNE 30, 1997
NOTE 4--ACQUISITION OF BUSINESS - CONTINUED
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 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. Goodwill will be amortized on a straight-
line basis over a forty year period. The consolidated financial statements
include the operating results of Paul Revere from April 1, 1997.
PRO FORMA RESULTS
The following pro forma results of operations for the three and six month
periods ended June 30, 1997 and 1996, give effect to the acquisitions 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, Paul Revere, and
GENEX with such adjustments as are necessary to present the results of
operations as if the acquisitions had occurred as of the beginning of each
period presented, are as follows:
Three Months Ended June 30 Six Months Ended June 30
1997 1996 1997 1996
(in millions of dollars)
------------------------------------------------------------
Revenue $993.8 $994.7 $2,021.5 $1,990.1
Income Before Federal Income Taxes 90.7 78.8 201.9 158.8
Net Income 59.7 48.2 129.5 97.5
Net Income per Common Share 0.84 0.67 1.84 1.35
-10-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
JUNE 30, 1997
NOTE 4--ACQUISITION OF BUSINESS - CONTINUED
Revenue and income before federal income taxes include $25.9 million of pre-tax
net realized investment gains for the acquired companies for the three months
ended June 30, 1996, $30.1 million for the six months ended June 30, 1996, and
$36.4 million for the 1997 period prior to acquisition. Net income includes
$16.8 million ($0.25 per share) of after-tax net investment gains for the three
months ended June 30, 1996, $19.6 million ($0.29 per share) for the six months
ended June 30, 1996, and $23.7 million ($0.35 per share) for the 1997 period
prior to acquisition.
NOTE 5--COMMITMENTS AND CONTINGENT LIABILITIES
Two alleged class action lawsuits have been filed in Superior Court in
Worcester, Massachusetts against the Company - one purporting to represent all
career agents of Paul Revere whose employment relationships ended on June 30,
1997 and were offered contracts to sell insurance policies as independent
producers, and the other purporting to represent independent brokers who sold
certain Paul Revere individual disability income policies with benefit riders.
Motions have been filed by the Company to dismiss most of the counts in the
complaints, which allege various breach of contract and statutory claims. To
date no class has been certified in either lawsuit. The Company has strong
defenses to both lawsuits and will vigorously defend its position and resist
certification of the classes. Although the alleged class action lawsuits are in
the very early stages, management does not currently expect these suits to
materially affect the financial position or results of operations of the
Company.
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.
-11-
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 June 30, 1997,
the related condensed consolidated statements of income for the three and six
month periods ended June 30, 1997 and 1996, and the condensed consolidated
statements of cash flows for the six month periods ended June 30, 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
August 8, 1997
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Provident acquired GENEX Services, Inc. ("GENEX") and The Paul Revere
Corporation ("Paul Revere") on February 28, 1997, and March 27, 1997,
respectively. The financial information contained herein includes the accounts
and operating results of GENEX and Paul Revere from the respective dates of
acquisition. Since GENEX and Paul Revere are reflected in the results of the
second quarter of 1997 and not the second quarter of 1996, the difference in
comparability of the periods is frequently attributable to that fact as
indicated below.
OPERATING RESULTS
Revenue excluding net realized investment gains and losses ("revenue")
increased $418.0 million, or 72.8 percent, to $992.3 million in the second
quarter of 1997 from $574.3 million in the second quarter of 1996. The increase
was the result of higher revenue in the individual life and disability segment
($311.8 million) and employee benefits segment ($109.2 million), which was
partly offset by slightly lower revenue in the other operations segment ($3.0
million).
In the first six months of 1997, revenue increased $392.3 million, or 33.6
percent, to $1,558.9 million from $1,166.6 million in the first six months of
1996. The increase was the result of higher revenue in the individual life and
disability segment ($322.0
-13-
million) and employee benefits segment ($103.7 million), which was partly offset
by lower revenue in the other operations segment ($33.4 million).
Income before net realized investment gains and losses and federal income
taxes ("income") increased $30.7 million, or 52.5 percent, to $89.2 million in
the second quarter of 1997, from $58.5 million in the second quarter of 1996.
The increase was the result of increased income in the individual life and
disability segment ($42.4 million), which was partly offset by lower income in
the employee benefits segment ($2.7 million) and other operations segment ($9.0
million).
In the first six months of 1997, income increased $34.8 million, or 30.9
percent, to $147.3 million, from $112.5 million in the first six months of 1996.
The increase was the result of increased income in the individual life and
disability segment ($45.8 million), which was partly offset by lower income in
the employee benefits segment ($0.7 million) and other operations segment ($10.3
million).
Net income increased $25.6 million, or 75.1 percent, to $59.7 million in
the second quarter of 1997, from $34.1 million in the second quarter of 1996.
Net realized investment gains after taxes were $1.0 million in the second
quarter of 1997, compared to after-tax losses of $3.3 million in the second
quarter of 1996. For the first six months of 1997, net income increased $32.0
million, or 46.7 percent, to $100.5 million, from $68.5 million in the first six
months of 1996. Net realized investment gains after taxes were $4.1
-14-
million in the first six months of 1997, compared to after-tax losses of $3.7
million in the first six months of 1996.
INDIVIDUAL LIFE AND DISABILITY
Revenue in the individual life and disability segment increased $311.8
million, or 120.2 percent, to $571.1 million in the second quarter of 1997, from
$259.3 million in the second quarter of 1996. The increase was primarily the
result of the acquisition of Paul Revere, which contributed $307.0 million of
revenue to this segment in the second quarter of 1997. Premium income in this
segment increased $204.0 million, or 127.8 percent, to $363.6 million in the
second quarter of 1997, from $159.6 million in the second quarter of 1996. The
increase was primarily the result of the acquisition of Paul Revere.
For the first six months of 1997, revenue in this segment increased $322.0
million, or 62.3 percent, to $839.0 million, from $517.0 million in the first
six months of 1996. The increase was primarily the result of the acquisition of
Paul Revere. Premium income in this segment increased $204.4 million, or 63.8
percent, to $525.0 million in the first six months of 1997, from $320.6 million
in the first six months of 1996, reflecting the acquisition of Paul Revere.
Premium income in the individual disability income line of business increased
$197.1 million, or 68.2 percent, to $485.9 million in the first six months of
1997, from $288.8 million in the first six months of 1996. The increase was
primarily the result of the acquisition of Paul Revere.
-15-
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). Similarly, the Company is phasing out the sale of individual
noncancelable disability policies with long-term own-occupation provisions by
the Paul Revere insurance subsidiaries. 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.
Income in the individual life and disability segment increased $42.4
million, or 179.7 percent, to $66.0 million in the second quarter of 1997, from
$23.6 million in the second quarter of 1996. The increase is primarily due to
the acquisition of Paul Revere and improved results in the Company's individual
disability income line of business. In this line, income increased $30.1
million, or 151.3 percent, to $50.0 million in the second quarter of 1997, from
$19.9 million in the second quarter of 1996. This improvement is primarily due
to a lower level of new claims in the second quarter of 1997 compared to the
second quarter of 1996, a higher level of claim resolutions, and the acquisition
of Paul Revere. Management believes substantial investments in the individual
disability claims management process since the first quarter of 1995 helped
produce the
-16-
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 specialized nature of disability claims,
and an increased level of staffing with experienced claim adjusters. The
individual life line of business produced income of $8.8 million in the second
quarter of 1997, compared to $3.3 million in the second quarter of 1996. The
individual annuities line of business produced income of $7.2 million in the
second quarter of 1997, compared to $0.4 million in the second quarter of 1996.
Both of these lines of business benefited from the acquisition of Paul Revere.
For the first six months of 1997, income in this segment increased $45.8
million, or 98.7 percent, to $92.2 million from $46.4 million in the first six
months of 1996. The increase is primarily due to the acquisition of Paul Revere
and improved results in the Company's individual disability income line of
business. In this line, income increased $37.1 million, or 107.8 percent, to
$71.5 million in the first six months of 1997, from $34.4 million in the first
six months of 1996. This improvement is primarily due to a lower level of new
claims in the first half of 1997 compared to the first half of 1996, a higher
level of claim resolutions, and the acquisition of Paul Revere. The individual
life line of business produced income of $13.1 million in the first half of
1997, compared to $11.4 million in the first half of 1996. The individual
annuities line of business produced income of $7.6 million in the first six
months of
-17-
1997, compared to $0.6 million in the first six months of 1996. Both of these
lines of business benefited from the acquisition of Paul Revere.
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. Current 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
-18-
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 a 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;
in previous years, both were 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 increased $109.2 million, or 72.9
percent, to $259.0 million in the second quarter of 1997, from $149.8 million in
the second quarter of 1996. The increase was primarily the result of an
increase in premium income in this segment of $76.7 million, or 61.8 percent, to
$200.9 million in the second quarter of 1997, from $124.2 million in the second
quarter of 1996. The increase was primarily the result of the acquisition of
Paul Revere, which added to premium income in the group life and group
disability lines of business. Premium income declined in the medical stop-loss
and affinity groups lines of business in the second
-19-
quarter of 1997, compared to the second quarter of 1996. In the second quarter
of 1997, revenue was positively impacted by the acquisition of GENEX. 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 the second quarter of 1997, GENEX's revenue totaled
$21.4 million.
For the first six months of 1997, revenue in this segment increased $103.7
million, or 33.3 percent, to $415.4 million from $311.7 million in the first six
months of 1996. Premium income increased $61.5 million, or 23.6 percent, to
$322.6 million in the first six months of 1997, from $261.1 million in the first
six months of 1996. The increase is the result of the acquisition of Paul
Revere, which added $70.7 million of premium income to the group life and group
disability lines of business. GENEX's revenue since the date of acquisition
totaled $28.6 million.
Income in the employee benefits segment declined $2.7 million, or 15.9
percent, to $14.3 million in the second quarter of 1997, from $17.0 million in
the second quarter of 1996. The decline is primarily the result of lower income
in the group life, medical stop-loss, and affinity groups lines of business.
This decline was partly offset by higher income in the group disability line of
business which produced income of $3.8 million in the second quarter of 1997
compared to $0.6 million in the second quarter of 1996, primarily due to the
acquisition of Paul Revere, which produced second quarter 1997 income of $1.9
million. The affinity groups line of business
-20-
produced income of $0.6 million in the second quarter of 1997 compared to $2.6
million in the second quarter of 1996. The group life line of business produced
income of $3.3 million in the second quarter of 1997 compared to $5.1 million in
the second 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.
The medical stop-loss line of business produced income of $2.3 million in the
second quarter of 1997, compared to $3.9 million in the second quarter of 1996.
The decline is the result of lower premium income in this line, which declined
to $9.9 million in the second quarter of 1997, from $13.2 million in the second
quarter of 1996.
For the first six months of 1997, income declined $0.7 million, or 2.2
percent, to $30.9 million, from $31.6 million in the first six months of 1996.
The decline is primarily the result of lower income in the voluntary benefits,
group life, and medical stop-loss lines of business, which were partly offset by
increased income in the group disability and affinity groups lines of business
and the acquisitions of Paul Revere and GENEX.
OTHER OPERATIONS
The other operations segment includes the Company's group pension products,
its corporate-owned life insurance ("COLI") product, the dental block acquired
from Paul Revere, the excess risk reinsurance line of business of Paul Revere,
corporate interest expense, goodwill amortization, and corporate (unallocated)
capital
-21-
and assets. These closed blocks of business 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.
On June 30, 1997, the Company announced that it had entered into a
marketing agreement with Ameritas Life Insurance Corporation ("Ameritas")
whereby Provident will market Ameritas' dental products. The two companies also
entered into an agreement that involves the transition of the Company's block of
dental insurance to Ameritas. The dental block, which was acquired in the Paul
Revere acquisition, produced $48.3 million in premium income in 1996 and $24.7
million in the first six months of 1997. The full transition of the dental
business to Ameritas is expected to be completed by November 1997.
Revenue in the other operations segment declined $3.0 million, or 1.8
percent, to $162.2 million in the second quarter of 1997, from $165.2 million in
the second quarter of 1996. The decline is primarily the result of a decrease
in funds under management resulting from the strategic decision to discontinue
the sale of products in the group pension line of business. Revenue in this
line declined to $78.6 million in the second quarter of 1997, from $105.9
million in the second quarter of 1996. This decline was partly offset by the
excess risk reinsurance line of business and dental business of Paul Revere,
which produced revenue of $10.9 million and $13.7 million, respectively, in the
second quarter of 1997.
-22-
For the first six months of 1997, revenue in this segment declined $33.4
million, or 9.9 percent, to $304.5 million, from $337.9 million in the first six
months of 1996. The decline is primarily the result of a decrease in funds
under management resulting from the discontinuation of the sale of products in
the group pension business. Revenue in this line declined $54.5 million, or
24.9 percent, to $164.1 million in the first six months of 1997, from $218.6
million in the first six months 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 totaled $3.82 billion at June 30, 1997,
compared to $5.52 billion at June 30, 1996, a decrease of 30.8 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
$1.87 billion at June 30, 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
-23-
traditional GICs mature, capital will be available for use by the Company as
amounts allocated to this line are released.
Income in the second quarter of 1997 declined $9.0 million to $8.9 million
from $17.9 million in the second quarter of 1996. The decline in this segment
was due to lower income in the group pension line of business, which declined
$7.7 million to $6.9 million in the second quarter of 1997 from $14.6 million in
the second 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 declined
to $4.5 million in the second quarter of 1997, compared to $6.6 million in the
second quarter of 1996. The excess risk reinsurance line acquired with Paul
Revere produced income of $1.3 million in the second quarter of 1997. Interest
expense in the second quarter of 1997 totaled $12.1 million, compared to $4.6
million in the second quarter of 1996.
For the first six months of 1997, income in this segment declined $10.3
million to $24.2 million, from $34.5 million in the first six months of 1996.
The decline is primarily the result of lower income in the group pension line,
which produced income of $17.7 million in the first six months of 1997, compared
to $27.3 million in the first six months of 1996. Interest expense in the first
six months of 1997 totaled $15.3 million, compared to $8.3 million in the first
six months of 1996.
Management expects that income in 1997 from the group pension line will
decline from the levels recorded in 1996 as the funds under
-24-
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
On March 27, 1997, the Company consummated the acquisition of Paul Revere
("Paul Revere Merger") pursuant to the Amended and Restated Agreement and Plan
of Merger ("Amended Agreement"). Under the terms of the Amended Agreement,
Textron Inc.("Textron") received as consideration for its shares a combination
of cash and Company common stock. Pursuant to a Voting Agreement dated as of
April 29, 1996 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 public secondary offering of the Company's stock was completed on
May 5, 1997, from which the Company received $74.0 million of additional paid-in
capital.
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
-25-
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
for general corporate uses. At June 30, 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 6.095
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.
-26-
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 the greater of (a) ten percent of the insurance company's surplus to
policyholders as of the thirty-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
-27-
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 second 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.
During the third quarter of 1997, the Company expects to complete the sale
of $277.7 million of commercial mortgage loans acquired through the merger with
Paul Revere. The transaction is expected to produce a realized investment gain,
increase the liquidity, and improve the asset quality and asset/liability
management of the investment portfolio.
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
-28-
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 investments totaled
$31.6 million at June 30, 1997, or 0.17 percent of invested assets.
The Company's investment in mortgage-backed securities totaled $2.9 billion
at June 30, 1997. Investments in mortgage-backed securities excluding Paul
Revere totaled $2.4 billion on an amortized cost basis at December 31, 1996. At
June 30, 1997, the mortgage-backed securities for the combined companies had an
average life of 9.7 years and effective duration of 6.5 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
-29-
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 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 June 30, 1997, was $1,098.4 million, representing 5.9 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 $891.1 million at December 31, 1996,
representing 6.7 percent of invested assets.
-30-
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. 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 first quarter hedges terminate and long-term assets are purchased.
During the second quarter of 1997, the Company executed a series of cash
flow hedges in its individual disability income portfolio, hedging $250.0
million of cash flows in the year 1997 using futures contracts, $215.0 million
of cash flows in years 1999 through 2002 using forward interest rate swaps, and
$510.0 million of cash flows in the years 1998 through 2002 using options on
forward interest rate swaps. Management estimates that the yields on cash flows
in the 1997 hedge will be between 8.03 percent and 8.32 percent, the forward
swaps are expected to produce yields between 8.00 percent and 8.10
-31-
percent, and the options on futures produced a deferred gain of $2.8 million and
are expected to ultimately produce yields between 8.00 percent and 8.25 percent.
The purpose of these actions in the individual disability income portfolio
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.
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 expected
future cash flows for the single premium annuity portfolio in the years 2002 and
2003.
During the second 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 $1.1 million. This was offset
by a $1.1 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
expected future cash flows for the single premium annuity portfolio in the years
2002 and 2003. The purpose of these actions 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-
-32-
adjusted yield on long-term assets purchased when the group pension hedges
terminate will be approximately 8.52 percent.
-33-
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) 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 August 12, 1997 relating to the Company's press
release announcing earnings, dividend increase and two-for-one stock
split.
-34-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Provident Companies, Inc.
(Registrant)
Date: August 13, 1997 /s/ J. Harold Chandler
----------------------------------
J. Harold Chandler
Chairman, President and
Chief Executive Officer
Date: August 13, 1997 /s/ Thomas R. Watjen
----------------------------------
Thomas R. Watjen
Vice Chairman and
Chief Financial Officer
-35-
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
to
FORM 10-Q
PROVIDENT COMPANIES, INC.
-36-
INDEX OF EXHIBITS
EXHIBIT PAGE
Exhibit 15 Letter re: unaudited interim financial information 38
Exhibit 27 Financial Data Schedule (for SEC use only) 39
-37-