EXHIBIT 99.1
FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997 AND FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997, AND 1996, INCLUDING THE AUDITORS' REPORTS THEREON
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Stockholders
UNUMProvident Corporation and Subsidiaries
We have audited the accompanying consolidated statements of financial condition
of UNUMProvident Corporation and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of income, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
The consolidated financial statements give retroactive effect to the merger of
UNUM Corporation and Provident Companies, Inc. on June 30, 1999, which has been
accounted for using the pooling of interests method as described in the notes to
the consolidated financial statements. Our audits also included the financial
statement schedules listed in the index at exhibit 99.4. These financial
statements and schedules are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedules based on our audits. We did not audit the financial statements and
schedules of the former UNUM Corporation which statements reflect total assets
constituting 39% in 1998 and 36% in 1997, and total revenues constituting 54% in
1998, 54% in 1997, and 64% in 1996 of the related consolidated totals. Those
statements and schedules were audited by other auditors whose report has been
furnished to us, and our opinion, in so far as it relates to data included for
the former UNUM Corporation, is based solely on the report of the other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of UNUMProvident
Corporation and subsidiaries at December 31, 1998 and 1997, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 after giving retroactive effect to the merger
of UNUM Corporation, as described in the notes to the consolidated financial
statements, in conformity with generally accepted accounting principles. Also,
in our opinion, based on our audits and the report of other auditors, the
related financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
/s/ ERNST & YOUNG LLP
Chattanooga, Tennessee
August 2, 1999
1
REPORT OF PRICEWATERHOUSECOOPERS LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
UNUMProvident Corporation and Subsidiaries
In our opinion, the consolidated balance sheets and the related consolidated
statements of income, comprehensive income, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of the former
UNUM Corporation and its subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Corporation's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
Portland, Maine
February 2, 1999, except for footnote 19
for which the date is August 2, 1999
2
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UNUMProvident Corporation and Subsidiaries
December 31
1998 1997
(in millions of dollars)
-----------------------------
Assets
Investments
Fixed Maturity Securities
Available-for-Sale - at fair value (amortized cost: $20,581.6; $22,384.4) $22,732.2 $24,346.0
Held-to-Maturity - at amortized cost (fair value: $352.5; $336.6) 307.0 306.8
Equity Securities - at fair value (cost: $24.0; $32.2) 33.1 40.7
Mortgage Loans 1,321.2 1,148.8
Real Estate 309.8 341.9
Policy Loans 2,227.2 2,112.4
Other Long-term Investments 10.4 24.4
Short-term Investments 245.1 182.0
--------- --------
Total Investments 27,186.0 28,503.0
Other Assets
Cash and Bank Deposits 111.2 94.5
Premiums Receivable 570.1 464.8
Reinsurance Receivable 4,871.0 2,428.4
Deposit Assets 729.7 688.3
Accrued Investment Income 502.5 523.5
Deferred Policy Acquisition Costs 2,060.5 1,757.4
Value of Business Acquired 570.5 699.0
Goodwill 814.7 856.8
Property and Equipment - at cost less accumulated depreciation 367.8 305.4
Miscellaneous 405.2 378.5
Separate Account Assets 413.0 340.5
--------- ---------
Total Assets $38,602.2 $37,040.1
========= =========
See notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION- Continued
UNUMProvident Corporation and Subsidaries
December 31
1998 1997
(in millions of dollars)
------------------------------------
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,384.9 $ 1,276.5
Reserves for Future Policy and Contract Benefits 22,271.7 20,704.0
Unearned Premiums 219.0 219.7
Other Policyholders' Funds 4,102.7 5,332.9
Federal Income Tax
Current 105.8 61.0
Deferred 864.0 646.0
Short-term Debt 323.7 277.3
Long-term Debt 1,225.2 1,240.0
Other Liabilities 1,246.0 1,228.1
Separate Account Liabilities 413.0 340.5
--------- ---------
Total Liabilities 32,156.0 31,326.0
--------- ---------
Commitments and Contingent Liabilities--Note 17
Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debt Securities of the Company 300.0 -
--------- ---------
Stockholders' Equity--Note 11
Preferred Stock - 156.2
Common Stock, $0.10 par
Authorized: 725,000,000 shares
Issued: 237,802,647 and 236,938,872 shares 23.8 23.7
Additional Paid-in Capital 959.2 954.8
Accumulated Other Comprehensive Income
Net Unrealized Gains on Securities 969.4 835.7
Foreign Currency Translation Adjustment (54.7) (36.7)
Retained Earnings 4,279.2 3,797.7
Treasury Stock - at cost: 176,295 and 29,346 shares (9.2) (1.5)
Deferred Compensation (21.5) (15.8)
-------- --------
Total Stockholders' Equity 6,146.2 5,714.1
-------- --------
Total Liabilities and Stockholders' Equity $38,602.2 $37,040.1
========= =========
See notes to consolidated financial statements.
4
CONSOLIDATED STATEMENTS OF INCOME
UNUMProvident Corporation and Subsidiaries
Year Ended December 31
1998 1997 1996
(in millions of dollars, except share data)
-----------------------------------------------
Revenue
Premium Income $6,129.0 $5,293.1 $4,288.8
Net Investment Income 2,035.4 2,015.7 1,893.4
Net Realized Investment Gains (Losses) 55.0 11.5 (5.2)
Other Income 299.9 357.0 148.2
-------- -------- --------
Total Revenue 8,519.3 7,677.3 6,325.2
-------- -------- --------
Benefits and Expenses
Policyholder Benefits 5,449.7 4,856.1 4,165.6
Commissions 826.5 716.2 555.2
Interest and Debt Expense 119.9 84.9 58.5
Deferral of Policy Acquisition Costs (703.3) (537.3) (406.1)
Amortization of Deferred Policy Acquisition Costs 377.5 301.3 289.4
Amortization of Value of Business Acquired and Goodwill 66.6 52.7 7.7
Other Operating Expenses 1,462.2 1,286.7 1,087.1
-------- -------- --------
Total Benefits and Expenses 7,599.1 6,760.6 5,757.4
-------- -------- --------
Income Before Federal Income Taxes 920.2 916.7 567.8
Federal Income Taxes
Current 128.3 192.3 219.7
Deferred 174.5 106.8 (35.5)
-------- -------- --------
Total Federal Income Taxes 302.8 299.1 184.2
-------- -------- --------
Net Income $ 617.4 $ 617.6 $ 383.6
======== ======== ========
Earnings Per Common Share - Basic $ 2.60 $ 2.62 $ 1.75
Earnings Per Common Share - Assuming Dilution $ 2.54 $ 2.57 $ 1.72
See notes to consolidated financial statements.
5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
UNUMProvident Corporation and Subsidiaries
Accumulated
Additional Other
Preferred Common Paid-in Comprehensive Retained Treasury Deferred
Stock Stock Capital Income Earnings Stock Compensation Total
(in millions of dollars)
---------------------------------------------------------------------------------------------
Balance at December 31, 1995 $ 156.2 $10.6 $ 447.2 $ 287.1 $3,061.0 $ - $ (6.9) $3,955.2
Comprehensive Income
Net Income 383.6 383.6
Change in Net Unrealized Gains
on Securities (net of tax credit
of $45.2) (141.8) (141.8)
Change in Foreign Currency
Translation Adjustment (net of
tax credit of $0.1) 21.5 21.5
--------
Total Comprehensive Income 263.3
--------
Common Stock Activity (0.1) (79.5) (3.7) (83.3)
Dividends to Stockholders (133.5) (133.5)
------- ----- ------- ------- -------- ----- ------- --------
Balance at December 31, 1996 156.2 10.5 367.7 166.8 3,311.1 - (10.6) 4,001.7
Comprehensive Income
Net Income 617.6 617.6
Change in Net Unrealized Gains
on Securities (net of tax
of $351.0) 662.5 662.5
Change in Foreign Currency
Translation Adjustment (net of
tax credit of $7.8) (30.3) (30.3)
--------
Total Comprehensive Income 1,249.8
--------
Shares Issued for the Acquisition
of Business 1.5 736.0 737.5
Two-for-One Stock Split 11.9 (11.9) -
Common Stock Activity (0.2) (137.0) (5.2) (142.4)
Treasury Stock Acquired (1.5) (1.5)
Dividends to Stockholders (131.0) (131.0)
------- ----- ------- ------- -------- ----- ------- --------
Balance at December 31, 1997 156.2 23.7 954.8 799.0 3,797.7 (1.5) (15.8) 5,714.1
Comprehensive Income
Net Income 617.4 617.4
Change in Net Unrealized Gains
on Securities (net of tax expense
of $67.2) 133.7 133.7
Change in Foreign Currency
Translation Adjustment (net of
tax credit of $7.8) (18.0) (18.0)
--------
Total Comprehensive Income 733.1
--------
Preferred Stock Redeemed (156.2) (156.2)
Common Stock Activity 0.1 4.4 (5.7) (1.2)
Treasury Stock Acquired (7.7) (7.7)
Dividends to Stockholders (135.9) (135.9)
------- ----- ------- ------- -------- ----- ------ --------
Balance at December 31, 1998 $ $23.8 $ 959.2 $ 914.7 $4,279.2 $(9.2) $(21.5) $6,146.2
======= ===== ======= ======= ======== ===== ====== ========
See notes to consolidated financial statements.
6
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNUMProvident Corporation and Subsidiaries
Year Ended December 31
1998 1997 1996
(in millions of dollars)
------------------------------------------------
Cash Flows from Operating Activities
Net Income $ 617.4 $ 617.6 $ 383.6
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities
Policy Acquisition Costs Capitalized (703.3) (537.3) (406.1)
Amortization of Policy Acquisition Costs 377.5 301.3 289.4
Amortization of Value of Business Acquired and Goodwill 66.6 52.7 7.7
Depreciation 35.1 38.8 39.9
Net Realized Investment (Gains) Losses (55.0) (11.5) 5.2
Reinsurance Receivable (48.9) (233.1) (754.2)
Insurance Reserves and Liabilities 1,475.4 1,322.4 1,289.8
Federal Income Taxes 211.5 76.3 8.5
Other (257.0) (294.3) 63.4
--------- --------- ---------
Net Cash Provided by Operating Activities 1,719.3 1,332.9 927.2
--------- --------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments
Available-for-Sale Securities 2,117.3 2,524.7 4,107.0
Proceeds from Maturities of Investments
Available-for-Sale Securities 1,513.1 1,628.2 1,890.9
Held-to-Maturity Securities 0.5 1.1 100.5
Proceeds from Sales and Maturities of Other Investments 217.7 623.7 450.4
Purchase of Investments
Available-for-Sale Securities (3,849.2) (4,264.9) (3,521.6)
Held-to-Maturity Securities (1.9) (23.4) (48.6)
Other Investments (532.7) (410.7) (440.5)
Net (Purchases) Sales of Short-term Investments (67.9) 403.8 (1,085.4)
Acquisition of Business - (860.3) -
Disposition of Business 58.0 - -
Other (73.3) (45.3) (129.8)
--------- --------- ---------
Net Cash Provided (Used) by Investing Activities $ (618.4) $ (423.1) $ 1,322.9
--------- --------- ---------
See notes to consolidated financial statements.
7
CONSOLIDATED STATEMENTS OF CASH FLOWS-Continued
UNUMProvident Corporation and Subsidairies
Year Ended December 31
1998 1997 1996
(in millions of dollars)
-------------------------------------------------------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts $ 184.3 $ 813.8 $ 989.6
Maturities and Benefit Payments from
Policyholder Accounts (1,250.7) (2,409.1) (2,927.6)
Net Short-term Debt Borrowings (Repayments) (74.5) 140.1 (43.7)
Issuance of Long-term Debt 900.0 893.3 200.0
Long-term Debt Repayments (793.1) (347.6) (215.0)
Issuance of Company-Obligated Mandatorily
Redeemable Preferred Securities 300.0 - -
Redemption of Preferred Stock (156.2) - -
Issuance of Common Stock 11.9 389.8 5.8
Dividends Paid to Stockholders (139.1) (139.2) (125.3)
Repurchase of Common Stock (72.7) (286.7) (119.1)
Other 4.6 34.8 15.4
--------- --------- ---------
Net Cash Used by Financing Activities (1,085.5) (910.8) (2,219.9)
--------- --------- ---------
Effect of Foreign Exchange Rate Changes on Cash 1.3 (1.7) (0.3)
--------- --------- ---------
Net Increase (Decrease) in Cash and Bank Deposits 16.7 (2.7) 29.9
Cash and Bank Deposits at Beginning of Year 94.5 97.2 67.3
--------- --------- ---------
Cash and Bank Deposits at End of Year $ 111.2 $ 94.5 $ 97.2
========= ========= =========
See notes to consolidated financial statements.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies
Basis of Presentation: The accompanying consolidated financial statements have
been restated to give retroactive effect to the merger of UNUM Corporation
(UNUM) and Provident Companies, Inc. (Provident) which occurred on June 30, 1999
and was accounted for as a pooling of interests. While the consummation date of
the merger was subsequent to the date of these financial statements, the
consolidated financial statements reported herein give effect to the merger as
if it had been completed at the beginning of the earliest period presented.
The Company values its available-for-sale fixed maturity and equity securities
at fair value, with unrealized holding gains and losses reported as a component
of comprehensive income. Companies are required to also adjust deferred
acquisition costs and/or certain policyholder liabilities to reflect the changes
that would have been necessary if the unrealized investment gains and losses
related to the available-for-sale securities had been realized. Prior to the
merger, UNUM adjusted policyholder liabilities and Provident adjusted deferred
policy acquisition costs (DPAC) and value of business acquired (VOBA) for those
products where these assets existed. To present financial information in a
common reporting format, management has determined that the combined entity will
adjust policyholder liabilities rather than DPAC and VOBA. Prior period
financial statements have been restated to reflect this reclassification. The
reclassification did not change other comprehensive income, accumulated other
comprehensive income, or fixed maturity and equity securities. The
reclassification reflected in the December 31, 1998 consolidated statement of
financial condition resulted in an increase of $329.7 million in DPAC, $1.5
million in VOBA, and, $331.2 million in reserves for future policy and contract
benefits. The reclassification reflected in the December 31, 1997 consolidated
statement of financial condition resulted in an increase of $362.8 million in
DPAC, $59.6 million in VOBA, and, $422.4 million in reserves for future policy
and contract benefits. Certain additional reclassification adjustments have been
made to conform the companies' presentations in the consolidated financial
statements.
The accompanying consolidated financial statements have been prepared on the
basis of generally accepted accounting principles. Such accounting principles
differ from statutory accounting practices prescribed or permitted by state
regulatory authorities (see Note 18). The consolidated financial statements
include the accounts of UNUMProvident Corporation and its subsidiaries. Material
intercompany transactions have been eliminated.
Operations: The Company does business primarily in North America and operates
principally in the life and health insurance business. The Employee Benefits
segment includes group long-term and short-term disability insurance, group life
insurance, accidental death and dismemberment coverages, group long-term care,
and the results of managed disability. The Individual segment includes results
from the individual disability, individual life, and individual long-term care
lines of business. The Voluntary Benefits segment includes the results of
products sold to employees through payroll deduction at the work site. These
products include life insurance and health products, primarily disability,
accident and sickness, and cancer. The Other operating segment includes results
from reinsurance pools and management and other products no longer actively
marketed, including corporate-owned life insurance, group pension, health
insurance, and individual annuities. 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. See Note 14 for further
information on the operating segments.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect amounts reported in the financial statements and
accompanying notes. Such estimates and assumptions could change in the future
as more information becomes known, which could impact the amounts reported and
disclosed herein.
Investments: Investments are reported in the consolidated statements of
financial condition as follows:
Available-for-Sale Fixed Maturity Securities are reported at fair value.
Held-to-Maturity Fixed Maturity Securities are generally reported at amortized
cost.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Equity Securities are reported at fair value.
Mortgage Loans are generally carried at amortized cost less an allowance for
probable losses.
Real Estate classified as investment real estate is carried at cost less
accumulated depreciation. Real estate acquired through foreclosure is valued at
fair value at the date of foreclosure. If investment real estate is determined
to be permanently impaired, the carrying amount of the asset is reduced to fair
value. Occasionally, investment real estate is reclassified to real estate held
for sale when it no longer meets the Company's investment criteria. Real estate
held for sale is valued net of a valuation allowance that reduces the carrying
value to the lower of cost less accumulated depreciation or fair value less
estimated cost to sell. Accumulated depreciation on real estate was $48.5
million and $53.8 million as of December 31, 1998 and 1997, respectively.
Policy Loans are presented at unpaid balances.
Other Long-term Investments are carried at cost plus the Company's equity in
undistributed net earnings since acquisition.
Short-term Investments are carried at cost.
Fixed maturity securities include bonds and redeemable preferred stocks. Equity
securities include common stocks and nonredeemable preferred stocks. Fixed
maturity and equity securities not bought and held for the purpose of selling in
the near term but for which the Company does not have the positive intent and
ability to hold to maturity are classified as available-for-sale. Fixed
maturity securities that the Company has the positive intent and ability to hold
to maturity are classified as held-to-maturity. The Company determines the
appropriate classification of fixed maturity securities at the time of purchase.
Changes in the fair value of available-for-sale fixed maturity securities and
equity securities are reported as other comprehensive income. These amounts are
net of deferred federal income taxes and valuation adjustments to reserves for
future policy and contract benefits which would have been recorded had the
related unrealized gains or losses on these securities been realized.
Realized investment gains and losses, which are reported as a component of
revenue in the consolidated statements of income, are based upon specific
identification of the investments sold and do not include amounts allocable to
separate accounts. At the time a decline in the value of an investment is
determined to be other than temporary, a loss is recorded which is included in
realized investment gains and losses.
The Company discontinues the accrual of investment income on invested assets
when it is determined that collectability is doubtful. The Company recognizes
investment income on impaired loans when the income is received.
Derivative Financial Instruments: Interest Rate Swap Agreements are agreements
in which two parties agree to exchange, at specified intervals, interest payment
streams calculated on an agreed-upon notional principal amount with at least one
stream based on a specified variable rate. The underlying notional principal is
not exchanged between the parties. The Company has certain forward interest
rate swap agreements where the exchange of interest payments does not begin
until a specified future date. The Company intends to settle the forward
interest rate swap agreements prior to the commencement of the exchange of
interest payment streams.
The fair values of interest rate swap agreements which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of interest rate swap
agreements which hedge liabilities are not reported in the consolidated
statements of financial condition. Amounts to be paid or received pursuant to
interest rate swap agreements are accrued and recognized in the consolidated
statements of income as an adjustment to net investment income for asset hedges
or as an adjustment to policyholder benefits for liability hedges.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
The Company accounts for all of its interest rate swap agreements as hedges.
Accordingly, any gains or losses realized on closed or terminated interest rate
swap agreements are deferred and amortized to net investment income for asset
hedges or policyholder benefits for liability hedges over the expected remaining
life of the hedged item. If the hedged item matures or terminates earlier than
anticipated, the remaining unamortized gain or loss is amortized to net
investment income or policyholder benefits in the current period. If the hedged
asset is disposed, the remaining unamortized gain or loss is recognized as an
adjustment to net realized investment gains and losses. Gains or losses realized
on interest rate swap agreements which are terminated when the hedged assets are
sold or which are terminated because the hedged anticipated transaction is no
longer likely to occur are reported in the consolidated statements of income as
a component of net realized investment gains and losses. The Company regularly
monitors the effectiveness of its hedging programs. In the event a hedge becomes
ineffective, it is marked-to-market, resulting in a charge or credit to net
investment income or policyholder benefits.
Futures and Forwards Contracts are commitments to either purchase or sell a
financial instrument at a specific future date for a specified price. The
Company invests only in futures and forwards contracts which have U.S. Treasury
securities as the underlying investments. Changes in the market value of
contracts are generally settled on a daily basis. The notional amounts of
futures and forwards contracts represent the extent of the Company's involvement
but not the future cash requirements, as the Company intends to close out open
positions prior to settlement. All of the Company's futures and forwards
contracts are accounted for as hedges.
The fair values of futures and forwards which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of open futures and
forwards which hedge liabilities are reported in the consolidated statements of
financial condition as a component of other liabilities. Gains or losses
realized on the termination of futures and forwards contracts are accounted for
in the same manner as interest rate swap agreements.
Option Contracts give the owner the right, but not the obligation, to buy or
sell a financial instrument at an agreed-upon price on or before a specific
date. The purchasing counterparty pays a premium to the selling counterparty
for this right. The notional amounts of contracts represent the Company's
involvement but not the future cash requirements, as the Company intends to
close out contracts prior to the expiration date when the market price of the
underlying financial instrument exceeds the option price or allow contracts to
expire if the option price exceeds the market price. All of the Company's
options contracts are accounted for as hedges. The book and fair values of
options contracts are reported in the consolidated statements of financial
condition in a manner similar to the underlying hedged item. Gains or losses on
the termination of options contracts are accounted for in the same manner as
interest rate swap agreements.
Deferred Policy Acquisition Costs: Certain costs of acquiring new business
which vary with and are primarily related to the production of new business have
been deferred. Such costs include commissions, other agency compensation,
certain selection and policy issue expenses, and certain field expenses.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing subsequent to the year of
issue.
Deferred policy acquisition costs related to traditional policies are amortized
over the premium paying period of the related policies in proportion to the
ratio of the present value of annual expected premium income to the present
value of total expected premium income. Adjustments are made each year to
recognize actual persistency experience as compared to assumed experience.
Deferred policy acquisition costs related to interest-sensitive policies are
amortized over the lives of the policies in relation to the present value of
estimated gross profits from surrender charges and mortality, investment, and
expense margins. Adjustments are made each year to reflect actual experience
for assumptions which deviate significantly compared to assumed experience.
Deferred policy acquisition costs for the Lloyd's of London (Lloyd's) business
are amortized proportionately over the period the premium is earned.
Adjustments are made periodically to reflect actual experience for assumptions
which deviate significantly compared to assumed experience.
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Loss recognition is performed when, in the judgment of management, adverse
deviations from original assumptions have occurred and may be likely to
continue such that recoverability of deferred policy acquisition costs on a line
of business is questionable. Insurance contracts are grouped on a basis
consistent with the Company's manner of acquiring, servicing, and measuring
profitability of the contracts. If loss recognition testing indicates that
deferred policy acquisition costs are not recoverable, the deficiency is charged
to expense. Once a loss recognition adjustment is required, loss recognition
testing is generally performed on an annual basis using then current assumptions
until the line of business becomes immaterial or results improve significantly.
The assumptions used in loss recognition testing represent management's best
estimates of future experience.
Value of Business Acquired: Value of business acquired represents the present
value of future profits recorded in connection with the acquisition of a block
of insurance policies. The asset is amortized based upon expected future
premium income for traditional insurance policies and estimated future gross
profits for interest-sensitive insurance policies, with the accrual of interest
added to the unamortized balance at interest rates principally ranging from
5.55% to 7.60%. The Company periodically reviews the carrying amount of value
of business acquired using the same methods used to evaluate deferred policy
acquisition costs.
Goodwill: Goodwill is the excess of the amount paid to acquire a business over
the fair value of the net assets acquired. Goodwill is amortized on a straight-
line basis over a period not to exceed 40 years. The accumulated amortization
for goodwill was $63.8 million and $40.5 million as of December 31, 1998 and
1997, respectively. The carrying amount of goodwill is regularly reviewed for
indicators of impairment in value.
Property and Equipment: Property and equipment is depreciated on the straight-
line method over its estimated useful life. The accumulated depreciation for
property and equipment was $284.3 million and $252.4 million as of December 31,
1998 and 1997, respectively.
Revenue Recognition: Traditional life and accident and health products are long
duration contracts, and premium income is recognized as revenue when due from
policyholders. If the contracts are experience rated, the estimated ultimate
premium is recognized as revenue over the period of the contract. The estimated
ultimate premium, which is revised to reflect current experience, is based on
estimated claim costs, expenses, and profit margins. For interest-sensitive
products, the amounts collected from policyholders are considered deposits, and
only the deductions during the period for cost of insurance, policy
administration, and surrenders are included in revenue. Policyholders' funds
represent funds deposited by contract holders and are not included in revenue.
The Company follows the periodic method of accounting for its Lloyd's business
in which premiums are recognized as revenue over the policy term, and claims,
including an estimate of claims incurred but not reported, are recognized as
they occur. Premiums for the Lloyd's business are based on participation in the
individual syndicate underwriting years that generate premiums over a three year
period of time. The Company has participated in the Lloyd's market for a number
of years and uses its historical experience plus information obtained from its
managing agents to estimate revenues, losses, expenses, and the related assets
and liabilities. Additionally, an independent actuarial review of the
syndicates' open reserves is performed annually, and management periodically
reviews its estimates as information is received from the Lloyd's syndicates.
Any resulting adjustments to the estimates are reflected in the current results.
Policy and Contract Benefits: Policy and contract benefits, principally related
to accident and health insurance policies, are based on reported losses and
estimates of incurred but not reported losses for traditional life and accident
and health products. For interest-sensitive products, benefits are the amounts
paid and expected to be paid on insured claims in excess of the policyholders'
policy fund balances.
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Policy and Contract Benefits Liabilities: Active life reserves for future
policy and contract benefits on traditional life and accident and health
products have been provided on the net level premium method. The reserves are
calculated based upon assumptions as to interest, withdrawal, morbidity, and
mortality that were appropriate at the date of issue. Withdrawal assumptions are
based on actual Company experience. Morbidity and mortality assumptions are
based upon industry standards adjusted as appropriate to reflect actual Company
experience. The assumptions vary by plan, year of issue, and policy duration and
include a provision for adverse deviation.
Disabled lives reserves for future policy and contract benefits on disability
policies are calculated based upon assumptions as to interest and claim
termination rates that are currently appropriate. Claim termination rate
assumptions are based upon industry standards adjusted as appropriate to reflect
actual Company experience. The assumptions vary by year of claim incurral and
may include a provision for adverse deviation. The interest rate assumptions
used for discounting Provident's claim reserves are based on projected portfolio
yield rates, after consideration for defaults and investment expenses, for the
assets supporting the liabilities for the various product lines. The assets for
each product line are selected according to the specific investment strategy for
that product line to produce asset cash flows that follow similar timing and
amount patterns to those of the anticipated liability payments. The interest
rate assumptions used for discounting UNUM's claim reserves are based on the
same investment strategy for assets backing both liabilities and surplus. While
UNUM's and Provident's historical methods for calculating the discount rate for
disability claim reserves are both in accordance with generally accepted
accounting principles, management believes that the combined entity should have
consistent discount rate accounting policies and methods for applying these
policies for similar products. Accordingly on June 30, 1999, subsequent to the
date of the consolidated financial statements presented herein and in
conjunction with the merger, the Company adopted Provident's method of
calculating the discount rate for claim reserves. See Note 2.
Reserves for future policy and contract benefits on group single premium
annuities have been provided on a net single premium method. The reserves are
calculated based upon assumptions as to interest, mortality, and retirement that
were appropriate at the date of issue. Mortality assumptions are based upon
industry standards adjusted as appropriate to reflect actual Company experience.
The assumptions vary by year of issue and include a provision for adverse
deviation.
The interest rate assumptions used to calculate reserves for future policy and
contract benefits are as follows:
December 31
1998 1997
-----------------------------------------------------------------
Active Life Reserves - Current Year Issues
Traditional Life 6.75% to 8.75% 7.25% to 10.00%
Individual Disability 6.00% to 9.00% 6.00% to 9.00%
Disabled Lives Reserves - Current Year Claims
Individual Disability 5.50% to 8.00% 5.50% to 8.00%
Group Disability 7.40% to 8.95% 6.50% to 9.27%
Disabled Lives Reserves - Prior Year Claims
Individual Disability 5.50% to 8.00% 5.50% to 8.00%
Group Disability 7.40% to 7.60% 3.90% to 8.90%
Interest assumptions for active life reserves are generally graded downward over
a period of years. Reserves for future policy and contract benefits on
interest-sensitive products are principally policyholder account values
determined on the retrospective deposit method.
Policyholders' Funds: Policyholders' funds represent customer deposits plus
interest credited at contract rates. The Company controls its interest rate
risk by investing in quality assets which have an aggregate duration that
closely matches the expected duration of the liabilities. For guaranteed
investment contracts (GICs), which are no longer marketed, the Company uses a
cash flow matching investment strategy.
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Liabilities for Restructuring Activities: Liabilities for restructuring
activities are recorded when management, prior to the balance sheet date,
commits to execute an exit plan that will result in the incurral of costs that
have no future economic benefit or approves a plan of termination and
communicates sufficient detail of the plan to employees. Liabilities for
restructuring activities are included in other liabilities in the consolidated
statements of financial condition.
Federal Income Taxes: Deferred taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
statement purposes and the amounts used for income tax purposes. Deferred taxes
have been measured using enacted statutory income tax rates and laws that are
currently in effect. A valuation allowance is established for deferred tax
assets when it is more likely than not that an amount will not be realized.
Separate Accounts: The separate account amounts shown in the accompanying
consolidated financial statements represent contributions by contract holders to
variable-benefits and fixed-benefits pension plans. The contract purchase
payments and the assets of the separate accounts are segregated from other
Company funds for both investment and administrative purposes. Contract purchase
payments received under variable annuity contracts are subject to deductions for
sales and administrative fees. Also, the sponsoring company of the separate
accounts receives management fees which are based on the net asset values of the
separate accounts.
Translation of Foreign Currency: Revenues and expenses of the Company's foreign
operations, principally Canada and the United Kingdom, are translated at average
exchange rates. Assets and liabilities are translated at the rate of exchange
on the balance sheet date. The translation gain or loss is generally reported
in accumulated other comprehensive income, net of deferred tax.
Accounting for Participating Individual Life Insurance: Participating policies
issued by the former Union Mutual Life Insurance Company (Union Mutual) prior to
its conversion to a stock life insurance company in 1986 will remain
participating as long as they remain in force. A Participation Fund Account
(PFA) was established for the benefit of all of Union Mutual's individual
participating life and annuity policies and contracts. The assets of the PFA
provide for the benefit, dividend, and certain expense obligations of the
participating individual life insurance policies and annuity contracts. The
experience of the PFA and its operations have been excluded from the
consolidated statements of income. The PFA was $371.1 million and $367.3 million
at December 31, 1998, and 1997, respectively, and represented approximately 1.0%
of consolidated assets and 1.2% of consolidated liabilities for both December
31, 1998 and 1997.
Changes in Accounting Principles:
Statement of Financial Accounting Standards No. 130 (SFAS 130), Reporting
Comprehensive Income
In 1998, the Company adopted the provisions of SFAS 130 which establish
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.
The adoption of SFAS 130 had no impact on the Company's net income or
stockholders' equity.
Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures
about Segments of an Enterprise and Related Information
In 1998, the Company adopted the provisions of SFAS 131 which establish
standards for reporting information for segments of a business enterprise. See
Note 14 for further discussion of operating segments. The adoption of SFAS 131
did not have an effect on the Company's financial position or results of
operations.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Statement of Financial Accounting Standards No. 132 (SFAS 132), Employers'
Disclosures about Pensions and Other Postretirement Benefits
In 1998, the Company adopted the provisions of SFAS 132 which revise employers'
disclosures about pension and other postretirement benefit plans. It
standardizes the disclosure requirements for pensions and other postretirement
benefits to the extent practicable, requires additional information on changes
in the benefit obligations and fair values of plan assets that will facilitate
financial analysis, and eliminates certain disclosures required by Statements of
Financial Accounting Standards No. 87, Employers' Accounting for Pensions, No.
88, Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits, and No. 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions. Disclosures for prior periods
have been restated for comparative purposes (see Note 10). The adoption of SFAS
132 had no effect on the Company's financial position or results of operations.
Statement of Financial Accounting Standards No. 125 (SFAS 125), Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities
In 1997, the Company adopted the provisions of SFAS 125 which provide accounting
and reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial-components approach that focuses on control. SFAS
125 also establishes new rules for determining whether a transfer of financial
assets constitutes a sale and, if so, the determination of any resulting gain or
loss. The adoption of SFAS 125 did not have a material effect on the Company's
financial position or results of operations.
Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings Per
Share
In 1997, the Company adopted the provisions of SFAS 128 which establish
computation and reporting standards for earnings per share. SFAS 128 simplifies
the standards for computing earnings per share and makes them comparable to
international earnings per share standards. SFAS 128 requires dual presentation
on the face of the income statement of earnings per share and earnings per share
assuming dilution and requires a reconciliation of the numerator and denominator
of the earnings per share computation to the numerator and denominator of the
earnings per share assuming dilution computation (see Note 11). Earnings per
share is computed using the weighted average number of common shares outstanding
and does not consider any potential dilution. Earnings per share assuming
dilution reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity. Historical earnings per common share amounts have been restated in
accordance with the provisions of SFAS 128.
Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for
Stock-Based Compensation
SFAS 123 defines a fair value based method of accounting for stock-based
employee compensation plans. Under this method, compensation cost is measured
at the grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. SFAS 123 also allows an
entity to continue to measure compensation cost using the intrinsic value based
method of accounting prescribed by Accounting Principles Board Opinion No. 25
(Opinion 25), Accounting for Stock Issued to Employees. Under this method,
compensation cost is the excess, if any, of the quoted market price of the stock
at grant date or other measurement date over the amount an employee must pay to
acquire the stock. The Company adopted the provisions of SFAS 123 in 1996 (see
Note 12), but elected to continue to measure compensation cost for stock-based
compensation under the expense recognition provisions of Opinion 25. The
adoption of SFAS 123, therefore, did not have an effect on the Company's
financial position or results of operations.
Accounting Pronouncements Outstanding:
Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for
Derivative Instruments and Hedging Activities
In 1998, the FASB issued SFAS 133 which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. SFAS 133 specifies a special method of
accounting for certain hedging transactions, prescribes the type of items and
transactions that may be hedged, and provides the criteria which must be met in
order to qualify for hedge accounting.
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
The accounting for changes in the fair value of a derivative depends on the
intended use of the derivative and the resulting designation as follows:
Fair value hedge. Changes in the fair value of both the derivative and the
hedged item attributable to the risk being hedged are recognized in income.
Cash flow hedge. To the extent it is effective, changes in the fair value
of the derivative are recognized as a component of accumulated other
comprehensive income in stockholders' equity until the hedged item affects
earnings. Any ineffective portion must be recognized in income at the same
time the change in fair value is recognized on the statement of financial
condition.
Foreign currency exposures hedge. In a hedge of foreign currency exposures
in a net investment in a foreign operation, to the extent the hedge is
effective, the change in the fair value of the derivative is treated as a
translation gain or loss and recognized in accumulated other comprehensive
income offsetting other translation gains and losses arising in
consolidation. Any ineffective portion must be recognized in income at the
same time the change in fair value of the derivative is recognized on the
statement of financial condition.
For a derivative not designated as a hedging instrument, the gain or loss is
recognized in income in the period of change.
Subsequent to the date of the consolidated financial statements presented
herein, Statement of Financial Accounting Standards No. 137 (SFAS 137),
Accounting for Derivative Instruments and Hedging Activities--Deferral of the
Effective Date of FASB Statement No. 133 was issued in June 1999. SFAS 137
defers for one year the effective date of SFAS 133. The Company plans to adopt
the provisions of SFAS 133 effective January 1, 2001. At this time the Company
has not determined the effects that adoption of SFAS 133 will have on its
financial statements.
Statement of Position 98-1 (SOP 98-1), Accounting for the Costs of Computer
Software Developed for or Obtained for Internal Use
In 1998, the American Institute of Certified Public Accountants (AICPA) issued
SOP 98-1 which requires the capitalization of certain costs incurred in
connection with developing or obtaining software for internal use. SOP 98-1 is
to be applied prospectively from the date of adoption. Subsequent to the
consolidated financial statements presented herein, the Company fully adopted
the provisions of SOP 98-1 effective January 1, 1999. The adoption did not have
a material effect on the Company's financial position or results of operations.
Statement of Position 98-7 (SOP 98-7), Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk
In 1998, the America Institute of Certified Public Accountants (AICPA) issued
SOP 98-7, which provides guidance on applying the deposit method of accounting
to insurance and reinsurance contracts that do not transfer insurance risk. The
Company is required to adopt SOP 98-7 effective January 1, 2000. Previously
issued financial statements should not be restated unless the SOP is adopted
prior to the effective date and during an interim period. The adoption of SOP
98-7 is not expected to have a material impact on the Company's results of
operations, liquidity, or financial position.
Statement of Position 97-3 (SOP 97-3), Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments
In 1997, the AICPA issued SOP 97-3 which provides guidance for determining when
an entity should recognize a liability or an asset for insurance-related
assessments and how to measure these items. Subsequent to the consolidated
financial statements presented herein, the Company adopted the provisions of SOP
97-3 effective January 1, 1999. The adoption did not have a material effect on
the Company's financial position or results of operations.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 2--Merger
On November 22, 1998, Provident and UNUM entered into a merger agreement,
pursuant to which on June 30, 1999 UNUM merged with and into Provident under the
name UNUMProvident Corporation. On June 30, 1999, prior to the completion of the
merger, each outstanding share of Provident common stock was reclassified and
converted into 0.73 of a share of Provident common stock. Immediately after this
reclassification, the merger was completed, and each share of UNUM common stock
issued and outstanding immediately prior to the merger was converted into one
share of the Company's common stock, and the par value was reduced from $1.00 to
$0.10 per share. In the merger, the shares of Provident common stock were not
further affected, but thereafter became shares of the Company's common stock.
UNUM common stock held in treasury was retired. Stockholders' equity and per
share amounts have been adjusted to reflect that these items were completed at
the beginning of the earliest period presented.
Subsequent to the date of the consolidated financial statements presented
herein, the Company in the second quarter of 1999 recorded expenses related to
the merger and the early retirement offer to employees. These expenses related
to the merger and the early retirement offers to employees have not been
reflected in these consolidated financial statements. The expenses related to
the merger and the early retirement offer are as follows (in millions):
Employee related expense $ 45.2
Exit activities related to duplicate facilities/asset abandonments 57.4
Investment banking, legal, and accounting fees 39.6
------
Subtotal 142.2
Expense related to the early retirement offer to employees 125.9
------
Subtotal 268.1
Income tax benefit 74.3
------
Total $193.8
======
Employee related expense consists of employee severance costs, restricted stock
costs which fully vested upon stockholder adoption of the merger agreement or
upon completion of the merger, and outplacement costs to assist employees who
have been involuntarily terminated. Severance benefits and costs associated
with the vesting of restricted stock are $27.7 million and $17.5 million,
respectively. The Company currently estimates that in total approximately 1,400
positions will be eliminated over a twelve month period beginning June 30, 1999,
with an estimated 1,000 of these positions eliminated through the early
retirement offer.
Exit activities related to duplicate facilities/asset abandonments consist of
closing of duplicate offices and write-off of redundant computer hardware and
software. The Company currently expects to close approximately 90 duplicate
field offices over a period of one year after June 30, 1999, the completion date
of the merger. The cost associated with these office closures is approximately
$25.6 million, which represents the cost of future minimum lease payments less
any estimated amounts recovered under subleases. Also, the total book value of
physical assets, primarily computer equipment, redundant systems, and systems
incapable of supporting the combined entity, are being abandoned as a result of
the merger. This abandonment resulted in a write-down of the assets' book values
by approximately $31.8 million.
The expenses related to the merger reduced second quarter 1999 earnings $142.2
million before tax and $112.0 million after tax. The expense related to the
early retirement offer reduced second quarter 1999 earnings $125.9 million
before tax and $81.8 million after tax.
Additionally during the second quarter of 1999 and subsequent to date of the
supplemental consolidated financial statements presented herein, 546,362 shares
of outstanding restricted stock became unrestricted and stock options on
5,301,683 shares became immediately exercisable effective with the merger in
accordance with Provident's and UNUM's restricted stock and stock option plan
provisions concerning a change in control. The expense related to restricted
stock vesting has been included in merger-related expenses discussed above. The
Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations in accounting for the stock
option plans. Accordingly, no compensation cost was recognized for stock option
vesting.
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 2--Merger - Continued
Prior to the merger, UNUM's process and assumptions used to calculate the
discount rate for claim reserves of certain disability businesses differed from
that used by Provident. While UNUM's and Provident's methods were both in
accordance with generally accepted accounting principles, management believed
that the combined entity should have consistent discount rate accounting
policies and methods for applying those policies for similar products. UNUM's
former methodology used the same investment strategy for assets backing both
liabilities and surplus. Provident's methodology, which allows for different
investment strategies for assets backing surplus than those backing product
liabilities, was determined by management to be the more appropriate approach
for the Company. Accordingly, the Company adopted Provident's method of
calculating the discount rate for claim reserves.
During the second quarter of 1999 and subsequent to date of the consolidated
financial statements presented herein, the Company recorded an increase in the
claim reserves of $240.7 million before tax and $156.5 million after tax related
to the change in method of calculating the discount rate. This increase in claim
reserves has not been reflected in these consolidated financial statements.
The discount rates affected by this change in UNUM's methodology are as follows:
June 30, 1999
-----------------------------------------
Current Rates Former Rates
-----------------------------------------
Group Long-term Disability (North America) 6.75% 7.74%
Group Long-term Disability and Individual Disability (United Kingdom) 7.45% 8.80%
Individual Disability (North America) 6.88% 7.37%
The unpaid claim reserves for these disability lines as of June 30, 1999 were
$5,318.3 million using the former method for determining reserve discount rates
and $5,559.0 million using the current method.
The Company continues to evaluate its accounting policies, including assumptions
underlying the application thereof, as well as its financial statement
classifications and related disclosures. It may be necessary to further revise
those accounting policies, practices, and classifications that are determined to
be most appropriate. The evaluations are expected to be completed by year end
1999 and could result in further changes to accounting policies, accounting
estimates, or financial statement classifications which could be material to the
Company's results of operations for 1999.
The results of operations for the separate companies and the combined amounts
are as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
----------------------------------------------------------
Revenue
UNUM $4,581.3 $4,124.1 $4,033.3
Provident 3,938.0 3,553.2 2,291.9
-------- -------- --------
Combined Revenue $8,519.3 $7,677.3 $6,325.2
======== ======== ========
Net Income
UNUM $ 363.4 $ 370.3 $ 238.0
Provident 254.0 247.3 145.6
-------- -------- --------
Combined Net Income $ 617.4 $ 617.6 $ 383.6
======== ======== ========
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 2--Merger - Continued
The balance sheets for the separate companies and the combined amounts are as
follows:
December 31, 1998
---------------------------------------------------------
UNUM Provident Combined
(in millions of dollars)
---------------------------------------------------------
Assets
Total Investments $ 9,853.3 $17,332.7 $27,186.0
Reinsurance Receivable 1,770.0 3,101.0 4,871.0
All Other Assets 3,559.6 2,985.6 6,545.2
--------- --------- ---------
Total Assets $15,182.9 $23,419.3 $38,602.2
========= ========= =========
Liabilities and Stockholders' Equity
Policy and Contract Benefits, Reserves for Future
Policy and Contract Benefits, and Unearned Premiums $ 9,201.4 $14,674.2 $23,875.6
Other Policyholders' Funds 875.4 3,227.3 4,102.7
All Other Liabilities 2,368.4 1,809.3 4,177.7
--------- --------- ---------
Total Liabilities 12,445.2 19,710.8 32,156.0
--------- --------- ---------
Company-Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary Trust
Holding Solely Junior Subordinated
Debt Securities of the Company - 300.0 300.0
--------- --------- ---------
Stockholders' Equity 2,737.7 3,408.5 6,146.2
--------- --------- ---------
Total Liabilities and Stockholders' Equity $15,182.9 $23,419.3 $38,602.2
========= ========= =========
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 3--Fair Values of Financial Instruments
The carrying amounts and fair values of the Company's financial instruments are
as follows:
December 31
(in millions of dollars)
---------------------------------------------------------------------------
1998 1997
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------------------------------------------------------------------
Assets
Fixed Maturity Securities:
Available-for-Sale $22,538.2 $22,538.2 $24,212.2 $24,212.2
Derivatives Hedging Available-for-Sale 194.0 194.0 133.8 133.8
Held-to-Maturity 307.0 352.5 306.8 336.6
Equity Securities 33.1 33.1 40.7 40.7
Mortgage Loans 1,321.2 1,443.0 1,148.8 1,261.5
Policy Loans 2,227.2 2,371.6 2,112.4 2,504.6
Short-term Investments 245.1 245.1 182.0 182.0
Cash and Bank Deposits 111.2 111.2 94.5 94.5
Other Assets:
Deposit Assets 729.7 729.7 688.3 688.3
Liabilities
Policyholders' Funds:
GICs 725.9 755.4 1,737.4 1,770.0
Deferred Annuity Products 2,487.2 2,487.2 2,724.5 2,680.5
Supplementary Contracts without
Life Contingencies 107.1 107.1 90.1 90.1
Short-term Debt 323.7 323.7 277.3 277.3
Long-term Debt 1,225.2 1,304.9 1,240.0 1,254.4
Company-Obligated Mandatorily Redeemable
Preferred Securities 300.0 312.4 - -
Derivatives Hedging Liabilities (4.2) (4.2) (7.4) (7.7)
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 3--Fair Values of Financial Instruments - Continued
The following methods and assumptions were used by the Company in estimating the
fair values of its financial instruments:
Fixed Maturity Securities: Fair values for fixed maturity securities are based
on quoted market prices, where available. For fixed maturity securities not
actively traded, fair values are estimated using values obtained from
independent pricing services or, in the case of private placements, are
estimated by discounting expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments. See
Note 4 for the amortized cost and fair values of securities by security type and
by maturity date.
Equity Securities: Fair values for equity securities are based on quoted market
prices.
Mortgage Loans: Fair values for mortgage loans are estimated using discounted
cash flow analyses, using interest rates currently being offered for similar
mortgage loans to borrowers with similar credit ratings and maturities.
Mortgage loans with similar characteristics are aggregated for purposes of the
calculations.
Policy Loans: Fair values for policy loans are estimated using discounted cash
flow analyses, using interest rates currently being offered.
Short-term Investments, Cash and Bank Deposits, and Deposit Assets: Carrying
amounts for short-term investments, cash and bank deposits, and deposit assets
approximate fair value.
Policyholders' Funds: Fair values for GICs are estimated using discounted cash
flow calculations, based on current market interest rates available for similar
contracts with maturities consistent with those remaining for the contracts
being valued. At December 31, 1998, the carrying amounts for deferred annuity
products approximate fair value. At December 31, 1997, fair values for deferred
annuity products were estimated using the cash surrender values of the annuity
contracts. The carrying amounts for supplementary contracts without life
contingencies approximate fair value.
Fair values for insurance contracts other than investment contracts are not
required to be disclosed. However, the fair values of liabilities under all
insurance contracts are taken into consideration in the Company's overall
management of interest rate risk, which minimizes exposure to changing interest
rates through the matching of investment maturities with amounts due under
insurance contracts.
Short-term Debt: The carrying amounts for short-term debt approximate fair
value.
Long-term Debt and Company-Obligated Mandatorily Redeemable Preferred
Securities: Fair values for long-term debt and company-obligated mandatorily
redeemable preferred securities were obtained from independent pricing services
or discounted cash flow analyses based on current incremental borrowing rates
for similar types of borrowing arrangements.
Derivatives: Fair values of derivative financial instruments are based on
market quotes or pricing models and represent the net amount of cash the Company
would have received or paid if the contracts had been settled or closed on
December 31.
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 4--Investments
Securities
The amortized cost and fair values of securities by security type are as
follows:
December 31, 1998
(in millions of dollars)
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------------------------------------------------
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 248.2 $ 75.3 $ - $ 323.5
States, Municipalities, and Political Subdivisions 1,204.2 57.4 - 1,261.6
Foreign Governments 868.3 203.4 0.1 1,071.6
Public Utilities 3,814.5 447.1 19.4 4,242.2
Mortgage-backed Securities 1,782.2 144.1 0.4 1,925.9
All Other Corporate Bonds 12,517.8 1,361.7 135.3 13,744.2
Redeemable Preferred Stocks 146.4 27.6 10.8 163.2
----------- -------- --------- ---------
Total Fixed Maturity Securities 20,581.6 2,316.6 166.0 22,732.2
Equity Securities 24.0 10.6 1.5 33.1
----------- -------- --------- ---------
$ 20,605.6 $2,327.2 $ 167.5 $22,765.3
=========== ======== ========= =========
Held-to-Maturity Securities
United States Government and
Government Agencies and Authorities $ 13.5 $ 3.9 $ - $ 17.4
States, Municipalities, and Political Subdivisions 2.4 0.2 - 2.6
Mortgage-backed Securities 276.1 35.4 - 311.5
All Other Corporate Bonds 15.0 6.0 - 21.0
----------- -------- -------- ---------
$ 307.0 $ 45.5 $ - $ 352.5
=========== ======== ======== =========
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 4--Investments - Continued
December 31, 1997
(in millions of dollars)
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 385.4 $ 65.4 $ - $ 450.8
States, Municipalities, and Political Subdivisions 956.1 37.8 0.2 993.7
Foreign Governments 885.9 150.2 - 1,036.1
Public Utilities 3,955.4 373.9 3.7 4,325.6
Mortgage-backed Securities 3,046.8 138.6 6.4 3,179.0
All Other Corporate Bonds 13,017.0 1,211.7 17.9 14,210.8
Redeemable Preferred Stocks 137.8 14.7 2.5 150.0
--------- -------- ------- ---------
Total Fixed Maturity Securities 22,384.4 1,992.3 30.7 24,346.0
Equity Securities 32.2 9.8 1.3 40.7
--------- -------- ------- ---------
$22,416.6 $2,002.1 $ 32.0 $24,386.7
========= ======== ======= =========
Held-to-Maturity Securities
United States Government and
Government Agencies and Authorities $ 13.1 $ 2.6 $ - $ 15.7
States, Municipalities, and Political Subdivisions 2.9 0.2 - 3.1
Mortgage-backed Securities 276.9 23.7 - 300.6
All Other Corporate Bonds 13.9 3.3 - 17.2
--------- -------- ------- ---------
$ 306.8 $ 29.8 $ - $ 336.6
========= ======== ======= =========
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 4--Investments - Continued
The amortized cost and fair values of fixed maturity securities by maturity date
are shown below. The maturity dates have not been adjusted for possible calls
or prepayments.
December 31, 1998
(in millions of dollars)
---------------------------------
Amortized Fair
Cost Value
---------------------------------
Available-for-Sale Securities
1 year or less $ 550.0 $ 627.6
Over 1 year through 5 years 3,418.2 3,783.3
Over 5 years through 10 years 5,972.9 6,376.2
Over 10 years 8,858.3 10,019.2
--------- ---------
18,799.4 20,806.3
Mortgage-backed Securities 1,782.2 1,925.9
--------- ---------
$20,581.6 $22,732.2
========= =========
Held-to-Maturity Securities
1 year or less $ 0.2 $ 0.3
Over 1 year through 5 years 1.4 1.4
Over 5 years through 10 years 0.2 0.3
Over 10 years 29.1 39.0
--------- ---------
30.9 41.0
Mortgage-backed Securities 276.1 311.5
--------- ---------
$ 307.0 $ 352.5
========= =========
At December 31, 1998, the total investment in below-investment-grade fixed
maturity securities (securities rated below Baa3 by Moody's Investors Service or
an equivalent internal rating) was $1,455.5 million or 5.4 percent of invested
assets. The amortized cost of these securities was $1,463.1 million.
Deposit assets in the form of marketable securities held in trust are reported
in other assets in the consolidated statements of financial condition.
Unrealized gains on these securities were $211.6 million and $127.7 million,
respectively, at December 31, 1998 and 1997.
Adjustments to reserves for future policy and contract benefits that would have
been necessary if the unrealized investment gains and losses related to the
available-for-sale securities had been realized as of December 31, 1998 and
1997, were $891.7 million and $819.1 million, respectively.
The components of the change in net unrealized gains on securities included in
other comprehensive income (loss) is as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
-----------------------------------------------------
Change in Net Unrealized Gains (Losses)
Before Reclassification Adjustment $244.6 $1,194.6 $(630.6)
Reclassification Adjustment for Net Realized
Investment (Gains) Losses (55.0) (11.5) 5.2
Change in Unrealized Gains on Deposit Assets 83.9 127.8 -
Change in the Adjustment to Reserves for
Future Policy and Contract Benefits (72.6) (297.4) 438.4
Change in Deferred Tax (67.2) (351.0) 45.2
------ -------- -------
Change in Net Unrealized Gains $133.7 $ 662.5 $(141.8)
====== ======== =======
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Mortgage Loans
Mortgage loans are impaired when, based on current information and events, it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. The recorded investment in mortgage
loans considered to be impaired was $20.7 million and $43.4 million,
respectively, at December 31, 1998 and 1997. Included in the December 31, 1998
amount of $20.7 million were loans of $9.0 million which had a related allowance
for losses of $2.4 million and loans of $11.7 million which had no related
allowance for losses. Included in the December 31, 1997 amount of $43.4 million
were loans of $20.8 million which had a related allowance for losses of $3.5
million and loans of $22.6 million which had no related allowance for losses.
Investment Valuation Allowances
Changes in the investment valuation allowances were as follows:
Balance at Balance
Beginning at End
of Year Additions Deductions of Year
(in millions of dollars)
------------------------------------------------------
Year Ended December 31, 1996
Mortgage Loans $51.2 $ 1.0 $13.5 $38.7
Real Estate 38.2 2.0 3.9 36.3
----- ----- ----- -----
Total $89.4 $ 3.0 $17.4 $75.0
===== ===== ===== =====
Year Ended December 31, 1997
Mortgage Loans $38.7 $ 3.3 $ 7.1 $34.9
Real Estate 36.3 10.6 6.2 40.7
----- ----- ----- -----
Total $75.0 $13.9 $13.3 $75.6
===== ===== ===== =====
Year Ended December 31, 1998
Mortgage Loans $34.9 $ 2.3 $ 4.4 $32.8
Real Estate 40.7 10.5 - 51.2
----- ----- ----- -----
Total $75.6 $12.8 $ 4.4 $84.0
===== ===== ===== =====
Additions represent realized investment losses and deductions represent the
allowance released upon disposal or restructuring of the related asset.
Net Investment Income
Sources for net investment income are as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
-------------------------------------------------------
Fixed Maturity Securities $1,708.4 $1,659.8 $1,542.4
Equity Securities 0.4 0.4 0.4
Mortgage Loans 106.4 121.1 114.7
Real Estate 32.5 40.5 45.8
Policy Loans 206.5 198.7 193.0
Other Long-term Investments 9.8 27.3 11.2
Short-term Investments 59.8 31.2 59.7
-------- -------- --------
Gross Investment Income 2,123.8 2,079.0 1,967.2
Less Investment Expenses 64.3 38.9 49.3
Less Investment Income on PFA Assets 24.1 24.4 24.5
-------- -------- --------
Net Investment Income $2,035.4 $2,015.7 $1,893.4
======== ======== ========
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 4--Investments - Continued
Realized Investment Gains and Losses
Realized investment gains (losses) are as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
-------------------------------------------
Fixed Maturity Securities
Gross Gains $ 71.0 $ 80.8 $ 72.1
Gross Losses (16.1) (60.2) (42.2)
Equity Securities 4.2 0.6 (1.3)
Mortgage Loans, Real Estate, and Other Invested Assets (4.5) (6.5) 7.0
Derivatives 0.4 (3.2) (40.8)
------ ------ ------
$ 55.0 $ 11.5 $ (5.2)
====== ====== ======
Note 5--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 assets with its insurance liabilities.
Derivative Risks
The basic types of risks associated with derivatives are market risk (that the
value of the derivative will be adversely impacted by changes in the market,
primarily the change in interest rates) and credit risk (that the counterparty
will not perform according to the terms of the contract). The market risk of the
derivatives should generally offset the market risk associated with the hedged
financial instrument or liability.
To help limit the credit exposure of the derivatives, the Company has entered
into master netting agreements with its counterparties whereby contracts in a
gain position can be offset against contracts in a loss position. The Company
also typically enters into bilateral, cross-collateralization agreements with
its counterparties to help limit the credit exposure of the derivatives. These
agreements require the counterparty in a loss position to submit acceptable
collateral with the other counterparty in the event the net loss position meets
or exceeds an agreed upon amount. The Company's current credit exposure on
derivatives, which is limited to the value of those contracts in a net gain
position, was $51.9 million at December 31, 1998.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 5--Derivative Financial Instruments - Continued
Hedging Activity
The table below summarizes by notional amounts the activity for each category of
derivatives.
Interest Rate Swaps
------------------------------------
Receive Receive Receive
Variable/ Fixed/Pay Fixed/Pay
Pay Fixed Fixed Variable Forwards Futures Options Total
--------- --------- --------- -------- -------- -------- --------
(in millions of dollars)
-------------------------------------------------------------------------------
Balance at December 31, 1995 $900.0 $ - $ 861.2 $ - $ 15.0 $ - $1,776.2
Additions - - 400.0 - 2,048.3 - 2,448.3
Terminations 600.0 - 463.6 - 1,875.1 - 2,938.7
--------- --------- -------- -------- -------- -------- --------
Balance at December 31, 1996 300.0 - 797.6 - 188.2 - 1,285.8
Acquisition of Business--Note 15 - - 9.4 390.0 - - 399.4
Additions - 168.3 420.0 - 1,399.8 2,034.5 4,022.6
Terminations 300.0 - 114.6 250.0 1,144.5 1,625.0 3,434.1
--------- --------- -------- -------- -------- -------- --------
Balance at December 31, 1997 - 168.3 1,112.4 140.0 443.5 409.5 2,273.7
Additions - - 90.0 - 356.0 207.8 653.8
Terminations - - 122.4 140.0 688.5 405.0 1,355.9
--------- --------- -------- -------- -------- -------- --------
Balance at December 31, 1998 $ - $ 168.3 $1,080.0 $ - $ 111.0 $ 212.3 $1,571.6
========= ========= ======== ======== ======== ======== ========
Additions and terminations reported above for futures and options include roll
activity, which is the closing out of an old contract and initiation of a new
one when a contract is about to mature but the need for it still exists.
The following table summarizes the timing of anticipated settlements of interest
rate swaps outstanding at December 31, 1998, whereby the Company receives a
fixed rate and pays a variable rate. The weighted average interest rates assume
current market conditions.
1999 2000 2001 2002 Total
(in millions of dollars)
----------------------------------------------
Receive Fixed/Pay Variable:
Notional Value $320.0 $330.0 $280.0 $150.0 $1,080.0
Weighted Average Receive Rate 7.70% 7.30% 7.70% 7.54% 7.56%
Weighted Average Pay Rate 5.07% 5.07% 5.07% 5.07% 5.07%
Hedging programs for derivative activity are as follows:
Program 1
The Company has executed a series of cash flow hedges in the individual
disability portfolio and the group single premium annuities portfolio. The
purpose of these hedges is to lock in the reinvestment rates on future cash
flows and protect the Company from the potential adverse impact of declining
interest rates on the associated policy reserves. The Company uses futures
contracts to partially offset hedges on fixed maturity securities purchased
prior to the termination date of interest rate swaps and forwards. The Company
also uses futures contracts to replace terminated forwards and interest rate
swaps in order to maintain hedges until the fixed maturity securities are
purchased.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 5--Derivative Financial Instruments - Continued
The following table summarizes the hedging activity under this program:
Notional
Amount
Outstanding Deferred
Additions Terminations at December 31 Gain
(in millions of dollars)
------------------------------------------------------------
Individual Disability
1996
Interest Rate Swaps $ 200.0 $ 225.0 $ 470.0 $ 3.6
Futures 144.5 134.5 10.0 3.6
-------- -------- -------- -----
Total $ 344.5 $ 359.5 $ 480.0 $ 7.2
======== ======== ======== =====
1997
Interest Rate Swaps $ 420.0 $ 30.0 $ 860.0 $ 1.7
Forwards 390.0 250.0 140.0 23.2
Futures 247.5 214.0 43.5 2.4
Options - U.S. Treasury Interest Rate 550.0 195.0 355.0 0.1
Options - Interest Rate Swaps 850.0 850.0 - 3.3
-------- -------- -------- -----
Total $2,457.5 $1,539.0 $1,398.5 $30.7
======== ======== ======== =====
1998
Interest Rate Swaps $ 90.0 $ - $ 950.0 $ -
Forwards - 140.0 - 28.2
Futures 50.0 93.5 - 0.1
Options - U.S. Treasury Interest Rate 135.0 355.0 135.0 0.4
Credit Options 70.0 - 70.0 -
-------- -------- -------- -----
Total $ 345.0 $ 588.5 $1,155.0 $28.7
======== ======== ======== =====
Group Single Premium Annuities
1996
Interest Rate Swaps $ 200.0 $ 70.0 $ 130.0 $ -
======== ======== ======== =====
1997
Interest Rate Swaps $ - $ - $ 130.0 $ -
Options - Interest Rate Swaps 300.0 300.0 - 0.5
-------- -------- -------- -----
Total $ 300.0 $ 300.0 $ 130.0 $ 0.5
======== ======== ======== =====
1998
Interest Rate Swaps $ - $ - $ 130.0 $ -
======== ======== ======== =====
In 1998, 1997, and 1996, the Company amortized into net investment income $1.9
million, $0.6 million, and $0.1 million, respectively, of the deferred gains
from this program. Realized investment gains and losses from this program
during 1998, 1997 and 1996 were immaterial.
At December 31, 1998 and 1997, the Company had an unrealized gain of $194.0
million and $133.8 million, respectively, on the open interest rate swaps,
forwards, and futures. These derivatives are scheduled to be terminated in the
years 1999 through 2002 as assets are purchased with the future anticipated cash
flows.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 5--Derivative Financial Instruments - Continued
Program 2
In 1998 and 1997, the Company sold indexed annuity products whereby a portion of
the crediting rate on the annuity was based on the performance of the S&P 500
stock index. In order to hedge this fluctuating credit rate, the Company
purchased options with the S&P 500 stock index as the underlying item. These
options will be settled with a net cash payment to the Company at the expiration
date if the S&P 500 index moves above the option contract's strike price;
otherwise, no cash payment will take place at expiration. At December 31, 1998,
the outstanding notional amount of these options was $7.3 million, and the fair
value and carrying amount were $4.2 million.
Program 3
In 1998 and 1997, the Company opened interest rate futures contracts and wrote
options on interest rate futures in order to hedge the borrowing rate on the
anticipated refinancing of long-term debt (see Note 9). The Company realized a
$10.3 million before-tax investment loss when these contracts were terminated.
The loss on these contracts was deferred and is being amortized as an adjustment
to interest and debt expense.
At December 31, 1998, the Company had no open contracts under this program.
Program 4
The Company routinely uses forwards and futures to protect margins by reducing
the risk of changes in interest rates between the time of asset purchase and the
associated sale of an asset or sale of new business.
Gains or losses on termination of these forwards and futures are deferred and
reported as an adjustment of the carrying amount of the hedged asset or
liability and amortized into earnings over the lives of the hedged items. The
net deferred gain associated with this activity was $28.9 million and $30.2
million at December 31, 1998 and 1997, respectively.
The deferred gain from this program amortized into income in the consolidated
statements of income was $1.3 million, $2.0 million, and $2.2 million for the
years ended December 31, 1998, 1997, and 1996, respectively.
At December 31, 1998, the Company had no open contracts under this program.
Program 5
In 1994, the Company announced that it would discontinue the sale of traditional
GICs. At that time, the Company decided to convert from a duration matching
investment approach to a cash flow matching investment approach for its GIC
business. The Company hedged the risk that a rise in interest rates would
reduce the price on future sales of assets which would be necessary to fund
maturing liabilities by entering into forward interest rate swaps (receive
variable/pay fixed).
During 1996, the Company terminated $600.0 million of these forward swaps as
scheduled, realizing a $36.1 million before-tax investment loss. In addition,
the Company used offsetting futures contracts to partially remove the hedge as
fixed maturities were sold prior to the termination date of the interest rate
swaps. The Company realized a $5.3 million before-tax investment loss on the
termination of these futures contracts. The Company sold $423.0 million of
fixed maturity securities associated with this hedge, realizing a $19.6 million
before-tax investment gain.
During 1997, the Company terminated the remaining $300.0 million of these
forward swaps as scheduled, realizing a $4.1 million before-tax investment loss.
In addition, the Company used offsetting futures contracts to partially remove
the hedge as fixed maturity securities were sold prior to the termination date
of the interest rate swaps. The Company realized a $0.1 million before-tax
investment gain on the termination of these futures contracts. The Company sold
$302.0 million of fixed maturity securities associated with this hedge,
realizing a $4.3 million before-tax investment gain.
At December 31, 1998, the Company had no open contracts under this program.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 5--Derivative Financial Instruments - Continued
Program 6
In 1997, the Company borrowed (Pounds)100 million ($168.3 million) through a
private placement with an investor in the United Kingdom (see Note 9). Upon
issuance of the (Pounds)100 million borrowing, the Company entered into currency
and interest rate swap agreements that converted the principal amount to U.S.
dollars and the interest obligation on the debt from a pound sterling based
fixed rate to a U.S. dollar fixed rate. The swap agreement expires in 2007.
Program 7
The Company also uses futures contracts to hedge anticipated cash flows. At
December 31, 1998, the outstanding notional amount of these futures was $111.0
million with an unrealized loss of $0.3 million. The deferred gain at December
31, 1998 was immaterial. The Company had no open contracts under this program
at December 31, 1997.
Note 6--Value of Business Acquired
A reconciliation of value of business acquired is as follows:
1998 1997
(in millions of dollars)
--------------------------------------------------
Balance at January 1 $699.0 $ 63.0
Acquisition of Business 5.0 675.0
Disposition of Business (90.6) -
Interest Accrued 43.2 37.6
Amortization (81.8) (72.1)
Change in Foreign Currency Translation Adjustment (4.3) (4.5)
------ ------
Balance at December 31 $570.5 $699.0
====== ======
The estimated net amortization of value of business acquired for each of the
next five years is $38.1 million in 1999, $37.1 million in 2000, $36.2 million
in 2001, $35.3 million in 2002, and $34.3 million in 2003.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 7--Liability for Unpaid Claims and Claim Adjustment Expenses
Changes in the liability for unpaid claims and claim adjustment expenses were as
follows:
1998 1997 1996
(in millions of dollars)
------------------------------------------------------------
Balance at January 1 $12,638.6 $ 8,623.1 $8,080.0
Less Reinsurance Recoverables 1,494.3 753.4 468.8
Less Effect of Unrealized Gains 659.3 411.0 644.7
--------- --------- --------
Net Balance at January 1 10,485.0 7,458.7 6,966.5
Acquisition of Business--Note 15 - 2,295.4 -
Incurred Related to:
Current Year 4,220.9 3,434.9 2,602.6
Prior Years
Interest 646.6 585.5 466.2
Incurred 40.8 42.1 7.0
--------- --------- --------
Total Incurred 4,908.3 4,062.5 3,075.8
--------- --------- --------
Paid Related to:
Current Year 1,266.7 959.4 858.2
Prior Years 2,582.3 2,372.2 1,725.4
--------- --------- --------
Total Paid 3,849.0 3,331.6 2,583.6
--------- --------- --------
Net Balance at December 31 11,544.3 10,485.0 7,458.7
Plus Reinsurance Recoverables 1,614.8 1,494.3 753.4
Plus Effect of Unrealized Gains 728.3 659.3 411.0
--------- --------- --------
Balance at December 31 $13,887.4 $12,638.6 $8,623.1
========= ========= ========
The majority of the net balances are related to disabled lives claims with long-
tail payouts on which interest earned on assets backing liabilities is an
integral part of pricing and reserving. Interest accrued on prior year reserves
has been calculated on the opening reserve balance less one-half year's cash
payments at the average reserve discount rate used by the Company during 1998,
1997, and 1996.
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 claim reserves. Adjustments to the reserve assumptions will be
made if expectations change. Given that insurance products contain inherent
risks and uncertainties, the ultimate liability may be more or less than such
estimates indicate.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 7--Liability for Unpaid Claims and Claim Adjustment Expenses - Continued
During the fourth quarter of 1998, the Company recorded a $153.0 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 $153.0 million
claim reserve increase represents the estimated value of cash payments to be
made to these claimants over the life of the claims as a result of the claims
operations integration activities.
Management believes the reserve adjustment was 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 merger has had 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 have been
distracted from normal claims management activities as a result of planning and
implementing the integration of the two companies' claims organizations. In
addition, employee turnover and additional training have reduced 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 the Company worked to develop the
strategic direction of the Company's 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. 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. For the first six months of
1999, approximately 90 claims managers and benefit specialists have spent nearly
40 percent of their time developing the detailed integration plans. Effective
with the merger, all claims personnel are expected to be involved in the process
of implementing the new work processes and required training. The implementation
and training efforts are estimated to require an average of one month of
productive time from each of the claims staff between June 30, 1999 and December
31, 1999. Management now believes that implementation and related systems
conversions will continue into the second quarter of 2000. However, due to
actions taken by management to mitigate effects on resolution rates, the effect
on resolution rates is not anticipated to extend beyond the end of 1999. Actions
by management to mitigate the effect on resolution rates include aggressive
hiring of new claims staff, restrictions on early retirement elections,
selective use of personnel for integration planning, and significant
communications with staff members.
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 claims 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 are expensed in the period incurred and are not
material in relation to results of operations. Management reviewed its
integration plans and the actions intended to mitigate the impact of the
integration with claims 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., before adjusting for the effect
of the claims operations integration activities), are 90 percent for the first
and second quarters of 1999, 84 percent for the third quarter, and 89 percent
for the fourth quarter of 1999. The revised claim resolution rates for the
third quarter and fourth 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 effect of integration activities on resolution rates
is not expected to extend beyond December 31, 1999.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 7--Liability for Unpaid Claims and Claim Adjustment Expenses - Continued
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 in 1997. Subsequent to the Paul Revere
acquisition and integration, management 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 management 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
percent to 90.4 percent in 1996 and 80.3 percent 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 merger are
very different from the Paul Revere acquisition, the claims integration
activities are similar, and the Paul Revere 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 have impacted
the Company as a result of the merger. One primary difference is that the
duration of the potential disruption in the 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 of 1999 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 quarters of
1999 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 percent 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 $153.0 million as the estimated
value of projected additional claim payments resulting from these claims
operations integration activities. This reserve increase was reflected as a
$142.6 million increase in benefits and reserves for future benefits, and a
$10.4 million reduction in other income. The effect of lower claim resolutions
emerged quarterly in the amount of $39.2 million and $36.2 million in the first
and second quarter of 1999, and is expected to emerge quarterly in the amount of
$47.6 million in the third quarter, and $33.0 million in the fourth quarter of
1999. If claim resolutions emerge as expected, there will be no impact to
results of operations during 1999. Any variance from the assumptions will be
reflected in operations in the current period. The adverse impact of the claims
operations integration activities on resolution rates is not expected to
continue beyond 1999. 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 are 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.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 8--Federal Income Taxes
A reconciliation of the income tax attributable to continuing operations
computed at U.S. federal statutory tax rates to the income tax expense as
included in the consolidated statements of income follows:
Year Ended December 31
1998 1997 1996
----------------------------------------------------------------
Statutory Income Tax Rate 35.0% 35.0% 35.0%
Tax-preferred Investment Income (3.1) (2.5) (3.7)
Other Items, Net 1.0 0.1 1.1
---- ---- ----
Effective Tax Rate 32.9% 32.6% 32.4%
==== ==== ====
Significant components of the Company's deferred federal income tax liability
are as follows:
December 31
1998 1997
(in millions of dollars)
---------------------------------------
Deferred Tax Liability
Deferred Policy Acquisition Costs $ 361.2 $ 307.4
Bond Market Discount 15.7 4.3
Net Unrealized Investment Gains 592.3 478.7
Value of Business Acquired 199.9 240.8
Property and Equipment 19.6 15.0
Other 52.1 42.5
-------- --------
Total Deferred Tax Liability 1,240.8 1,088.7
-------- --------
Deferred Tax Asset
Reserves 118.8 249.4
Realized Investment Gains and Losses 55.9 49.3
Postretirement Benefits 54.5 53.4
Other Employee Benefits 38.2 41.3
Alternative Minimum Tax Credits 35.2 -
Accrued Liabilities 30.2 15.0
Other 52.2 41.3
-------- --------
Total Deferred Tax Asset 385.0 449.7
Valuation Allowance for Deferred Tax Asset 8.2 7.0
-------- --------
Net Deferred Tax Asset 376.8 442.7
-------- --------
Net Deferred Tax Liability $ 864.0 $ 646.0
======== ========
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 8--Federal Income Taxes - Continued
Under the Life Insurance Company Tax Act of 1959, life companies were required
to maintain a policyholders' surplus account containing the accumulated portion
of current income which had not been subjected to income tax in the year earned.
The Deficit Reduction Act of 1984 requires that no future amounts be added after
1983 to the policyholders' surplus account. Further, any future distributions
from the account would become subject to federal income taxes at the general
corporate federal income tax rate then in effect. The amount of the
policyholders' surplus account at December 31, 1998, is approximately $233.4
million. Future distributions from the policyholders' surplus account are deemed
to occur if a statutorily prescribed maximum for the account is less than the
value of the account or if dividend distributions exceed the total amount
accumulated as currently taxable income in the year earned. If the entire
policyholders' surplus account were deemed distributed in 1999, this would
result in a tax of approximately $81.7 million. No current or deferred federal
income taxes have been provided on these amounts because management considers
the conditions under which such taxes would be paid to be remote.
The Company's consolidated statements of income includes the following amounts
of income subject to foreign taxation and the related foreign income tax
expense:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
----------------------------------------------------------
Income Before Tax Subject to Foreign Taxation $76.5 $73.3 $33.9
===== ===== =====
Foreign Income Tax Expense (Credit):
Current $26.8 $26.5 $10.4
Deferred 0.3 (1.5) 4.1
----- ----- -----
Total $27.1 $25.0 $14.5
===== ===== =====
The Company's subsidiaries had operating loss carryforwards totaling $15.3
million and alternative minimum tax credit carryforwards totaling $35.2 million
as of December 31, 1998. The operating loss carryforwards will expire, if not
utilized, in 1999 through 2004; the alternative minimum tax credits do not
expire.
Federal income taxes paid during 1998, 1997, and 1996 were $104.8 million,
$192.8 million, and $168.9 million, respectively.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 9--Debt and Company-Obligated Mandatorily Redeemable Preferred Securities
Debt
Short-term debt consists of the following at December 31 (dollars in millions):
1998 1997
---------------------------------------------------------------------
Weighted Weighted
Average Average
Interest Interest
Balance Rate Balance Rate
---------------------------------------------------------------------
Commercial Paper $ 85.7 5.5% $ 50.9 6.3%
Current Portion of Medium-term Notes Payable 21.4 7.0 68.0 6.1
Private Placement 168.3 5.8 - -
Reverse Repurchase Agreements 39.4 5.8 150.7 6.4
Other Short-term Debt 8.9 1.1 7.7 1.0
------- -------
Total $ 323.7 $ 277.3
======= =======
Long-term debt consists of the following:
December 31
1998 1997
(in millions of dollars)
--------------------------------------------
Notes @ 6.75% due 2028, callable at or above par $ 250.0 $ -
Notes @ 7.25% due 2028, callable at or above par 200.0 -
Notes @ 7.0% due 2018, non-callable 200.0 -
Notes @ 6.375% due 2005, non-callable 200.0 -
Monthly Income Debt Securities @ 8.8% due 2025, callable in 2000 at par 172.5 172.5
Medium-term Notes @ 5.9% to 7.5% due 2000 to 2028, non-callable 202.7 174.2
Private Placement @ 5.8% due 2007, callable - 168.3
Borrowing under Revolving Credit Facility with Variable Interest Rate
based on London Interbank Offered Rate plus a Margin - 725.0
-------- --------
Total $1,225.2 $1,240.0
======== ========
Of the $1,225.2 million of long-term debt at December 31, 1998, $60.0 million
will mature in 2000, $35.0 million will mature in 2002, and $1,130.2 million
will mature in 2003 and thereafter.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 9--Debt and Company-Obligated Mandatorily Redeemable Preferred Securities -
Continued
The Company has a committed revolving credit facility totaling $500.0 million,
which expires October 1, 2001. The Company's commercial paper program is
supported by the revolving credit facility and is available for general
liquidity needs, capital expansion, and acquisitions. The committed revolving
credit facility contains certain covenants that, among other provisions, require
maintenance of certain levels of stockholders' equity and limits on debt levels.
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 these two facilities is
for general corporate uses. At December 31, 1998, approximately $714.0 million
was available for additional financing under the Company's existing revolving
credit facilities.
Interest paid on short-term and long-term debt during 1998, 1997, and 1996 was
$100.5 million, $84.7 million, and $57.9 million, respectively.
In 1997, the Company borrowed $168.3 million through a private placement.
Subsequent to the date of the consolidated financial statements presented
herein, the investor under the terms of the agreement exercised the right to
redeem the private placement at par value during the second quarter of 1999. The
Company refinanced this debt by issuing $200.0 million of variable rate medium-
term notes in June of 1999, due in June of 2000. The notes had an interest rate
of 5.135% at June 30, 1999.
Company-Obligated Mandatorily Redeemable Preferred Securities
In March 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.
Interest costs related to these securities are reported in the consolidated
statements of income as a component of interest and debt expense. Interest paid
on these securities during 1998 was $11.1 million.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 10--Pensions and Other Postretirement Benefits
The Company sponsors several defined benefit pension and postretirement plans
for its employees. The following tables provide the changes in the benefit
obligation and fair value of plan assets for the years ended December 31, 1998
and 1997, and statements of the funded status of the plans as of December 31,
1998 and 1997.
Pension Benefits Postretirement Benefits
-------------------------------------------------------------------
1998 1997 1998 1997
(in millions of dollars)
-------------------------------------------------------------------
Change in Benefit Obligation
Balance at January 1 $ 538.6 $ 393.0 $ 125.5 $ 113.2
Service Cost 23.3 18.1 5.5 3.4
Interest Cost 38.3 31.9 9.5 7.4
Plan Amendments - - 8.7 -
Actuarial (Gain) Loss 19.1 18.1 9.8 (6.5)
Acquisition of Business - Note 15 - 92.2 - 13.5
Benefits Paid (18.6) (14.7) (6.9) (5.5)
------- ------- ------- -------
Balance at December 31 600.7 538.6 152.1 125.5
------- ------- ------- -------
Change in Fair Value of Plan Assets
Balance at January 1 705.0 487.9 9.5 8.5
Actual Return on Plan Assets 110.2 144.5 0.5 0.5
Acquisition of Business - Note 15 - 91.4 - -
Company Contributions 12.8 - 6.8 6.0
Benefits Paid (18.6) (14.7) (6.9) (5.5)
Other Transfers - (4.1) - -
------- ------- ------- -------
Balance at December 31 809.4 705.0 9.9 9.5
------- ------- ------- -------
Funded (Underfunded) Status of the Plans at December 31 208.7 166.4 (142.2) (116.0)
Unrecognized Net Actuarial Gains (179.5) (158.9) (1.4) (13.2)
Unrecognized Prior Service Cost (20.6) (23.1) (13.7) (24.0)
Unrecognized Net Transition Obligation 1.7 2.1 - -
------- ------- ------- -------
Prepaid (Accrued) Benefit Cost $ 10.3 $ (13.5) $(157.3) $(153.2)
======= ======= ======= =======
At December 31, 1998, the plan assets included 448,784 shares of the Company's
common stock with a fair value of $26.2 million. The amount of dividends paid
during 1998 was not material. The weighted average assumptions used in the
measurement of the Company's benefit obligation as of December 31, 1998 and 1997
are as follows:
Pension Benefits Postretirement Benefits
-----------------------------------------------------------------------
1998 1997 1998 1997
-----------------------------------------------------------------------
Discount Rate 6.75% 7.25% 6.75% 7.25%
Expected Return on Plan Assets 8.50 to 9.25% 8.65 to 9.00% 8.50% 8.50%
Rate of Compensation Increase 4.00 to 4.25% 4.65 to 4.75% - -
For measurement purposes, the annual rate of increase in the per capita cost of
covered health care benefits assumed for 1999 was a range of 5.00% to 8.67%. The
rate range was assumed to change gradually to a rate of 5.00% for 2005 and
remain at that level thereafter.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 10--Pensions and Other Postretirement Benefits - Continued
The assumed health care cost trend rate has a significant effect on the amounts
reported. A 1% change in the assumed health care cost trend rate would have the
following effects:
1% Increase 1% Decrease
(in millions of dollars)
------------------------------------------
Effect on the Service and Interest Cost Components of Net
Periodic Postretirement Health Care Benefit Cost $ 1.6 $ (1.4)
Effect on the Health Care Component of the Accumulated
Postretirement Benefit Obligation $14.1 $(12.6)
The following table provides the components of the net periodic benefit cost
(credit) for the plans during 1998, 1997, and 1996.
Pension Benefits Postretirement Benefits
-----------------------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
(in millions of dollars)
-----------------------------------------------------------------------------------------
Service Cost $ 23.3 $ 22.0 $ 17.5 $ 5.5 $ 4.1 $ 6.3
Interest Cost 38.3 35.7 27.7 9.5 8.4 9.5
Expected Return on Plan Assets (62.8) (50.6) (35.9) (0.8) (0.7) (0.7)
Net Amortization and Deferral (9.2) (7.1) (4.9) (4.0) (5.3) (2.8)
------ ------ ------ ----- ----- -----
Net Periodic Benefit Cost (Credit) $(10.4) $ - $ 4.4 $10.2 $ 6.5 $12.3
====== ====== ====== ===== ===== =====
Note 11--Stockholders' Equity and Earnings Per Share
Stockholders' Equity
In accordance with the restated certificate of incorporation, the Company has
25,000,000 shares of preferred stock authorized with a par value of $0.10 per
share. No preferred shares have been issued to date.
During February 1998, the Company redeemed its 8.10% cumulative preferred stock
outstanding of $156.2 million at $150 per share equivalent to $25 per depositary
share. At December 31, 1997, there were 6,249,202 shares issued and outstanding.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 11--Stockholders' Equity and Earnings Per Share - Continued
In March 1997 and July 1997, the Boards of Directors of UNUM and Provident,
respectively, authorized two-for-one stock splits. These stock splits were
effected in the form of stock dividends distributed in 1997. As a result of this
action, $11.9 million was transferred from additional paid-in capital to common
stock. Historical share and per share amounts in the consolidated financial
statements and notes thereto reflect these stock splits.
Earnings Per Common Share
The computations of earnings per common share and earnings per common share
assuming dilution are as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars, except share data)
------------------------------------------------------------
Numerator
Net Income $ 617.4 $ 617.6 $ 383.6
Preferred Stock Dividends 1.9 12.7 12.7
---------- ---------- ----------
Income Available to Common Stockholders $ 615.5 $ 604.9 $ 370.9
========== ========== ==========
Denominator (000s)
Weighted Average Common Shares - Basic 236,975.2 230,741.2 212,401.5
Dilution for Assumed Exercise of Stock Options 5,373.7 5,077.0 2,899.6
---------- ---------- ----------
Weighted Average Common Shares - Assuming Dilution 242,348.9 235,818.2 215,301.1
========== ========== ==========
Earnings Per Common Share - Basic $ 2.60 $ 2.62 $ 1.75
========== ========== ==========
Earnings Per Common Share - Assuming Dilution $ 2.54 $ 2.57 $ 1.72
========== ========== ==========
Options to purchase approximately 2.4 million on common shares in 1998 were not
considered dilutive because the options' exercise prices were greater than the
average market price. These options were excluded from the calculation of
earnings per common share assuming dilution. Nondilutive options excluded from
the calculation of earnings per common share assuming dilution for 1997 and 1996
were immaterial.
Note 12--Incentive Compensation and Stock Purchase Plans
Annual Incentive Compensation
The Company has several annual incentive plans for certain employees and
executive officers that are designed to encourage achievement of certain goals.
Compensation cost recognized in the consolidated statements of income for annual
incentive plans is $38.1 million, $43.6 million, and $45.3 million for 1998,
1997, and 1996, respectively.
Stock Plans
Under the Stock Plan of 1999 (Stock Plan), the Company has available up to
7,500,000 shares of common stock for awards to its employees, officers,
producers, and directors. Awards may be in the form of stock options, stock
appreciation rights, restricted stock awards, dividend equivalent awards, or any
other right or interest relating to stock. The number of shares available to be
issued as restricted stock or unrestricted stock awards is limited to 2,250,000
shares. The exercise price for stock options issued under the stock Plan shall
not be less than the fair market value of the Company's stock as of the date.
The options have a maximum term of ten years after the date of grant.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Prior to the Stock Plan, the Company had various stock option and stock award
programs. For all stock option plans the exercise price of each option was not
less than the fair market value of the Company's stock at the date of grant. In
accordance with stock plan provisions, outstanding stock options and restricted
stock became immediately exerciseable as a result of a change in control (see
Note 2).
Summaries of the Company's stock options issued under the various plans are as
follows:
1998 1997 1996
---------------------------- ----------------------------- -----------------------------
Shares Weighted Average Shares Weighted Average Shares Weighted Average
(000s) Exercise Price (000s) Exercise Price (000s) Exercise Price
--------- ----------------- --------- ------------------ --------- ------------------
Outstanding at January 1 15,516 $26.01 13,833 $21.90 12,802 $20.17
Granted 2,406 51.68 4,587 36.09 3,144 27.55
Exercised (2,402) 22.45 (2,028) 20.44 (1,509) 18.50
Forfeited or Expired (497) 34.89 (876) 27.92 (604) 23.13
------ ------ ------
Outstanding at December 31 15,023 30.43 15,516 26.01 13,833 21.90
====== ====== ======
December 31, 1998
--------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------------------ -----------------------------------
Weighted Average
Range of Shares Remaining Weighted Average Shares Weighted Average
Exercise Prices (000s) Contractual Life Exercise Price (000s) Exercise Price
- ---------------- -------------- ---------------- ----------------- ---------------- ----------------
$10 to 15 1,457 2.7 $ 14.33 1,457 $ 14.33
16 to 24 3,945 5.6 19.85 2,336 20.14
25 to 37 5,332 6.8 30.22 2,901 28.61
38 to 58 4,289 8.6 45.90 582 39.12
-------------- ----------------
10 to 58 15,023 6.6 30.43 7,276 23.87
============== ================
The Company granted 145,180, 419,639 and 186,600 shares of restricted stock to
certain employees during 1998, 1997, and 1996 with a weighted average grant date
fair value of $52.05, $38.11 and $29.68 per common share, respectively.
Employee Stock Purchase Plan (ESPP)
Substantially all of the Provident employees were eligible to participate in an
ESPP. Under the plan, up to 1,460,000 shares of the Company's common shares are
authorized for issuance. Stock may be purchased at the end of each financial
quarter at a purchase price of 85 percent of the lower of its beginning or end
of quarter market prices. The Company sold 75,575, 79,423, and 50,094 shares to
employees with a weighted average exercise price of $39.00, $33.74, and $20.11
per share in 1998, 1997, and 1996, respectively.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Compensation Cost Under the Fair Value Approach (SFAS 123)
The Company applies Opinion 25 and related interpretations in accounting for the
stock option plans and ESPP. Accordingly, no compensation costs has been
recognized for these plans. Compensation cost for the Company's stock option
plans and ESPP under the fair value approach was estimated as of the grant date
using Black-Scholes option pricing models. Assumptions used in estimating
compensation cost for UNUM plans were as follows:
Year Ended December 31
1998 1997 1996
---------------------------------------------------------------------
Volatility 23.8% to 26.4% 22.7% to 24.2% 23.1% to 24.8%
Risk-free Rate of Return 4.2% to 5.3% 5.7% to 6.8% 5.2% to 6.5%
Dividend Payout Rate 1.0% 1.0% 1.5%
Time of Exercise 4 to 8 years 4 to 8 years 4 to 8 years
Weighted Average Fair Value of
Options Granted During the Year $12.88 $8.56 $6.92
The weighted average assumptions used in estimating compensation cost for
Provident plans were as follows:
Year Ended December 31
1998 1997 1996
-----------------------------------------------------------
Volatility 17.9% 18.0% 18.2%
Risk-free Rate of Return 5.6% 6.5% 5.7%
Dividend Payout Rate Per Share $0.548 $0.493 $0.493
Time of Exercise
Stock Option Plan
Executives 8 years 7 years 7 years
Non-executives 7 years 6 years 6 years
ESPP 3 months 3 months 3 months
Weighted Average Fair Value of Awards Granted During the Year
Stock Option Plan $14.59 $10.08 $ 5.04
ESPP $ 9.51 $ 7.70 $ 4.63
Had compensation cost for these plans been determined in accordance with the
provisions of SFAS 123, the Company's net income and earnings per common share
would have been as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars, except share data)
---------------------------------------------------------
Net Income $608.5 $603.0 $375.5
Earnings Per Common Share - Basic 2.56 2.56 1.71
Earnings Per Common Share - Assuming Dilution 2.51 2.51 1.69
Unrecognized compensation cost under SFAS 123 for options which had not vested
at December 31, 1998 was $27.0 million after tax.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Limited Stock Appreciation Rights (LSARs)
Between 1991 and 1994, certain officers of the Company were granted LSARs in
conjunction with their options for those years. An LSAR is meant to compensate
an officer if the associated option loses value due to a change in control by
allowing the officer to receive payment for the difference between the option
exercise price and the higher of (a) the highest price paid per share in
connection with the change in control or (b) the highest fair market value per
share as reported at any time during the 60 day period preceding the change in
control. As an underlying stock option is exercised, the LSARs are automatically
cancelled. The LSARs were amended such that the merger of UNUM and Provident
would not be considered a change of control. At December 31, 1998, 1997, and
1996, there were 495,750, 557,800, and 796,600 LSARs outstanding, respectively.
Note 13--Reinsurance
The Company routinely assumes and cedes reinsurance with other insurance
companies. The primary purpose of ceded reinsurance is to limit losses from
large exposures; however, if the assuming reinsurer is unable to meet its
obligations, the Company remains contingently liable. The Company evaluates the
financial condition of reinsurers and monitors concentration of credit risk to
minimize this exposure. The reinsurance receivable at December 31, 1998,
relates to approximately 98 reinsurance relationships. Of the seven major
relationships which account for approximately 80 percent of the reinsurance
receivable amount at December 31, 1998, five are with companies rated A+ or
better by either the A.M. Best Company or Standard & Poor's, and the other two
are fully securitized by investment-grade fixed maturity securities held in
trust.
Reinsurance activity is accounted for on a basis consistent with the terms of
the reinsurance contracts and the accounting used for the original policies
issued. Premium income and policyholder benefits are presented in the
supplemental consolidated statements of income net of reinsurance ceded. The
total amounts supplemental deducted for reinsurance ceded are as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
---------------------------------------------------------
Premium Income $544.5 $673.2 $411.9
Policyholder Benefits 575.2 596.0 382.7
Premium income assumed was $525.2 million, $456.0 million, and $304.4 million
during 1998, 1997, and 1996, respectively.
Centre Life Reinsurance Limited
In 1996, the Company executed a definitive reinsurance agreement with Centre
Life Reinsurance Limited (Centre Re), a Bermuda-based reinsurance specialist,
for reinsurance coverage of the existing United States non-cancellable
individual active life reserves of one of the Company's insurance subsidiaries,
UNUM Life Insurance Company of America. This agreement reinsures all claims
incurred on or after January 1, 1996. Under the agreement, Centre Re has an
obligation to absorb losses within a defined risk layer. The Company retains
the risk for all experience up to Centre Re's defined risk layer, or attachment
point. Once the attachment point is reached, Centre Re assumes the risk for all
experience up to a contractually defined risk limit. Any experience above Centre
Re's defined risk limit reverts back to the Company. As of December 31, 1998,
the attachment point had not been reached.
The following discloses the various layers in the agreement at December 31, 1998
(in millions of dollars):
Net GAAP Reserves $486
Experience Layer 249
----
Attachment Point 735
Centre Re's Defined Risk Layer 235
----
Defined Risk Limit $970
====
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
Under this agreement, the Company funds a trust account equal to the amount of
the Company's exposure. This trust account provides security for amounts due by
the Company prior to reaching the attachment point. The Company controls the
management of the business, including premium collection and claims management,
under this agreement. All premiums, less amounts for management expenses and
claim payments, are transferred to the trust account on a quarterly basis. The
Company also acts as the investment manager for 80 percent of the assets in the
trust with Centre Re managing the remaining 20 percent.
This reinsurance agreement transfers risk and is accounted for as a long-
duration reinsurance contract in accordance with the provisions of SFAS No. 113,
Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts. The underlying operating results of this contract are reflected in
other income, and any realized gains or losses from sales of assets are
reflected as realized investment gains and losses in the Company's consolidated
statements of income.
Included in other assets in the consolidated statements of financial condition
at December 31, 1998, is a deposit asset of approximately $419.0 million. The
deposit asset is comprised of the Company's experience layer and unrealized
gains or losses on the marketable securities held in the trust. Unrealized gains
or losses on marketable securities held in the trust and the related effects on
claim reserves are included in other comprehensive income in the equity section
of the Company's consolidated statements of financial condition.
In 1994, the Company recorded a premium deficiency reserve strengthening related
to this subsequently reinsured non-cancellable individual disability block of
business. The reinsurance fees due Centre Re are expenses that were not
contemplated when reserves were strengthened in 1994. Since these fees would
have caused this reinsured block of business to be in a loss situation, the
Company recognized a before tax charge of $49.7 million when the agreement was
executed during 1996. The charge represented the present value of the
anticipated minimum amount of fees to be paid to Centre Re under the reinsurance
agreement for a period of six years. The Company has the right, but no
obligation, to recapture the business after six years without penalty. The
Company paid $9.4 million in fees to Centre Re during 1998 and 1997.
Reinsurance Pools and Management
Subsequent to the date of the consolidated financial statements presented
herein, the Company during the first quarter of 1999 recognized a before-tax
charge of $101.1 million ($88.0 million after tax) relating to its reinsurance
businesses. The charge consisted of the following:
Lloyd's of London Estimated Losses
The periodic method of accounting is followed for Lloyd's syndicate
participation, which requires the premiums be recognized as revenue over the
policy term and claims, including the estimate of claims incurred but not
reported, to be recognized as incurred. During the first quarter of 1999, the
Company received more information about the Lloyd's market from various sources,
including managing agents/underwriters syndicate reports and published
information from Moody's Investors Service. The information received indicated
significant deterioration in the loss experience of open years of account
primarily related to significant losses in certain syndicates (space and
aviation, accident and health, and other non-marine classes of business) and
continued pressure on the pricing of insurance coverage provided by the Lloyd's
market. In addition, the Company discussed projected results of the Lloyd's
market with the underwriters of the syndicates that are managed through a
subsidiary of the Company. These projected results also indicated future
deterioration of the open years of account. Using this information and recent
experience with prior revisions of estimated losses in this business, the
Company performed a review of its claim reserve liabilities related to its open
years of account.
The review of estimates related to open years of account was performed based on
a periodic review of these estimates as information was received from the
Lloyd's syndicates. The review resulted in revised best estimates of the
expected ultimate profit (loss) for each open year of account, which were
significantly below the levels
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
estimated in 1998. The resulting charge to earnings in the amount of $44.0
million was reflected in the Company's income in the first quarter of 1999 for
the open years of account 1996 through 1999. In addition to the risk
participation charge, the Company recorded a charge of $1.5 million, which
represented the reduction of previously recognized profit commissions related to
the Lloyd's management company operations.
Reinsurance Facility Losses
As a result of the review performed on the Lloyd's syndicates discussed above
and other third party publicized reinsurance exposures, the Company undertook a
periodic review of certain other reinsurance facilities related to new
information regarding the ultimate cost of settling claims. The reinsurance
pool business consists of more than 20 different pool facilities, the majority
of which are managed by the subsidiary Duncanson & Holt, Inc. and a few which
are managed by third parties. Reserve assumptions are periodically reviewed to
support the determination of the ultimate cost of settling claims for certain
reinsurance pools. During the first quarter of 1999, the Company reviewed the
actuarial assumptions used to set reserves for certain reinsurance facilities
based on the most current information available from the reinsurance pool
managers. The Company also received new information pertaining to a reinsurance
pool managed by a third party that indicated a reserve increase was required.
The Company relied primarily on the third party pool manager's judgement and
recorded its portion of the reserve as reflected in the reinsurance pool
statement from the third party pool manager. The new information received from
the managed facilities and the third party facility indicated deterioration in
loss experience, primarily related to a longer duration of claims and increased
incidence of new claims in certain facilities. The result of these reviews was
an increase to claim reserves of $28.6 million, which was recorded in the first
quarter of 1999. The Company determined that the increase to reserves was
needed based on revised actuarial assumptions to reflect current and expected
trends in claims experience and expenses.
Goodwill Impairment
When an event or change in circumstance occurs that indicates the recoverability
of an asset should be assessed for impairment, a recoverability test is
performed to determine if an impairment has occurred. Following the poor
results of the reinsurance businesses in the first quarter of 1999, the Company
updated the goodwill recoverability test using the most current results and
forecasts. The goodwill recoverability test used the held for use model that
compares the undiscounted cash flows of these businesses to determine whether
those cash flows can recover the unamortized goodwill. After factoring in the
first quarter results and current revised forecasts due to recent poor
performance for these businesses, future undiscounted cash flows were
insufficient to recover the entire goodwill amount, indicating that the goodwill
was impaired. Goodwill recoverability testing of these businesses performed
prior to March 31, 1999, had indicated that the goodwill was not impaired.
As a result of the impairment, the Company calculated the estimated fair value
of these businesses. In estimating the fair value, two valuation techniques
were utilized, a discounted free cash flow model and a multiple of earnings
model. The Company believed that these valuation techniques were appropriate
for this type of business as these techniques were what the Company would use in
evaluating a potential acquisition of this type of business. The results of the
two valuation techniques created a range of fair values from $47.0 million to
$64.0 million. The Company evaluated the range of values produced by the
valuation techniques and using internal management judgement of the potential
liquidation value, the Company determined its best estimate of fair value of its
investment to be the midpoint of the range, or $55.0 million. The estimated
fair value of $55.0 million was compared to $82.0 million of book value for the
investment, resulting in a write-down of goodwill in the amount of $27.0 million
in the first quarter of 1999.
Also, subsequent to the date of the consolidated financial statements presented
herein, the Company in the second quarter of 1999 stated its intent to sell its
reinsurance management operations, assuming the transaction would achieve the
Company's financial objectives. The Company estimated the fair value of the
operations using the held-for-sale model, which compares the carrying value of
the asset with the fair value less costs to sell the asset. This resulted in an
additional write-down of goodwill in the amount of $2.0 million before and after
tax during the second quarter of 1999.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
Information received in August 1999 indicates that in certain reinsurance pools
there are disputes among the pool members and reinsurance participants
concerning the scope of their obligations and liabilities within the complex
pool arrangements, including a pool for which a subsidiary of the Company acted
as pool underwriting agent and another subsidiary is a pool member. It is
likely that the Company's agent subsidiary will be brought into a dispute,
arbitration, or litigation with other pool members or reinsurers of the pool for
which it acted as agent and which have been subject to a recent arbitration
proceeding, but it is unclear what exposure the Company's subsidiary may
ultimately have to share in losses of pool members or reinsurers because of the
subsidiary's activities as agent in placing reinsurance.
Other Reinsurance
In 1995, the Company entered into an indemnity and assumption reinsurance
agreement with another insurance company in connection with the sale of the
group medical business. Total premium income and policy and contract benefits
ceded under this reinsurance agreement were $41.7 million and $33.3 million,
respectively, for the year ended December 31, 1998, $182.9 million and $153.8
million, respectively, for the year ended December 31, 1997, and $224.6 million
and $188.5 million, respectively, for the year ended December 31, 1996.
Substantially all of the business reinsured under the indemnity reinsurance
agreement was assumptively reinsured effective April 1, 1998.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 14--Segment Information
Selected data by segment is as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
--------------------------------------------------
Premium Income
Employee Benefits $ 3,364.4 $ 2,810.1 $2,277.6
Individual 1,675.4 1,480.3 1,105.9
Voluntary Benefits 666.7 626.6 583.6
Other 422.5 376.1 321.7
--------- --------- --------
6,129.0 5,293.1 4,288.8
Net Investment Income and Other Income
Employee Benefits 661.0 599.8 451.6
Individual 895.2 772.3 527.1
Voluntary Benefits 103.7 93.9 80.1
Other 643.7 877.1 943.6
Corporate 31.7 29.6 39.2
--------- --------- --------
2,335.3 2,372.7 2,041.6
Total Revenue (Excluding Net Realized Investment Gains and Losses)
Employee Benefits 4,025.4 3,409.9 2,729.2
Individual 2,570.6 2,252.6 1,633.0
Voluntary Benefits 770.4 720.5 663.7
Other 1,066.2 1,253.2 1,265.3
Corporate 31.7 29.6 39.2
--------- --------- --------
8,464.3 7,665.8 6,330.4
Benefits and Expenses
Employee Benefits 3,489.1 2,940.4 2,354.3
Individual 2,348.0 2,012.5 1,553.2
Voluntary Benefits 639.3 610.4 562.5
Other 965.5 1,096.0 1,189.4
Corporate 157.2 101.3 98.0
--------- --------- --------
7,599.1 6,760.6 5,757.4
Income (Loss) Before Net Realized Investment Gains
and Losses and Federal Income Taxes
Employee Benefits 536.3 469.5 374.9
Individual 222.6 240.1 79.8
Voluntary Benefits 131.1 110.1 101.2
Other 100.7 157.2 75.9
Corporate (125.5) (71.7) (58.8)
--------- --------- --------
865.2 905.2 573.0
Net Realized Investment Gains (Losses) 55.0 11.5 (5.2)
--------- --------- --------
Income Before Federal Income Taxes 920.2 916.7 567.8
Federal Income Taxes 302.8 299.1 184.2
--------- --------- --------
Net Income $ 617.4 $ 617.6 $ 383.6
========= ========= ========
Assets
Employee Benefits $ 9,275.7 $ 8,174.1
Individual 15,887.7 14,870.9
Voluntary Benefits 2,057.3 1,827.1
Other 9,610.2 10,613.0
Corporate 1,771.3 1,555.0
--------- ---------
$38,602.2 $37,040.1
========= =========
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 14--Segment Information - Continued
Included in benefits and expenses above is amortization of deferred policy
acquisition costs, value of business acquired, and goodwill. Amortization of
these items by segment is as follows:
Year Ended December 31
1998 1997 1996
(in millions of dollars)
------------------------------------------
Employee Benefits $ 85.2 $ 69.3 $ 60.6
Individual 108.4 95.8 113.5
Voluntary Benefits 101.6 88.3 78.1
Other 120.9 82.4 38.6
Corporate 28.0 18.2 6.3
------ ------ ------
$444.1 $354.0 $297.1
====== ====== ======
Note 15--Acquisition of Business
GENEX Services, Inc.
On February 28, 1997, the Company acquired GENEX Services, Inc. and GENEX
Services of Canada, Inc. (GENEX) at a price of $70.0 million. GENEX is a
provider of case management, vocational rehabilitation, and related services to
corporations, third party administrators, and insurance companies. These
services are utilized in the management of disability and worker's compensation
cases. The acquisition, financed through borrowings on the Company's revolving
credit facility, was accounted for by the purchase method. The fair values of
the assets acquired and liabilities assumed were $17.9 million and $8.9 million,
respectively. The purchase price has been allocated to goodwill and will be
amortized on a straight-line basis over a 25 year period. The consolidated
financial statements include the operating results of GENEX from March 1, 1997.
The Paul Revere Corporation
On March 27, 1997, the Company acquired 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
(13,904,763 shares of common stock), common equity of $437.5 million (17,038,200
shares of common stock) and cash of $2.5 million issued to Paul Revere
shareholders, internally generated funds of $145.0 million, and borrowings on
the Company's revolving credit facility of $305.0 million. The acquisition was
accounted for by the purchase method. The fair values of the assets acquired
and liabilities assumed were $6,667.9 million and $6,809.1 million,
respectively. The purchase price has been allocated principally to the value of
business acquired with the remainder being allocated to goodwill. The interest
rate used to determine the value of business acquired for traditional products
was the reserve discount rate. The interest rate used for interest-sensitive
products was based on the current interest rate credited on account values. The
value of business acquired will be amortized with interest based on premium
income for the traditional individual life and disability products and on the
estimates of future gross profits for interest-sensitive individual life
products. Goodwill will be amortized on a straight-line basis over a 40 year
period. The consolidated financial statements include the operating results of
Paul Revere from April 1, 1997.
The purchase price allocation at the date of acquisition was preliminary. The
initial purchase price allocation consisted of adjustments of $188 million to
reflect changes in the reserve assumptions including those for interest rates,
the inclusion of overhead expenses, the addition of provisions for adverse
deviation, and an adjustment to conform to the Company's reserving methods. The
provisions for adverse deviation allow for possible unfavorable deviations from
assumptions, such as mortality, morbidity, interest, persistency, and expenses.
The provisions for adverse deviation are an integral part of each assumption
underlying the reserves held by the Company. Individual disability insurance
contracts are long duration
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 15--Acquisition of Business - Continued
contracts that may remain in force for as long as thirty to fifty years. As
actual experience with respect to assumptions such as mortality, morbidity,
interest, persistency, and expenses varies from that assumed in the initial
purchase accounting reserves, it will be reflected in income at that time. At
March 27, 1997, the reserve assumptions had been established; however, the
ability to fully apply those assumptions was incomplete as the necessary models
and databases were not completely developed. Subsequent to the date of the
acquisition, the Company continued to gather and analyze additional data and
refine models and application of the assumptions in order to estimate the fair
value of assets and liabilities acquired. In estimating the fair value of
reserve liabilities, the Company segmented reserves by certain characteristics
such as occupation, age, benefit period, issue year, etc. that were in much more
detail than that used by Paul Revere. The most significant changes from Paul
Revere's approach were related to applying more detailed assumptions for benefit
periods. The Company segments its reserves by lifetime-benefit period and non-
lifetime-benefit period recognizing the important difference in these contract
provisions. The Company needed time to complete the purchase price allocation.
The purchase price allocation was completed in the fourth quarter of 1997 and
resulted in an increase in reserves of $157.8 million from that included in the
original purchase price allocation. The primary increases were related to
revaluing policy liabilities in accordance with Accounting Principles Board
Opinion No. 16, Business Combinations. The final purchase price allocation also
resulted in an increase in goodwill of $151.5 million from the original purchase
price allocation. The purchase price allocation and subsequent adjustments are
shown below by major balance sheet category.
March 31, 1997
-------------------------------------------------------
Initial Subsequent Final
Balance as Adjustment Balance as
Reported by to Purchase Reported by
The Company Allocation the Company
(in millions of dollars)
-------------------------------------------------------
Assets
Total Investments $5,723.1 $ 22.9 $5,746.0
Deferred Federal Income Tax Asset 107.3 56.8 164.1
Value of Business Acquired 672.1 (24.1) 648.0
Goodwill 531.7 151.5 683.2
All Other Assets 749.6 8.2 757.8
-------- ------ --------
Total Assets $7,783.8 $215.3 $7,999.1
======== ====== ========
Liabilities and Stockholders' Equity
Policy and Contract Benefits, Reserves for Future Policy
and Contract Benefits, and Unearned Premiums $4,302.2 $157.8 $4,460.0
Other Policyholders' Funds 1,985.9 51.4 2,037.3
All Other Liabilities 305.7 6.1 311.8
-------- ------ --------
Total Liabilities 6,593.8 215.3 6,809.1
Stockholders' Equity 1,190.0 - 1,190.0
-------- ------ --------
Total Liabilities and Stockholders' Equity $7,783.8 $215.3 $7,999.1
======== ====== ========
Subsequent to the initial valuation, certain not readily marketable investments
were sold for $22.9 million more than originally estimated. Under purchase
accounting the $22.9 million is required to be recorded as an offset to goodwill
by increasing the market values originally assumed.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 15--Acquisition of Business - Continued
The adjustments to policy and contract benefits, reserves for future policy and
contract benefits, and unearned premiums; other policyholders' funds; and value
of business acquired reflect the use of the Company's reserve assumptions which
were established at March 31, 1997. These assumptions include provisions for
adverse deviation and give effect to the inclusion of overhead expense which
Paul Revere was not permitted to do under generally accepted accounting
principles at September 30, 1996 when the premium deficiency charge was
recorded. Subsequent to the initial valuation run, the valuation models were
updated to conform to the Company's approach using more detailed models than
used by Paul Revere. The offset to these adjustments was to the value of
business acquired and goodwill. The reserve assumptions were established at
March 31, 1997 and were held constant as the models were updated.
The adjustment to all other liabilities primarily reflects the reclassification
of certain amounts between balance sheet categories to reflect the Company's
reporting practices. The adjustment to the deferred federal income tax asset
reflects the tax impact of the adjustments recorded for the various asset and
liability categories. Goodwill is the offsetting adjustment for the changes
noted above.
Pro Forma Results
The following pro forma results of operations for the years ended December 31,
1997 and 1996, give effect to the acquisitions and the related financing
arrangements, including the acquisition of debt and issuance of common stock
equity. The pro forma results of operations, prepared from historical financial
results of operations of the Company, Paul Revere, and GENEX, with such
adjustments as are necessary to present the results of operations as if the
acquisitions had occurred as of the beginning of each year presented, are as
follows:
Year Ended December 31
1997 1996
(in millions of dollars, except share data)
----------------------------------------------
Revenue Excluding Net Realized Investment Gains and Losses $8,085.8 $7,960.1
Revenue Including Net Realized Investment Gains and Losses 8,133.7 8,003.5
Income Before Net Realized Investment Gains and Losses
and Federal Income Taxes 917.2 256.9
Income Before Federal Income Taxes 965.1 300.3
Net Income 646.6 200.9
Earnings Per Common Share - Basic 2.66 0.77
Earnings Per Common Share - Assuming Dilution 2.61 0.76
In 1996, Paul Revere strengthened reserves in its individual disability segment
by $380.0 million before income taxes, which resulted in a decrease in net
income of $244.3 million ($0.99 per common share assuming dilution). The
reserve strengthening resulted from a comprehensive study, completed in October
1996, of the adequacy the individual disability reserves under generally
accepted accounting principles.
Note 16--Sales of Portions of Lines 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
Provident's individual and tax-sheltered annuity business. In addition,
American General acquired a number of miscellaneous group pension lines of
business which were no longer actively marketed by Provident. The sale was
completed during the second quarter of 1998.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 16--Sales of Portions of Lines of Business - Continued
In consideration for the transfer of statutory reserves, American General paid
the Company a ceding commission of $58.0 million. In connection with the sale,
the Company wrote off $18.7 million of goodwill associated with the annuity
business acquired from Paul Revere. Total liabilities of $2,518.9 million were
assumed by American General, and total assets, excluding the resulting
reinsurance receivable, decreased $2,506.7 million. The gain recognized at the
time of the sale increased 1998 operating earnings by $12.2 million before tax
and $1.4 million after tax. Total revenue and income before federal income
taxes for the annuity business sold were $152.7 million and $23.7 million,
respectively, in 1997 and $24.6 and $0.1 million, respectively, in 1996.
Included in these amounts were net realized investment gains of $8.0 million in
1997 and $0.5 million in 1996.
In the fourth quarter of 1996, the Company sold certain of UNUM's tax-sheltered
annuity businesses to various affiliates of Lincoln National Corporation
(Lincoln). For those contractholders who consented, the contracts were
reinsured on an assumption basis which legally releases the Company from future
contractual obligations to the respective contractholders. For those
contractholders who have not given consent to the assumption of reinsurance, the
Company recorded a deposit asset representing the assets which support those
contracts. At December 31, 1998, the deposit asset related to those
contractholders was approximately $257.0 million.
To effect the sale of this business, the Company transferred assets of
approximately $2,690.0 million into a trust account held for the benefit of
Lincoln. The sale resulted in a deferred before-tax gain of $80.8 million, of
which $72.6 million before tax and $47.0 million after tax was recognized during
1997.
Note 17--Commitments and Contingent Liabilities
In 1997, two alleged class action lawsuits were 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 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 42 individual
lawsuits on behalf of current and former Paul Revere sales managers alleging
various breach of contract claims. Subsequent to the date of the consolidated
financial statements presented herein, two additional lawsuits have been filed
to bring the total number of individual lawsuits to 44. 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 above mentioned 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.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 18--Statutory Financial Information
Statutory Net Income, Capital and Surplus, and Dividends
The Company's insurance subsidiaries' statutory net income, as reported in
conformity with statutory accounting practices prescribed by state regulatory
authorities, for the years ended December 31, 1998, 1997, and 1996, was $227.0
million, $298.2 million, and $274.8 million, respectively. Statutory capital
and surplus at December 31, 1998 and 1997, was $2,582.1 million and $2,314.2
million, respectively.
Regulatory restrictions limit the amount of dividends available for distribution
to the Company from its insurance subsidiaries, without prior approval by
regulatory authorities, to the greater of ten percent of an insurer's statutory
surplus as regards policyholders as of the preceding year end or the statutory
net gain from operations, excluding realized investment gains and losses, of the
preceding year. The payment of dividends is further limited to the amount of
statutory unassigned surplus. Based on these restrictions, $303.3 million will
be available for the payment of dividends to the Company from its top-tier
domestic insurance subsidiaries during 1999. The Company also has the ability
to draw a dividend from its United Kingdom-based affiliate, UNUM Limited. Such
dividends are limited in amount, based on insurance company legislation in the
United Kingdom, which requires a minimum solvency margin. The amount available
under current law for payment of dividends to the Company from UNUM Limited
during 1999 is approximately $20.0 million.
Permitted Statutory Accounting Practices
The Company's insurance subsidiaries prepare their statutory-basis financial
statements in accordance with accounting practices prescribed or permitted by
the National Association of Insurance Commissioners (NAIC) and the applicable
state regulatory authorities. Prescribed statutory accounting practices include
state laws, regulations, and general administrative rules, as well as a variety
of publications of the NAIC. Permitted statutory accounting practices encompass
all accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. At December 31, 1998, the Company had not applied any
permitted accounting practices that differed from prescribed statutory
accounting practices that had a material impact on the financial position or
results of operations of the insurance subsidiaries.
In 1998, the NAIC approved a codification of statutory accounting practices
effective January 1, 2001, which will serve as a comprehensive and standardized
guide to statutory accounting principles. Following implementation, statutory
accounting principles will continue to be governed by individual state laws and
permitted practices until adoption by the various states. Accordingly, before
codification becomes effective for the Company's insurance subsidiaries, their
states of domicile must adopt codification as the prescribed basis of
accounting. The adoption of the codification will change, to some extent, the
accounting practices that the Company's insurance subsidiaries use to prepare
their statutory financial statements.
Deposits
At December 31, 1998, the Company's insurance subsidiaries had on deposit with
regulatory authorities securities with a book value of $1,653.1 million held for
the protection of policyholders.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
Note 19--Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations for 1998
and 1997:
1998
---------------------------------------------------------------------
4th 3rd 2nd 1st
---------------------------------------------------------------------
(in millions of dollars, except share data)
---------------------------------------------------------------------
Premium Income $1,569.8 $1,560.5 $1,506.1 $1,492.6
Net Investment Income 502.4 494.4 513.5 525.1
Net Realized Investment Gains 24.2 16.4 5.1 9.3
Total Revenue 2,165.2 2,144.9 2,107.1 2,102.1
Income Before Federal Income Taxes 131.5 275.9 265.5 247.3
Net Income 93.0 186.3 173.5 164.6
Earnings Per Common Share - Basic .39 .79 .73 .69
Earnings Per Common Share - Assuming Dilution .39 .77 .71 .67
1997
---------------------------------------------------------------------
4th 3rd 2nd 1st
---------------------------------------------------------------------
(in millions of dollars, except share data)
---------------------------------------------------------------------
Premium Income $1,437.0 $1,414.2 $1,373.5 $1,068.4
Net Investment Income 530.1 527.2 530.4 428.0
Net Realized Investment Gains (Losses) 0.9 9.6 (1.5) 2.5
Total Revenue 2,037.0 2,028.7 1,983.0 1,628.6
Income Before Federal Income Taxes 224.2 240.9 217.1 234.5
Net Income 152.0 162.5 147.3 155.8
Earnings Per Common Share - Basic .63 .67 .61 .73
Earnings Per Common Share - Assuming Dilution .61 .66 .60 .71
In the fourth quarter of 1998, the Company recorded a $153.0 million before-tax
charge 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
merger. The Company also recorded an $8.0 million reserve strengthening for
single premium annuities during the fourth quarter. The after-tax impact of
these charges was $104.6 million.
During the second quarter of 1998, the Company recognized a $12.2 million gain
on the sale of certain of Provident's annuity businesses. The after-tax impact
of the gain was $1.4 million.
Certain reinsurance pools managed by Duncanson & Holt Inc. received new claims
information from ceding enterprises about certain older pool years and completed
an analysis of recent claims deterioration. As a result of these factors, these
pools strengthened claim reserves which resulted in the Company recording a
charge of $18.4 million in the fourth quarter of 1997. Also in the fourth
quarter of 1997, the Company recorded $6.5 million of costs related to the
management and field office reorganization within its North American Reinsurance
Operations, which were primarily lease exit and severance costs. The after-tax
impact of these charges was $16.2 million.
In October 1996, the Company closed on the sale of certain of UNUM's tax-
sheltered annuity businesses. The Company recognized novation gains of $3.5
million, $1.7 million, $9.4 million, and $58.0 million during the fourth, third,
second, and
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UNUMProvident Corporation and Subsidiaries
first quarters, respectively. The after-tax impact of the gains was $2.3
million, $1.1 million, $6.1 million, and $37.5 million.
54