Exhibit (13)
Portions of the
Annual Report to Stockholders
for year ended December 31, 1997
(attached)
47
CONSOLIDATED STATEMENTS OF INCOME BY SEGMENT
Year Ended December 31 1997 1996(1) 1995(1)
-------- ------- -------
(in millions of dollars)
Premium Income
Individual Life and Disability $1,286.6 $ 646.1 $ 647.4
Employee Benefits 671.9 452.0 423.7
Other Operations 95.2 77.6 180.8
---- ---- -----
2,053.7 1,175.7 1,251.9
Net Investment Income and Other Income
Individual Life and Disability 615.7 378.9 351.7
Employee Benefits 211.8 103.5 96.6
Other Operations 656.9 642.4 886.8
----- ----- -----
1,484.4 1,124.8 1,335.1
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Individual Life and Disability 1,902.3 1,025.0 999.1
Employee Benefits 883.7 555.5 520.3
Other Operations 752.1 720.0 1,067.6
----- ----- -------
3,538.1 2,300.5 2,587.0
Benefits and Expenses
Individual Life and Disability 1,670.0 909.6 965.1
Employee Benefits 820.4 509.4 488.1
Other Operations 682.5 646.7 926.1
----- ----- -----
3,172.9 2,065.7 2,379.3
Income Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Individual Life and Disability 232.3 115.4 34.0
Employee Benefits 63.3 46.1 32.2
Other Operations 69.6 73.3 141.5
---- ---- -----
365.2 234.8 207.7
Net Realized Investment Gains(Losses) 15.1 (8.6) (31.7)
---- ----- ------
Income Before Federal Income Taxes 380.3 226.2 176.0
Federal Income Taxes 133.0 80.6 60.4
------ ------ ------
Net Income $247.3 $145.6 $115.6
====== ====== ======
(1) Results by segment for 1996 and 1995 have been reclassified to conform to current year
reporting.
48
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
- ------------
The Company 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 for 1997
and not 1996 or 1995, the difference in comparability of the years is frequently
attributed to that fact.
Effective with year-end 1997, the Company has changed its reporting
segments to reflect the lines of business the Company will continue to focus on
for growth in the future. The segments as they have been historically
constituted and as they will be constituted in the future are shown in the table
below.
SEGMENTS HISTORICAL STRUCTURE REVISED STRUCTURE
-------- -------------------- -----------------
INDIVIDUAL LIFE
AND DISABILITY: Individual Disability Income Individual Disability Income
Individual Life Individual Life
Individual Annuities Excess Risk Reinsurance
EMPLOYEE BENEFITS: Voluntary Benefits Voluntary Benefits
Group Life Group Life
Group Disability Group Disability
Affinity Groups Affinity Groups
Medical Stop-Loss GENEX
GENEX
OTHER OPERATIONS: Corporate-Owned Life Corporate-Owned Life
Group Pension Group Pension
Medical and Dental Medical and Dental
Excess Risk Reinsurance Individual Annuities
Medical Stop-Loss
Operating Results:
- -----------------
Revenue excluding net realized investment gains and losses (hereinafter
"revenue") increased $1.24 billion, or 53.8 percent, to $3.54 billion in 1997
from $2.30 billion in 1996. Revenue includes premium income, net investment
income, and other income. This increase resulted from increased revenue in the
Individual Life and Disability segment ($877.3 million),
49
Employee Benefits segment ($328.2 million), and Other Operations segment ($32.1
million).
In 1996, revenue declined $286.5 million, or 11.1 percent, to $2.30 billion
from $2.59 billion in 1995. This decline resulted from decreased revenue in the
Other Operations segment ($347.6 million). This decline was partly offset by
increased revenue in the Individual Life and Disability segment ($25.9 million)
and Employee Benefits segment ($35.2 million).
Income before net realized investment gains and losses and federal income
taxes (hereinafter "income") increased $130.4 million or 55.5 percent, to $365.2
million in 1997 from $234.8 million in 1996. This increase resulted from higher
income in the Individual Life and Disability segment ($116.9 million) and
Employee Benefits segment ($17.2 million). These increases were partly offset
by decreased income in the Other Operations segment ($3.7 million).
In 1996, income increased $27.1 million, or 13.0 percent, to $234.8 million
from $207.7 million in 1995. The increase resulted from higher income in the
Individual Life and Disability segment ($81.4 million) and Employee Benefits
segment ($13.9 million). These increases were partly offset by decreased income
in the Other Operations segment ($68.2 million).
Net income totaled $247.3 million in 1997, compared to $145.6 million in
1996 and $115.6 million in 1995. Net realized investment gains after federal
income taxes were $9.8 million in 1997 compared to losses of $5.4 million in
1996 and $20.7 million in 1995.
50
Individual Life and Disability Operating Results
- ------------------------------------------------
INDIVIDUAL LIFE AND DISABILITY OPERATING RESULTS
Year Ended December 31 1997 1996(1) 1995(1)
--------- -------- --------
(in millions of dollars)
Revenue Excluding Net Realized Investment Gains
Premium Income
Individual Disability Income $1,207.7 $582.8 $584.5
Individual Life 78.9 63.3 62.9
-------- ------- -------
Total Premium Income 1,286.6 646.1 647.4
Net Investment Income 589.8 371.8 341.6
Other Income 25.9 7.1 10.1
-------- ------- -------
Total 1,902.3 1,025.0 999.1
-------- ------- -------
Benefits and Expenses
Policy and Contract Benefits 771.6 459.6 425.9
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 425.3 221.3 305.1
Amortization of Deferred Policy Acquisition Costs 62.8 54.2 57.4
Other Expenses 410.3 174.5 176.7
-------- ------- -------
Total 1,670.0 909.6 965.1
-------- ------- -------
Income Before Net Realized Investment
Gains and FIT 232.3 115.4 34.0
Net Realized Investment Gains 7.9 8.0 4.1
-------- ------- -------
Income Before FIT $240.2 $123.4 $38.1
======== ======= =======
Sales - Annualized New Premiums
Individual Disability Income $103.9 $45.1 $55.2
Individual Life $9.6 $6.7 $7.1
(1) Results for 1996 and 1995 have been reclassified to conform to current
year reporting.
51
Revenue in the Individual Life and Disability segment increased $877.3
million, or 85.6 percent, to $1,902.3 million in 1997 from $1,025.0 million in
1996. The increase was primarily the result of the acquisition of Paul Revere,
which contributed $851.9 million of revenue to this segment in 1997. Premium
income in this segment increased $640.5 million, or 99.1 percent, to $1,286.6
million in 1997 from $646.1 million in 1996. The increase was primarily the
result of the acquisition of Paul Revere, which contributed $636.5 million of
premium income to this segment in 1997. Within this segment, revenue in the
individual disability income line of business increased $840.1 million, or 94.1
percent, to $1,733.1 million in 1997 from $893.0 million in 1996. Revenue in the
individual life line of business increased $37.2 million, or 28.2 percent, to
$169.2 million in 1997 from $132.0 million in 1996. Both of these lines of
business benefited from the Paul Revere acquisition.
In 1996, revenue in this segment increased $25.9 million, or 2.6 percent,
to $1,025.0 million from $999.1 million in 1995. Net investment income
increased $30.2 million, or 8.8 percent, to $371.8 million in 1996 from $341.6
million in 1995. This increase was primarily the result of an increased
allocation of capital to the individual disability income line of business.
Premium income in this segment declined $1.3 million or 0.2 percent, to $646.1
million in 1996 from $647.4 million in 1995. In the individual disability
income line of business, premium income declined $1.7 million, or 0.3 percent,
to $582.8 million in 1996 from $584.5 million in 1995. In the individual life
line of business, premium income increased $0.4 million, or 0.6 percent, to
$63.3 million in 1996 from $62.9 million in 1995.
In November 1994, the Company announced its intention to discontinue
selling individual noncancelable disability contracts with long-term own-
occupation provisions (other than conversion policies available under existing
contractual arrangements). Similarly, the Company has begun phasing out the
sale by the Paul Revere insurance subsidiaries of individual noncancelable
disability policies with long-term own-occupation provisions. The Company is
focusing on replacing the traditional noncancelable long-term own-occupation
contracts with "loss of earnings" contracts which insure income rather
52
than occupation. During the ongoing transition to new products, the Company
continues to offer traditional contracts, which are generally being repriced and
modified until they are replaced.
Following the discontinuation of sales by the Provident insurance
subsidiaries of these traditional individual noncancelable disability contracts,
the Company in general experienced a decline in annualized new premiums through
the first quarter of 1996. In the remaining quarters of 1996 sales were
generally flat from quarter to quarter. In 1997, sales declined compared to the
previous year, reflecting the disruption associated with the consolidation of
the Company's and Paul Revere's sales offices, realignment of the field sales
force, and the continued product transition which involves both repriced and
modified traditional noncancelable own-occupation contracts, as well as
additional loss of earnings contracts which are priced based on coverages
provided.
Revenue is not expected to be significantly impacted by the transition in
products due to continued favorable persistency. The magnitude and duration of
the decline in sales, such as that experienced during 1997, are dependent on
the response of customers and competitors in the industry.
Income in the Individual Life and Disability segment increased $116.9
million, or 101.3 percent, to $232.3 million in 1997 from $115.4 million in
1996. This 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 $112.3 million, or 123.0 percent, to $203.6
million in 1997 from $91.3 million in 1996. This improvement is primarily due
to the acquisition of Paul Revere and a higher level of net claim resolutions.
Management believes the substantial investment 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
53
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 $28.7 million in 1997, an
increase of $4.6 million, or 19.1 percent, over the $24.1 million in 1996. The
increase is the result of the acquisition of Paul Revere.
In 1996, income in this segment increased $81.4 million, or 239.4 percent,
to $115.4 million from $34.0 million in 1995. In the individual disability
income line, income increased $78.2 million to $91.3 million in 1996 from $13.1
million in 1995. This significant improvement is primarily due to a lower level
of new claims in the third and fourth quarters of 1996 along with higher levels
of claim resolutions, resulting from the substantial investment in the
individual disability claims management process. In addition, net investment
income in this line increased due to a higher allocation of capital to this line
of business. Income in the individual life line of business increased $3.2
million, or 15.3 percent, to $24.1 million in 1996 from $20.9 million in 1995.
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 reserve adequacy studies to determine the continued adequacy of the
reserves that were established. Based upon the December 1997 reserve adequacy
study, which incorporated management's best estimate for the assumptions used,
reserves were adequate at December 31, 1997.
The Company continually studies and refines 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
54
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 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.
Employee Benefits Operating Results
- -----------------------------------
Revenue in the Employee Benefits segment increased $328.2 million, or 59.1
percent, to $883.7 million in 1997 from $555.5 million in 1996. This increase
was primarily the result of an increase in premium income in this segment of
$219.9 million, or 48.7 percent, to $671.9 million in 1997 from $452.0 million
in 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. In 1997, Paul Revere added $211.4 million to premium income
and $241.3 million to revenue. GENEX contributed $72.3 million of revenue in
1997 subsequent to its acquisition.
In 1996, revenue in this segment increased $35.2 million, or 6.8 percent,
to $555.5 million from $520.3 million in 1995. This increase is primarily due
to higher premium income which increased $28.3 million, or 6.7 percent, to
$452.0 million in 1996 from $423.7 million in 1995. Each line of business in
this segment produced increased premium income in 1996 compared to 1995. Net
investment income in this segment increased $6.5 million, or 7.2 percent, to
$96.9 million in 1996 from $90.4 million in 1995.
55
EMPLOYEE BENEFITS OPERATING RESULTS
Year Ended December 31 1997 1996(1) 1995(1)
------- ------- -------
(in millions of dollars)
Revenue Excluding Net Realized Investment Gains
Premium Income
Voluntary Benefits $79.3 $70.6 $66.3
Group Life 265.8 190.6 175.9
Group Disability 249.1 89.5 84.9
Affinity Groups 77.7 101.3 96.6
-------- ------- -------
Total Premium Income 671.9 452.0 423.7
Net Investment Income 130.3 96.9 90.4
Other Income 81.5 6.6 6.2
-------- ------- -------
Total 883.7 555.5 520.3
-------- ------- -------
Benefits and Expenses
Policy and Contract Benefits 486.7 332.5 346.0
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 86.4 73.7 48.1
Amortization of Deferred Policy Acquisition Costs 9.2 8.4 12.0
Other Expenses 238.1 94.8 82.0
-------- ------- -------
Total 820.4 509.4 488.1
-------- ------- -------
Income Before Net Realized Investment
Gains and FIT 63.3 46.1 32.2
Net Realized Investment Gains 3.6 - 3.9
-------- ------- -------
Income Before FIT $66.9 $46.1 $36.1
======== ======= =======
Sales - Annualized New Premiums
Voluntary Benefits $28.7 $23.0 $20.2
Group Life $55.2 $37.8 $24.2
Group Disability $70.9 $16.5 $10.7
(1) Results for 1996 and 1995 have been reclassified to conform to current
year reporting.
56
Income in the Employee Benefits segment increased $17.2 million, or 37.3
percent, to $63.3 million in 1997 from $46.1 million in 1996. This increase was
primarily due to increased income in the group disability line of business,
which increased $11.5 million to $15.6 million in 1997 from $4.1 million in
1996. This increase was primarily due to the acquisition of Paul Revere. Also
within this segment, income in the affinity groups line increased $5.5 million
to $9.5 million in 1997 from $4.0 million in 1996. Income in the voluntary
benefits line improved $0.4 million, or 2.7 percent, to $15.1 million in 1997
from $14.7 million in 1996. GENEX produced $2.0 million of income in this
segment in 1997. Partly offsetting these increases was a decline in income in
the group life line, which decreased $2.2 million, or 9.4 percent, to $21.1
million in 1997 from $23.3 million in 1996.
In 1996, income in this segment increased $13.9 million, or 43.2 percent,
to $46.1 million from $32.2 million in 1995. This increase is primarily due to
improved results in the voluntary benefits and group disability lines of
business. Income in the voluntary benefits line increased to $14.7 million in
1996 from $7.9 million in 1995. Income in the group disability line was $4.1
million in 1996, compared to a loss of $11.3 million in 1995. Both lines
benefited from improved profitability following repricing actions in 1995. The
improvement in income in these lines of business was partly offset by lower
income in the group life and affinity groups lines of business.
57
Other Operations Operating Results
- ----------------------------------
OTHER OPERATIONS OPERATING RESULTS
Year Ended December 31 1997 1996(1) 1995(1)
------- ------- -------
(in millions of dollars)
Revenue Excluding Net Realized Investment Gains and Losses
Premium Income
Corporate-Owned Life $24.5 $23.6 $24.8
Group Pension 1.9 1.9 0.5
Medical Stop-Loss 37.0 49.4 62.2
Other (Includes Medical and Dental) 31.8 2.7 93.3
-------- -------- --------
Total Premium Income 95.2 77.6 180.8
Net Investment Income 634.6 621.4 789.3
Gain on Sale of Group Medical Business -- -- 21.8
Other Income 22.3 21.0 75.7
-------- -------- --------
Total 752.1 720.0 1,067.6
-------- -------- --------
Benefits and Expenses
Policy and Contract Benefits 429.5 424.4 647.8
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 158.6 149.7 131.7
Other Expenses 94.4 72.6 146.6
-------- -------- --------
Total 682.5 646.7 926.1
-------- -------- --------
Income Before Net Realized Investment Gains and
Losses and FIT 69.6 73.3 141.5
Net Realized Investment Gains (Losses) 3.6 (16.6) (39.7)
-------- -------- --------
Income Before FIT $73.2 $56.7 $101.8
======== ======== ========
Funds Under Management and Equivalents at End of Year
Individual Annuities $2,345.2 $278.7 $260.1
Group Pension Single Premium Annuities $1,199.1 $1,188.1 $1,197.8
Traditional GICs $1,603.6 $3,204.3 $4,838.0
Synthetic GICs $97.8 $2,176.6 $2,571.9
Other $353.5 $373.0 $447.2
(1) Results for 1996 and 1995 have been reclassified to conform to current
year reporting.
58
On December 8, 1997, the Company entered into a definitive agreement to
sell its in-force individual and tax-sheltered annuity business to various
affiliates of American General Corporation ("American General"). The Company and
American General also entered into a preliminary agreement whereby American
General will market the Company's individual disability products and the Company
will market American General's individual annuity products. The in-force
business being sold consists primarily of individual fixed annuities and tax-
sheltered annuities in Provident Life and Accident Insurance Company
("Accident"), Provident National Assurance Company ("National"), The Paul Revere
Life Insurance Company ("Paul Revere Life"), The Paul Revere Variable Annuity
Insurance Company ("Paul Revere Variable"), and The Paul Revere Protective Life
Insurance Company ("Paul Revere Protective"). In addition, American General is
acquiring a number of miscellaneous group pension lines of business sold in the
1970's and 1980's which are no longer actively marketed. The sale does not
include the Company's block of traditional GICs or group single premium
annuities, which will continue in a run-off mode. In consideration for the
transfer of the annuity reserves, American General is paying the Company a
ceding commission of approximately $58.0 million. The annuities being sold to
American General represent approximately $2.4 billion of statutory reserves. The
transaction, which is subject to requisite regulatory approvals and certain
other conditions, is expected to close in the second quarter of 1998.
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 involved 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 $39.2
million in 1997. The full transition of the dental business to Ameritas was
completed in November 1997.
Revenue in the Other Operations segment increased $32.1 million, or 4.5
percent, to $752.1 million in 1997 from $720.0 million in 1996. This increase
is primarily the result of the acquisition of Paul Revere, which added $150.4
million of revenue in 1997, including $119.1 million of revenue in the
59
individual annuities line of business. This increase was partly offset by a
decline in funds under management resulting from the discontinuation of the sale
of products in the group pension line of business. Revenue in this line of
business declined $107.8 million to $300.6 million in 1997 from $408.4 million
in 1996. Revenue in the corporate-owned life insurance line of business
increased by $9.0 million, or 4.5 percent, to $210.3 million in 1997 from $201.3
million in 1996, primarily due to increased net investment income.
In 1996, revenue in this segment declined $347.6 million, or 32.6 percent,
to $720.0 million from $1,067.6 million in 1995. This decline was partially due
to the sale of the medical services line of business, which, prior to its sale
on April 30, 1995, contributed operating revenue of $146.1 million and a gain
from the sale of the business of $21.8 million. In addition, revenue in the
group pension line of business declined $177.2 million, or 30.3 percent, to
$408.4 million in 1996 from $585.6 million in 1995 due to a decrease in funds
under management resulting from the strategic decision to discontinue the sale
of traditional GICs. Premium income in this segment declined $103.2 million, or
57.1 percent, to $77.6 million in 1996 from $180.8 million in 1995. This
decline is primarily due to the sale of the medical services line of business,
which produced $90.9 million of premium income prior to its sale in the second
quarter of 1995.
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 $3.16 billion at December 31,
1997, compared to $4.77 billion at December 31, 1996, and $6.48 billion at
December 31, 1995.
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 has sold this block of business through an assumptive
reinsurance transaction. The last of these contracts was transferred in
60
January 1998. Synthetic GIC funds totaled $97.8 million at December 31, 1997,
$2.18 billion at December 31, 1996, and $2.57 billion at December 31, 1995.
Management expects that revenue in 1998 from this segment will decline from
the levels recorded in 1997 as the funds under management decline and the sale
of the individual annuities line of business is completed.
Income in the Other Operations segment declined $3.7 million, or 5.0
percent, to $69.6 million in 1997 from $73.3 million in 1996. This decline is
primarily the result of lower income in the group pension line of business,
which produced income of $35.3 million in 1997, a decline of $12.3 million, or
25.8 percent, from $47.6 million in 1996. The decline is primarily due to lower
funds under management. The medical stop-loss line also produced lower income in
1997, declining $3.6 million, or 35.3 percent, to $6.6 million in 1997 from
$10.2 million in 1996. These declines were partly offset by higher income in the
individual annuities line of business, which increased primarily due to the
acquisition of Paul Revere. Income in this line was $17.9 million in 1997
compared to $1.9 million in 1996. Interest expense on long-term debt totaled
$38.7 million in 1997, compared to $12.4 million in 1996.
In 1996, income in this segment declined $68.2 million, or 48.2 percent, to
$73.3 million from $141.5 million in 1995. This decline was partially due to
the sale of the medical services lines of business, which produced operating
income of $3.2 million and a gain from the sale of $21.8 million during 1995.
In addition, the decline in this segment was due to lower income in the group
pension line of business, which declined $26.1 million, or 35.4 percent, to
$47.6 million in 1996 from $73.7 million in 1995. The decline in this line was
primarily the result of lower funds under management and lower income from a
reduced amount of capital allocated to this line. Income from the corporate-
owned life insurance line of business declined slightly to $19.7 million in 1996
from $20.5 million in 1995. Income from the medical stop-loss line of business
declined $6.2
61
million, or 37.8 percent, to $10.2 million in 1996 from $16.4 million in 1995.
Liquidity and Capital Resources
- -------------------------------
On March 27, 1997, the Company consummated the acquisition of Paul Revere
("Paul Revere Merger"). The Paul Revere Merger was financed through common
equity issuance to Zurich Insurance Company, a Swiss insurer, and its
affiliates, common equity issuance and cash to Paul Revere stockholders, debt,
and internally generated funds. The debt financing was provided through an
$800.0 million revolving bank credit facility with various domestic and
international banks. The revolving bank credit facility was established in 1996
to provide partial financing for the purchase of Paul Revere and GENEX, to
refinance the existing bank term notes of $200.0 million, and for general
corporate uses. At December 31, 1997 and 1996, outstanding borrowings under the
revolving bank credit facility were $725.0 million and $200.0 million,
respectively. The revolving bank credit facility was repaid on February 24,
1998. The Company redeemed its outstanding 8.10% cumulative preferred stock,
which had an aggregate value of $156.2 million, on February 24, 1998. The debt
repayment and preferred stock redemption were funded through short-term
borrowings.
In May 1997, the Securities and Exchange Commission declared effective a
shelf registration statement pursuant to which the Company may issue up to
$900.0 million in debt and/or equity securities. On March 16, 1998, the Company
completed a public offering of $200.0 million of 7.25% senior notes due March
15, 2028. On March 16, 1998, Provident Financing Trust I, a subsidiary trust of
the Company, issued $300.0 million of 7.405% capital securities in a public
offering. These capital securities, which mature on March 15, 2038, are fully
and unconditionally guaranteed by the Company, have a liquidation value of
$1,000 per capital security, and have a mandatory redemption feature under
certain circumstances. The Company issued 7.405% junior subordinated deferrable
interest debentures
62
which mature on March 15, 2038, to the subsidiary trust in connection with the
capital securities offering.
The Company has $400.0 million available for debt and/or equity securities
under its shelf registration statement following the issuance of the senior
notes and the capital securities.
In March 1998, the Company entered into a commitment letter for a $150.0
million five-year revolving credit facility and a $150.0 million 364-day
revolving credit facility with various domestic and international banks. The
purpose of the facility is for general corporate uses.
The Company believes the cash flow from its operations will be sufficient
to meet its operating and financing cash flow requirements. Periodically, the
Company may issue debt or equity securities to fund internal expansion,
acquisitions, investment opportunities, and the retirement of the Company's debt
and equity.
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 the Company's insurance subsidiaries' states
of domicile, regulatory approval is required if an insurance company seeks to
make loans to affiliates in amounts equal to or in excess of three percent of
the insurer's admitted assets or to pay cash dividends in any twelve month
period in excess of the greater of
63
such company's net gain from operations of the preceding year or ten percent of
its surplus as regards policyholders as of the preceding year end, each as
determined in accordance with accounting practices prescribed or permitted by
insurance regulatory authorities. An aggregate of $141.5 million was available
in 1997 for the payment of dividends and other distributions by the Company's
top-tier insurance subsidiaries without regulatory approval, of which amount
$109.9 million was paid. The Company anticipates that $151.9 million will be
available in 1998 for such purposes.
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 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 1997, the Company sold commercial mortgage loans acquired through
the Paul Revere Merger with a principal amount of $268.1 million and a book
value of $258.4 million. The purpose of this transaction was to 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, 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.
64
Investments
- -----------
Investment activities are an integral part of the Company's business, and
profitability is significantly affected by investment results. Invested assets
are segmented into portfolios which support the various product lines.
Generally, the investment strategy for the portfolios is to match the effective
asset durations with related expected liability durations and to maximize
investment returns, subject to constraints of quality, liquidity,
diversification, and regulatory considerations. This discussion should be read
in connection with Note 3 of the Notes to Consolidated Financial Statements.
The following table provides the distribution of invested assets for the years
indicated.
- ------------------------------------------------------------------------------------------
December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------
Investment-Grade Fixed Maturity Securities 82.2% 77.0% 79.3%
Below-Investment-Grade Fixed Maturity Securities 6.6 6.7 6.2
Equity Securities 0.1 0.1 --
Mortgage Loans 0.1 -- 0.7
Real Estate 0.4 1.1 1.4
Policy Loans 10.2 13.1 10.7
Other 0.4 2.0 1.7
- ------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0%
- ------------------------------------------------------------------------------------------
The following table provides certain investment information and results for
the years indicated.
- --------------------------------------------------------------------------------------------
Year Ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------------------
(in millions of dollars)
- --------------------------------------------------------------------------------------------
Average Cash and Invested Assets $17,808.2 $14,056.3 $14,914.4
Net Investment Income $ 1,354.7 $ 1,090.1 $ 1,221.3
Average Yield * 7.6% 7.8% 8.2%
Net Realized Investment Gains (Losses) $ 15.1 $ (8.6) $ (31.7)
- --------------------------------------------------------------------------------------------
*Average yield is determined by dividing net investment income by the average
cash and invested assets for the year. Excluding net unrealized gains and losses
on securities, the yield is 8.0%, 8.1%, and 8.3% for 1997, 1996, and 1995,
respectively. See Note 3 of the Notes to Consolidated Financial Statements.
For the past three years, the Company's exposure to non-current investments
has improved significantly from prior years.
65
These non-current investments are primarily foreclosed real estate and mortgage
loans which became more than thirty days past due in their principal and
interest payments. Non-current investments totaled $6.7 million at December 31,
1997, or 0.03 percent of invested assets, as compared to $7.3 million at
December 31, 1996, or 0.05 percent of invested assets, and $31.9 million at
December 31, 1995, or 0.22 percent of invested assets.
During 1997, the Company sold eight foreclosed properties with a book value
of $26.1 million. During 1996, the Company sold four foreclosed properties with
a book value of $11.8 million. During 1995, the Company sold twelve foreclosed
properties with a book value of $39.6 million.
The Company's investment in mortgage-backed securities totaled $3.1 billion
on an amortized cost basis at December 31, 1997, and $2.4 billion at December
31, 1996. At December 31, 1997, the mortgage-backed securities for the combined
companies had an average life of 9.2 years and effective duration of 6.7 years
as compared to an average life of 8.3 years and effective duration of 6.0 years
at December 31, 1996. 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.
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
66
not anticipate any liquidity problem caused by the investments in below-
investment-grade securities, nor does it expect these investments to adversely
affect its ability to hold its other investments to maturity.
The Company's exposure to below-investment-grade fixed maturity securities
at December 31, 1997, was $1,297.1 million, representing 6.6 percent of invested
assets, below the Company's internal limit of 10.0 percent of invested assets
for this type of investment. The Company's exposure to below-investment-grade
fixed maturities totaled $891.1 million at December 31, 1996, 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 continually models and
tests all asset and liability portfolios to improve interest rate risk
management and net yields. Testing the asset and liability portfolios under
various interest rate and economic scenarios allows management to choose the
most appropriate investment strategy as well as to prepare for the most
disadvantageous outcomes. This analysis is the precursor to the Company's
activities in derivative financial instruments (see Note 4 of the Notes to
Consolidated Financial Statements).
Year 2000
- ---------
In 1996, the Company completed the planning phase of a project to modify
its computer information systems enabling proper processing of date data
relating to the year 2000 and beyond. The Company is now in the process of
executing its plan and expects all systems to be compliant by the end of 1998.
The total incremental cost of the project is estimated to be between $6.7
million and $8.3 million. The Company is expensing all costs associated with
these system changes.
67
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(in millions of dollars, except share data) 1997 1996 1995 1994 1993
- ------------------------------------------- ------------ ------------ ------------ ------------ ------------
STATEMENT OF OPERATIONS DATA
Premium Income $ 2,053.7 $ 1,175.7 $ 1,251.9 $ 1,382.6 $ 1,400.2
Net Investment Income 1,354.7 1,090.1 1,221.3 1,238.6 1,318.7
Net Realized Investment Gains (Losses) 15.1 (8.6) (31.7) (30.1) 43.6
Other Income 129.7 34.7 113.8 171.1 175.5
------------ ----------- ----------- ----------- -----------
Total Revenue 3,553.2 2,291.9 2,555.3 2,762.2 2,938.0
Benefits and Changes in Reserves 2,358.1 1,661.2 1,904.6 1,981.2 2,502.8
Operating Expenses 814.8 404.5 474.7 580.1 575.3
------------ ----------- ----------- ----------- -----------
Income (Loss) Before Federal Income Taxes 380.3 226.2 176.0 200.9 (140.1)
Federal Income Taxes (Credit) 133.0 80.6 60.4 65.6 (58.9)
------------ ----------- ----------- ----------- -----------
Net Income (Loss) $ 247.3 $ 145.6 $ 115.6 $ 135.3 $ (81.2)
============ =========== =========== =========== ===========
Earnings Per Common Share $ 1.88 $ 1.46 $ 1.13 $ 1.35 $ (1.02)
============ =========== =========== =========== ===========
Earnings Per Common Share - Assuming Dilution $ 1.84 $ 1.44 $ 1.13 $ 1.35 $ (1.02)
============ =========== =========== =========== ===========
Weighted Average Common Shares Outstanding (000s) 124,505.4 91,044.8 90,762.7 90,622.1 90,401.8
Weighted Average Common Shares Outstanding -
Assuming Dilution (000s) 127,253.2 92,154.5 90,931.8 90,729.9 90,401.8
Assets $ 23,177.6 $ 14,992.5 $ 16,301.3 $ 17,149.9 $ 16,891.9
Long-term Debt Including Capital Lease Obligations $ 725.0 $ 200.0 $ 200.0 $ 202.5 $ 247.6
Stockholders' Equity $ 3,279.3 $ 1,738.6 $ 1,652.3 $ 1,169.1 $ 1,401.6
Stockholders' Equity Per Common Share $ 23.11 $ 17.34 $ 16.48 $ 11.17 $ 13.76
Stockholders' Equity Per Common Share Excluding
Net Unrealized Gains and Losses on Securities(1) $ 18.49 $ 16.34 $ 15.33 $ 14.46 $ 13.76
Dividends Per Common Share $ .38 $ .36 $ .36 $ .52 $ .52
(1) Adoption of Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," effective
January 1, 1994.
68
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Shareholders
Provident Companies, Inc.
We have audited the accompanying consolidated statements of financial condition
of Provident Companies, Inc. and Subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of income, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Provident Companies, Inc. and Subsidiaries at December 31, 1997 and 1996, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
Ernst & Young LLP
Chattanooga, Tennessee
February 3, 1998
except for Note 18, as to which
the date is March 16, 1998
69
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Provident Companies, Inc. and Subsidiaries
December 31
1997 1996
(in millions of dollars)
-----------------------------------
Assets
Investments
Fixed Maturity Securities
Available-for-Sale - at fair value (amortized cost: $15,491.4; $10,384.3) $17,035.1 $10,880.1
Held-to-Maturity - at amortized cost (fair value: $336.6; $263.1) 306.8 264.5
Equity Securities - at fair value (cost: $11.1; $7.2) 10.0 4.9
Mortgage Loans 17.8 -
Real Estate 87.1 151.1
Policy Loans 1,983.9 1,749.0
Other Long-term Investments 22.6 15.5
Short-term Investments 57.5 252.3
--------- ---------
Total Investments 19,520.8 13,317.4
Other Assets
Cash and Bank Deposits 37.7 19.3
Accounts Receivable 92.5 40.1
Premiums Receivable 73.9 72.3
Reinsurance Receivable 987.2 468.3
Accrued Investment Income 363.2 268.3
Deferred Policy Acquisition Costs 362.9 421.8
Value of Business Acquired 560.8 5.9
Goodwill 732.3 -
Property and Equipment - at cost less accumulated depreciation 109.2 59.0
Miscellaneous 26.2 19.6
Separate Account Assets 310.9 300.5
--------- ---------
Total Assets $23,177.6 $14,992.5
========= =========
70
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
Provident Companies, Inc. and Subsidiaries
December 31
1997 1996
(in millions of dollars)
-----------------------------------
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 531.2 $ 411.7
Reserves for Future Policy and Contract Benefits 13,001.1 8,051.3
Unearned Premiums 192.7 58.8
Experience Rating Refunds 133.1 164.0
Policyholders' Funds 4,194.9 3,717.1
Federal Income Tax Liability
Current 40.3 34.6
Deferred 149.8 14.5
Short-term Debt 150.7 -
Long-term Debt 725.0 200.0
Other Liabilities 468.6 301.4
Separate Account Liabilities 310.9 300.5
--------- ---------
Total Liabilities 19,898.3 13,253.9
--------- ---------
Commitments and Contingent Liabilities--Note 16
Stockholders' Equity--Note 10
Preferred Stock 156.2 156.2
Common Stock
Authorized: 150,000,000 shares
Issued: 135,160,109 and 91,255,258 shares 135.2 45.6
Additional Paid-in Capital 750.6 11.4
Net Unrealized Gain on Securities 624.3 90.9
Foreign Currency Translation Adjustment (20.7) (5.2)
Retained Earnings 1,635.2 1,439.7
Treasury Stock - at cost:
40,200 shares (1.5) -
--------- ---------
Total Stockholders' Equity 3,279.3 1,738.6
--------- ---------
Total Liabilities and Stockholders' Equity $23,177.6 $14,992.5
========= =========
See notes to consolidated financial statements.
71
CONSOLIDATED STATEMENTS OF INCOME
Provident Companies, Inc. and Subsidiaries
Year Ended December 31
1997 1996 1995
(in millions of dollars, except share data)
----------------------------------------------------
Revenue
Premium Income $2,053.7 $1,175.7 $1,251.9
Net Investment Income 1,354.7 1,090.1 1,221.3
Net Realized Investment Gains (Losses) 15.1 (8.6) (31.7)
Other Income 129.7 34.7 113.8
-------- -------- --------
Total Revenue 3,553.2 2,291.9 2,555.3
-------- -------- --------
Benefits and Expenses
Policy and Contract Benefits 1,687.8 1,216.5 1,419.7
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 670.3 444.7 484.9
Amortization
Deferred Policy Acquisition Costs 74.4 64.0 71.0
Value of Business Acquired 31.2 0.5 4.9
Goodwill 12.6 - -
Salaries 191.1 77.3 99.8
Commissions 220.9 124.0 131.9
Other Operating Expenses 284.6 138.7 167.1
-------- -------- --------
Total Benefits and Expenses 3,172.9 2,065.7 2,379.3
-------- -------- --------
Income Before Federal Income Taxes 380.3 226.2 176.0
Federal Income Taxes 133.0 80.6 60.4
-------- -------- --------
Net Income $ 247.3 $ 145.6 $ 115.6
======== ======== ========
Earnings Per Common Share $ 1.88 $ 1.46 $ 1.13
======== ======== ========
Earnings Per Common Share - Assuming Dilution $ 1.84 $ 1.44 $ 1.13
======== ======== ========
See notes to consolidated financial statements.
72
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Provident Companies, Inc. and Subsidiaries
Year Ended December 31
1997 1996 1995
(in millions of dollars)
-----------------------------------------------------
Preferred Stock
Balance at Beginning and End of Year $ 156.2 $ 156.2 $ 156.2
-------- -------- --------
Common Stock
Balance at Beginning of Year 45.6 45.4 45.4
Issued During Year 22.1 0.2 -
Two-for-One Stock Split 67.5 - -
-------- -------- --------
Balance at End of Year 135.2 45.6 45.4
-------- -------- --------
Additional Paid-in Capital
Balance at Beginning of Year 11.4 5.8 4.8
Contributions During Year 806.7 5.6 1.0
Two-for-One Stock Split (67.5) - -
-------- -------- --------
Balance at End of Year 750.6 11.4 5.8
-------- -------- --------
Net Unrealized Gain (Loss) on Securities
Balance at Beginning of Year 90.9 101.9 (302.3)
Change During Year 533.4 (11.0) 404.2
-------- -------- --------
Balance at End of Year 624.3 90.9 101.9
-------- -------- --------
Foreign Currency Translation Adjustment
Balance at Beginning of Year (5.2) (4.8) (5.4)
Change During Year (15.5) (0.4) 0.6
-------- -------- --------
Balance at End of Year (20.7) (5.2) (4.8)
-------- -------- --------
Retained Earnings
Balance at Beginning of Year 1,439.7 1,347.8 1,270.4
Net Income 247.3 145.6 115.6
Dividends to Stockholders
(Paid Per Common Share: $0.38; $0.36; $0.36) (51.8) (53.7) (38.2)
-------- -------- --------
Balance at End of Year 1,635.2 1,439.7 1,347.8
-------- -------- --------
Treasury Stock
Balance at Beginning of Year - - -
Purchased During Year (1.5) - -
-------- -------- --------
Balance at End of Year (1.5) - -
-------- -------- --------
Total Stockholders' Equity $3,279.3 $1,738.6 $1,652.3
======== ======== ========
See notes to consolidated financial statements
73
CONSOLIDATED STATEMENTS OF CASH FLOWS
Provident Companies, Inc. and Subsidiaries
Year Ended December 31
1997 1996 1995
(in millions of dollars)
---------------------------------------------------------
Cash Flows from Operating Activities
Net Income $ 247.3 $ 145.6 $ 115.6
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities
Policy Acquisition Costs Capitalized (143.5) (71.4) (88.1)
Amortization of Policy Acquisition Costs 74.4 64.0 71.0
Amortization of Value of Business Acquired and Goodwill 43.8 0.5 4.9
Depreciation 20.7 10.6 19.4
Net Realized Investment (Gains) Losses (15.1) 8.6 31.7
Premiums Receivable 6.4 3.2 (13.2)
Reinsurance Receivable 44.4 (33.0) 2.0
Accrued Investment Income (10.7) 9.1 4.1
Insurance Reserves and Liabilities 595.8 546.8 581.8
Federal Income Taxes 23.5 (11.9) (11.4)
Other (60.0) (11.5) (42.9)
--------- --------- ---------
Net Cash Provided by Operating Activities 827.0 660.6 674.9
--------- --------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments
Available-for-Sale Securities 1,872.6 1,592.6 1,359.9
Other Investments 92.9 141.8 1,172.5
Proceeds from Maturities of Investments
Available-for-Sale Securities 1,170.5 1,115.7 880.8
Held-to-Maturity Securities 1.1 100.5 0.7
Other Investments 295.9 13.0 248.7
Purchase of Investments
Available-for-Sale Securities (2,904.3) (1,630.7) (1,680.1)
Held-to-Maturity Securities (23.4) (48.6) (183.9)
Other Investments (180.5) (177.5) (236.6)
Net (Purchases) Sales of Short-term Investments 393.1 (21.5) 58.7
Acquisition of Business (860.3) - -
Disposition of Business - - (48.9)
Other (19.2) (75.5) (67.0)
--------- --------- ---------
Net Cash Provided (Used) by Investing Activities $ (161.6) $ 1,009.8 $ 1,504.8
--------- --------- ---------
74
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
Provident Companies, Inc. and Subsidiaries
Year Ended December 31
1997 1996 1995
(in millions of dollars)
---------------------------------------------------------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts $ 528.7 $ 392.5 $ 530.6
Maturities and Benefit Payments from
Policyholder Accounts (2,081.9) (2,023.8) (2,663.5)
Net Short-term Debt Borrowings (Repayments) 150.7 (1.4) (13.0)
Net Long-term Borrowings 425.9 - -
Issuance of Common Stock 389.8 5.8 1.0
Dividends Paid to Stockholders (60.0) (45.5) (45.3)
Other 0.5 (3.5) -
--------- --------- ---------
Net Cash Used by Financing Activities (646.3) (1,675.9) (2,190.2)
--------- --------- ---------
Effect of Foreign Exchange Rate Changes on Cash (0.7) - -
--------- --------- ---------
Net Increase (Decrease) in Cash and Bank Deposits 18.4 (5.5) (10.5)
Cash and Bank Deposits at Beginning of Year 19.3 24.8 35.3
--------- --------- ---------
Cash and Bank Deposits at End of Year $ 37.7 $ 19.3 $ 24.8
========= ========= =========
See notes to consolidated financial statements.
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies
Basis of Presentation: The accompanying financial statements have been prepared
on the basis of generally accepted accounting principles. Such accounting
principles differ from statutory accounting practices prescribed or permitted by
state regulatory authorities (see Note 17). The consolidated financial
statements include the accounts of Provident Companies, Inc. and its wholly-
owned subsidiaries (the Company). Material intercompany transactions have been
eliminated.
Operations: The Company does business in the fifty states, the District of
Columbia, Puerto Rico, and ten provinces and two territories of Canada. The
Company operates principally in the life and health insurance business.
Individual life products and individual disability income products are reported
in the Individual Life and Disability segment and are marketed primarily through
personal producing general agents, brokerage offices, and corporate marketing
arrangements. The Employee Benefits segment contains products that are sold to
or through corporate customers and certain affinity groups, including permanent
and term life insurance, disability, cancer, accident and sickness, and
accidental death and dismemberment protection. The Other Operations segment
reports corporate results, primarily investment earnings not specifically
allocated to a line of business, and also includes results from products no
longer actively marketed, including guaranteed investment contracts (GICs),
group single premium annuities, medical stop-loss, and corporate-owned life
insurance. This segment also includes the results of the group medical business
which was sold effective April 30, 1995 and the individual and tax-sheltered
annuities business expected to be sold in the second quarter of 1998 (see Notes
15 and 16).
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect amounts reported in the financial statements and
accompanying notes. Such estimates and assumptions could change in the future
as more information becomes known, which could impact the amounts reported and
disclosed herein.
Investments: Investments are reported in the consolidated statements of
financial condition as follows:
Available-for-Sale Fixed Maturity Securities are reported at fair value.
Held-to-Maturity Fixed Maturity Securities are generally reported at amortized
cost.
Equity Securities are reported at fair value.
Mortgage Loans are carried at the fair value of collateral.
Real Estate that the Company expects to hold and use is carried at cost less
accumulated depreciation which is calculated using principally the straight-line
method. Real estate to be disposed of is carried at the lower of cost less
accumulated depreciation or fair value less cost to sell.
Policy Loans are presented at unpaid balances.
Other Long-term Investments are carried at cost plus the Company's equity in
undistributed net earnings since acquisition.
Short-term Investments are carried at cost.
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Fixed maturity securities include bonds and redeemable preferred stocks. Equity
securities include common stocks and nonredeemable preferred stocks. Fixed
maturity and equity securities not bought and held for the purpose of selling in
the near term but for which the Company does not have the positive intent and
ability to hold to maturity are classified as available-for-sale. Fixed
maturity securities that the Company has the positive intent and ability to hold
to maturity are classified as held-to-maturity. The Company determines the
appropriate classification of fixed maturity securities at the time of purchase.
Realized investment gains and losses, which are reported as a component of
revenue in the consolidated statements of income, are based upon specific
identification of the investments sold and do not include amounts allocable to
separate accounts. At the time a decline in the value of an investment is
determined to be other than temporary, a loss is recorded which is included in
realized investment gains and losses.
Derivative Financial Instruments:
Interest Rate Swap Agreements are agreements in which two parties agree to
exchange, at specified intervals, interest payment streams calculated on an
agreed-upon notional principal amount with at least one stream based on a
specified variable rate. The underlying notional principal is not exchanged
between the parties. The Company has certain forward interest rate swap
agreements where the exchange of interest payments does not begin until a
specified future date. The Company intends to settle the forward interest rate
swap agreements prior to the commencement of the exchange of interest payment
streams.
The fair values of interest rate swap agreements which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of interest rate swap
agreements which hedge liabilities are not reported in the consolidated
statements of financial condition. Amounts to be paid or received pursuant to
interest rate swap agreements are accrued and recognized in the consolidated
statements of income as an adjustment to net investment income for asset hedges
or as an adjustment to policy and contract benefits for liability hedges.
The Company accounts for all of its interest rate swap agreements as hedges.
Accordingly, any gains or losses realized on closed or terminated interest rate
swap agreements are deferred and amortized to net investment income for asset
hedges or policy and contract benefits for liability hedges over the expected
remaining life of the hedged item. If the hedged item matures or terminates
earlier than anticipated, the remaining unamortized gain or loss is amortized to
net investment income or policy and contract benefits in the current period.
Gains or losses realized on interest rate swap agreements which are terminated
when the hedged assets are sold or which are terminated because the hedged
anticipated transaction is no longer likely to occur are reported in the
consolidated statements of income as a component of net realized investment
gains and losses. The Company regularly monitors the effectiveness of its
hedging programs. In the event a hedge becomes ineffective, it is marked-to-
market, resulting in a charge or credit to net investment income or policy and
contract benefits.
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Futures and Forwards contracts are commitments to either purchase or sell a
financial instrument at a specific future date for a specified price. The
Company invests only in futures and forwards contracts which have U.S. Treasury
securities as the underlying investments. Changes in the market value of
contracts are generally settled on a daily basis. The notional amounts of
futures and forwards contracts represent the extent of the Company's involvement
but not the future cash requirements, as the Company intends to close out open
positions prior to settlement. All of the Company's futures and forwards
contracts are accounted for as hedges.
The fair values of futures and forwards which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of open futures and
forwards which hedge liabilities are reported in the consolidated statements of
financial condition as a component of other liabilities. Gains or losses
realized on the termination of futures and forwards contracts are accounted for
in the same manner as interest rate swap agreements.
Options contracts give the owner the right, but not the obligation, to buy or
sell a financial instrument at an agreed-upon price on or before a specific
date. The purchasing counterparty pays a premium to the selling counterparty
for this right. The notional amounts of contracts represent the Company's
involvement but not the future cash requirements, as the Company intends to
close out contracts prior to the expiration date when the market price of the
underlying financial instrument exceeds the option price or allow contracts to
expire if the option price exceeds the market price. All of the Company's
options contracts are accounted for as hedges. The book and fair values of
options contracts are reported in the statements of financial condition in a
manner similar to the underlying hedged item. Gains or losses on the
termination of options contracts are accounted for in the same manner as
interest rate swap agreements.
Deferred Policy Acquisition Costs: Certain costs of acquiring new business
which vary with and are primarily related to the production of new business have
been deferred. Such costs include commissions, other agency compensation,
certain selection and policy issue expenses, and certain field expenses.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing subsequent to the year of
issue.
Deferred policy acquisition costs related to traditional individual life and
individual disability income are amortized over the premium paying period of the
related policies in proportion to the ratio of the present value of annual
expected premium income to the present value of total expected premium income.
Adjustments are made each year to recognize actual persistency experience as
compared to assumed experience.
Deferred policy acquisition costs related to interest-sensitive individual life
and individual annuity policies are amortized over the lives of the policies in
relation to the present value of estimated gross profits from surrender charges
and mortality, investment, and expense margins. Adjustments are made each year
to reflect actual experience for assumptions which deviate significantly
compared to assumed experience.
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
The amortization periods do not exceed 25 years for traditional and interest-
sensitive individual life policies, 20 years for individual disability income
policies, and 15 years for individual annuity policies. Loss recognition is
performed when, in the judgment of management, adverse deviations from original
assumptions have occurred and may be likely to continue such that
recoverability of deferred policy acquisition costs on a line of business is
questionable. Insurance contracts are grouped on a basis consistent with the
Company's manner of acquiring, servicing, and measuring profitability of the
contracts. If loss recognition testing indicates that deferred policy
acquisition costs are not recoverable, the deficiency is charged to expense.
Once a loss recognition adjustment is required, loss recognition testing is
generally performed on an annual basis using then current assumptions until the
line of business becomes immaterial or results improve significantly. The
assumptions used in loss recognition testing represent management's best
estimates of future experience.
Value of Business Acquired: Value of business acquired represents the present
value of future profits recorded in connection with the acquisition of a block
of insurance policies. The asset is amortized based upon expected future
premium income for traditional insurance policies and estimated future gross
profits for interest-sensitive insurance policies, with the accrual of interest
added to the unamortized balance at interest rates ranging from 5.55% to 7.60%.
The Company periodically reviews the carrying amount of value of business
acquired using the same methods used to evaluate deferred policy acquisition
costs.
Goodwill: Goodwill is the excess of the amount paid to acquire a business over
the fair value of the net assets acquired. Goodwill is amortized on a straight-
line basis over a period not to exceed 40 years. The carrying amount of
goodwill is regularly reviewed for indicators of impairment in value.
Property and Equipment: Property and equipment is depreciated on the straight-
line method over its estimated useful life. The accumulated depreciation for
property and equipment was $115.7 million and $84.4 million as of December 31,
1997 and 1996, respectively.
Revenue Recognition: For traditional life and accident and health products, the
amounts collected from policyholders are recognized as premium income over the
premium paying period and are reported net of experience rating refunds and
unearned premiums. For interest-sensitive products, the amounts collected from
policyholders are considered deposits, and only the deductions during the period
for cost of insurance, policy administration, and surrenders are included in
revenue. Policyholders' funds represent funds deposited by contract holders and
are not included in revenue.
Policy and Contract Benefits: Policy and contract benefits, principally related
to accident and health insurance policies, are based on reported losses and
estimates of incurred but not reported losses for traditional life and accident
and health products. For interest-sensitive products, benefits are the amounts
paid and expected to be paid on insured claims in excess of the policyholders'
policy fund balances.
Reserves for Future Policy and Contract Benefits: Active life reserves for
future policy and contract benefits on traditional life and accident and health
products have been provided on the net level premium method. The reserves are
calculated based upon assumptions as to interest, withdrawal, morbidity, and
mortality that were appropriate at the date of issue. Withdrawal assumptions
are based on actual Company experience. Morbidity and mortality assumptions are
based upon industry standards adjusted as appropriate to reflect actual Company
experience. The assumptions vary by plan, year of issue, and policy duration
and include a provision for adverse deviation.
Disabled lives reserves for future policy and contract benefits on disability
income policies are calculated based upon assumptions as to interest and claim
termination rates that are currently appropriate. Termination rate assumptions
are based upon industry standards adjusted as appropriate to reflect actual
Company experience. The assumptions vary by year of claim incurral.
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Reserves for future policy and contract benefits on group single premium
annuities have been provided on a net single premium method. The reserves are
calculated based upon assumptions as to interest, mortality, and retirement that
were appropriate at the date of issue. Mortality assumptions are based upon
industry standards adjusted as appropriate to reflect actual Company experience.
The assumptions vary by year of issue and include a provision for adverse
deviation.
The interest rate assumptions used to calculate reserves for future policy and
contract benefits are as follows:
December 31
1997 1996
-----------------------------------------------------------------
Active Life Reserves - Current Year Issues
Traditional Life 7.25% to 10.00% 7.25% to 10.00%
Individual Disability Income 7.00% to 7.75% 7.00% to 7.75%
Disabled Lives Reserves - Current Year Claims
Individual Disability Income 7.75% to 8.00% 8.00%
Group Disability Income 6.50% to 8.00% 7.00%
Disabled Lives Reserves - Prior Year Claims
Individual Disability Income 7.75% to 8.00% 8.00%
Group Disability Income 3.90% to 8.90% 6.00% to 7.00%
Interest assumptions for active life reserves are generally graded downward over
a period of years. Reserves for future policy and contract benefits on
interest-sensitive products are principally policyholder account values
determined on the retrospective deposit method.
Policyholders' Funds: Policyholders' funds represent customer deposits plus
interest credited at contract rates. The Company controls its interest rate
risk by investing in quality assets which have an aggregate duration that
closely matches the expected duration of the liabilities. For GICs, which are
no longer marketed, the Company uses a cash flow matching investment strategy.
Synthetic GICs: The Company discontinued accepting new synthetic GIC deposits
in 1996 and in 1997 sold this block of business through an assumptive
reinsurance agreement. All remaining contracts were transferred in January
1998. Prior to this time, the Company issued synthetic GICs to trustees of
employee benefit plans pursuant to the terms of which the trustees owned and
retained the assets related to these contracts. Such assets were not included
in the Company's consolidated statements of financial condition. Accumulated
funds from the sale of synthetic GICs were $97.8 million and $2,176.6 million at
December 31, 1997 and 1996, respectively.
Federal Income Taxes: Deferred taxes have been recorded for significant
temporary differences between financial statement income and taxable income.
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Separate Accounts: The separate account amounts shown in the accompanying
financial statements represent contributions by contract holders to variable-
benefits and fixed-benefits pension plans. The contract purchase payments and
the assets of the separate accounts are segregated from other Company funds for
both investment and administrative purposes. Contract purchase payments
received under variable annuity contracts are subject to deductions for sales
and administrative fees. Also, the sponsoring company of the separate accounts
receives management fees which are based on the net asset values of the separate
accounts.
Translation of Foreign Currency: Revenues and expenses of the Company's
Canadian operations are translated at average exchange rates. Assets and
liabilities are translated at the rate of exchange on the balance sheet date.
The translation gain or loss is generally reported in stockholders' equity, net
of deferred tax credits of $5.0 million and $2.8 million at December 31, 1997
and 1996, respectively.
Changes in Accounting Principles:
Statement of Financial Accounting Standards No. 125 (SFAS 125), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
In 1997, the Company adopted the provisions of SFAS 125 which provide accounting
and reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial-components approach that focuses on control. SFAS
125 also establishes new rules for determining whether a transfer of financial
assets constitutes a sale and, if so, the determination of any resulting gain or
loss. The adoption of SFAS 125 did not have a material effect on the Company's
financial position or results of operations.
Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings Per
Share"
In 1997, the Company adopted the provisions of SFAS 128 which establish
computation and reporting standards for earnings per share. SFAS 128 simplifies
the standards for computing earnings per share and makes them comparable to
international earnings per share standards. SFAS 128 requires dual presentation
on the face of the income statement of earnings per share and earnings per share
assuming dilution and requires a reconciliation of the numerator and denominator
of the earnings per share computation to the numerator and denominator of the
earnings per share assuming dilution computation (see Note 10). Earnings per
share is computed using the weighted average number of common shares outstanding
and does not consider any potential dilution. Earnings per share assuming
dilution reflects the potential dilution that could 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 that then shared in the earnings of the
entity. Historical earnings per common share amounts have been restated in
accordance with the provisions of SFAS 128.
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
In 1996, the Company adopted the provisions of SFAS 121 which require that long-
lived assets and certain identifiable intangibles to be held and used by an
entity be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Measurement of an impairment loss for long-lived assets and identifiable
intangibles that an entity expects to hold and use should be based on the fair
value of the asset. SFAS 121 also requires that long-lived assets and certain
intangibles to be disposed of generally be reported at the lower of the carrying
amount or fair value less cost to sell.
The primary assets of the Company which are subject to SFAS 121 are investment
real estate, property and equipment, and goodwill. The effect of the adoption
of SFAS 121 on the Company's financial position and results of operations was
immaterial.
Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation"
SFAS 123 defines a fair value based method of accounting for stock-based
employee compensation plans. Under this method, compensation cost is measured
at the grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. SFAS 123 also allows an
entity to continue to measure compensation cost using the intrinsic value based
method of accounting prescribed by Accounting Principles Board Opinion No. 25
(Opinion 25), "Accounting for Stock Issued to Employees." Under this method,
compensation cost is the excess, if any, of the quoted market price of the stock
at grant date or other measurement date over the amount an employee must pay to
acquire the stock. SFAS 123 requires entities electing to continue accounting
for stock-based employee compensation plans under Opinion 25 to make pro forma
disclosures of net income and earnings per share as if the fair value based
method of accounting defined under SFAS 123 had been applied. The Company
adopted the disclosure provisions of SFAS 123 in 1996 (see Note 11), but elected
to continue to measure compensation cost for stock-based compensation under the
expense recognition provisions of Opinion 25. The adoption of SFAS 123,
therefore, did not have an effect on the Company's financial position or results
of operations.
Accounting Pronouncements Outstanding:
Statement of Financial Accounting Standards No. 130 (SFAS 130),"Reporting
Comprehensive Income"
In 1997, the Financial Accounting Standards Board (FASB) issued SFAS 130 which
establishes standards for reporting and presentation of comprehensive income and
its components (revenues, expenses, gains, and losses) in a full set of
financial statements. Comprehensive income is the change in equity of an entity
during a period from transactions and other events except those resulting from
investments by and distributions to stockholders. SFAS 130 requires all items
recognized under accounting standards as components of comprehensive income to
be reported in a financial statement that is displayed with the same prominence
as other financial statements. Application of SFAS 130 will not impact amounts
reported for net income. The Company plans to adopt SFAS 130 in 1998.
Statement of Financial Accounting Standards No. 131 (SFAS 131),"Disclosures
about Segments of an Enterprise and Related Information"
In 1997, the FASB issued SFAS 131 which establishes standards for reporting
information for segments of a business enterprise including, but not limited to,
profit or loss, assets, products and services, geographic areas of operation,
and major customers. The Company plans to adopt SFAS 131 in 1998.
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 2--Fair Values of Financial Instruments
The carrying amounts and fair values of the Company's financial instruments are
as follows:
December 31
(in millions of dollars)
------------------------------------------------------------------------
1997 1996
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------------------------------------
Assets
Fixed Maturity Securities
Available-for-Sale $16,901.3 $16,901.3 $10,859.9 $10,859.9
Derivatives Hedging Available-for-Sale 133.8 133.8 20.2 20.2
Held-to-Maturity 306.8 336.6 264.5 263.1
Equity Securities 10.0 10.0 4.9 4.9
Mortgage Loans 17.8 17.8 - -
Policy Loans 1,983.9 2,376.1 1,749.0 2,080.5
Short-term Investments 57.5 57.5 252.3 252.3
Cash and Bank Deposits 37.7 37.7 19.3 19.3
Liabilities
Policyholders' Funds
GICs 1,603.6 1,618.5 3,204.3 3,230.9
Deferred Annuity Products 2,321.0 2,281.0 281.4 266.0
Supplementary Contracts without
Life Contingencies 86.7 86.7 61.1 61.1
Short-term Debt 150.7 150.7 - -
Long-term Debt 725.0 725.0 200.0 200.0
Derivatives Hedging Liabilities (7.4) (7.7) - 3.0
The following methods and assumptions were used by the Company in estimating the
fair values of its financial instruments:
Fixed Maturity Securities: Fair values for fixed maturity securities are based
on quoted market prices, where available. For fixed maturity securities not
actively traded, fair values are estimated using values obtained from
independent pricing services or, in the case of private placements, are
estimated by discounting expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments. See
Note 3 for the amortized cost and fair values of securities by security type and
by maturity date.
Equity Securities: Fair values for equity securities are based on quoted market
prices.
Mortgage Loans: Fair values for mortgage loans are based on estimated sales
prices at the balance sheet date.
Policy Loans: Fair values for policy loans are estimated using discounted cash
flow analyses, using interest rates currently being offered.
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 2--Fair Values of Financial Instruments - Continued
Short-term Investments and Cash and Bank Deposits: Carrying amounts for short-
term investments and cash and bank deposits approximate fair value.
Policyholders' Funds: Fair values of the Company's liability for GICs are
estimated using discounted cash flow calculations, based on current market
interest rates available for similar contracts with maturities consistent with
those remaining for the contracts being valued. Fair values of the Company's
liability for deferred annuity products are estimated using the cash surrender
values of the annuity contracts. The carrying amounts for supplementary
contracts without life contingencies approximate fair value.
Fair values for the Company's insurance contracts other than investment
contracts are not required to be disclosed. However, the fair values of
liabilities under all insurance contracts are taken into consideration in the
Company's overall management of interest rate risk, which minimizes exposure to
changing interest rates through the matching of investment maturities with
amounts due under insurance contracts.
Short-term and Long-term Debt: The carrying amounts for short-term and long-
term debt approximate fair value.
Derivatives: Fair values of the Company's derivative financial instruments are
based on market quotes, pricing models, or formulas using current interest rates
and assumptions and represent the net amount of cash the Company would have
received or paid if the contracts had been settled or closed on December 31.
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments
Securities
The amortized cost and fair values of securities by security type are as
follows:
December 31, 1997
(in millions of dollars)
----------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------------------------------------------------------
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 336.6 $ 62.9 $ - $ 399.5
States, Municipalities, and Political Subdivisions 13.6 1.2 - 14.8
Foreign Governments 526.3 109.9 - 636.2
Public Utilities 2,586.4 284.9 3.6 2,867.7
Mortgage-backed Securities 2,841.8 136.2 6.4 2,971.6
All Other Corporate Bonds 9,052.4 963.0 16.8 9,998.6
Redeemable Preferred Stocks 134.3 14.7 2.3 146.7
--------- -------- ----- ---------
Total Fixed Maturity Securities 15,491.4 1,572.8 29.1 17,035.1
Equity Securities 11.1 0.2 1.3 10.0
--------- -------- ----- ---------
$15,502.5 $1,573.0 $30.4 $17,045.1
========= ======== ===== =========
Held-to-Maturity Securities
United States Government and
Government Agencies and Authorities $ 13.1 $ 2.6 $ - $ 15.7
States, Municipalities, and Political Subdivisions 2.9 0.2 - 3.1
Mortgage-backed Securities 276.9 23.7 - 300.6
All Other Corporate Bonds 13.9 3.3 - 17.2
--------- -------- ----- ---------
$ 306.8 $ 29.8 $ - $ 336.6
========= ======== ===== =========
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
December 31, 1996
(in millions of dollars)
----------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------------------------------------------------------
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 6.4 $ 0.8 $ - $ 7.2
Foreign Governments 156.5 19.9 - 176.4
Public Utilities 2,421.5 206.4 7.4 2,620.5
Mortgage-backed Securities 2,156.9 28.4 33.3 2,152.0
All Other Corporate Bonds 5,595.6 306.2 26.8 5,875.0
Redeemable Preferred Stocks 47.4 2.1 0.5 49.0
--------- ------ ----- ---------
Total Fixed Maturity Securities 10,384.3 563.8 68.0 10,880.1
Equity Securities 7.2 - 2.3 4.9
--------- ------ ----- ---------
$10,391.5 $563.8 $70.3 $10,885.0
========= ====== ===== =========
Held-to-Maturity Securities
United States Government and
Government Agencies and Authorities $ 13.5 $ 1.5 $ - $ 15.0
States, Municipalities, and Political Subdivisions 3.2 0.2 - 3.4
Mortgage-backed Securities 234.9 3.3 8.1 230.1
All Other Corporate Bonds 12.9 1.7 - 14.6
--------- ------ ----- ---------
$ 264.5 $ 6.7 $ 8.1 $ 263.1
========= ====== ===== =========
86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
The amortized cost and fair values of fixed maturity securities by maturity date
are shown below. The maturity dates have not been adjusted for possible calls
or prepayments.
December 31, 1997
(in millions of dollars)
----------------------------------------
Amortized Fair
Cost Value
----------------------------------------
Available-for-Sale Securities
1 year or less $ 437.5 $ 515.3
Over 1 year through 5 years 1,341.0 1,528.7
Over 5 years through 10 years 2,973.4 3,150.5
Over 10 years 7,897.7 8,869.0
--------- ---------
12,649.6 14,063.5
Mortgage-backed Securities 2,841.8 2,971.6
--------- ---------
$15,491.4 $17,035.1
========= =========
Held-to-Maturity Securities
1 year or less $ 0.5 $ 0.5
Over 1 year through 5 years 2.2 2.4
Over 5 years through 10 years 0.3 0.3
Over 10 years 26.9 32.8
--------- ---------
29.9 36.0
Mortgage-backed Securities 276.9 300.6
--------- ---------
$ 306.8 $ 336.6
========= =========
The adjustments associated with reporting securities at fair value and the
changes that would have been necessary if the unrealized investment gains and
losses related to the securities had been realized are as follows:
December 31
1997 1996
(in millions of dollars)
-----------------------------------
Assets
Fixed Maturity Securities $1,543.7 $ 495.8
Equity Securities (1.1) (2.3)
Deferred Policy Acquisition Costs (362.8) (240.9)
Value of Business Acquired (59.6) -
Liabilities
Reserve for Future Policy and Contract Benefits 161.2 112.8
Deferred Federal Income Taxes 334.7 48.9
Stockholders' Equity
Net Unrealized Gain on Securities 624.3 90.9
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
At December 31, 1997, the total investment in below-investment-grade fixed
maturity securities (securities rated below Baa3 by Moody's Investors Service
or an equivalent internal rating) was $1,297.1 million or 6.6 percent of
invested assets. The amortized cost of these securities was $1,232.4 million.
Mortgage Loans
Changes in the mortgage loan loss reserve are as follows:
1997 1996 1995
(in millions of dollars)
-------------------------------------------------
Balance at January 1 $ 1.0 $ 12.0 $ 49.0
Additions Charged to Realized Investment Losses - - 3.0
Release Due to Sale or Direct Write-Down of Loans - (11.0) (40.0)
----- ------ ------
Balance at December 31 $ 1.0 $ 1.0 $ 12.0
===== ====== ======
In 1997, the Company sold mortgage loans with a principal amount of $268.1
million and a book value of $258.4 million. The sale of the mortgage loans,
which were acquired through an acquisition of business (see Note 14), resulted
in a before-tax realized investment gain of $10.9 million.
In 1996, the Company sold mortgage loans with a principal amount of $81.6
million and a book value of $75.9 million which resulted in a before-tax
realized investment loss of $5.7 million.
In October 1995, the Company sold commercial mortgage loans with a principal
amount and a book value of $962.4 million through a securitization
collateralized by 366 loans. In May 1995, the Company sold restructured
mortgage loans with a principal amount of $147.5 million and a book value of
$122.6 million. The transactions resulted in before-tax realized investment
gains (losses) of $8.9 million and $(23.1) million, respectively.
Real Estate
Accumulated depreciation on real estate was $23.3 million and $28.5 million as
of December 31, 1997 and 1996, respectively.
88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
Net Investment Income
Sources for net investment income are as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
--------------------------------------------------
Fixed Maturity Securities $1,120.7 $ 900.2 $ 961.4
Equity Securities 0.4 0.4 0.4
Mortgage Loans 10.5 2.6 100.7
Real Estate 17.4 25.8 29.6
Policy Loans 192.0 182.8 163.9
Other Long-term Investments 24.5 3.9 4.3
Short-term Investments 13.6 7.4 6.9
-------- -------- --------
Gross Investment Income 1,379.1 1,123.1 1,267.2
Investment Expenses 24.4 33.0 45.9
-------- -------- --------
Net Investment Income $1,354.7 $1,090.1 $1,221.3
======== ======== ========
Realized Investment Gains and Losses
Realized investment gains (losses) are as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
--------------------------------------------------
Fixed Maturity Securities $18.1 $ 37.1 $ 14.9
Equity Securities (0.1) (1.3) 0.2
Mortgage Loans and Real Estate 1.0 (3.7) (26.9)
Other Invested Assets (0.7) 0.1 -
Derivatives (3.2) (40.8) (19.9)
----- ------ ------
$15.1 $ (8.6) $(31.7)
===== ====== ======
Net realized investment gains and losses include writedowns and changes in the
reserve for losses on mortgage loans and foreclosed real estate of $1.4 million,
$(5.0) million, and $(29.0) million for 1997, 1996, and 1995, respectively.
89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
Proceeds from sales of fixed maturity and equity securities and the related
gross gains and losses realized on those sales are as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
------------------------------------------------------
Proceeds from Sales
Available-for-Sale Fixed Maturity Securities $1,871.7 $1,592.0 $1,353.1
Equity Securities 0.9 0.6 6.8
Gross Gains
Available-for-Sale Fixed Maturity Securities 63.7 50.1 35.3
Equity Securities - - 1.3
Gross Losses
Available-for-Sale Fixed Maturity Securities 45.6 13.0 20.4
Equity Securities 0.1 1.3 1.1
Note 4--Derivative Financial Instruments
The Company uses interest rate swaps, exchange-traded interest rate futures
contracts, and options to hedge interest rate risks and to match assets with its
insurance liabilities. Interest rate forward contracts are also used to some
extent in the hedging process.
Derivative Risks
The basic types of risks associated with derivatives are market risk (that the
value of the derivative will be adversely impacted by changes in the market,
primarily the change in interest rates) and credit risk (that the counterparty
will not perform according to the terms of the contract). The market risk of
the derivatives should generally offset the market risk associated with the
hedged financial instrument or liability.
To help limit the credit exposure of the derivatives, the Company has entered
into master netting agreements with its counterparties whereby contracts in a
gain position can be offset against contracts in a loss position. The Company
also typically enters into bilateral, cross-collateralization agreements with
its counterparties to help limit the credit exposure of the derivatives. These
agreements require the counterparty in a loss position to submit acceptable
collateral with the other counterparty in the event the net loss position meets
or exceeds an agreed upon amount. The Company's current credit exposure on
derivatives, which is limited to the value of those contracts in a net gain
position, was $50.9 million at December 31, 1997.
90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Hedging Activity
The table below summarizes by notional amounts the activity for each category of
derivatives.
Interest Rate Swaps
-----------------------------
Receive Receive
Variable/ Fixed/
Pay Fixed Pay Variable Forwards Futures Options Total
(in millions of dollars)
--------------------------------------------------------------------------------------------
Balance at December 31, 1994 $800.0 $ 726.0 $ - $ 205.0 $ - $1,731.0
Additions 300.0 495.0 - 947.5 820.0 2,562.5
Terminations 200.0 359.8 - 1,137.5 820.0 2,517.3
------ -------- ------ -------- -------- --------
Balance at December 31, 1995 900.0 861.2 - 15.0 - 1,776.2
Additions - 400.0 - 477.0 - 877.0
Terminations 600.0 463.6 - 482.0 - 1,545.6
------ -------- ------ -------- -------- --------
Balance at December 31, 1996 300.0 797.6 - 10.0 - 1,107.6
Acquisition of Business--Note 14 - 9.4 390.0 - - 399.4
Additions - 420.0 - 1,257.3 2,034.5 3,711.8
Terminations 300.0 114.6 250.0 823.8 1,625.0 3,113.4
------ -------- ------ -------- -------- --------
Balance at December 31, 1997 $ - $1,112.4 $140.0 $ 443.5 $ 409.5 $2,105.4
====== ======== ====== ======== ======== ========
Additions and terminations reported above for futures and options include roll
activity, which is the closing out of an old contract and initiation of a new
one when the futures contract is about to mature but the need for it still
exists.
The following table summarizes the timing of anticipated settlements of interest
rate swaps outstanding at December 31, 1997, and the related weighted average
interest receive rate or pay rate assuming current market conditions.
1998 1999 2000 2001 2002 Total
(in millions of dollars)
--------------------------------------------------------
Receive Fixed/Pay Variable
Notional Value $13.0 $420.0 $249.4 $280.0 $150.0 $1,112.4
Weighted Average Receive Rate 5.00% 7.30% 7.76% 7.70% 7.54% 7.51%
Weighted Average Pay Rate 5.72 5.79 5.86 5.81 5.81 5.81
91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Derivative activity falls under seven hedging programs as follows:
Program 1
The Company routinely uses forwards and futures to protect margins by reducing
the risk of changes in interest rates between the time of asset purchase and the
associated sale of an asset or sale of new business. The majority of the 1995
activity ($500.0 million) was a hedge of the reinvestment of the proceeds from
the securitization of the Company's commercial mortgage loan portfolio (see Note
3).
Gains or losses on termination of these forwards and futures are deferred and
reported as an adjustment of the carrying amount of the hedged asset or
liability and amortized into earnings over the lives of the hedged items. The
net deferred gain associated with this activity was $30.2 million and $29.3
million at December 31, 1997 and 1996, respectively.
The deferred gain from this program was amortized into income in the
consolidated statements of income as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
------------------------------------------------
Net Investment Income $ 1.0 $ 1.0 $ 0.2
Policy and Contract Benefits 1.0 1.2 3.8
----- ----- -----
$ 2.0 $ 2.2 $ 4.0
===== ===== =====
At December 31, 1997, the Company had no open futures contracts under this
program.
Program 2
In 1994 and 1993, the Company created $101.0 million of synthetic fixed rate
assets consisting of variable rate mortgage-backed securities combined with
index amortizing swaps (receive fixed/pay variable). These synthetic fixed rate
assets back fixed rate GICs. During this time, the Company also created $625.0
million of synthetic variable rate GICs consisting of fixed rate GICs combined
with index amortizing swaps (receive fixed/pay variable), which were then backed
by variable rate mortgage-backed securities. The notional amount of index
amortizing swaps associated with this program was $113.0 million and $197.6
million at December 31, 1997 and 1996, respectively. The notional amount of
these swaps reduces based on an amortization schedule indexed to a constant
maturity treasury rate. Under market conditions at December 31, 1997, the
remaining swaps are expected to amortize fully over the next two years.
92
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Income (expense) from settlements of payment streams on these interest rate swap
agreements as reported in the consolidated statements of income was as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
----------------------------------------------------
Net Investment Income $ - $ - $ 0.9
Policy and Contract Benefits 0.2 0.3 (4.7)
----- ----- -----
$ 0.2 $ 0.3 $(3.8)
===== ===== =====
Program 3
In December 1994, the Company announced that it would discontinue the sale of
traditional GICs. At that time, the Company decided to convert from a duration
matching investment approach to a cash flow matching investment approach for its
GIC business. The Company hedged the risk that a rise in interest rates would
reduce the price on future sales of assets which would be necessary to fund
maturing liabilities by entering into $1.1 billion notional amount of forward
interest rate swaps (receive variable/pay fixed) and $205.0 million notional
amount of short interest rate futures contracts. The majority of this hedge was
initiated in 1994, with the last $300.0 million of swaps initiated in 1995.
The $205.0 million futures position was terminated in 1995 as planned when
$208.7 million of fixed maturity securities were sold to fund maturing GICs.
The Company realized a $0.1 million before-tax investment gain on the futures
and a $5.6 million before-tax investment loss on the fixed maturity securities,
a net result which was consistent with the original hedge expectations. The
first $200.0 million swap position was terminated in 1995; however, fixed
maturity securities sales did not occur as originally anticipated because the
Company had adequate cash flow from other sources to fund the maturing GICs.
The primary source of this other cash flow was the securitization of the
commercial mortgage loan portfolio which had not been anticipated at the time
this hedge was initiated (see Note 3). The Company realized a $20.0 million
before-tax investment loss on the termination of this swap position in 1995.
During 1996, the Company terminated $600.0 million of these forward swaps as
scheduled, realizing a $36.1 million before-tax investment loss. In addition,
the Company used offsetting futures contracts to partially remove the hedge as
fixed maturities were sold prior to the termination date of the interest rate
swaps. The Company realized a $5.3 million before-tax investment loss on the
termination of these futures contracts. The Company sold $423.0 million of
fixed maturity securities associated with this hedge, realizing a $19.6 million
before-tax investment gain.
During 1997, the Company terminated the remaining $300.0 million of these
forward swaps as scheduled, realizing a $4.1 million before-tax investment loss.
In addition, the Company used offsetting futures contracts to partially remove
the hedge as fixed maturity securities were sold prior to the termination date
of the interest rate swaps. The Company realized a $0.1 million before-tax
investment gain on the termination of these futures contracts. The Company sold
$302.0 million of fixed maturity securities associated with this hedge,
realizing a $4.3 million before-tax investment gain.
Program 4
In 1995, the Company purchased $820.0 million in put options on treasury
securities to hedge the risk that a rise in interest rates would reduce the
price realized on the securitization of the commercial mortgage loan portfolio.
The options expired without value, and the $7.6 million price of the option was
reported as an adjustment to the net realized investment gain from the mortgage
loan sale.
93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Program 5
The Company has executed a series of cash flow hedges in the individual
disability income portfolio and the group single premium annuities portfolio.
The purpose of these hedges is to lock in the reinvestment rates on future cash
flows and protect the Company from the potential adverse impact of declining
interest rates on the associated policy reserves. The Company uses futures
contracts to partially offset hedges on fixed maturity securities purchased
prior to the termination date of interest rate swaps and forwards. The Company
also uses futures contracts to replace terminated forwards and interest rate
swaps in order to maintain hedges until the fixed maturity securities are
purchased. The following table summarizes the hedging activity under this
program:
Notional Before-Tax
Amount Realized
Outstanding Investment Deferred
Additions Terminations at December 31 Gain (Loss) Gain
(in millions of dollars)
-------------------------------------------------------------------------------------
Individual Disability Income
1995
Interest Rate Swaps $ 495.0 $ - $ 495.0 $ - $ -
======== ======== ======== ===== =====
1996
Interest Rate Swaps $ 200.0 $ 225.0 $ 470.0 $ 0.6 $ 3.6
Futures 144.5 134.5 10.0 - 3.6
-------- -------- -------- ----- -----
Total $ 344.5 $ 359.5 $ 480.0 $ 0.6 $ 7.2
======== ======== ======== ===== =====
1997
Interest Rate Swaps $ 420.0 $ 30.0 $ 860.0 $ - $ 1.7
Forwards 390.0 250.0 140.0 - 23.2
Futures 247.5 214.0 43.5 - 2.4
Options - U.S. Treasury Interest Rate 550.0 195.0 355.0 0.1 0.1
Options - Interest Rate Swaps 850.0 850.0 - 0.7 3.3
-------- -------- -------- ----- -----
Total $2,457.5 $1,539.0 $1,398.5 $ 0.8 $30.7
======== ======== ======== ===== =====
Group Single Premium Annuities
1996
Interest Rate Swaps $ 200.0 $ 70.0 $ 130.0 $(0.1) $ -
======== ======== ======== ===== =====
1997
Interest Rate Swaps $ - $ - $ 130.0 $ - $ -
Options - Interest Rate Swaps 300.0 300.0 - - 0.5
-------- -------- -------- ----- -----
Total $ 300.0 $ 300.0 $ 130.0 $ - $ 0.5
======== ======== ======== ===== =====
94
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
In 1997 and 1996, the Company amortized into net investment income $0.6 million
and $0.1 million, respectively, of the deferred gains from this program. At
December 31, 1997, the Company had an unrealized gain of $133.8 million on the
open interest rate swaps, forwards, and futures. These derivatives are
scheduled to be terminated in the years 1998 through 2002 as assets are
purchased with the future anticipated cash flows.
Program 6
In 1997, the Company began selling indexed annuity products whereby a portion of
the crediting rate on the annuity is based on the performance of the S&P 500
stock index. In order to hedge this fluctuating credit rate, the Company
purchased options with the S&P 500 stock index as the underlying item. These
options will be settled with a net cash payment to the Company at the expiration
date if the S&P 500 index moves above the option contract's strike price;
otherwise, no cash payment will take place at expiration. At December 31, 1997,
the outstanding notional amount of these options was $4.5 million, and the fair
value and carrying amount were $1.6 million.
Program 7
In 1997, the Company opened $400.0 million of interest rate futures contracts
and wrote $50.0 million of options on interest rate futures in order to hedge
the borrowing rate on the anticipated refinancing of long-term debt (see Note
18). The Company realized a $2.9 million before-tax investment loss when $250.0
million of the interest rate futures contracts were terminated and rolled into
1998. The loss on the interest rate futures contracts and the $0.7 million
option premium received were deferred and will be amortized as an adjustment to
interest expense on long-term debt.
95
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 5--Value of Business Acquired
A reconciliation of value of business acquired for the year ended 1997 is as
follows (in millions of dollars):
Balance at January 1 $ 5.9
Acquisition of Business--Note 14 645.7
Interest Accrued 33.1
Amortization (64.3)
Adjustment for Unrealized Investment Gains (59.6)
------
Balance at December 31 $560.8
======
The carrying amounts of value of business acquired in 1996 and 1995 were
immaterial.
The estimated net amortization of value of business acquired for each of the
next five years is as follows (in millions of dollars):
1998 $40.7
1999 39.4
2000 38.3
2001 36.9
2002 35.6
96
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 6--Liability for Unpaid Claims and Claim Adjustment Expenses
Changes in the liability for unpaid claims and claim adjustment expenses were as
follows:
1997 1996 1995
(in millions of dollars)
---------------------------------------------------
Balance at January 1 $3,047.5 $2,824.7 $2,472.9
Less Reinsurance Recoverables 372.1 343.2 237.6
-------- -------- --------
Net Balance at January 1 2,675.4 2,481.5 2,235.3
Acquisition of Business--Note 14 2,295.4 - -
Incurred Related to:
Current Year 1,537.3 910.6 960.0
Prior Years
Interest 285.0 173.3 155.0
Incurred (30.5) (65.5) (31.1)
-------- -------- --------
Total Incurred 1,791.8 1,018.4 1,083.9
-------- -------- --------
Paid Related to:
Current Year 337.2 322.4 359.0
Prior Years 1,011.3 502.1 478.7
-------- -------- --------
Total Paid 1,348.5 824.5 837.7
-------- -------- --------
Net Balance at December 31 5,414.1 2,675.4 2,481.5
Plus Reinsurance Recoverables 857.7 372.1 343.2
-------- -------- --------
Balance at December 31 $6,271.8 $3,047.5 $2,824.7
======== ======== ========
The majority of the net balances are related to disabled lives claims with long-
tail payouts on which interest earned on assets backing liabilities is an
integral part of pricing and reserving. Interest accrued on prior year
reserves has been calculated on the opening reserve balance less one-half year's
cash payments at the average rate at which the Company's reserves were
discounted during 1997, 1996, and 1995.
97
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 7--Federal Income Taxes
A reconciliation of the income tax attributable to continuing operations
computed at U.S. federal statutory tax rates to the income tax expense as
included in the consolidated statements of income follows:
Year Ended December 31
1997 1996 1995
----------------------------------------------------
Statutory Federal Income Tax Rate 35.0% 35.0% 35.0%
Tax-preferred Investment Income (0.6) (1.1) (2.1)
Net Prior Years Tax Refunds - (0.1) (0.8)
Other Items, Net 0.6 1.8 2.2
---- ---- ----
Effective Tax Rate 35.0% 35.6% 34.3%
==== ==== ====
98
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 7--Federal Income Taxes - Continued
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial statement
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred federal income tax liability are as follows:
December 31
1997 1996
(in millions of dollars)
--------------------------------
Deferred Tax Liability
Deferred Policy Acquisition Costs $ 68.0 $133.6
Bond Market Discount 4.3 11.2
Net Unrealized Investment Gains 334.7 48.9
Value of Business Acquired 217.6 2.3
Property and Equipment 10.5 9.8
Other 34.5 13.4
------ ------
Total Deferred Tax Liability 669.6 219.2
------ ------
Deferred Tax Asset
Reserves 367.4 105.5
Realized Investment Gains and Losses 53.1 44.7
Postretirement Benefits 26.8 20.9
Other Employee Benefits 29.3 24.4
Other 43.2 9.2
------ ------
Total Deferred Tax Asset 519.8 204.7
------ ------
Net Deferred Tax Liability $149.8 $ 14.5
====== ======
The Company is required to establish a valuation allowance for any portion of
the deferred tax asset that management believes will not be realized. In the
opinion of management, it is more likely than not that the Company will realize
the benefit of the deferred tax asset and, therefore, no such valuation
allowance has been established.
99
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 7--Federal Income Taxes - Continued
Under the Life Insurance Company Tax Act of 1959, life companies were required
to maintain a policyholders' surplus account containing the accumulated portion
of current income which had not been subjected to income tax in the year earned.
The Deficit Reduction Act of 1984 requires that no future amounts be added after
1983 to the policyholders' surplus account. Further, any future distributions
from the account would become subject to federal income taxes at the general
corporate federal income tax rate then in effect. The amount of the
policyholders' surplus account at December 31, 1997, is approximately
$202.0 million. Future distributions from the policyholders' surplus account
are deemed to occur if a statutorily prescribed maximum for the account is less
than the value of the account or if dividend distributions exceed the total
amount accumulated as currently taxable income in the year earned. If the
entire policyholders' surplus account were deemed distributed in 1998, this
would result in a tax of approximately $70.7 million. No current or deferred
federal income taxes have been provided on these amounts because management
considers the conditions under which such taxes would be paid to be remote.
During 1997, the Company held an appellate conference with the Internal
Revenue Service for tax years 1986 through 1992 and is awaiting a response to
its comprehensive settlement proposal covering all issues for such years. The
Internal Revenue Service continued its examination of the Company's federal
income tax returns for tax years 1993 through 1995. Management believes this
appellate conference and examination will have no material adverse impact on the
Company's financial statements.
In 1996, the Company received a refund that had been accrued in 1995 relating to
the final settlement of litigation for tax years 1980 through 1983. The refund
of taxes was $1.5 million and interest on the refund was $4.2 million. The
Company also received a refund that had been accrued in 1994 relating to a final
settlement of the remaining issues in dispute for the 1984 and 1985 tax years.
The refund of taxes was $3.1 million and related interest was $5.9 million.
During 1996, the Internal Revenue Service concluded its examination of the
Company's federal income tax returns for tax years 1990 through 1992 and issued
a Revenue Agent's Report proposing a tax deficiency of $26.0 million for these
years. Although this proposed deficiency has been appealed, the Company made an
additional payment for these years of $13.0 million tax and $5.2 million
interest to preclude the accrual of interest at punitive rates on any portion of
the proposed deficiency that the Company could possibly lose. Net income for
1996 was increased by $0.9 million as a result of these tax refunds and
payments.
In 1995, the Company received a refund that was previously accrued in 1994
relating to a final settlement of the remaining issues in litigation for the
1966 through 1979 tax years. The refund of taxes was $1.1 million and interest
on the refund was $4.8 million. The Company also accrued refunds of federal
income tax of $1.5 million and related interest of $3.5 million attributable to
a final settlement of the remaining issues in litigation for tax years 1980
through 1983. Overall, including interest received, net income in 1995 was
increased by $4.0 million as a result of the receipt and accrual of these
refunds.
Federal income taxes paid during 1997, 1996, and 1995 were $122.7 million, $92.5
million, and $71.8 million, respectively.
100
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 8--Debt
Short-term debt at December 31, 1997, was $150.7 million and consisted of
reverse repurchase agreements with a weighted average interest rate of 6.38
percent. At December 31, 1996, there was no short-term debt outstanding.
During 1996, the Company entered into an $800.0 million five-year revolving
credit facility with various domestic and international banks. The purpose of
this arrangement was to provide partial financing for the purchase of The Paul
Revere Corporation and GENEX Services, Inc. (see Note 14), to refinance the
existing bank term notes of $200.0 million, and for general corporate uses.
Interest is variable based upon a London Interbank Offered Rate (LIBOR) plus a
margin. At December 31, 1997, the outstanding borrowing under the revolving
credit facility was $725.0 million (see Note 18).
During 1996, the Company repaid the $200.0 million bank term notes which were
due on or before December 1, 1996.
Interest paid on short-term and long-term debt during 1997, 1996, and 1995 was
$41.4 million, $17.1 million, and $22.4 million, respectively. Interest expense
during 1997, 1996, and 1995 was $42.5 million, $17.8 million, and $22.3 million,
respectively.
Note 9--Retirement Benefits
Pension Plans
The Company provides noncontributory defined benefit pension plans for eligible
employees. The benefits are based on years of service and the employee's
highest consecutive five years of compensation. The Company's funding policy is
to contribute amounts to the plans sufficient to meet the minimum funding
requirements set forth in the Employee Retirement Income Security Act of 1974,
plus such additional amounts as the Company may determine to be appropriate.
Plan assets are invested in two separate accounts of a subsidiary of the
Company, one of which invests in listed equity securities and the other in
corporate obligations and U.S. bonds, and in an unrelated trust consisting of
bonds and equity securities.
101
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 9--Retirement Benefits - Continued
The pension plans' funded status and the amount recognized in the Company's
consolidated statements of financial condition are as follows:
December 31
1997 1996
(in millions of dollars)
--------------------------------------------
Actuarial present value of benefit obligation - vested $252.2 $160.8
====== ======
Accumulated benefit obligation $255.2 $161.6
====== ======
Projected benefit obligation $308.2 $189.8
Plan assets at fair value 380.8 220.2
------ ------
Plan assets in excess of projected benefit obligation 72.6 30.4
Unrecognized net actuarial gains (72.1) (29.9)
Unrecognized prior service cost 2.7 2.4
Unrecognized net transition obligation 0.6 0.6
------ ------
Accrued pension asset $ 3.8 $ 3.5
====== ======
Weighted average discount rate used in determining the
projected benefit obligation 7.25% 7.25%
Weighted average rate of compensation increase 4.65% 4.50%
Net periodic pension cost (benefit) included the following components:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
---------------------------------------------------------
Service cost $ 9.1 $ 4.0 $ 5.7
Interest cost 20.5 12.6 12.6
Actual return on plan assets (83.1) (28.1) (43.1)
Net amortization and deferral 53.0 7.5 26.5
Curtailment cost - - 1.0
------ ------ ------
$ (0.5) $ (4.0) $ 2.7
====== ====== ======
Expected long-term rate of return on plan assets 8.65% 8.50% 7.75%
102
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 9--Retirement Benefits - Continued
Postretirement Plans
The Company sponsors two types of defined benefit postretirement plans other
than pensions for full-time employees who have ten years of credited service
with the Company and have reached age 55. One plan provides medical and dental
benefits, and the other provides life insurance benefits. The postretirement
health care plan is contributory, with retiree contributions adjusted
periodically, and contains other cost-sharing features such as deductibles and
coinsurance. It is the Company's expressed intent to increase the health care
plan's retiree contribution rate as the cost of health care increases. The life
insurance plan is noncontributory and is partially funded through life insurance
contracts issued by the Company. The health care plan is unfunded.
The following tables show the accumulated postretirement benefit obligation, the
amount recognized in the Company's consolidated statements of financial
condition, and the net periodic postretirement benefit cost.
December 31
1997 1996
(in millions of dollars)
-------------------------------
Accumulated postretirement benefit obligation:
Retirees $50.8 $43.2
Fully eligible active plan participants 3.0 1.7
Other active plan participants 14.2 14.3
----- -----
68.0 59.2
Plan assets at fair value 9.0 8.5
----- -----
Accumulated postretirement benefit obligation in excess of plan assets 59.0 50.7
Unrecognized net gain 11.0 7.6
----- -----
Accrued postretirement benefit liability $70.0 $58.3
===== =====
Weighted average discount rate used in determining the
accumulated postretirement benefit obligation 7.25% 7.25%
103
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 9--Retirement Benefits - Continued
Net periodic postretirement benefit cost included the following components:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
------------------------------------------------------
Service cost $ 1.5 $ 1.5 $ 1.9
Interest cost 4.4 4.0 4.6
Actual return on plan assets (0.5) (0.5) (0.5)
Net amortization and deferral (3.2) (3.0) (3.4)
----- ----- -----
$ 2.2 $ 2.0 $ 2.6
===== ===== =====
Expected long-term rate of return on plan assets 8.50% 8.50% 8.50%
The postretirement benefit costs for 1997, 1996, and 1995 assume a weighted
average annual rate of increase in the per capita cost of covered health care
benefits of 8 percent, 9 percent, and 12 percent, respectively, decreasing
gradually to 5 percent for 2004 and thereafter. The health care cost trend rate
assumption has a significant effect on the amounts reported. Increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation as of December 31,
1997, by $4.5 million and the aggregate of net periodic postretirement benefit
cost for 1997 by $0.5 million.
Curtailment Gains
During 1995, the Company recognized curtailment gains of $16.6 million and $7.7
million in its pension and postretirement plans, respectively. The gains
resulted from the sale of the group medical business (see Note 15) and the
consequent termination of participation in the Company's benefit plans of
certain employees. The gains were included in the determination of the total
gain recognized on the sale.
104
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 10--Stockholders' Equity and Earnings Per Share
Preferred Stock
In 1993, the Company issued 1,041,667 shares of 8.10% cumulative preferred
stock, liquidation preference $150 per share evidenced by depositary receipts
for 6,250,002 depositary shares each representing a one-sixth interest of a
preferred share, of which 6,249,202 were issued and outstanding as of December
31, 1997 and 1996 (see Note 18).
Common Stock
On July 30, 1997, the Board of Directors authorized a two-for-one stock split
effected in the form of a stock dividend distributed on September 30, 1997, to
stockholders of record on August 28, 1997. The common stock par value of $1 per
share remained unchanged. Historical share and per share amounts in the
consolidated financial statements and notes thereto have been restated to
reflect the stock split.
In 1996, the Company's shareholders approved an amendment to the Company's
Amended and Restated Certificate of Incorporation to increase from 65,000,000 to
150,000,000 the number of shares of common stock which the Company is authorized
to issue.
Earnings Per Common Share
The computations of earnings per common share and earnings per common share
assuming dilution are as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars, except share data)
--------------------------------------------------------
Numerator:
Net Income $ 247.3 $ 145.6 $ 115.6
Preferred Stock Dividends 12.7 12.7 12.7
------------ ----------- -----------
Income Available to Common Stockholders $ 234.6 $ 132.9 $ 102.9
============ =========== ===========
Denominator (000s):
Weighted Average Common Shares 124,505.4 91,044.8 90,762.7
Dilution for Assumed Exercise of Stock Options 2,747.8 1,109.7 169.1
------------ ----------- -----------
Weighted Average Common Shares - Assuming Dilution 127,253.2 92,154.5 90,931.8
============ =========== ===========
Earnings Per Common Share $ 1.88 $ 1.46 $ 1.13
============ =========== ===========
Earnings Per Common Share - Assuming Dilution $ 1.84 $ 1.44 $ 1.13
============ =========== ===========
105
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans
Incentive Compensation
The Company has in effect a two-part management incentive compensation plan, the
first part of which is cash-based and is designed to encourage achievement of
specific annual goals in which key employees participate. The compensation cost
recognized in the consolidated statements of income for this part of the plan is
$6.4 million, $3.6 million, and $2.9 million for 1997, 1996, and 1995,
respectively. The second part of this plan is a stock option plan. The Company
applies Opinion 25 and related interpretations in accounting for the stock
option plan. For stock options subject to stock price performance, the
compensation cost recognized in the consolidated statements of income was $2.0
million and $2.4 million for 1996 and 1995, respectively. All price performance
requirements were met by December 31, 1996, for these stock options.
Under the 1994 stock plan, the Company may grant options of up to 10,000,000
shares of common stock. The exercise price of each option equals the market
price of the Company's stock on the date of grant. The options cannot be
exercised until at least one year after the date of grant and have a maximum
term of ten years after the date of grant.
Options granted prior to 1994 were granted under the 1989 stock option plan.
Under that plan, the Company could grant options of up to 1,400,000 shares of
common stock over the five year term of the plan which ended effective December
31, 1993. The exercise price of each option equaled the market price of the
Company's stock on the date of grant. The options outstanding under this plan
are currently exercisable and have a maximum term of ten years after the date of
grant.
106
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans - Continued
Summaries of the Company's stock options are as follows:
1997 1996 1995
------------------------- ------------------------- -------------------------
Shares Weighted Average Shares Weighted Average Shares Weighted Average
(000s) Exercise Price (000s) Exercise Price (000s) Exercise Price
----- ---------------- ----- ---------------- ----- ----------------
Outstanding at January 1 4,239 $13.38 3,297 $12.41 1,771 $13.67
Granted 3,454 24.50 1,347 15.57 2,006 11.35
Exercised (562) 14.49 (322) 12.08 (98) 10.36
Forfeited (193) 24.36 (62) 15.40 (206) 13.02
Expired - - (21) 14.65 (176) 13.45
----- ----- -----
Outstanding at December 31 6,938 18.52 4,239 13.38 3,297 12.41
===== ===== =====
December 31
1997 1996 1995
(shares in thousands)
--------------------------------------------------------------
Exercisable 3,728 2,954 953
Exercisable based on
additional service 3,210 1,285 1,950
Exercisable based on
stock price performance 0 0 394
----- ----- -----
Outstanding 6,938 4,239 3,297
===== ===== =====
December 31, 1997
-----------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
--------------------------------------------------------------- -----------------------------------
Weighted Average
Range of Shares Remaining Weighted Average Shares Weighted Average
Exercise Prices (000s) Contractual Life Exercise Price (000s) Exercise Price
--------------- ----- ----------------- ------------------ ----- ----------------
$ 9.00 to 13.99 1,960 3.8 years $11.40 1,960 $11.40
14.00 to 18.99 1,724 5.1 15.30 1,724 15.30
19.00 to 23.99 2,587 9.0 23.72 4 20.58
24.00 to 28.99 635 9.1 27.38 21 26.37
29.00 to 35.99 32 7.4 32.34 19 33.03
----- -----
9.00 to 35.99 6,938 6.6 18.52 3,728 13.41
===== =====
In 1997, the Company granted 267,040 shares of nonvested stock to certain key
employees with a weighted average grant date fair value of $28.12 per common
share. The compensation cost recognized in the consolidated statements of
income for the year ended December 31, 1997 was $1.2 million.
107
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans - Continued
Employee Stock Purchase Plan
In 1995, the Company established an employee stock purchase plan to promote and
maintain widespread employee stock ownership. The plan became effective in the
fourth quarter of 1995 and conforms to Internal Revenue Code Section 423. Under
the plan, the Company is authorized to issue up to 2,000,000 shares of common
stock to its employees, nearly all of whom are eligible to participate. Under
the terms of the plan, eligible employees may purchase common stock of the
Company at the end of each three-month financial quarter. The purchase price of
the stock is 85 percent of the lower of its beginning of the quarter or end of
the quarter market price. The maximum amount of stock a participating employee
may purchase under the plan in any one calendar year is limited to $25,000 in
fair market value of the stock as determined at the beginning of each purchase
period. The Company sold 108,799, 68,622, and 63,870 shares to employees with a
weighted average exercise price of $24.63, $14.68, and $11.53 per share in 1997,
1996, and 1995, respectively. The Company applies Opinion 25 and related
interpretations in accounting for the stock purchase plan. Accordingly, no
compensation cost has been recognized.
Compensation Cost Under the Fair Value Approach (SFAS 123)
Compensation cost for the Company's management incentive compensation plan and
employee stock purchase plan under the fair value approach was estimated as of
the grant date using the Black-Scholes option pricing model with the following
weighted average assumptions:
Year Ended December 31
1997 1996 1995
--------------------------------------------------
Volatility 18.0% 18.2% 19.1%
Risk-free rate of return 6.5% 5.7% 7.6%
Dividend payout rate per share $0.36 $0.36 $0.36
Time of exercise
Management Incentive Compensation Plan
Executives 7 years 7 years 5 years
Non-executives 6 years 6 years 4 years
Employee Stock Purchase Plan 3 months 3 months 3 months
Weighted average fair value of options granted during the year
Management Incentive Compensation Plan $7.36 $3.68 $2.46
Employee Stock Purchase Plan $5.62 $3.38 $2.63
108
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans - Continued
Had compensation cost for the two plans been determined in accordance with the
provisions of SFAS 123, the Company's pro forma net income and earnings
per common share would have been as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars, except share data)
---------------------------------------------------------
Net Income $241.6 $143.6 $114.2
Earnings Per Common Share 1.84 1.44 1.12
Earnings Per Common Share - Assuming Dilution 1.81 1.42 1.12
Note 12--Reinsurance
The Company routinely assumes and cedes reinsurance with other insurance
companies. The primary purpose of ceded reinsurance is to limit losses from
large exposures; however, if the reinsurer is unable to meet its obligations,
the originating issuer of the insurance coverage retains the liability. Premium
income, policy and contract benefits, and change in reserves for future policy
and contract benefits and policyholders' funds are presented in the consolidated
statements of income net of reinsurance ceded.
In May 1995, the Company entered into an indemnity and assumption reinsurance
agreement with Healthsource Insurance Company in connection with the sale of the
group medical business (see Note 15). Under the terms of the reinsurance
agreement, the Company ceded to Healthsource Insurance Company premium income
and associated obligations and liabilities arising with respect to medical
indemnity and dental and vision insurance issued by the Company in certain
states where Healthsource Insurance Company was not licensed and approved to
transact this type of business. Total premium income and policy and contract
benefits ceded under this reinsurance agreement were $182.9 million and $153.8
million, respectively, for the year ended December 31, 1997, $224.6 million and
$188.5 million, respectively, for the year ended December 31, 1996, and $170.6
million and $137.5 million, respectively, for the year ended December 31, 1995.
In 1997, the reinsurance agreement was assigned by Healthsource Insurance
Company, with the consent of the Company, to Connecticut General Life Insurance
Company. It is anticipated that this business will be assumed by Connecticut
General Life Insurance Company beginning April 1998.
The total amounts deducted for reinsurance ceded are as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
---------------------------------------------------------
Premium Income $270.4 $305.5 $249.2
Policy and Contract Benefits 282.7 265.5 202.7
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 3.6 26.4 44.7
109
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 12--Reinsurance - Continued
Reinsurance ceded and assumed consists of the following:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
------------------------------------------------------
Reclassified
------------------------------------
Ceded
Life Insurance in Force (Amount of Insurance) $6,184.7 $4,347.9 $4,258.5
Premium Income
Individual Life and Disability 40.6 48.2 47.8
Employee Benefits 39.8 16.1 14.8
Other Operations 190.0 241.2 186.6
Assumed
Life Insurance in Force (Amount of Insurance) $ 416.2 $ 437.0 $ 460.2
Premium Income
Individual Life and Disability 167.2 35.3 36.9
Employee Benefits 1.0 0.5 0.4
Other Operations 6.2 15.7 15.0
Segment information for 1996 and 1995 has been reclassified to conform to
current year reporting.
110
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 13--Segment Information
Selected data by segment is as follows:
Year Ended December 31
1997 1996 1995
(in millions of dollars)
------------------------------------------------------
Reclassified
------------------------------------
Revenue (Excluding Net Realized Investment
Gains and Losses)
Individual Life and Disability $ 1,902.3 $ 1,025.0 $ 999.1
Employee Benefits 883.7 555.5 520.3
Other Operations 752.1 720.0 1,067.6
--------- --------- ---------
Total $ 3,538.1 $ 2,300.5 $ 2,587.0
========= ========= =========
Income Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Individual Life and Disability $ 232.3 $ 115.4 $ 34.0
Employee Benefits 63.3 46.1 32.2
Other Operations 69.6 73.3 141.5
--------- --------- ---------
Total $ 365.2 $ 234.8 $ 207.7
========= ========= =========
Revenue (Including Net Realized Investment
Gains and Losses)
Individual Life and Disability $ 1,910.2 $ 1,033.0 $ 1,003.2
Employee Benefits 887.3 555.5 524.2
Other Operations 755.7 703.4 1,027.9
--------- --------- ---------
Total $ 3,553.2 $ 2,291.9 $ 2,555.3
========= ========= =========
Income Before Federal Income Taxes
Individual Life and Disability $ 240.2 $ 123.4 $ 38.1
Employee Benefits 66.9 46.1 36.1
Other Operations 73.2 56.7 101.8
--------- --------- ---------
Total $ 380.3 $ 226.2 $ 176.0
========= ========= =========
Assets
Individual Life and Disability $11,051.1 $ 5,735.0 $ 5,443.9
Employee Benefits 2,145.2 1,490.0 1,407.8
Other Operations 9,981.3 7,767.5 9,449.6
--------- --------- ---------
Total $23,177.6 $14,992.5 $16,301.3
========= ========= =========
Total revenue (excluding net realized investment gains and losses) includes
premium income, net investment income, and other income. Total revenue
(including net realized investment gains and losses) includes premium income,
net investment income, net realized investment gains and losses, and other
income. Assets have been allocated to the segments based upon identifiable
liabilities and allocated stockholders' equity. Segment information for 1996
and 1995 has been reclassified to conform to current year reporting. The
reclassification, which reflects the Company's current marketing and operational
structure, did not change total Revenue, total Income Before Federal Income
Taxes, or total Assets.
111
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 14--Acquisition of Business
GENEX Services, Inc.
On February 28, 1997, the Company acquired GENEX Services, Inc. and GENEX
Services of Canada, Inc. (GENEX) 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 values of
the assets acquired and liabilities assumed were $17.9 million and $8.9 million,
respectively. The purchase price has been allocated to goodwill and will be
amortized on a straight-line basis over a 25 year period. The consolidated
financial statements include the operating results of GENEX from March 1, 1997.
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 (19,047,620 shares of common stock), common equity of
$437.5 million (23,340,000 shares of common stock) and cash of $2.5 million
issued to Paul Revere shareholders, 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
values of the assets acquired and liabilities assumed were $6,680.0 million and
$6,675.4 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. Goodwill will be
amortized on a straight-line basis over a 40 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 years ended December 31,
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 year presented, are as
follows:
Year Ended December 31
1997 1996
(in millions of dollars, except share data)
-------------------------------------------
Revenue Excluding Net Realized Investment
Gains and Losses $3,958.1 $3,930.2
Revenue Including Net Realized Investment
Gains and Losses 4,009.6 3,970.2
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes 377.2 (81.3)
Income (Loss) Before Federal Income Taxes 428.7 (41.3)
Net Income (Loss) 276.3 (37.1)
Earnings Per Common Share 1.96 (0.37)
112
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 14--Acquisition of Business - Continued
In 1996, Paul Revere strengthened reserves in its individual disability segment
by $380.0 million before income taxes which resulted in a decrease in net income
of $244.3 million ($1.83 per common share). The reserve strengthening resulted
from a comprehensive study, completed in October 1996, of the adequacy of the
individual disability reserves under generally accepted accounting principles.
Note 15--Sale of a Portion of a Line of Business
In December 1994, the Company entered into an Asset and Stock Purchase Agreement
with Healthsource, Inc. (Healthsource) whereby Healthsource agreed to acquire
certain assets and assume certain liabilities of the Company's group medical
business. The sale was completed on May 31, 1995, effective April 30, 1995.
The Company received $131.0 million in cash and $100.0 million of a new issue of
Healthsource 6.25% preferred stock which was redeemed at par in the first
quarter of 1996. Pursuant to the Asset and Stock Purchase Agreement, assets
were transferred to Healthsource which had a carrying value of approximately
$297.5 million. Liabilities assumed by Healthsource in connection with the
transferred business totaled $221.5 million. Total revenue and income before
federal income taxes for the group medical business were $146.2 million and $3.3
million, respectively, for the four month period ended April 30, 1995. The gain
on sale of the Company's group medical business increased 1995 operating
earnings by $21.8 million ($0.24 per common share) before taxes and $14.2
million ($0.16 per common share) after taxes.
Note 16--Commitments and Contingent Liabilities
Commitments
In December 1997, the Company entered into a definitive agreement with American
General Corporation (American General) under which various affiliates of
American General will acquire the Company's individual and tax-sheltered annuity
business for approximately $58.0 million in cash. In addition, American General
is acquiring a number of miscellaneous group pension lines of business which are
no longer actively marketed. The sale does not include the Company's Canadian
annuity business, traditional GICs, or group single premium annuities. The
transaction is expected to close in the second quarter of 1998. The Company
expects to record a gain when the transaction is closed.
Contingent Liabilities
Two alleged class action lawsuits have been filed in Superior Court in
Worcester, Massachusetts against the Company. One of the alleged lawsuits
purports to represent all career agents of Paul Revere whose employment
relationships ended on June 30, 1997, and who were offered contracts to sell
insurance policies as independent producers, and the other purports 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. In addition, the same
plaintiff's attorney who has filed the purported class action lawsuits has filed
41 individual lawsuits on behalf of current and former Paul Revere sales
managers alleging various breach of contract claims. The Company has strong
defenses and will vigorously defend its position in these cases as well.
Although the alleged class action lawsuits and the 41 individual lawsuits are in
the early stages, management does not currently expect these suits to materially
affect the financial position or results of operations of the Company.
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.
113
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 17--Statutory Financial Information
Statutory Net Income, Capital and Surplus, and Dividends
The Company's insurance subsidiaries' statutory net income, as reported in
conformity with statutory accounting practices prescribed by state regulatory
authorities, for the years ended December 31, 1997, 1996, and 1995, was $76.1
million, $104.9 million, and $67.1 million, respectively. Statutory capital and
surplus at December 31, 1997 and 1996, was $1,128.2 million
and $674.2 million, respectively.
Regulatory restrictions limit the amount of dividends available for distribution
to the Company from its insurance subsidiaries, without prior approval by
regulatory authorities, to the greater of ten percent of an insurer's statutory
surplus as regards policyholders as of the preceding year end or the statutory
net gain from operations, excluding realized investment gains and losses, of the
preceding year. The payment of dividends is further limited to the amount of
statutory unassigned surplus. Based on these restrictions, it is anticipated
that $151.9 million will be available for the payment of dividends to the
Company from its top-tier insurance subsidiaries during 1998.
Permitted Statutory Accounting Practices
The Company's insurance subsidiaries prepare their statutory-basis financial
statements in accordance with accounting practices prescribed or permitted by
the National Association of Insurance Commissioners (NAIC) and the applicable
state regulatory authorities. Prescribed statutory accounting practices include
state laws, regulations, and general administrative rules, as well as a variety
of publications of the NAIC. Permitted statutory accounting practices encompass
all accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. At December 31, 1997, the Company had not applied any
permitted accounting practices that differed from prescribed statutory
accounting practices that had a material impact on the financial position or
results of operations of the insurance subsidiaries.
The NAIC currently is in the process of recodifying statutory accounting
practices, the result of which is expected to standardize prescribed statutory
accounting practices. Accordingly, that project, which is expected to be
completed in 1998, will likely change, to some extent, prescribed statutory
accounting practices and may result in changes to the accounting practices that
the Company's insurance subsidiaries use to prepare their statutory financial
statements.
Deposits
At December 31, 1997, the Company's insurance subsidiaries had on deposit with
regulatory authorities securities with a book value of $902.3 million held for
the protection of policyholders.
Note 18--Subsequent Events
On February 24, 1998, the Company repaid the $725.0 million outstanding
borrowing on its revolving credit facility and redeemed its cumulative preferred
stock outstanding of $156.2 million at $150 per share equivalent to $25 per
depositary share. The debt repayment and preferred stock redemption were funded
through short-term borrowings.
114
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 18--Subsequent Events - Continued
In May 1997, the Securities and Exchange Commission declared effective a shelf
registration statement pursuant to which the Company may issue up to $900.0
million in debt and/or equity securities. On March 16, 1998, the Company
completed a public offering of $200.0 million of 7.25% senior notes due March
15, 2028. On March 16, 1998, Provident Financing Trust I, a subsidiary trust of
the Company, issued $300.0 million of 7.405% capital securities in a public
offering. These capital securities, which mature on March 15, 2038, are fully
and unconditionally guaranteed by the Company, have a liquidation value of
$1,000 per capital security, and have a mandatory redemption feature under
certain circumstances. The Company issued 7.405% junior subordinated deferrable
interest debentures which mature on March 15, 2038, to the subsidiary trust in
connection with the capital securities offering.
The Company has $400.0 million available for debt and/or equity securities under
its shelf registration statement following the issuance of the senior notes and
capital securities.
Note 19--Supplemental Data on Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations for 1997
and 1996:
1997
--------------------------------------------------------------
4th 3rd 2nd 1st
(in millions of dollars, except share data)
--------------------------------------------------------------
Premium Income $582.2 $594.0 $590.0 $287.5
Net Investment Income 364.6 362.9 364.7 262.5
Net Realized Investment Gains 2.0 6.9 1.5 4.7
Total Revenue 991.0 997.1 993.8 571.3
Income Before Federal Income Taxes 117.3 109.5 90.7 62.8
Net Income 75.8 71.0 59.7 40.8
Earnings Per Common Share .54 .50 .42 .40
Earnings Per Common Share - Assuming Dilution .53 .49 .41 .39
1996
----------------------------------------------------------------
4th 3rd 2nd 1st
(in millions of dollars, except share data)
----------------------------------------------------------------
Premium Income $292.4 $287.4 $291.3 $304.6
Net Investment Income 268.0 269.5 274.1 278.5
Net Realized Investment Gains (Losses) 1.4 (4.1) (5.3) (0.6)
Total Revenue 568.5 562.7 569.0 591.7
Income Before Federal Income Taxes 67.8 51.8 53.2 53.4
Net Income 43.9 33.2 34.1 34.4
Earnings Per Common Share .45 .33 .34 .34
Earnings Per Common Share - Assuming Dilution .44 .33 .34 .34
115