SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended September 30, 1998.
Commission file number 1-11834
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PROVIDENT COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 62-1598430
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 Fountain Square, Chattanooga, Tennessee 37402
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(Address of principal executive offices)
(Zip Code)
(423)755-1011
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(Registrant's telephone number, including area code)
None
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Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding for each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT SEPTEMBER 30, 1998
- ----------------------------- ---------------------------------
Common Stock, $1.00 Par Value 135,242,680
Total number of pages are 152
PROVIDENT COMPANIES, INC.
INDEX
PAGE
PART I.
FORWARD LOOKING STATEMENTS 3
FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial
Condition at September 30, 1998 and December 31, 1997 4
Condensed Consolidated Statements of Income
for the Three Months and Nine Months
Ended September 30, 1998 and 1997 6
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 1998 and 1997 7
Notes to Condensed Consolidated Financial Statements 8
Independent Auditors' Review Report 14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 40
-2-
PART 1
FORWARD LOOKING STATEMENTS
From time to time, the Company may publish forward-looking statements relating
to such matters as financial performance and the business of the Company. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order for the Company to comply with the terms
of the safe harbor the Company notes that a variety of factors could cause the
Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's forward
looking statements, which involve certain risks and uncertainties. These
factors include, (i) heightened competition, including specifically the
intensification of price competition, the entry of new competitors, and the
development of new products by new and existing competitors; (ii) adverse state
and federal legislation and regulation, including limitations on premium levels,
increases in minimum capital requirements, and other financial viability
requirements; (iii) failure to develop multiple distribution channels in order
to obtain new customers or failure to retain existing customers; (iv) inability
to carry out product design, marketing and sales plans, including, among others,
planned changes to existing products (which may result in reduced market
acceptance of the revised products) or planned strategies to penetrate new
market segments; (v) loss of key executives; (vi) changes in interest rates
causing a reduction of investment income; (vii) general economic and business
conditions which are less favorable than expected; (viii) unanticipated changes
in industry trends; (ix) inaccuracies in assumptions regarding future morbidity,
persistency, mortality, and interest rates or portfolio yield used in
calculating reserve amounts; (x) failure to continue improvement of the
Company's disability insurance claims management process; and (xi) failure to
develop and maintain systems and other information technology that are
sufficient to support Company initiatives and changes; (xii) failure to
substantially complete the Company's Year 2000 project in a manner that avoids a
material adverse impact on results of operations arising from Year 2000 issues;
and (xiii) litigation involving the Company's business and activities. See "Risk
Factors" included in the Company's report on Form 10-K for the year ended
December 31, 1997 (pp.17-20), incorporated herein by reference. See also "Year
2000 Issues" below.
-3-
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
September 30 December 31
1998 1997
(in millions of dollars)
----------------------------------
(Unaudited)
ASSETS
Investments
Fixed Maturity Securities
Available-for-Sale $14,946.5 $17,035.1
Held-to-Maturity 298.9 306.8
Equity Securities 12.7 10.0
Mortgage Loans 17.8 17.8
Real Estate 43.7 87.1
Policy Loans 2,101.4 1,983.9
Other Long-term Investments 33.9 22.6
Short-term Investments 44.0 57.5
--------- ---------
Total Investments 17,498.9 19,520.8
Cash and Bank Deposits 42.3 37.7
Accounts and Premiums Receivable 109.8 166.4
Reinsurance Receivable 3,171.2 987.2
Accrued Investment Income 363.1 363.2
Deferred Policy Acquisition Costs 413.7 362.9
Value of Business Acquired 498.7 560.8
Goodwill 697.5 732.3
Property and Equipment 118.0 109.2
Miscellaneous 33.6 26.2
Separate Account Assets 320.2 310.9
--------- ---------
TOTAL ASSETS $23,267.0 $23,177.6
========= =========
See notes to condensed consolidated financial statements.
-4-
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
September 30 December 31
1998 1997
(in millions of dollars)
---------------------------------------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy and Contract Benefits $ 513.0 $ 531.2
Reserves for Future Policy and Contract Benefits
and Unearned Premiums 13,674.9 13,193.8
Policyholders' Funds and Experience Rating Refunds 3,482.6 4,328.0
Federal Income Tax Liability 347.0 190.1
Short-term Debt 98.9 150.7
Long-term Debt 600.0 725.0
Other Liabilities 481.9 468.6
Separate Account Liabilities 320.2 310.9
--------- ---------
TOTAL LIABILITIES 19,518.5 19,898.3
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COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED
SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR
SUBORDINATED DEBT SECURITIES OF THE COMPANY 300.0 -
--------- ---------
COMMITMENTS AND CONTINGENT LIABILITIES - NOTE 6
STOCKHOLDERS' EQUITY
Preferred Stock - 156.2
Common Stock, $1 par 135.8 135.2
Additional Paid-in Capital 756.3 750.6
Retained Earnings 1,821.6 1,635.2
Accumulated Other Comprehensive Income--Note 7 745.7 603.6
Treasury Stock (10.9) (1.5)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 3,448.5 3,279.3
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $23,267.0 $23,177.6
========= =========
See notes to condensed consolidated financial statements.
-5-
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars, except share data)
---------------------------------------------------------------
REVENUE
Premium Income $ 593.2 $ 594.0 $ 1,759.8 $ 1,471.5
Net Investment Income 329.5 362.9 1,039.6 990.1
Net Realized Investment Gains 9.2 6.9 18.2 13.1
Other Income 43.4 33.3 134.3 87.5
------------ ------------ ------------ ------------
TOTAL REVENUE 975.3 997.1 2,951.9 2,562.2
------------ ------------ ------------ ------------
BENEFITS AND EXPENSES
Policy and Contract Benefits 445.7 451.8 1,377.8 1,212.2
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 163.8 197.3 486.2 507.7
Amortization
Deferred Policy Acquisition Costs 19.3 21.4 58.2 57.9
Value of Business Acquired 7.9 9.1 25.2 19.3
Goodwill 5.2 4.2 16.1 8.6
Interest Expense on Debt 20.0 12.0 54.0 27.8
Salaries 57.1 55.1 168.5 132.1
Commissions 58.6 65.0 189.7 161.9
Other Operating Expenses 71.9 71.7 213.4 171.7
------------ ------------ ------------ ------------
TOTAL BENEFITS AND EXPENSES 849.5 887.6 2,589.1 2,299.2
------------ ------------ ------------ ------------
INCOME BEFORE FEDERAL INCOME TAXES 125.8 109.5 362.8 263.0
FEDERAL INCOME TAXES 43.9 38.5 135.0 91.5
------------ ------------ ------------ ------------
NET INCOME $ 81.9 $ 71.0 $ 227.8 $ 171.5
============ ============ ============ ============
NET INCOME PER COMMON SHARE
Basic $ 0.61 $ 0.50 $ 1.67 $ 1.34
Assuming Dilution $ 0.59 $ 0.49 $ 1.63 $ 1.31
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic 135,210,161 134,962,688 135,101,280 120,928,246
Assuming Dilution 138,491,624 137,939,702 138,589,198 123,492,809
DIVIDENDS PER COMMON SHARE $ 0.10 $ 0.10 $ 0.30 $ 0.28
See notes to condensed consolidated financial statements.
-6-
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
Nine Months Ended September 30
1998 1997
(in millions of dollars)
---------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 631.7 $ 763.9
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sales of Investments 1,039.9 1,256.6
Proceeds from Maturities of Investments 923.1 1,334.7
Purchase of Investments (1,821.7) (2,195.1)
Net Sales of Short-term Investments 10.4 362.1
Acquisition of Business--Note 4 - (860.0)
Disposition of Business--Note 5 58.0 -
Other (19.4) (23.2)
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NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 190.3 (124.9)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits to Policyholder Accounts 66.0 415.7
Maturities and Benefit Payments from Policyholder Accounts (802.5) (1,704.8)
Net Short-term Debt Repayments (51.8) -
Net Long-term Borrowings (Repayments) (125.0) 425.9
Issuance of Company Obligated Mandatorily Redeemable Preferred Securities 300.0 -
Redemption of Preferred Stock (156.2) -
Issuance of Common Stock 6.3 388.4
Dividends Paid to Stockholders (44.6) (43.3)
Other (9.4) 0.5
--------- ---------
NET CASH USED BY FINANCING ACTIVITIES (817.2) (517.6)
--------- ---------
Effect of Foreign Exchange Rate Changes on Cash (0.2) (0.7)
--------- ---------
NET INCREASE IN CASH AND BANK DEPOSITS 4.6 120.7
CASH AND BANK DEPOSITS AT BEGINNING OF PERIOD 37.7 19.3
--------- ---------
CASH AND BANK DEPOSITS AT END OF PERIOD $ 42.3 $ 140.0
========= =========
See notes to condensed consolidated financial statements.
-7-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine month periods ended
September 30, 1998, are not necessarily indicative of the results that may be
expected for the year ended December 31, 1998. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1997.
NOTE 2--DEBT AND EQUITY SECURITIES
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.
In May 1997, the Securities and Exchange Commission declared effective a shelf
registration statement pursuant to which the Company could 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 wholly-owned
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 $300.0
million of 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 sole assets of the subsidiary trust are the junior
subordinated debt securities. On July 9, 1998, the Company completed a public
offering of $200.0 million of 6.375% senior notes due July 15, 2005, and $200.0
million of 7% senior notes due July 15, 2018.
-8-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 3--SEGMENT INFORMATION
A summary by segment of the Company's revenue and income before federal income
taxes, excluding and including net realized investment gains and losses,
follows:
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars)
----------------------------------------------------------------
Revenue (Excluding Net Realized Investment
Gains and Losses)
Individual Disability and Life $565.4 $544.1 $1,683.9 $1,341.9
Employee Benefits 277.8 248.9 808.7 643.5
Other Operations 122.9 197.2 441.1 563.7
------ ------ -------- --------
Total $966.1 $990.2 $2,933.7 $2,549.1
====== ====== ======== ========
Income Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Individual Disability and Life $ 82.1 $ 64.9 $ 235.5 $ 150.8
Employee Benefits 32.0 20.3 90.5 44.6
Other Operations 2.5 17.4 18.6 54.5
------ ------ -------- --------
Total $116.6 $102.6 $ 344.6 $ 249.9
====== ====== ======== ========
-9-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 3--SEGMENT INFORMATION - CONTINUED
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars)
----------------------------------------------------------------
Revenue (Including Net Realized Investment
Gains and Losses)
Individual Disability and Life $568.6 $547.5 $1,698.0 $1,351.7
Employee Benefits 277.7 251.1 810.3 645.3
Other Operations 129.0 198.5 443.6 565.2
------ ------ -------- --------
Total $975.3 $997.1 $2,951.9 $2,562.2
====== ====== ======== ========
Income Before Federal Income Taxes
Individual Disability and Life $ 85.3 $ 68.3 $ 249.6 $ 160.6
Employee Benefits 31.9 22.5 92.1 46.4
Other Operations 8.6 18.7 21.1 56.0
------ ------ -------- --------
Total $125.8 $109.5 $ 362.8 $ 263.0
====== ====== ======== ========
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.
-10-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 4--ACQUISITION OF BUSINESS
GENEX SERVICES, INC.
On February 28, 1997, the Company acquired GENEX Services, Inc. and GENEX
Services of Canada, Inc. (GENEX) 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 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 is being 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, common equity of $437.5 million 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 products. Goodwill is being amortized on a straight-
line basis over a 40 year period.
The following pro forma results of operations for the nine months ended
September 30, 1997, 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 the period presented, are as
follows:
Nine Months Ended
September 30, 1997
(in millions of
dollars, except share
data)
------------------------
Revenue $3,018.6
Income Before Federal Income Taxes 311.4
Net Income 200.5
Net Income per Common Share
Basic 1.42
Assuming Dilution 1.39
-11-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 4--ACQUISITION OF BUSINESS - CONTINUED
Revenue and income before federal income taxes include $36.4 million of pre-tax
net realized investment gains for the acquired companies for the 1997 period
prior to acquisition. Net income includes $23.7 million ($0.18 per common
share) of after-tax net investment gains for the 1997 period prior to
acquisition.
NOTE 5--SALE OF A PORTION OF A LINE OF BUSINESS
In December 1997, the Company entered into an agreement with American General
Corporation (American General) under which various affiliates of American
General agreed to acquire certain assets and assume certain liabilities of the
Company's individual and tax-sheltered annuity business for approximately $58.0
million in cash. In addition, American General acquired a number of
miscellaneous group pension lines of business which were no longer actively
marketed by the Company. The sale did not include the Company's Canadian annuity
business, traditional guaranteed investment contracts, or group single premium
annuities. The sale was completed during the second quarter of 1998. Assets
transferred to American General in connection with the business sold had a
carrying value of approximately $2,413.3 million, and liabilities assumed by
American General totaled $2,493.1 million. In connection with the sale, the
Company wrote off $18.7 million of goodwill associated with the annuity business
acquired from Paul Revere. The gain recognized at the time of the sale of this
business increased 1998 operating earnings by $12.2 million ($0.09 per common
share) before taxes and $1.4 million ($0.01 per common share) after taxes.
Note 6--COMMITMENTS AND CONTINGENT LIABILITIES
Two alleged class action lawsuits have been filed in Superior Court in
Worcester, Massachusetts (the Court) against the Company - one purporting to
represent all career agents of Paul Revere whose employment relationships ended
on June 30, 1997 and were offered contracts to sell insurance policies as
independent producers, and the other purporting to represent independent brokers
who sold certain Paul Revere individual disability income policies with benefit
riders. Motions filed by the Company to dismiss most of the counts in the
complaints, which allege various breach of contract and statutory claims, have
been denied, but the cases remain at a preliminary stage. To date, no class has
been certified in either lawsuit. The Company has filed a conditional
counterclaim in each action which requests a substantial return of commissions
should the Court agree with the plaintiff's interpretation of the contract. 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 filed a
motion in federal court to compel arbitration for 16 of the plaintiffs who are
licensed by the National Association of Securities Dealers and have executed the
Uniform Application for Registration or Transfer in the Securities Industry
(Form U-4). 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.
-12-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
Provident Companies, Inc. and Subsidiaries
SEPTEMBER 30, 1998
NOTE 7--COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income, which establishes standards for reporting and presentation of
comprehensive income and its components. SFAS 130 requires foreign currency
translation adjustments and unrealized holding gains and losses on the Company's
available-for-sale fixed maturity and equity securities, which prior to adoption
were reported separately in stockholders' equity, to be reported as components
of comprehensive income. Prior periods have been reclassified to conform to the
requirements of SFAS 130. SFAS 130 had no impact on the Company's net income or
stockholders' equity.
The components of accumulated other comprehensive income, net of related tax,
are as follows:
September 30 December 31
1998 1997
(in millions of dollars)
-------------------------------------
Net Unrealized Gain on Securities $775.7 $624.3
Foreign Currency Translation Adjustment (30.0) (20.7)
------ ------
Accumulated Other Comprehensive Income $745.7 $603.6
====== ======
The components of comprehensive income, net of related tax, are as follows:
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars)
-------------------------------------------------------
Net Income $ 81.9 $ 71.0 $227.8 $171.5
Change in Net Unrealized Gain on Securities 35.5 217.3 151.4 365.0
Change in Foreign Currency Translation Adjustment (3.8) (2.8) (9.3) (1.5)
------ ------ ------ ------
Comprehensive Income $113.6 $285.5 $369.9 $535.0
====== ====== ====== ======
-13-
INDEPENDENT AUDITORS' REVIEW REPORT
Board of Directors and Shareholders
Provident Companies, Inc.
We have reviewed the accompanying condensed consolidated statement of financial
condition of Provident Companies, Inc. and Subsidiaries as of September 30,
1998, and the related condensed consolidated statements of income for the three
and nine month periods ended September 30, 1998 and 1997, and the condensed
consolidated statements of cash flows for the nine month periods ended September
30, 1998 and 1997. These financial statements are the responsibility of the
Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, which will be
performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial condition of Provident
Companies, Inc. and Subsidiaries as of December 31, 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
year then ended, not presented herein, and in our report dated February 3, 1998,
we expressed an unqualified opinion on those consolidated financial statements.
In our opinion, the information set forth in the accompanying condensed
consolidated statement of financial condition as of December 31, 1997, is fairly
stated in all material respects in relation to the consolidated statement of
financial condition from which it has been derived.
Chattanooga, Tennessee
November 10, 1998
-14-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 of the
first nine months of 1998 but for only seven and six months of the first nine
months of 1997, respectively, the difference in comparability of the periods is
frequently attributable to that fact as indicated below.
OPERATING RESULTS
Revenue excluding net realized investment gains and losses ("revenue")
declined $24.1 million, or 2.4 percent, to $966.1 million in the third quarter
of 1998 from $990.2 million in the third quarter of 1997. The decline was the
result of lower revenue in the other operations segment ($74.3 million), which
was partly offset by slightly higher revenue in the individual disability and
life segment ($21.3 million) and employee benefits segment ($28.9 million).
In the first nine months of 1998, revenue increased $384.6 million, or 15.1
percent, to $2,933.7 million from $2,549.1 million in the first nine months of
1997. The increase was the result of higher revenue in the individual
disability and life segment ($342.0 million) and employee benefits segment
($165.2 million), which was partly offset by lower revenue in the other
operations segment ($122.6 million).
-15-
Income before net realized investment gains and losses and federal income
taxes ("income") increased $14.0 million, or 13.6 percent, to $116.6 million in
the third quarter of 1998, from $102.6 million in the third quarter of 1997.
The increase was the result of increased income in the individual disability and
life segment ($17.2 million) and employee benefits segment ($11.7 million),
which was partly offset by lower income in the other operations segment ($14.9
million).
In the first nine months of 1998, income increased $94.7 million, or 37.9
percent, to $344.6 million, from $249.9 million in the first nine months of
1997. The increase was the result of increased income in the individual life
and disability segment ($84.7 million) and the employee benefits segment ($45.9
million), which was partly offset by lower income in the other operations
segment ($35.9 million).
Net income increased $10.9 million, or 15.4 percent, to $81.9 million in
the third quarter of 1998, from $71.0 million in the third quarter of 1997. Net
realized investment gains after taxes were $6.0 million in the third quarter of
1998, compared to $4.7 million in the third quarter of 1997. For the first nine
months of 1998, net income increased $56.3 million, or 32.8 percent, to $227.8
million, from $171.5 million in the first nine months of 1997. Net realized
investment gains after taxes were $12.0 million in the first nine months of
1998, compared to $8.8 million in the first nine months of 1997.
The gain recognized at the time of the sale of the Company's annuity
business (discussed in detail in the other operations segment) increased
operating results for the nine month period ending September 30, 1998 by $12.2
million before taxes and $1.4 million after taxes.
-16-
INDIVIDUAL DISABILITY AND LIFE
Revenue in the individual disability and life segment increased $21.3
million, or 3.9 percent, to $565.4 million in the third quarter of 1998, from
$544.1 million in the third quarter of 1997. The increase was primarily the
result of an increase in investment income of $22.2 million, or 13.5 percent, to
$186.2 million in the third quarter of 1998, compared to $164.0 million in the
third quarter of 1997. This increase is primarily due to increased capital
allocation to this line of business and a shift in investment mix to higher
yielding investments in the Paul Revere portfolio. Premium income in this
segment declined $5.5 million, or 1.5 percent, to $369.3 million in the third
quarter of 1998, from $374.8 million in the third quarter of 1997. The decline
was primarily the result of lower premium income in both the individual
disability income and individual life lines of business.
For the first nine months of 1998, revenue in this segment increased $342.0
million, or 25.5 percent, to $1,683.9 million, from $1,341.9 million in the
first nine months of 1997. The increase was primarily the result of the
acquisition of Paul Revere. Net investment income increased $123.4 million, or
29.3 percent, to $545.1 million in the first nine months of 1998, from $421.7
million in the first nine months of 1997, primarily due to the acquisition of
Paul Revere, the shift in investment mix to higher yielding investments, and
increased capital allocation. Premium income in this segment increased $204.3
million, or 22.6 percent, to $1,108.3 million in the first nine months of 1998,
from $904.0 million in the first nine months of 1997, reflecting the acquisition
of Paul Revere.
In November 1994, the Company announced its intention to discontinue the
sale of individual disability products which combined lifetime benefits and
short elimination periods with own-occupation provisions (other than conversion
policies available under existing contractual arrangements). At the same
-17-
time the Company began introducing products that insured "loss of earnings" as
opposed to occupations, and these products generally contained more limited
benefit periods and longer elimination periods. Since the acquisition of Paul
Revere in March 1997, the Company has discontinued the sale of certain Paul
Revere products that are not consistent with the Company's strategic direction
for its product portfolio. The Company expects to continue to offer selected
Paul Revere products with own-occupation (while not working) features applying
stricter underwriting standards. The Company has filed new rates for some of
these products and is in the process of repricing other of these selected
products and making modifications to their features where appropriate. Going
forward, the Company expects to offer a limited portfolio of own-occupation
based coverages along with its more complete line of loss of earnings related
disability coverages.
In the third quarter of 1998, new annualized sales in the individual
disability income line totaled $28.2 million, compared to $31.5 million in the
third quarter of 1997 and $26.7 million in the second quarter of 1998,
reflecting the continued product transition. On a pro forma basis, sales of
individual disability income contracts declined in 1998 compared to the previous
year, reflecting the disruption associated with the continued product transition
and, secondarily, with the consolidation of the Company's and Paul Revere's
sales offices and related realignment of the field sales force.
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 from previous years, such as that experienced during 1997
and the first nine months of 1998, are dependent on the response of customers
and competitors in the industry.
-18-
Income in the individual disability and life segment increased $17.2
million, or 26.5 percent, to $82.1 million in the third quarter of 1998, from
$64.9 million in the third quarter of 1997. Income from the individual
disability income line of business increased $15.7 million, or 27.7 percent, to
$72.3 million in the third quarter of 1998, from $56.6 million in the third
quarter of 1997. This increase is primarily due to increased investment income
in the individual disability income line of business and a lower level of new
claims relative to the third quarter of 1997. Management believes substantial
investments in the individual disability claims management process since the
first quarter of 1995 helped produce the improvement that has occurred in this
line over the past three years. The major elements of this investment include
an emphasis on early intervention to better respond to the specific nature of
the claims, increased specialization to properly adjudicate the increasingly
specialized nature of disability claims, and an increased level of staffing with
experienced claim adjusters. Also in this segment, income in the individual
life line of business increased $1.5 million, or 18.1 percent, to $9.8 million
in the third quarter of 1998, from $8.3 million in the third quarter of 1997.
This increase is primarily due to improved mortality experience.
For the first nine months of 1998, income in this segment increased $84.7
million, or 56.2 percent, to $235.5 million from $150.8 million in the first
nine months of 1997. The increase is primarily due to the acquisition of Paul
Revere and improved results in the Company's individual disability income line
of business. Income in the individual disability income line of business
increased $78.3 million, or 60.5 percent, to $207.7 million in the first nine
months of 1998, from $129.4 million in the first nine months of 1997. This
improvement is primarily due to the acquisition of Paul Revere. Also in this
segment, income in the individual life line of business increased $6.4 million,
or 29.9 percent, to $27.8 million in the first nine months of 1998, from $21.4
million in the first nine months of 1997. This increase is primarily due to the
acquisition of Paul Revere, higher investment income, and improved mortality
experience.
-19-
EMPLOYEE BENEFITS
Revenue in the employee benefits segment increased $28.9 million, or 11.6
percent, to $277.8 million in the third quarter of 1998, from $248.9 million in
the third quarter of 1997. The increase was primarily the result of an increase
in premium income in this segment of $22.1 million, or 11.6 percent, to $212.6
million in the third quarter of 1998, from $190.5 million in the third quarter
of 1997. The increase in premium income was primarily the result of increased
premium income in the group disability and group life lines of business.
For the first nine months of 1998, revenue in this segment increased $165.2
million, or 25.7 percent, to $808.7 million from $643.5 million in the first
nine months of 1997. Premium income increased $121.9 million, or 24.7 percent,
to $614.7 million in the first nine months of 1998, from $492.8 million in the
first nine months of 1997. The increase is the result of the acquisition of
Paul Revere and increased premium income in the group disability, group life,
and voluntary benefits lines of business. Also in this segment, revenue from
GENEX totaled $71.1 million in the first nine months of 1998 compared to $50.3
million of revenue contributed in 1997 subsequent to its acquisition.
Income in the employee benefits segment increased $11.7 million, or 57.6
percent, to $32.0 million in the third quarter of 1998, from $20.3 million in
the third quarter of 1997. Income in the group disability line of business
increased to $12.2 million in the third quarter of 1998 compared to $7.4 million
in the third quarter of 1997, primarily due to the impact of updated factors
used in calculating Social Security offset amounts and probabilities and claim
termination rates, resulting from year-end 1997 group disability reserve
studies. Voluntary benefits reported income of $6.3 million in the third quarter
of 1998 compared
-20-
to $4.7 million in the third quarter of 1997. The group life line of business
produced income of $9.3 million in the third quarter of 1998 compared to $5.2
million in the third quarter of 1997.
For the first nine months of 1998, income increased $45.9 million, or 102.9
percent, to $90.5 million, from $44.6 million in the first nine months of 1997.
The increase is primarily the result of the acquisition of Paul Revere and
improved results in the group disability, group life, and voluntary benefits
lines of business. The group disability line of business produced income of
$42.6 million in the first nine months of 1998 compared to $14.9 million in the
first nine months of 1997, primarily due to the acquisition of Paul Revere and
the impact of updated factors used in calculating Social Security offset amounts
and probabilities and claim termination rates, resulting from year-end 1997
group disability reserve studies. Voluntary benefits reported income of $14.3
million in the first nine months of 1998 compared to $11.6 million in the first
nine months of 1997. The group life line of business produced income of $25.4
million in the first nine months of 1998 compared to $9.5 million in the first
nine months of 1997.
OTHER OPERATIONS
The other operations segment includes the Company's group pension products,
corporate-owned life insurance ("COLI"), medical stop-loss, individual
annuities, corporate interest expense, goodwill amortization, and corporate
(unallocated) capital and assets. The closed blocks of business have been
segregated for reporting and monitoring purposes.
Effective January 1, 1998, the Company entered into an agreement with
Connecticut General Life Insurance Company ("Connecticut General") for
Connecticut General to reinsure, on a 100% coinsurance basis, the Company's in-
force medical stop-loss insurance coverages sold to clients of CIGNA Healthcare
-21-
and its affiliates ("CIGNA"). This reinsured block constitutes substantially
all of the Company's medical stop-loss insurance business. The small portion
remaining consists of medical stop-loss coverages sold to clients other than
those of CIGNA. These coverages will not be renewed. During 1997, the medical
stop-loss business produced revenue of $38.1 million and income of $6.6 million.
During the first nine months of 1998, this business produced revenue of $10.4
million.
Effective April 30, 1998, the Company closed the sale of its in-force
individual and tax-sheltered annuity business to various affiliates of American
General Corporation ("American General"). The in-force business sold consisted
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 acquired a number of miscellaneous
group pension lines of business sold in the 1970's and 1980's which are no
longer actively marketed. Pursuant to an administrative services agreement, an
affiliate of American General will be providing administrative services to
registered separate accounts of Paul Revere Variable and National. The sale did
not include the Company's block of traditional guaranteed investment contracts
("GICs") or group single premium annuities, which will continue in a run-off
mode. In consideration for the transfer of the approximately $2.4 billion of
statutory reserves, American General paid the Company a ceding commission of
approximately $58.0 million.
On June 30, 1997, the Company announced that it had agreed to transfer its
dental business to Ameritas Life Insurance Corporation ("Ameritas"). The dental
block, which was acquired in the Paul
-22-
Revere acquisition, produced $39.2 million in premium income in 1997. The full
transition of the dental business to Ameritas was completed in November 1997.
Revenue in the other operations segment declined $74.3 million, or 37.7
percent, to $122.9 million in the third quarter of 1998, from $197.2 million in
the third quarter of 1997. Revenue from the group pension line of business
declined $22.1 million, or 31.6 percent, to $47.9 million in the third quarter
of 1998, from $70.0 million in the third quarter of 1997. This decline is
primarily the result of a decrease in funds under management resulting from the
strategic decision to discontinue the sale of products in the group pension line
of business.
For the first nine months of 1998, revenue in this segment declined $122.6
million, or 21.7 percent, to $441.1 million, from $563.7 million in the first
nine months of 1997. Included in the 1998 year-to-date revenue is a gain of
$12.2 million from the sale of the annuity business. The decline is primarily
the result of a decrease in funds under management resulting from the
discontinuation of the sale of products in the group pension business. Revenue
in this line declined $75.4 million, or 32.2 percent, to $158.7 million in the
first nine months of 1998, from $234.1 million in the first nine months of 1997.
Management expects that revenue in 1998 from this segment will decline from
the levels recorded in 1997 due to the decline in funds under management and the
sale of the individual annuity line of business.
Income in the other operations segment declined $14.9 million, or 85.6
percent, to $2.5 million in the third quarter of 1998, from $17.4 million in the
third quarter of 1997. The decline in this segment was due in part to the sale
of the annuity line and the medical stop-loss line, as well as lower income in
the
-23-
group pension line of business, which declined to $7.7 million in the third
quarter of 1998, from $10.3 million in the third quarter of 1997 primarily due
to the result of lower funds under management and lower income from a reduced
amount of capital allocated to this line. Income from the COLI line of business
increased to $9.6 million in the third quarter of 1998 from $5.2 million in the
third quarter of 1997. Interest expense on debt totaled $15.8 million in the
third quarter of 1998, compared to $12.0 million in the third quarter of 1997.
Goodwill amortization totaled $5.2 million in the third quarter of 1998,
compared to $4.2 million in the third quarter of 1997.
For the first nine months of 1998, income in this segment declined $35.9
million, or 65.9 percent, to $18.6 million in the first nine months of 1998,
from $54.5 million in the first nine months of 1997. The decline in this
segment was due in part to lower income in the group pension line of business,
which declined to $21.7 million in the first nine months of 1998, from $28.0
million in the first nine months of 1997 primarily as a result of lower funds
under management and lower income from a reduced amount of capital allocated to
this line. Income from the COLI line of business increased to $20.6 million in
the first nine months of 1998 from $14.4 million in the first nine months of
1997. Interest expense on debt totaled $48.8 million in the first nine months
of 1998, compared to $27.8 million in the first nine months of 1997. Goodwill
amortization totaled $16.1 million in the first nine months of 1998, compared to
$8.6 million in the first nine months of 1997. Included in the 1998 year-to-
date income is a gain of $12.2 million from the sale of the annuity business.
Management expects that income in 1998 from this segment will continue to
decline from the levels recorded in 1997 due to the sale of the annuity line and
the continued run-off of the group pension business.
-24-
LIQUIDITY AND CAPITAL RESOURCES
On March 27, 1997, the Company consummated the acquisition of Paul Revere
("Paul Revere Merger"), which 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,
outstanding borrowings under the revolving bank credit facility were $725.0
million. The revolving bank credit facility was repaid on February 24, 1998.
The Company also 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
borrowing.
In May 1997, the Securities and Exchange Commission declared effective a
shelf registration statement pursuant to which the Company could 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 wholly-owned
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 $300.0
million of 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 sole assets of the subsidiary trust are the junior
subordinated debt securities.
-25-
In April 1998, the Company entered into 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 facilities is
for general corporate purposes. There are no outstanding borrowings under
either of the credit facilities.
On July 9, 1998, the Company completed a public offering of $200.0 million
of 6.375% senior notes due July 15, 2005, and $200.0 million of 7.0% senior
notes due July 15, 2018. After completion of this offering, there are no
remaining debt or equity securities available under the Company's shelf
registration statement.
As the Company announced on September 14, 1998, Capital Z Financial
Services Fund II, L.P. is a party to an agreement with Zurich Insurance Company
pursuant to which it may purchase all of the 12,698,414 shares of the Company's
common stock held by Zurich. Capital Z is a global private equity fund focused
on investing in insurance, financial and healthcare services and other related
businesses. Zurich is the largest investor in Capital Z. The transaction, which
is subject to certain conditions, is still pending.
The Company believes the cash flow from its operations will be sufficient
to meet its operating and financial 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
-26-
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 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 $109.9 million was paid. The Company anticipates
that $151.9 million will be available in 1998 for such purposes. On October 28,
1998, the respective Boards of Directors of National, Paul Revere Protective,
and Paul Revere Variable approved, subject to and contingent on the required
regulatory approvals, extraordinary dividends to be paid by the companies to
their respective parents of $25.0 million, $100.0 million, and $50.0 million,
respectively. The dividends are to be paid on or before December 31, 1998.
The Company's liquidity requirements are met primarily by cash flow
provided from operations, principally in its insurance subsidiaries. Premium
and investment income, as well as maturities and sales of invested assets,
provide the primary sources of cash. Cash flow from operations was sufficient
in the third quarter and first nine months of 1998. 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
-27-
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 transition 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.
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. The following table provides the
distribution of invested assets for the periods indicated.
-28-
September 30, December 31,
------------- -----------------
1998 1997 1996
------------- ------ -----
Investment-Grade Fixed Maturity Securities 79.4% 82.2% 77.0%
Below-Investment-Grade Fixed Maturity Securities 7.7 6.6 6.7
Equity Securities 0.1 0.1 0.1
Mortgage Loans 0.1 0.1 --
Real Estate 0.3 0.4 1.1
Policy Loans 12.0 10.2 13.1
Other 0.4 0.4 2.0
----- ----- -----
Total 100.0% 100.0% 100.0%
===== ===== =====
The following table provides certain investment information and results for
the years indicated.
Nine Months Ended
September 30, Year Ended December 31,
1998 1997 1996
----------------- --------- ---------
(in millions of dollars)
Average Cash and Invested Assets $18,437.8 $17,808.2 $14,056.3
Net Investment Income $ 1,039.6 $ 1,354.7 $ 1,090.1
Average Yield * 7.5% 7.6% 7.8%
Net Realized Investment Gains (Losses) $ 18.2 $ 15.1 $ (8.6)
- ----------------
*Average yield is determined by dividing net investment income by the average
cash and invested assets for the period. Excluding net unrealized gains and
losses on securities, the yield is 8.3%, 8.0%, and 8.1% for the first nine
months of 1998, full year 1997, and full year 1996, respectively.
For the past three years, the Company's exposure to non-current investments
has improved significantly from prior years. These non-current investments are
primarily foreclosed real estate and mortgage loans which became more than
thirty days past due in their principal and interest payments. Non-current
investments totaled $12.2 million at September 30, 1998, or 0.07 percent of
invested assets.
-29-
The Company's investment in mortgage-backed securities totaled $2.3 billion
on an amortized cost basis at September 30, 1998 and $3.1 billion at December
31, 1997. At September 30, 1998, the mortgage-backed securities had an average
life of 9.4 years and effective duration of 8.5 years. The mortgage-backed
securities are valued on a monthly basis using valuations supplied by the
brokerage firms that are dealers in these securities. The primary risk involved
in investing in mortgage-backed securities is the 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 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 September 30, 1998, was $1,355.9 million, representing 7.7 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 $1,297.1 million at December 31, 1997,
representing 6.6 percent of invested assets.
-30-
Changes in interest rates and individuals' behavior affect the amount and
timing of asset and liability cash flows. Management regularly 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.
The Company utilizes forward interest rate swaps, forward treasury
purchases, and options on forward interest rate swaps to manage and increase
yield on cash flows expected from current holdings. All transactions are
hedging in nature and not speculative. Almost all transactions are associated
with the individual disability product portfolio. During the first quarter of
1998, transactions of this type totaled $415.0 million in notional amount,
increasing yield on $63.5 million of purchased securities by approximately 153
basis points. During the second quarter of 1998, transactions of this type
totaled $30.0 million in notional amount, increasing yield on $30.5 million of
purchased securities by approximately 141 basis points. During the third
quarter of 1998, there were no transactions of this type.
YEAR 2000 ISSUES
As are many other businesses in this country and abroad, the Company is
affected in numerous ways, both by its own computer information systems and by
third parties with which it has business relationships, in the processing of
date data relating to the year 2000 and beyond. Failure to adequately address
and substantially resolve year 2000 issues could, and as to mission critical
systems in certain circumstances would, have a material adverse effect on the
Company's business, results of operations, or financial condition. While there
can be no assurance as to its success, the Company has a project underway which
is intended and designed to avoid any such material adverse effect from year
2000 issues.
-31-
In 1996 the Company completed the significant aspects of the planning phase
of a project designed to modify its computer information systems to enable
proper processing of date data relating to the year 2000. This project has a
number of phases, including (i) planning; (ii) inventory (ascertaining the
various internal systems and external relationships potentially affected by year
2000 issues); (iii) analysis (determining the extent to which the system or
remediation or conversion to a compliant alternative); (iv) construction
(remediating the system in order to be compliant); (v) testing (subjecting the
integrated testing to validate interconnected and future date processing in the
forward year 2000 environment); and (vi) completion. The Company defines Year
2000 "compliant" or "compliance" to mean that software will have the ability to
(i) accept input and provide output of data involving dates or portions of dates
correctly and without ambiguity as to the twentieth or twenty-first centuries;
(ii) manage, store, manipulate, sort, sequence, and perform calculations with
respect to data involving dates or portions of dates before, during and after
January 1, 2000 (including single-century or multi-century date formulas)
without malfunction, abends, aborts; and (iii) manage the leap year occurring in
the year 2000 and any Special Dates. The term "Special Dates" means dates used
by programmers to create exceptions where no date could be determined as
specified to serve as end-of-file indicators or to facilitate sort routines.
The Company's approach has primarily been one of modifying or remediating
systems to make them compliant since there are not generally compliant
replacements available in the market that will meet the Company's operational
needs. In some instances non-compliant systems are being replaced with
available and usable compliant systems where that approach is both cost and time
effective.
In addition, there are different areas of remediation requiring different
solutions. These include the following: (i) business applications (systems
supporting core business processes; this area constitutes more than 75 percent
of the overall project effort), (ii) user developed systems (non-mission
critical systems developed by business areas in the Company for specific tasks),
(iii) hardware and software (computers, central operating systems, software
development, and non-information technology systems; this area requires
contacting vendors as to year 2000 compliance), (iv) enterprise computing
(compliance of the computing infrastructure and year 2000 test facilities), and
(v) business partners (other external business relationships that have year 2000
compliance issues; this area requires contacting third parties as to the status
of year 2000 compliance). Operational control of the project is the
responsibility of the project office.
-32-
The following table provides information as to the timeline of phases of
completion of the year 2000 project for different areas of the Company's
business:
Year 2000 Project--Time Line(1)
- -----------------------------------------------------------------------------------------------------------
Date 4Q 1995 1Q 1996 2Q 1996 3Q 1996 4Q 1996
- -----------------------------------------------------------------------------------------------------------
Business Impact analysis Initial project Development of Pilot
Applications completed plan developed methodology applications
chosen to
validate
methodology
- -----------------------------------------------------------------------------------------------------------
Project Office Corporate
awareness
activities begin
- -----------------------------------------------------------------------------------------------------------
-33-
Year 2000 Project--Time Line(1)
- -------------------------------------------------------------------------------------------------------
Date 1Q 1997 2Q 1997 3Q 1997 4Q 1997
- -------------------------------------------------------------------------------------------------------
Business Detail project Risk assessments Regression testing begins
Applications plan developed performed,
inventory complete
- -------------------------------------------------------------------------------------------------------
User Inventory Risk assessments completed
Developed Begins
Systems
- -------------------------------------------------------------------------------------------------------
Hardware and Vendor surveys Vendor Inventory of hardware and
Software initiated management software begins
program
formalized
- -------------------------------------------------------------------------------------------------------
Enterprise Future date time Upgrade of Definition/analysis/
Computing machine infrastructure work plan development/
environment products begins construction of in-house
planning begins system applications
- -------------------------------------------------------------------------------------------------------
Business Awareness
Partners campaign extends
to responses to
external
inquiries
- -------------------------------------------------------------------------------------------------------
Project Office Documentation and Project Office Formalized executive and
audit process formed board reporting
defined
- -------------------------------------------------------------------------------------------------------
-34-
Year 2000 Project--Time Line (Continued)(1)
- -------------------------------------------------------------------------------------------------------
Date 1Q 1998 2Q 1998 3Q 1998 4Q 1998
- -------------------------------------------------------------------------------------------------------
Business Construction Full compliance
Applications completed, business of business
applications begin applications
time machine testing
- -------------------------------------------------------------------------------------------------------
User Systems in Full compliance
Developed construction and of user
Systems testing developed
systems
- -------------------------------------------------------------------------------------------------------
Hardware and Inventory of field Standard software
Software office third party configuration
service providers established
- -------------------------------------------------------------------------------------------------------
Enterprise Time machine Certification Full compliance of
Computing environment testing of computing home office
constructed at 3 infrastructure infrastructure,
sites completed network and telephony
systems
- -------------------------------------------------------------------------------------------------------
Business Request for Contingency planning Contingency plans Business
Partners information sent process defined for finalized for all partner
to electronic critical business critical business interface
business partners processes interfaces testing
- -------------------------------------------------------------------------------------------------------
Project Office Testing metrics Business impact
established for time teams formulated
machine
- -------------------------------------------------------------------------------------------------------
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Year 2000 Project--Time Line (Continued)(1)
- -------------------------------------------------------------------------------------------------
Date 1Q 1999 2Q 1999 3Q 1999 4Q 1999 - 2000
- -------------------------------------------------------------------------------------------------
Business
Applications
- -------------------------------------------------------------------------------------------------
User
Developed
Systems
- -------------------------------------------------------------------------------------------------
Hardware and Contingency plans
Software implemented as
required
- -------------------------------------------------------------------------------------------------
Enterprise Upgrade and
Computing replacement of
all PC systems
completed
- -------------------------------------------------------------------------------------------------
Business Business Contingency plans
Partners partner implemented as
interface required
testing
completed
- -------------------------------------------------------------------------------------------------
Project Office Enterprise - Enterprise -
wide wide
integration integration
testing for testing for
re-certification re-certification
begins complete
- -------------------------------------------------------------------------------------------------
(1) With regard to GENEX, a separate operating subsidiary acquired in February
1997, the primary approach to attaining year 2000 compliance will be replacing
non-compliant systems with compliant systems. This process is expected to be
complete in the third quarter of 1999.
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With the exception of GENEX, the Company expects its systems to be
compliant by the end of 1998, although it is unlikely that the Company will have
received satisfactory assurances from third parties as to year 2000 compliance
by the end of 1998.
There are numerous instances in which third parties having a relationship
with the Company have year 2000 issues to address and resolve. These include
primarily vendors of hardware and software, holders of group insurance policies,
issuers of investment securities, financial institutions, governmental agencies,
and suppliers. An aspect of the project is to identify these third parties and
generally to contact them seeking written assurance as to the third party's
expectancy to be year 2000 compliant. Written requests have been sent to more
than 925 third parties. The nature of the Company's follow up depends upon its
assessment of the response and of the materiality of the effect of non-
compliance by the third party on the Company. For example, the Company follows
up with additional written requests and telephonic inquiries depending upon the
circumstances and in some instances determines that it is appropriate to test
third party systems about which it has received written assurance. In instances
in which the effect of non-compliance may be deemed materially adverse to the
Company's business, results of operations, or financial condition, the project
personnel are in the process of determining an appropriate contingency
arrangement. Project personnel have identified primary business areas which,
based on the status of current responses from third parties, have the potential
for year 2000 problems. At this time these include cash management,
underwriting, client services, and claims. Initial alternatives for contingent
arrangements have been selected, and project personnel are considering
appropriate documentation of potential procedural changes by the Company or
third party providers. With regard to material relationships, contingency plans
are expected to be complete by year end 1998.
Since inception of the project, the Company has expensed $6.4 million
through September 30, 1998, in connection with incremental cost of the year 2000
project and estimates an additional $1.9 million to complete the project.
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The effort of the information systems personnel and others devoted to the
project has been considerable. Temporary personnel in varying numbers have been
retained to assist full time personnel in some phases or aspects of the project.
The Company has utilized compensation programs to retain project personnel in
order to keep the project on schedule. While the project has required systems
management to more closely scrutinize the prioritization of information
technology projects, it is not believed that any deferral of information
technology projects has had a material impact on the Company. At various stages
during the project, the Company has used consultants on some particular aspects
of the project. The Company has also had occasional contact with certain peer
companies comparing approaches to year 2000 issues. The Company has not sought
and does not currently expect to obtain independent verification of its
processes for dealing with year 2000.
Given the range of possibilities that may occur in connection with non-
compliance with year 2000 that could affect the Company, particularly as a
consequence of third parties, the Company is unable to provide an estimate of
the impact of such non-compliance on its business, results of operations, or
financial condition. With regard to non-compliance resulting from the Company's
systems, which the Company believes to be less likely than that resulting from
third parties, the Company would devote its financial and personnel resources,
which include approximately 250 systems personnel who would be available, to
remediate the problem as soon as possible. With regard to non-compliance
resulting from third party failure, the Company is trying to determine through
responses and other appropriate action where there is any material likelihood of
non-compliance having a potentially material impact. In these instances it is
seeking to develop an appropriate contingency arrangement that will minimize
such impact; however, given the range of possibilities, no assurance can be
given that the Company's efforts will be successful.
The foregoing discussion of the year 2000 issue contains forward-looking
statements relating to such matters as financial performance and the business of
the Company. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor for forward-looking statements. In order for the Company to comply
with the terms of the safe harbor, the Company notes that a variety of factors
could cause the Company's actual results and experience relating to compliance
with year 2000 to differ materially from the anticipated results or other
expectations expressed in the Company's forward looking statements concerning
year 2000 issues, which involve certain risks and uncertainties. These factors
include (i) the unanticipated material impact of a system fault of the Company
relating to year 2000, (ii) the failure to successfully remediate, in spite of
testing, material systems of the Company, (iii) the time it may take to
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successfully remediate a failure once it occurs, as well as the resulting costs
and loss of revenues, and (iv) the failure of third parties to properly
remediate material year 2000 problems.
REVIEW BY INDEPENDENT ACCOUNTANTS
The condensed consolidated financial statements at September 30, 1998, and
for the three month and nine month periods then ended have been reviewed, prior
to filing, by Ernst and Young LLP, the Company's independent accountants, and
their report is included herein.
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PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 3.2 Amended and Restated By-Laws
Exhibit 10.18 American General Agreements
Exhibit 15 Letter re: unaudited interim financial information
Exhibit 27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K:
Form 8-K filed on September 22, 1998, relating to the sale of $200.0
million 6.375% Senior Notes due July 15, 2005, and $200.0 million 7.0%
Senior Notes due July 15, 2018, and incorporation of the Underwriting
Agreement and the opinions and comments of Alston & Bird LLP issued in
connection therewith into the Registration Statement under which the
Notes were issued.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Provident Companies, Inc.
(Registrant)
Date: November 12, 1998
/s/ J. Harold Chandler
------------------------------------
J. Harold Chandler
Chairman, President and
Chief Executive Officer
Date: November 12, 1998
/s/ Thomas R. Watjen
-----------------------------------
Thomas R. Watjen
Vice Chairman and
Chief Financial Officer
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
to
FORM 10-Q
PROVIDENT COMPANIES, INC.
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INDEX OF EXHIBITS
EXHIBIT PAGE
Exhibit 3.2 Amended and Restated By-Laws 44
Exhibit 10.18 American General Agreements 58
Exhibit 15 Letter re: unaudited interim financial information 151
Exhibit 27 Financial Data Schedule (for SEC use only) 152
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