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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q/A
Amendment No. 2 to the
----------------
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 31, 1999.
Commission file number 1-11834
PROVIDENT COMPANIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 62-1598430
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1 FOUNTAIN SQUARE,
CHATTANOOGA, TENNESSEE 37402
(Address of principal executive offices) (Zip Code)
(423) 755-1011
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [_]
Indicate the number of shares outstanding for each of the issuer's classes
of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT MARCH 31, 1999
_____________________________________ __________________________________
Common Stock, $1.00 Par Value 135,599,276
Total number of pages are
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This 10-Q Amendment is being filed primarily for the purpose of submitting
additional information concerning the proposed merger of Provident Companies,
Inc. with UNUM Corporation and activities associated therewith in Item 1.
Financial Statements (Unaudited) and Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations.
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
March 31, 1999 and December 31, 1998........................... 4
Condensed Consolidated Statements of Income for the Three Months
Ended March 31, 1999 and 1998.................................. 6
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 1999 and 1998........................... 7
Notes to Condensed Consolidated Financial Statements............ 8
Independent Auditors' Review Report............................. 18
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 28
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................ 29
2
PART 1
CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING STATEMENTS
This document contains certain forward-looking statements with respect to
the financial condition, results of operations and business of Provident
Companies, Inc. (the "Company"). These statements may be made directly in this
document referring to the Company or may be made part of this document by
reference to other documents filed with the Securities and Exchange Commission
by the Company, which is known as "incorporation by reference," and may
include statements for the period following the completion of the proposed
merger with UNUM Corporation ("UNUM"). You can find many of these statements
by looking for words such as "believes," "expects," "anticipates," "estimates"
or similar expressions in this document or in documents incorporated herein.
These forward-looking statements are subject to numerous assumptions, risks
and uncertainties. Factors that may cause actual results to differ from those
contemplated by the forward-looking statements include, among others, the
following possibilities:
. Competitive pressures in the insurance industry may increase
significantly through industry consolidation, competitor
demutualization, or otherwise.
. General economic or business conditions, both domestic and foreign, may
be less favorable than expected, resulting in, among other things, lower
than expected revenues, and the Company could experience higher than
expected claims or claims with longer duration than expected.
. Insurance reserve liabilities can fluctuate as a result of changes in
numerous factors, and such fluctuations can have material positive or
negative effects on net income.
. Costs or difficulties related to the integration of the business of the
Company and UNUM may be greater than expected.
. Legislative or regulatory changes may adversely affect the businesses in
which the Company is engaged.
. Necessary technological changes, including changes to address "year
2000" data systems issues, may be more difficult or expensive to make
than anticipated, and year 2000 issues at other companies may adversely
affect operations.
. Adverse changes may occur in the securities market.
. Changes in the interest rate environment may adversely affect profit
margins.
. The rate of customer bankruptcies may increase.
All subsequent written and oral forward-looking statements attributable to
the Company or any person acting on its behalf are expressly qualified in
their entirety by the cautionary statements contained or referred to in this
section. The Company does not undertake any obligation to release publicly any
revisions to such forward-looking statements to reflect events or
circumstances after the date of this document or to reflect the occurrence of
unanticipated events.
3
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31 December 31
1999 1998
----------- -----------
(in millions of
dollars)
(Unaudited) (Audited)
ASSETS
Investments
Fixed Maturity Securities:
Available-for-Sale.................................... $14,392.9 $14,835.3
Held-to-Maturity...................................... 312.8 307.0
Equity Securities...................................... 4.0 2.1
Mortgage Loans......................................... 17.8 17.8
Real Estate............................................ 43.6 43.6
Policy Loans........................................... 2,090.5 2,089.6
Other Long-term Investments............................ 8.4 8.4
Short-term Investments................................. 31.2 28.9
--------- ---------
Total Investments.................................... 16,901.2 17,332.7
Other Assets
Cash and Bank Deposits................................. 56.9 30.7
Accounts and Premiums Receivable....................... 142.9 98.4
Reinsurance Receivable................................. 3,057.4 3,101.0
Accrued Investment Income.............................. 368.7 335.1
Deferred Policy Acquisition Costs...................... 497.4 464.8
Value of Business Acquired............................. 483.7 490.0
Goodwill............................................... 687.5 692.3
Property and Equipment................................. 137.7 129.9
Miscellaneous.......................................... 38.4 35.5
Separate Account Assets................................ 388.2 377.7
--------- ---------
Total Assets............................................ $22,760.0 $23,088.1
========= =========
See notes to condensed consolidated financial statements.
4
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Continued)
March 31 December 31
1999 1998
----------- -----------
(in millions of
dollars)
(Unaudited) (Audited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy and Contract Benefits.......................... $ 533.5 $ 513.8
Reserves for Future Policy and Contract Benefits and
Unearned Premiums..................................... 13,923.2 13,829.2
Policyholders' Funds and Experience Rating Refunds.... 2,980.1 3,227.3
Federal Income Tax Liability.......................... 185.6 296.7
Short-term Debt....................................... 73.2 39.4
Long-term Debt........................................ 600.0 600.0
Other Liabilities..................................... 552.7 495.5
Separate Account Liabilities.......................... 388.2 377.7
--------- ---------
Total Liabilities................................... 19,236.5 19,379.6
--------- ---------
Commitments and Contingent Liabilities--Note 7
Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debt Securities of the Company.......... 300.0 300.0
--------- ---------
Stockholders' Equity
Common Stock, $1 par................................. 135.9 135.7
Additional Paid-in Capital........................... 764.0 762.0
Accumulated Other Comprehensive Income............... 438.2 685.7
Retained Earnings.................................... 1,894.6 1,834.3
Treasury Stock....................................... (9.2) (9.2)
--------- ---------
Total Stockholders' Equity.......................... 3,223.5 3,408.5
--------- ---------
Total Liabilities and Stockholders' Equity.......... $22,760.0 $23,088.1
========= =========
See notes to condensed consolidated financial statements.
5
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended
March 31
--------------------------
1999 1998
------------ ------------
(in millions of dollars,
except share data)
Revenue
Premium Income..................................... $ 619.1 $ 587.2
Net Investment Income............................. 326.8 361.8
Net Realized Investment Gains..................... 4.0 6.2
Other Income...................................... 38.5 38.4
------------ ------------
Total Revenue.................................... 988.4 993.6
------------ ------------
Benefits and Expenses
Policy and Contract Benefits...................... 463.3 467.0
Change in Reserves for Future Policy and Contract
Benefits and Policyholders' Funds.............. 170.0 168.6
Commissions....................................... 80.5 90.7
Interest and Debt Expense......................... 16.1 15.6
Increase in Deferred Policy Acquisition Costs..... (22.4) (20.9)
Amortization of Value of Business Acquired and
Goodwill......................................... 12.9 14.2
Other Operating Expenses.......................... 153.3 145.5
------------ ------------
Total Benefits and Expenses...................... 873.7 880.7
------------ ------------
Income Before Federal Income Taxes................. 114.7 112.9
Federal Income Taxes............................... 40.9 41.8
------------ ------------
Net Income......................................... $ 73.8 $ 71.1
============ ============
Net Income Per Common Share
Basic............................................. $ 0.54 $ 0.51
Assuming Dilution................................. $ 0.54 $ 0.50
Dividends Per Common Share......................... $ 0.10 $ 0.10
See notes to condensed consolidated financial statements.
6
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months
Ended March 31
----------------
1999 1998
------- -------
(in millions of
dollars)
Net Cash Provided by Operating Activities.................... $ 199.3 $ 188.2
------- -------
Cash Flows from Investing Activities
Proceeds from Sales of Investments.......................... 384.6 572.0
Proceeds from Maturities of Investments..................... 143.4 362.8
Purchase of Investments..................................... (474.7) (694.5)
Net Purchases of Short-term Investments..................... (2.3) (99.9)
Other....................................................... (12.9) (11.1)
------- -------
Net Cash Provided by Investing Activities.................... 38.1 129.3
------- -------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts........................... 12.9 102.3
Maturities and Benefit Payments from Policyholder Accounts.. (246.8) (427.2)
Net Short-term Borrowings................................... 33.8 422.9
Issuance of Long-term Debt.................................. -- 200.0
Long-term Debt Repayments................................... -- (725.0)
Issuance of Company-Obligated Mandatorily Redeemable
Preferred Securities....................................... -- 300.0
Redemption of Preferred Stock............................... -- (156.2)
Dividends Paid to Stockholders.............................. (13.5) (17.5)
Other....................................................... 2.2 3.1
------- -------
Net Cash Used by Financing Activities........................ (211.4) (297.6)
------- -------
Effect of Foreign Exchange Rate on Cash...................... 0.2 --
------- -------
Net Increase in Cash and Bank Deposits....................... 26.2 19.9
Cash and Bank Deposits at Beginning of Period................ 30.7 37.7
------- -------
Cash and Bank Deposits at End of Period...................... $ 56.9 $ 57.6
======= =======
See notes to condensed consolidated financial statements.
7
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1--Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. Operating results for the three month
period ended March 31, 1999, are not necessarily indicative of the results
that may be expected for the year ended December 31, 1999. 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, 1998.
Note 2--Changes in Accounting Principles
Effective January 1, 1999, the Company adopted the provisions of Statement
of Position 98-1 (SOP 98-1), Accounting for the Costs of Computer Software
Developed for or Obtained for Internal Use and Statement of Position 97-3 (SOP
97-3), Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments. SOP 98-1 requires the capitalization of certain costs incurred in
connection with developing or obtaining software for internal use. SOP 97-3
provides guidance for determining when an entity should recognize a liability
or an asset for insurance-related assessments and how to measure these items.
The effect of the adoptions of SOP 98-1 and SOP 97-3 on the Company's
financial position and results of operations was immaterial.
Note 3--Reserves for Policy and Contract Benefits
It is the Company's policy to estimate the ultimate cost of settling claims
in each reporting period based upon the information available to management at
the time. Actual claim resolution results are monitored and compared to those
anticipated in claim reserve assumptions. Claim resolution rate assumptions
are based upon industry standards adjusted as appropriate to reflect actual
Company experience as well as Company actions which would have a material
impact on claim resolutions. Company actions for which plans have been
established and committed to by management are factors which would modify past
experience in establishing claims reserves. Adjustments to the reserve
assumptions will be made if expectations change.
During the fourth quarter of 1998, the Company recorded a $93.6 million
increase in the reserve for individual and group disability claims incurred as
of December 31, 1998. Incurred claims include claims known as of that date and
an estimate of those claims that have been incurred but not yet reported.
Claims that have been incurred but not yet reported are considered liabilities
of the Company. These claims are expected to be reported during 1999 and will
be affected by the claims operations integration activities. The $93.6 million
claim reserve increase represents the estimated value of cash payments to be
made to these claimants as a result of the claim operations integration
activities. The cash payments will be paid over the life of the claims which
is expected to average approximately seven years. Management believes the
reserve adjustment is required based upon the integration plans it has in
place and to which it has committed and based upon its ability to develop a
reasonable estimate of the financial impact of the expected disruption to the
claims management process.
Claims management is an integral part of the disability operations.
Disruptions in that process can create material, short-term increases in claim
costs. The proposed merger of UNUM Corporation (UNUM) and the Company is
expected to have a near-term adverse impact on the efficiency and
effectiveness of the Company's claims management function resulting in some
delay in claim resolutions and additional claim payments to policyholders.
Claims personnel will be distracted from normal claims management activities
as a result of
8
Note 3--Reserves for Policy and Contract Benefits--Continued
planning and implementing the integration of the two companies' claims
organizations. In addition, employee turnover and additional training will
further reduce resources and productivity. An important part of the claims
management process is assisting disabled policyholders with rehabilitation
efforts. This complex activity is important to the policyholders because it
can assist them in returning to productive work and lifestyles more quickly,
and it is important to the Company because it shortens the duration of claim
payments and thereby reduces the ultimate cost of settling claims.
Immediately following the announcement of the merger and continuing into
December of 1998, senior management of UNUM and the Company worked to develop
the strategic direction of the UNUMProvident claims organization. As part of
the strategic direction, senior management committed claims management
personnel to be involved in developing the detailed integration plans and
implementing the plans during 1999. For the first six months of 1999, the
plans anticipate that 80 claims managers and benefit specialists will be
involved up to 30% of their time developing the detailed integration plans.
Once the merger is consummated, which was expected to be June 30, 1999, all
claims personnel are expected to be involved in the process of implementing
the new work processes and will require training. The implementation and
training efforts are estimated to require one month of productive time from
each of the claims staff between June 30, 1999 and December 31, 1999.
Management believes that the anticipated twelve month period is adequate to
execute the integration plans. Knowing that those involved in the claims
operations integration activities would not be available full time to perform
their normal claims management functions, management deemed it necessary to
anticipate this effect on the claim reserves at December 31, 1998.
The reserving process begins with the assumptions indicated by past
experience and modifies these assumptions for current trends and other known
factors. The Company anticipated the merger-related developments discussed
above would generate a significant change in claims department productivity,
reducing claim resolution rates, a key assumption when establishing reserves.
Management developed actions to mitigate the impact of the merger on claims
department productivity, including the hiring of additional claim staff and
the restriction of early retirement elections by claims personnel. Where
feasible, management also planned to obtain additional claims management
resources through outsourcing. All such costs will be expensed in the period
incurred and management does not expect these additional costs to be material
in relation to results of operations. Management reviewed its integration
plans and the actions intended to mitigate the impact of the integration with
claim managers to determine the extent of disruption in normal activities.
Considering all of the above, the revised claim resolution rates, as a
percentage of original assumptions (i.e., excluding the effect of the claim
operations integration activities), are 90% for the first and second quarters
of 1999, 85% for the third quarter, and 90% for the fourth quarter of 1999.
The revised claim resolution rates for the third quarter are lower than the
first and second quarters because all claims personnel are expected to be
involved in the implementation and training efforts. The integration
activities as indicated in the action plans are expected to be complete by
December 31, 1999.
In order to validate these assumptions, the Company also examined the
historical level and pattern of claims management effectiveness as reflected
in claim resolution rates for the insurance subsidiaries of The Paul Revere
Corporation (Paul Revere) which was acquired by the Company in 1997.
Subsequent to the Paul Revere acquisition and integration, the Company has
been able to develop experience studies for the Paul Revere business. These
studies are prepared for pricing purposes and to identify trends or changes in
the business. These studies, which were not available for the Paul Revere
business at the time of the acquisition, allowed the Company to gain a greater
understanding of the impact of the claims integration activities on the claim
resolution rates of the Paul Revere business. These studies show that the Paul
Revere business experienced a decline in its claim resolution rates from a
base in 1995 of 100% to 90.4% in 1996 and 80.3% in 1997. Changes in morbidity
and other factors were considered and reviewed to determine that a primary
cause of the reduced claim resolution rates was the disruption caused by the
change in the claims management process. Although the circumstances of the
UNUMProvident merger are very different, the claims integration activities are
similar, and the Paul Revere
9
Note 3--Reserves for Policy and Contract Benefits--Continued
experience is relevant. The primary circumstances that created claims
disruption for Paul Revere were the initial lack of clarity of the
organization, process, and structure, the need to plan for a significant
transition to new claims processes, and the training and implementation
related to those changes. All of those elements will impact the Company in the
UNUMProvident merger. One primary difference is that the duration of the
potential disruption in the UNUMProvident merger is not expected to be as long
as was the case with the Paul Revere acquisition. The Company's revised claim
resolution rates assumed for the first two quarters in 1999 (90%) were
compared to the Paul Revere experience in 1996, the period preceding the
acquisition. It was determined that the revised assumptions appeared to be
reasonable. During the third and fourth quarters of 1999, the claims
integration plans provide for increased activity due to training and
implementation of new processes. The Company's revised claim resolution rates
for the third and fourth quarter of 1999 are 85% and 90%, respectively. These
rates were compared to the Paul Revere experience in 1997, during the
implementation and training phase of the Paul Revere claims organization when
claims resolution rates declined to 80.3% of prior levels. Management judged
that it was reasonable to assume that the impact to the Company would be less
than it was to Paul Revere since some of the Company's claims management
practices will not change. The historical experience of Paul Revere provides a
statistical reference for the expected experience for the Company when
adjusted for the projected effects of the claims integration plans.
In order to evaluate the financial effect of merger-related integration
activities, the Company projected the ultimate cost of settling all claims
incurred as of December 31, 1998, using the revised claim resolution rates.
This projection was compared to the projection excluding the adjustment to the
claim resolution rates to obtain the amount of the charge. The Company
reviewed its estimates of the financial impact of the claims operations
integration activities with its actuaries and independent auditors.
Claim reserves at December 31, 1998 include $93.6 million as the estimated
value of projected additional claim payments resulting from these claims
operations integration activities. This reserve increase was reflected as an
increase in future reserves for policy and contract benefits. The effect of
lower claim resolutions is expected to emerge quarterly in the amount of $22.1
million for each of the first two quarters of 1999, $29.6 million in the third
quarter, and $19.8 million in the fourth quarter of 1999. If claim resolutions
emerge as expected, there will be no impact to income from operations during
1999. Any variance from the assumptions noted above will be reflected in
income in the current period. The adverse impact of the claims operations
integration activities on resolution rates is not expected to continue beyond
1999. The Company will report in its subsequent filings and will discuss
within the Individual and Employee Benefits segments sections of "Management's
Discussion and Analysis of Financial Condition and Results of Operations" the
status of the claims operations integration activities, the impact of these
activities, and any material variances from the revised estimate of claim
resolution rates. As part of the periodic review of claim reserves, management
will review the status and execution of the claims operations integration
plans with the claims management on a quarterly basis. The review will
consider claims operations integration activities planned for future periods
and evaluate whether the future planned activities will result in claim
resolution rates consistent with those considered in the reserve established
at December 31, 1998. The claim reserves may require further increases or
decreases as facts concerning the merger and its effect on benefits to
policyholders emerge. Among the factors that could affect the reserve
assumptions is the possible delay in the consummation of the merger, thus
delaying implementation of integration of the companies' claims management
operations. Other factors include the level of employee turnover, timing and
complexity of computer system conversions, and the timing and level of
training and integration activities of the claims management staff relative to
the original integration plans of the Company.
During the first quarter of 1999, claims operations integration activities
progressed as assumed. At December 31, 1998, management assumed the revised
claim resolution rates for the first quarter of 1999 to be 90% of assumptions
excluding the impact of the claims operations integration activities. The
actual experience for the first quarter of 1999 was 90%, resulting in a
reduction of $22.0 million from the $93.6 million additional 1998 claim
reserve adjustment. In the first quarter of 1999, there was not a significant
difference between the
10
Note 3--Reserves for Policy and Contract Benefits--Continued
$22.1 million effect anticipated in the $93.6 million additional claims
reserve adjustment and the effect of lower claim resolutions experienced. The
liability remaining for claim operations integration activities at March 31,
1999, was $71.6 million. Management expects the remaining claims operations
integration activities to impact claim reserves as anticipated at December 31,
1998, and its estimate of the reserve required for the remainder of 1999 is
unchanged from its original estimate made at year end 1998. Management will
continue to evaluate the impact of the proposed merger with UNUM on disability
claims experience and the assumptions related to expected claim resolutions.
Note 4--Earnings Per Common Share
Earnings per common share are determined as follows:
Three Months
Ended March 31
---------------------
1999 1998
---------- ----------
(in millions of
dollars)
Numerator:
Net Income............................................... $ 73.8 $ 71.1
Preferred Stock Dividends................................ -- 1.9
---------- ----------
Income Available to Common Stockholders.................. $ 73.8 $ 69.2
========== ==========
Denominator (000s):
Weighted Average Common Shares--Basic.................... 135,459.5 134,929.1
Dilutive Securities...................................... 2,225.1 3,716.2
---------- ----------
Weighted Average Common Shares--Assuming Dilution........ 137,684.6 138,645.3
========== ==========
Note 5--Comprehensive Income
The components of accumulated other comprehensive income, net of deferred
tax, are as follows:
March 31 December 31
1999 1998
-------- -----------
(in millions of
dollars)
Net Unrealized Gain on Securities.......................... $467.5 $721.0
Foreign Currency Translation Adjustment.................... (29.3) (35.3)
------ ------
Accumulated Other Comprehensive Income..................... $438.2 $685.7
====== ======
11
Note 5--Comprehensive Income--Continued
The components of comprehensive income (loss) and the related deferred tax
(credit) are as follows:
Three Months
Ended March 31
---------------
1999 1998
------- ------
(in millions
of dollars)
Net Income..................................................... $ 73.8 $ 71.1
------- ------
Change in Net Unrealized Gain on Securities:
Change Before Reclassification Adjustment..................... (386.0) 48.4
Reclassification Adjustment for Net Realized Investment Gains
Included in Net Income....................................... (4.0) (6.2)
Change in Foreign Currency Translation Adjustment.............. 9.2 3.7
------- ------
(380.8) 45.9
Change in Deferred Tax (Credit)................................ (133.3) 16.1
------- ------
Other Comprehensive Income (Loss).............................. (247.5) 29.8
------- ------
Comprehensive Income (Loss).................................... $(173.7) $100.9
======= ======
The deferred tax (credit) for other comprehensive income items is computed
at the federal statutory income tax rate.
12
Note 6--Segment Information
Selected data by segment is as follows:
Three Months
Ended March 31
----------------
1999 1998
------- -------
(in millions of
dollars)
Premium Income
Individual................................................. $ 377.6 $ 374.0
Employee Benefits.......................................... 207.0 170.2
Voluntary Benefits......................................... 22.4 20.8
Other...................................................... 12.1 22.2
------- -------
619.1 587.2
Net Investment Income and Other Income
Individual................................................. 192.7 186.8
Employee Benefits.......................................... 59.1 53.9
Voluntary Benefits......................................... 8.7 7.7
Other...................................................... 97.5 148.7
Corporate.................................................. 7.3 3.1
------- -------
365.3 400.2
Total Revenue (Excluding Net Realized Investment Gains and
Losses)
Individual................................................. 570.3 560.8
Employee Benefits.......................................... 266.1 224.1
Voluntary Benefits......................................... 31.1 28.5
Other...................................................... 109.6 170.9
Corporate.................................................. 7.3 3.1
------- -------
984.4 987.4
Benefit and Expenses
Individual................................................. 489.8 485.7
Employee Benefits.......................................... 237.1 198.7
Voluntary Benefits......................................... 27.0 25.3
Other...................................................... 97.9 156.6
Corporate.................................................. 21.9 14.4
------- -------
873.7 880.7
Income (Loss) Before Net Realized Investment Gains and
Losses and Federal Income Taxes
Individual................................................. 80.5 75.1
Employee Benefits.......................................... 29.0 25.4
Voluntary Benefits......................................... 4.1 3.2
Other...................................................... 11.7 14.3
Corporate.................................................. (14.6) (11.3)
------- -------
110.7 106.7
Net Realized Investment Gains............................... 4.0 6.2
------- -------
Income Before Federal Income Taxes.......................... 114.7 112.9
Federal Income Taxes........................................ 40.9 41.8
------- -------
Net Income.................................................. $ 73.8 $ 71.1
======= =======
Revenue earned on corporate assets, general corporate expenses, interest
expense on corporate debt, amortization of goodwill, and assets maintained for
general corporate purposes are included in the Corporate segment.
13
Note 7--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 subsidiaries of The Paul Revere Corporation
(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 44
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 44 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.
Note 8--Merger with UNUM Corporation
On November 22, 1998, the Company entered into an agreement with UNUM,
pursuant to which the Company and UNUM will merge under the name UNUMProvident
Corporation (UNUMProvident). Under the merger agreement, each outstanding
share of the Company's common stock will be reclassified and converted into
0.73 of a share of UNUMProvident common stock and each outstanding share of
UNUM common stock will be converted into one share of UNUMProvident common
stock. The merger will be accounted for as a pooling of interests. The merger
is subject to regulatory and Company stockholder and UNUM stockholder
approval.
The following unaudited pro forma combined condensed financial statements
and explanatory notes are presented to show the impact on the historical
financial positions and results of operations of the Company and UNUM of the
planned merger under the pooling of interests method of accounting. The
unaudited pro forma combined condensed financial statements combine the
historical financial information of the Company and UNUM as of March 31, 1999,
for the three month periods ended March 31, 1999 and March 31, 1998, and for
the years ended December 31, 1998, 1997, and 1996. The unaudited pro forma
combined condensed statements of income give effect to the merger as if it had
been completed at the beginning of the earliest period presented. The
unaudited pro forma combined condensed balance sheet assumes the merger was
completed on March 31, 1999. The unaudited combined condensed pro forma
financial statements as of March 31, 1999, for the three month periods ended
March 31, 1999 and March 31, 1998, and for the years ended December 31, 1998,
1997, and 1996 are based on and derived from, and should be read in
conjunction with, the Company's and UNUM's historical consolidated financial
statements and related notes.
On the date the merger is completed UNUMProvident will record expenses
related to the merger of approximately $139.0 million ($109.0 million net of
income taxes). The estimated expenses related to the merger include amounts
for severance and related costs, exit costs for duplicative facilities and
asset abandonments, and investment banking, legal and accounting fees. In
addition, the Company will record an expense related to the early retirement
offer on the date the merger is consummated of approximately $19.0 million
($13.0 million net
14
Note 8--Merger with UNUM Corporation--Continued
of income taxes). The early retirement offer to the Company's employees is
subject to acceptance by the employees and the closing of the merger.
Generally accepted accounting principles (GAAP) requires both contingencies to
be met before the charge is recognized. UNUM will record an expense related to
the early retirement offer of approximately $75.0 million ($53.0 million net
of income taxes). The UNUM early retirement offer to employees is not
contingent upon the closing of the merger; therefore, under GAAP, the charge
will be recorded as soon as the employees accept the offer. The employees have
until June 17, 1999 to accept the offer or the offer will expire.
The estimated expenses related to the merger and the early retirement
offers to employees have not been reflected in the unaudited pro forma
combined condensed balance sheet or statements of income and related per share
calculations. The estimated expenses related to the merger and to the early
retirement offers to employees increased $23.0 million from the $210.0 million
estimate previously reported in the Company's 1998 annual report on Form 10-K
(as amended). The increase was primarily a result of revised estimates for the
number of employees accepting the early retirement offer, which is more costly
than the severance plan, and exit activities related to duplicative facilities
and asset abandonments. The estimated expenses represent management's best
estimates based on available information at this time. Actual charges will
differ from these estimates.
The unaudited pro forma financial statements are presented for comparative
purposes only and are not necessarily indicative of the results of operations
that would have been realized had the merger been completed during the periods
or as of the date for which the pro forma financial statements are presented,
nor are they necessarily indicative of the results of operations in future
periods or the future financial position of UNUMProvident.
Provident Companies, Inc. and UNUM Corporation
Unaudited Pro Forma Combined Condensed Balance Sheet
As of March 31, 1999
Historical
-------------------- Pro Forma Pro Forma
Provident UNUM Adjustments Combined
--------- --------- ----------- ---------
(in millions of dollars)
Assets
Total Investments............ $16,901.2 $ 9,824.9 $ -- $26,726.1
Reinsurance Receivable....... 3,057.4 1,806.5 -- 4,863.9
All Other Assets............. 2,801.4 3,749.8 -- 6,551.2
--------- --------- -------- ---------
Total Assets.................. $22,760.0 $15,381.2 $ -- $38,141.2
========= ========= ======== =========
Liabilities and Stockholders'
Equity
Policy and Contract Benefits,
Reserves for Future Policy
and Contract Benefits, and
Unearned Premiums........... $14,456.7 $ 9,449.9 $ 230.0 (a) $24,136.6
Other Policyholders' Funds... 2,980.1 871.6 -- 3,851.7
All Other Liabilities........ 1,799.7 2,392.9 (80.0)(a) 4,112.6
--------- --------- -------- ---------
Total Liabilities............. 19,236.5 12,714.4 150.0 32,100.9
--------- --------- -------- ---------
Company-Obligated Mandatorily
Redeemable Preferred
Securities of Subsidiary
Trust Holding Solely Junior
Subordinated Debt Securities
of the Company............... 300.0 -- -- 300.0
--------- --------- -------- ---------
Stockholders' Equity
Common Stock................. 135.9 20.0 (132.1)(b) 23.8
Additional Paid-in Capital... 764.0 1,153.5 (948.0)(b) 969.5
Accumulated Other
Comprehensive Income........ 438.2 150.6 -- 588.8
Retained Earnings............ 1,894.6 2,439.9 (150.0)(a) 4,184.5
Treasury Stock............... (9.2) (1,080.1) 1,080.1 (b) (9.2)
Restricted Stock Deferred
Compensation................ -- (17.1) -- (17.1)
--------- --------- -------- ---------
Total Stockholders' Equity.... 3,223.5 2,666.8 (150.0) 5,740.3
--------- --------- -------- ---------
Total Liabilities and
Stockholders' Equity......... $22,760.0 $15,381.2 $ -- $38,141.2
========= ========= ======== =========
15
Note 8--Merger with UNUM Corporation--Continued
- --------
(a) The Company and UNUM are in the process of reviewing their accounting
policies and financial statement classifications and as a result of this
review, it may be necessary to adjust the combined financial statements to
conform to those accounting policies and classifications that are
determined to be most appropriate.
One aspect of this preliminary review has indicated that UNUM's process
and assumptions used to calculate the discount rate for claim reserves of
certain disability businesses differs from that used by the Company. While
the Company's and UNUM's current methods for calculating the discount rate
for disability claim reserves are in accordance with GAAP, both companies'
management believe that the combined entity should have consistent
discount rate accounting policies and methods for applying these policies
for similar products. Anticipated in the merger was the combination of the
investment functions of the Company and UNUM. UNUMProvident's investment
function will be managed by the Company's personnel, and the current
investment strategies of the Company will be utilized by the combined
entity. The current UNUM methodology uses the same investment strategy for
assets backing both liabilities and surplus. The Company's methodology,
which allows for different investment strategies for assets backing
surplus than those backing product liabilities, has been determined by
management to be the most appropriate approach for the combined entity.
Accordingly, UNUM will adopt the Company's method of calculating the
discount rate for claim reserves.
UNUM estimated the impact of this change in method on the estimate of
unpaid claim reserves and will record a pre-tax charge effective with the
merger of approximately $230.0 million ($150.0 million after tax). This
estimated merger-related adjustment has not been reflected in the
unaudited pro forma combined condensed statements of income and related
per share calculations. This estimate, which will be reported in operating
earnings of the merged companies, was based on a projection of UNUM's
investment portfolio and claim liabilities as of June 30, 1999, the
expected completion date of the merger. For the discount rates affected by
the change in UNUM's methodology, the current interest rates used to
discount UNUM's claim reserves and the projected interest rates using the
Company's method as of June 30, 1999, are as follows:
Current Rates Projected Rates
March 31, 1999 June 30, 1999
-------------- ---------------
Group Long-term Disability (North America).. 7.74% 6.65%
Group Long-term Disability and Individual
Disability (United Kingdom)................ 8.80% 7.74%
Individual Disability (North America)....... 7.37% 6.79%
UNUM's unpaid claim reserves for these disability lines as of June 30,
1999, were estimated to be $5,376.0 million using the UNUM method for
determining reserve discount rates and $5,606.0 million using the
Company's method.
(b) The pro forma adjustments to common stock, additional paid-in capital, and
treasury stock reflect the retirement of shares of UNUM common stock held
in treasury, the reclassification of the Company's stock on a 0.73 to 1.0
basis which results in 98.8 million shares issued to replace the 135.4
million shares of the Company's common stock held by stockholders on March
31, 1999, the reduction in par value of the Company's common stock from
$1.00 to $0.10, and the issuance to UNUM stockholders of 139.1 million
shares of UNUMProvident common stock pursuant to the merger (calculated by
multiplying the number of shares of UNUM common stock outstanding at March
31, 1999 of 139.1 million by the exchange ratio of 1.0 to 1.0 representing
the number of shares UNUM stockholders will receive for each share of UNUM
common stock they own immediately prior to consummation of the merger).
The number of shares of UNUMProvident common stock that will be issued
after completion of the merger will be based on the actual number of
shares of UNUM common stock and the Company's common stock (after
reclassification on a 0.73 to 1.0 basis) outstanding at the effective time
of the merger.
16
Note 8--Merger with UNUM Corporation--Continued
UNUMProvident Unaudited Combined Condensed Pro Forma Consolidated Statements
of Income
Three Months Ended
March 31 Year Ended December 31
-------------------- -------------------------------
1999 1998 1998 1997 1996
--------- --------- --------- --------- ---------
(in millions of dollars, except share data)
Revenue
Premium Income.......... $ 1,704.2 $ 1,505.6 $ 6,189.1 $ 5,317.4 $ 4,327.2
Net Investment Income... 499.6 525.1 2,035.4 2,015.7 1,893.4
Net Realized Investment
Gains (Losses)......... 7.2 9.3 55.0 11.5 (5.2)
Other Income............ 80.8 75.1 299.9 357.0 148.2
--------- --------- --------- --------- ---------
Total Revenue........... 2,291.8 2,115.1 8,579.4 7,701.6 6,363.6
--------- --------- --------- --------- ---------
Policyholder Benefits... 1,524.8 1,326.8 5,509.8 4,880.4 4,204.0
Commissions............. 242.5 233.4 826.5 716.2 555.2
Interest and Debt
Expenses............... 32.9 27.3 119.9 84.9 58.5
Increase in Deferred
Policy Acquisition
Costs.................. (118.0) (100.8) (325.8) (236.0) (116.7)
Amortization of Value of
Business Acquired and
Goodwill............... 42.7 16.9 66.6 52.7 7.7
Other Operating
Expenses............... 403.7 364.2 1,462.2 1,286.7 1,087.1
--------- --------- --------- --------- ---------
Total Benefits and
Expenses............... 2,128.6 1,867.8 7,659.2 6,784.9 5,795.8
--------- --------- --------- --------- ---------
Income Before Income
Taxes.................. 163.2 247.3 920.2 916.7 567.8
Income Taxes............ 73.9 82.7 302.8 299.1 184.2
--------- --------- --------- --------- ---------
Net Income.............. $ 89.3 $ 164.6 $ 617.4 $ 617.6 $ 383.6
========= ========= ========= ========= =========
Net Income Per Common
Share
Basic................... $ 0.38 $ 0.69 $ 2.60 $ 2.62 $ 1.75
Assuming Dilution....... $ 0.37 $ 0.67 $ 2.54 $ 2.57 $ 1.72
Average Shares
Outstanding (000s)
Basic................... 237,785.3 236,610.8 236,975.2 230,741.2 212,401.5
Assuming Dilution....... 242,253.2 242,573.6 242,348.9 235,818.2 215,301.1
The above unaudited pro forma combined condensed statements of income
reflect the results of operations of the Company and UNUM for the periods
presented. No adjustments have been made to arrive at the pro forma combined
condensed statements of income. Pro forma combined net income available to
common shareholders was $89.3 million for the three months ended March 31,
1999. Pro forma combined net income available to common shareholders was
$162.7 million for the three months ended March 31, 1998 and was net of
preferred stock dividends of $1.9 million. Pro forma combined net income
available to common shareholders of $615.5 million, $604.9 million, and $370.9
million for 1998, 1997, and 1996, respectively, was net of preferred stock
dividends of $1.9 million in 1998 and $12.7 million in both 1997 and 1996. The
pro forma combined basic and assuming dilution earnings per share for the
respective periods presented are based on the combined weighted average number
of common and dilutive potential common shares and adjusted weighted average
shares of the Company and UNUM. The number of weighted average common shares
and adjusted weighted average shares, including all dilutive potential common
shares, reflects the reclassification of the Company's common stock on a 0.73
to 1.0 basis and the conversion of each outstanding share of UNUM common stock
into one share of UNUMProvident common stock in the merger.
In April 1999, UNUM completed a comprehensive strategic review of its
reinsurance businesses. These businesses include reinsurance pool management
operations and risk assumption (pool participation, direct reinsurance, and
Lloyd's of London syndicate participation). UNUM's management concluded that
these businesses are not solidly aligned with UNUM's strength in the
disability insurance market. UNUM intends to sell the reinsurance management
operations and either reinsure the risk assumption businesses or place them in
run-off. As a result of the comprehensive review, UNUM recorded a special
charge of $101.1 million ($88.0 million after tax) in the first quarter of
1999. The charge includes reserve increases for estimated losses in the
Lloyd's of London syndicates and certain reinsurance pools, as well as a
write-down of goodwill.
17
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 March
31, 1999, and the related condensed consolidated statements of income and cash
flows for the three month periods ended March 31, 1999 and 1998. 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, 1998, 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 9,
1999, 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,
1998, is fairly stated in all material respects in relation to the
consolidated statement of financial condition from which it has been derived.
ERNST & YOUNG LLP
Chattanooga, Tennessee
May 12, 1999
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following should be read in conjunction with the "Condensed
Consolidated Financial Statements" and notes thereto included elsewhere in
this Form 10-Q and with the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Company's 1998 Form 10-K (as
amended).
Management believes that the trends in new annualized sales in the
Individual and Employee Benefits segments are important for investors to
assess in their analysis of the Company's results of operations. The trends in
new sales are indicators of the level of market acceptance of new products,
particularly in the individual disability income line of business, and the
Company's potential for growth in its respective markets. The Company has
closely linked its various incentive compensation plans for management and
employees to the achievement of its goals for new sales.
The following discussion of operating results by segment excludes net
realized investment gains and losses from revenue and income before taxes. The
Company's investment focus has been on investment income to support its
insurance liabilities as opposed to the generation of realized investment
gains. Due to the nature of the Company's business, a long-term focus is
necessary to maintain profitability over the life of the business. The
realization of investment gains and losses will impact future earnings levels
as the underlying business is long-term in nature and requires that the
Company be able to sustain the assumed interest rates in its liabilities.
However, income excluding realized investment gains and losses does not
replace net income as a measure of the Company's profitability.
Operating Results
Revenue excluding net realized investment gains and losses ("revenue")
declined $3.0 million, or 0.3 percent to $984.4 million in the first quarter
of 1999 from $987.4 million in the first quarter of 1998. Revenue includes
premium income, net investment income, and other income. This decline resulted
from lower revenue in the Other segment ($61.3 million), which was partly
offset by increased revenue in the Individual segment ($9.5 million), Employee
Benefits segment ($42.0 million), Voluntary Benefits segment ($2.6 million),
and Corporate segment ($4.2 million).
Income before net realized investment gains and losses and federal income
taxes ("income") increased $4.0 million, or 3.7 percent, to $110.7 million in
the first quarter of 1999 from $106.7 million in the first quarter of 1998.
This increase resulted from increased income in the Individual segment ($5.4
million), Employee Benefits segment ($3.6 million), and Voluntary Benefits
segment ($0.9 million). This increase was partly offset by lower income in the
Other segment ($2.6 million) and Corporate segment ($3.3 million).
Net income totaled $73.8 million in the first quarter of 1999, compared to
$71.1 million in the first quarter of 1998. Net realized investment gains
after federal income taxes were $2.6 million in the first quarter of 1999 and
$4.1 million in the first quarter of 1998.
Individual Segment Operating Results
Revenue in the Individual segment increased $9.5 million, or 1.7 percent,
to $570.3 million in the first quarter of 1999 from $560.8 million in the
first quarter of 1998. Premium income in this segment increased $3.6 million,
or 1.0 percent, to $377.6 million in the first quarter of 1999 from $374.0
million in the first quarter of 1998. Both the individual disability income
and individual life lines of business produced increases in premium income.
Also in this segment, net investment income increased $9.9 million, or 5.6
percent, to $186.1 million in the first quarter of 1999 from $176.2 million in
the first quarter of 1998, primarily due to increased capital allocation.
Management expects that premium income in the Individual segment will grow on
a year-over-year basis as the product transition in the individual disability
income line of business produces increasing levels of new sales of individual
disability products.
19
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 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 The Paul Revere Corporation ("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 continues to offer selected Paul Revere products with own-
occupation (while not working) features applying stricter underwriting
standards. The Company has filed new rates for the Paul Revere product that
was the leading seller during 1998. 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 first quarter of 1999, new annualized sales in the individual
disability income line totaled $27.6 million, compared to $26.2 million in the
first quarter of 1998. On a pro forma basis, sales of individual disability
income contracts declined in 1998 to $114.6 million from $127.3 million in
1997, reflecting the planned discontinuance of certain products and
restructuring of others 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 1998, are dependent on the response of customers and competitors in the
industry.
Income in the Individual segment increased $5.4 million, or 7.2 percent, to
$80.5 million in the first quarter of 1999 from $75.1 million in the first
quarter of 1998. The increase in this segment was the result of increased
income in the individual life line of business to $9.1 million in the first
quarter of 1999 from $6.9 million in the first quarter of 1998 and increased
income in the individual disability income line of business to $71.4 million
in the first quarter of 1999 from $68.2 million in the first quarter of 1998.
In the fourth quarter of 1998, the Company recorded a $81.0 million pre-tax
charge in the Individual segment for the expected increase in claims durations
due to management's expectation that productivity in the claims organization
will be impacted as a result of planning, consolidation, and integration
efforts related to the Company's merger with UNUM. Management expects the
claim integration efforts to have some benefits, primarily related to claims
incurred in future periods, as well as the potential for improved customer
satisfaction and lower ultimate claim costs as best practices in return to
work and claims management are implemented. As benefits related to the
integration become known, reserve assumptions will be revised, if appropriate.
Insurance policies that are impacted by the temporary change in claim
resolution rates will not perform as anticipated when priced. However, since
the cause of the additional claim cost is of a temporary nature, it is not
anticipated to have an effect on future policy pricing. The $81.0 million
reserve increase in the Individual segment is not considered material from a
capital adequacy position.
During the first quarter of 1999, those claim operations integration
activities progressed as assumed. At December 31, 1998, management assumed the
revised claim resolution rates for the first quarter of 1999 to be 90% of
assumptions, excluding the impact of the claims operations integration
activities. The actual experience for the first quarter of 1999 was 90%. If
the impact of merger related claim operations integration activities on claim
durations had not been anticipated at December 31, 1998, first quarter 1999
before-tax operating income for the individual disability line of business
would have been negatively impacted by $19.0 million. Management expects the
remaining claim operations integration activities to impact claim reserves as
anticipated at December 31, 1998. Management will continue to evaluate the
impact of the proposed merger with UNUM on disability claims experience and
the assumptions related to expected claim resolutions. If the claim operations
integration activities take longer than expected to implement or if they
result in unforeseen difficulties, claim durations could continue to increase
and income could be adversely affected.
20
Employee Benefits Segment Operating Results
Revenue in the Employee Benefits segment increased $42.0 million, or 18.7
percent, to $266.1 million in the first quarter of 1999 from $224.1 million in
the first quarter of 1998. Premium income in this segment increased $36.8
million, or 21.6 percent, to $207.0 million in the first quarter of 1999 from
$170.2 million in the first quarter of 1998. The increase is the result of
increased premium income in the group disability and group life lines of
business resulting from strong sales trends over the past several quarters.
Revenue from GENEX Services, Inc. ("GENEX") totaled $24.9 million in the first
quarter of 1999 compared to $22.4 million in the first quarter of 1998. New
annualized sales in this segment increased 67.4 percent to $128.4 million in
the first quarter of 1999 from $76.7 million in the first quarter of 1998.
Management expects that the rate of growth in new annualized sales will
moderate during the balance of 1999.
Income in the Employee Benefits segment increased $3.6 million, or 14.2
percent, to $29.0 million in the first quarter of 1999 from $25.4 million in
the first quarter of 1998. The increase is primarily the result of improved
results in the group life and accidental death and dismemberment line of
business to $16.3 million in the first quarter of 1999 from $9.4 million in
the first quarter of 1998. This improvement was partly offset by a decline in
the group disability line of business to $10.9 million in the first quarter of
1999 from $14.8 million in the first quarter of 1998.
As noted in the Individual Segment Operating Results, claim resolution
rates were revised downward in the fourth quarter of 1998 for claim operations
integration activities related to the merger with UNUM. The Company recorded a
$12.6 million pre-tax charge in the fourth quarter of 1998 in the Employee
Benefit segment related to the revised claim resolution rates. At December 31,
1998, management assumed the revised claim resolution rates for the first
quarter of 1999 to be 90% of assumptions, excluding the impact of the claims
operations integration activities. The actual experience for the first quarter
of 1999 was 90%. If the impact of merger related claim operations integration
activities on claim durations had not been anticipated at December 31, 1998,
first quarter 1999 before-tax operating income for the group disability line
of business would have been negatively impacted by $3.0 million.
Voluntary Benefits Segment Operating Results
Revenue in the Voluntary Benefits segment increased $2.6 million, or 9.1
percent, to $31.1 million in the first quarter of 1999 from $28.5 million in
the first quarter of 1998. The increase is primarily the result of an increase
in premium income in this segment of $1.6 million, or 7.7 percent, to $22.4
million in the first quarter of 1999 from $20.8 million in the first quarter
of 1998. Also in this segment, net investment income increased $0.8 million,
or 12.5 percent, to $7.2 million in the first quarter of 1999 from $6.4
million in the first quarter of 1998. New annualized sales in this segment
increased 2.9 percent to $10.6 million in the first quarter of 1999 from $10.3
million in the first quarter of 1998.
Income in the Voluntary Benefits segment increased $0.9 million, or 28.1
percent, to $4.1 million in the first quarter of 1999 from $3.2 million in the
first quarter of 1998. The increase is primarily the result of an increase in
revenue which offset a slight deterioration in mortality experience.
Other Segment Operating Results
The Other operating segment includes results from products no longer
actively marketed, including corporate-owned life insurance ("COLI"), group
pension, medical stop-loss, medical and dental, and individual annuities. It
is expected that revenue and earnings in this segment will decline over time
as these business lines wind down. The run-off of the group pension line
results in a decline in assets under management and, in turn, a continued
decline in the net investment income produced by the assets. Management
expects to reinvest the capital supporting these lines of business in the
future growth of the Individual, Employee Benefits and Voluntary Benefits
segments. The closed blocks of business have been segregated for reporting and
monitoring purposes.
21
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 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. The medical stop-loss business produced
revenue of $14.1 million in 1998.
On April 30, 1998, the Company closed the sale of its in-force individual
and tax-sheltered annuity business to American General Annuity Insurance
Company and The Variable Annuity Life Insurance Company, affiliates of
American General Corporation ("American General"). The sale was effected by
reinsurance in the form of 100% coinsurance agreements whereby the financial
liability for the various annuity lines was transferred to American General.
The in-force business sold consisted primarily of individual fixed annuities
and tax-sheltered annuities. In addition, American General acquired a number
of miscellaneous group pension lines of business sold in the 1970s and 1980s
which were no longer actively marketed by the Company. The sale does not
include the Company's block of 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.
Revenue in the Other segment declined $61.3 million, or 35.9 percent, to
$109.6 million in the first quarter of 1999 from $170.9 million in the first
quarter of 1998. The decline in revenue in this segment is primarily due to
lower net investment income, which declined $52.5 million, or 35.8 percent, to
$94.2 million in the first quarter of 1999 from $146.7 million in the first
quarter of 1998. This decline is primarily the result of a decrease in GIC
funds under management from $1,290.6 million as of March 31, 1998, to $422.3
million as of March 31, 1999, resulting from the strategic decision to
discontinue the sale of GICs. Also in this segment, premium income declined
$10.1 million, or 45.5 percent, to $12.1 million in the first quarter of 1999
from $22.2 million in the first quarter of 1998. This decline is primarily due
to the reinsurance of the medical stop-loss and annuity blocks of business.
Income in the Other segment declined $2.6 million, or 18.2 percent, to
$11.7 million in the first quarter of 1999 from $14.3 million in the first
quarter of 1998. Income in the group pension line of business declined to $4.4
million in the first quarter of 1999 from $8.1 million in the first quarter of
1998 primarily due to the result of lower funds under management and lower
income from a reduced amount of capital allocated to this line. Also within
this segment, results from the COLI line of business declined to $4.6 million
in the first quarter of 1999 from $5.4 million in the first quarter of 1998.
Corporate Segment Operating Results
The Corporate segment includes investment earnings on corporate assets not
specifically allocated to a line of business, corporate interest expense,
amortization of goodwill, and certain corporate expenses not allocated to a
line of business.
Revenue in the Corporate segment increased $4.2 million to $7.3 million in
the first quarter of 1999 from $3.1 million in the first quarter of 1998. This
increase is primarily the result of higher net investment income from
unallocated capital and surplus.
The Corporate segment reported a loss of $14.6 million in the first quarter
of 1999 compared to a loss of $11.3 million in the first quarter of 1998.
Interest and debt expense increased to $16.1 million in the first quarter of
1999 from $15.6 million in the first quarter of 1998.
Liquidity and Capital Resources
Cash flows from operations were $199.3 million for the three months ended
March 31, 1999 as compared to $188.2 million in the comparable period in 1998.
The Company believes the cash flow from its operations
22
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.
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 first quarter of 1999. 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.
In November 1998, the Company announced its plans to merge with UNUM, a
leading provider of disability products and other employee benefits, in a
transaction that will create UNUMProvident Corporation. See Note 7 of the
"Notes to Condensed Consolidated Financial Statements" for further discussion.
Investments
Investment activities are an integral part of the Company's business, and
profitability is significantly affected by investment results. Invested assets
are segmented into portfolios, which support the various product lines.
Generally, the investment strategy for the portfolios is to match the
effective asset durations with related expected liability durations and to
maximize investment returns, subject to constraints of quality, liquidity,
diversification, and regulatory considerations.
For the past three years, the Company's exposure to non-current investments
has improved significantly from prior years. 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 $18.8 million at March 31, 1999, or 0.11 percent of
invested assets.
The Company's investment in mortgage-backed securities approximates $1.9
billion on an amortized cost basis at March 31, 1999 and $2.0 billion at
December 31, 1998. At March 31, 1999, the mortgage-backed securities had an
average life of 11.1 years and effective duration of 8.6 years. The mortgage-
backed securities are valued on a monthly basis using valuations supplied by
the brokerage firms that are dealers in these securities. The primary risk
involved in investing in mortgage-backed securities is the uncertainty of the
timing of cash flows from the underlying loans due to prepayment of principal.
The Company uses models which incorporate economic variables and possible
future interest rate scenarios to predict future prepayment rates. The Company
has not invested in mortgage-backed derivatives, such as interest-only,
principal-only or residuals, where market values can be highly volatile
relative to changes in interest rates.
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 March 31, 1999, was $1,367.4 million, representing 8.1 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 $1,366.4 million at December 31, 1998, representing
7.9 percent of invested assets.
The Company utilizes forward interest rate swaps, forward treasury
purchases, and options on forward interest rate swaps to manage duration 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.
23
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 and/or mitigate any such material
adverse effect from year 2000 issues.
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 date 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 have been
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.
24
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--Timeline(1)
4Q 1995 1Q 1996 2Q 1996 3Q 1996 4Q 1996
--------------- --------------- --------------- -------------- --------------------
Business
Applications Impact analysis Initial project Development Pilot
completed plan of applications
developed methodology chosen to
validate
methodology
Project
Office Corporate
awareness
activities
begin
1Q 1997 2Q 1997 3Q 1997 4Q 1997
--------------- --------------- -------------- --------------------
Business Applications Detail project Risk Regression
plan assessments testing begins
developed performed;
inventory
completed
User Developed Systems Inventory Risk assessments
begins completed
Hardware and Software Vendor surveys Vendor Inventory of
initiated management hardware and
program software begins
formalized
Enterprise Computing Future date Upgrade of Definition/analysis/
time machine infrastructure work plan
environment products development/
planning begins begins construction of
in-house system
applications
Business Partners Awareness
campaign
extends to
responses to
external
inquiries
Project Office Documentation Project Office Formalized
and audit formed executive and
process defined board reporting
25
Year 2000 Project--Timeline (Continued)(1)
1Q 1998 2Q 1998 3Q 1998 4Q 1998
----------- -------------- ---------------- -----------------
Business
Applications Construction Full compliance
completed; of business
business applications
applications
begin time
machine
testing
User Developed Systems Systems in Full compliance
construction and of user
testing developed
systems
Hardware and Software Inventory of Standard
field office software
third party configuration
service established
providers
Enterprise Computing Time Certification Full compliance
machine testing of of home office
environment computing infrastructure;
constructed infrastructure network and
at completed telephony
3 sites systems
Business Partners Request for Contingency Contingency Business partner
information planning plans finalized interface testing
sent to process for all critical
electronic defined by business
business critical interfaces
partners business
processes
Project Office Testing Business impact
metrics teams
established formulated
for time
machine
26
Year 2000 Project--Timeline (Continued)(1)
1Q 1999 2Q 1999 3Q 1999 4Q 1999--2000
--------------- ----------------- ------- ----------------
Hardware and Software Contingency
plans
implemented as
required
Enterprise Computing Upgrade and
replacement
of all PC
systems
completed
Business Partners Business Contingency
partner interface plans
testing implemented as
completed required
Project Office Enterprise-- "Rollover" "Rollover" plan
wide plan executed;
integration developed; business and
testing for including information
recertification response systems
begins team response teams
requirements in place
Enterprise--
wide integration
testing for
recertification
completed
- --------
(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 fourth quarter of 1999.
With the exception of GENEX, as of December 31, 1998, the Company had
completed the compliance testing of its material business systems. Compliance
testing was conducted in an isolated, date-forward environment using the
Company's standard of compliance (see above). In March 1999, the Company began
periodically testing its systems in this date-forward environment to ensure
continued compliance into the next century. The first of these tests is
scheduled for completion on May 14, 1999. In addition, the Company has been
scheduling testing of external electronic interfaces with its business
partners.
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 has been 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. Those third parties have been contacted
regarding the testing of electronic interfaces. Project personnel have
identified primary business areas which, based on the status of current
responses from third parties and
27
their risk assessments, have the potential for year 2000 problems. 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 have determined alternatives for contingent
arrangements, and project personnel are considering appropriate documentation
of potential procedural changes by the Company or third party providers. At
this time these include various plans for investments and cash management,
underwriting, client services, workplace management, and claims. With regard
to material relationships, contingency plans are expected to be ready for
execution by the end of second quarter, 1999.
Since inception of the project, the Company has expensed $6.8 million
through March 31, 1999, in connection with incremental cost of the year 2000
project and estimates an additional $1.2 million to complete the project.
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
finalizing appropriate contingency arrangements that will minimize such
impact; however, given the range of possibilities, no assurance can be given
that the Company's efforts will be successful. In addition, the Company is
developing detailed plans for activities for managing the "rollover" event.
This includes plans for appropriate backup of data, year-end schedules,
limiting installations of new code and the availability of special response
groups tasked with identifying and resolving any issues which might occur in
2000. These groups include both information technology and business
professionals.
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 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company is subject to various market risk exposures including interest
rate risk and foreign exchange rate risk. The Company employs various
derivative programs to manage these material market risks. The operations of
the Company are subject to risk resulting from interest rate fluctuations,
primarily long-term U.S.
28
interest rates. Changes in interest rates and individuals' behavior affect the
amount and timing of asset and liability cash flows. Management continually
models and tests 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 within acceptable risk tolerances. This
analysis is the precursor to the Company's activities in derivative financial
instruments. The Company uses interest rate swaps, interest rate forward
contracts, exchange-traded interest rate futures contracts, and options to
hedge interest rate risks and to match asset durations and cash flows with
corresponding liabilities.
The Company is also subject to foreign exchange risk arising from its
Canadian operations and certain Canadian dollar denominated investment
securities. At March 31, 1999, there were no outstanding derivatives hedging
the foreign currency risk. Canadian operations represent 4.6% and 4.5% of
total assets at March 31, 1999 and December 31, 1998, respectively, and 5.1%
of total revenue for the three month periods ended March 31, 1999 and 1998.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" in the Company's 1998 Form 10-K for the qualitative and
quantitative aspects of market risk, including derivative financial instrument
activity. During the first quarter of 1999, there was no substantive change to
the Company's market risk.
REVIEW BY INDEPENDENT AUDITORS
The condensed consolidated financial statements at March 31, 1999, and for
the three months then ended have been reviewed, prior to filing, by Ernst &
Young LLP, the Company's independent auditors, and their report is included
herein.
PART II--OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 15 Letter re: unaudited interim financial information
Exhibit 27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K: None
29
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: June 1, 1999 /s/ J. Harold Chandler
_____________________________________
J. Harold Chandler
Chairman, President and
Chief Executive Officer
Date: June 1, 1999
/s/ Thomas R. Watjen
_____________________________________
Thomas R. Watjen
Vice Chairman and
Chief Financial Officer
30
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
to
FORM 10-Q
PROVIDENT COMPANIES, INC.
31
INDEX OF EXHIBITS
EXHIBIT
-------
Exhibit 15 Letter re: unaudited interim financial information
Exhibit 27 Financial Data Schedule (for SEC use only)
32