1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended June 30, 1995.
Commission file number 000-19388
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PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA
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(Exact name of registrant as specified in its charter)
TENNESSEE 62-1321664
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 Fountain Square, Chattanooga, Tennessee 37402
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(Address of principal executive offices)
(Zip Code)
(615) 755-1011
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(Registrant's telephone number, including area code)
None
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Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding for each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT JUNE 30, 1995
------------------------------- ----------------------------
A Common Stock, $1.00 Par Value 8,592,888
B Common Stock, $1.00 Par Value 36,795,968
Total number of pages included are 39
Exhibit Index Page 26
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PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial 2
Condition at June 30, 1995 and December 31, 1994
Condensed Consolidated Statements of Income for the 4
Three Months and Six Months Ended June 30, 1995 and 1994
Condensed Consolidated Statements of Cash Flows for the 5
Six Months Ended June 30, 1995 and 1994
Notes to Condensed Consolidated Financial Statements 6
Independent Auditors' Report on Review of Interim 10
Financial Information
Item 2. Management's Discussion and Analysis of Financial 11
Condition and Results of Operations
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits and Reports on Form 8-K 24
3
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
June 30 December 31
1995 1994
(in millions of dollars)
-----------------------
(Unaudited)
ASSETS
Investments
Fixed Maturity Securities
Available-for-Sale $12,113.5 $11,585.1
Held-to-Maturity 173.7 10.7
Equity Securities 7.2 7.3
Mortgage Loans 1,236.3 1,502.5
Real Estate 222.6 243.5
Policy Loans 1,434.4 1,361.5
Other Long-term Investments 12.8 10.1
Short-term Investments 58.2 296.9
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Total Investments 15,258.7 15,017.6
Cash and Bank Deposits 23.1 35.3
Accounts Receivable 40.1 72.8
Premiums Receivable 63.1 62.7
Reinsurance Receivable 459.5 300.1
Accrued Investment Income 299.9 281.8
Deferred Policy Acquisition Costs 460.0 638.2
Deferred Federal Income Tax Asset - 172.6
Property and Equipment 46.3 103.2
Miscellaneous 17.8 152.6
Separate Account Assets 343.7 313.0
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TOTAL ASSETS $17,012.2 $17,149.9
========= =========
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
June 30 December 31
1995 1994
(in millions of dollars)
-----------------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy and Contract Benefits $ 358.9 $ 354.1
Reserves for Future Policy and Contract Benefits
and Unearned Premiums 7,331.4 6,861.5
Policyholders' Funds and Experience Rating Refunds 6,733.0 7,707.7
Federal Income Tax Liability 67.2 33.4
Short-term Debt 13.4 14.4
Long-term Debt 200.3 202.5
Other Liabilities 389.5 494.2
Separate Account Liabilities 343.7 313.0
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TOTAL LIABILITIES 15,437.4 15,980.8
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COMMITMENTS AND CONTINGENT LIABILITIES - NOTE 4
STOCKHOLDERS' EQUITY
Preferred Stock 156.2 156.2
Common Stock, Class A 8.6 8.6
Common Stock, Class B 36.8 36.8
Additional Paid-in Capital 5.6 4.8
Net Unrealized Gain (Loss) on Securities 69.6 (302.3)
Foreign Currency Translation Adjustment (5.2) (5.4)
Retained Earnings 1,303.2 1,270.4
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TOTAL STOCKHOLDERS' EQUITY 1,574.8 1,169.1
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $17,012.2 $17,149.9
========= =========
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
Three Months Ended June 30 Six Months Ended June 30
1995 1994 1995 1994
(in millions of dollars, except share data)
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REVENUE
Premium Income $313.1 $346.4 $ 674.1 $ 695.2
Net Investment Income 309.8 305.8 622.8 610.5
Net Realized Investment Losses (24.6) (3.3) (28.5) (7.6)
Gain on Sale of a Portion of a
Line of Business - Note 5 21.8 - 21.8 -
Other Income 24.0 39.7 67.7 79.9
------ ------ -------- --------
TOTAL REVENUE 644.1 688.6 1,357.9 1,378.0
------ ------ -------- --------
BENEFITS AND EXPENSES
Policy and Contract Benefits 353.0 372.1 747.7 759.9
Change in Reserves for Future Policy and 119.0 111.9 271.2 210.0
Contract Benefits
Change in Policyholders' Funds 7.1 5.5 10.5 11.4
Amortization of Policy Acquisition Costs 18.1 15.5 35.2 31.5
Salaries 23.5 40.1 62.5 79.5
Other Operating Expenses 71.5 86.5 159.3 174.1
------ ------ -------- --------
TOTAL BENEFITS AND EXPENSES 592.2 631.6 1,286.4 1,266.4
------ ------ -------- --------
INCOME BEFORE FEDERAL INCOME TAXES 51.9 57.0 71.5 111.6
FEDERAL INCOME TAXES 16.9 19.4 24.2 38.4
------ ------ -------- --------
NET INCOME $ 35.0 $ 37.6 $ 47.3 $ 73.2
====== ====== ======== ========
NET INCOME PER COMMON SHARE - NOTE 2 $ 0.70 $ 0.76 $ 0.90 $ 1.48
WEIGHTED AVERAGE COMMON SHARES 45,383,342 45,300,240 45,372,442 45,286,319
OUTSTANDING
DIVIDENDS PER COMMON SHARE $ 0.18 $ 0.26 $ 0.36 $ 0.52
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
Six Months Ended June 30
1995 1994
(in millions of dollars)
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NET CASH PROVIDED BY OPERATING ACTIVITIES $ 353.1 $ 247.7
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sales of Investments 850.0 273.4
Proceeds from Maturities of Investments 601.5 1,376.1
Purchase of Investments (948.8) (2,424.5)
Net Sales of Short-term Investments 231.4 323.4
Disposition of Group Medical Business (48.9) -
Other (53.0) 97.0
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NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 632.2 (354.6)
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CASH FLOWS FROM FINANCING ACTIVITIES
Deposits to Policyholder Accounts 304.4 972.0
Maturities and Benefit Payments from Policyholder Accounts (1,278.3) (980.1)
Net Short-term Borrowings (1.0) 220.7
Issuance of Common Stock 0.8 1.3
Dividends Paid to Stockholders (22.7) (29.9)
Other (0.7) (43.2)
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NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES (997.5) 140.8
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NET INCREASE (DECREASE) IN CASH AND BANK DEPOSITS (12.2) 33.9
CASH AND BANK DEPOSITS AT BEGINNING OF PERIOD 35.3 32.0
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CASH AND BANK DEPOSITS AT END OF PERIOD $ 23.1 $ 65.9
========= =========
See notes to condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
JUNE 30, 1995
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. Operating results for the three and
six month periods ended June 30, 1995 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1995. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's annual report on Form 10-K for the year ended
December 31, 1994.
NOTE 2--EARNINGS PER SHARE
Earnings per common share are computed using net income less preferred stock
dividends ($3.1 million for the three month periods ended June 30, 1995 and
1994 and $6.3 million for the six month periods ended June 30, 1995 and 1994)
divided by the weighted average number of common shares outstanding. There is
no significant difference between earnings per share on a primary or fully
diluted basis.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
JUNE 30, 1995
NOTE 3--SEGMENT INFORMATION
A summary by segment of the Company's revenue and income before federal income
taxes, excluding and including net realized investment gains and losses,
follows:
Three Months Ended June 30 Six Months Ended June 30
1995 1994 1995 1994
(in millions of dollars)
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Revenue (Excluding Net Realized
Investment Gains and Losses)
Individual Life and Disability $251.1 $234.6 $ 501.5 $ 468.4
Employee Benefits 146.7 140.4 297.4 281.2
Other Operations 270.9 316.9 587.5 636.0
------ ------ -------- --------
Total $668.7 $691.9 $1,386.4 $1,385.6
====== ====== ======== ========
Income Before Net Realized
Investment Gains and Losses and
Federal Income Taxes
Individual Life and Disability $ 17.3 $ 15.8 $ 0.5 $ 30.0
Employee Benefits 8.1 22.0 20.5 39.0
Other Operations 51.1 22.5 79.0 50.2
------ ------ -------- --------
Total $ 76.5 $ 60.3 $ 100.0 $ 119.2
====== ====== ======== ========
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
JUNE 30, 1995
NOTE 3--SEGMENT INFORMATION - CONTINUED
Three Months Ended June 30 Six Months Ended June 30
1995 1994 1995 1994
(in millions of dollars)
-----------------------------------------------------------
Revenue (Including Net Realized
Investment Gains and Losses)
Individual Life and Disability $249.8 $236.7 $ 500.9 $ 473.5
Employee Benefits 147.1 141.5 298.1 282.3
Other Operations 247.2 310.4 558.9 622.2
------ ------ -------- --------
Total $644.1 $688.6 $1,357.9 $1,378.0
====== ====== ======== ========
Income (Loss) Before Federal Income Taxes
Individual Life and Disability $ 16.0 $ 17.9 $ (0.1) $ 35.1
Employee Benefits 8.5 23.1 21.2 40.1
Other Operations 27.4 16.0 50.4 36.4
------ ------ -------- --------
Total $ 51.9 $ 57.0 $ 71.5 $ 111.6
====== ====== ======== ========
The Other Operations segment now includes the results of the group medical
business which was sold in the second quarter of 1995. Previously, these
results were reported separately in the Medical Services segment.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA AND SUBSIDIARIES
JUNE 30, 1995
NOTE 4--COMMITMENTS AND CONTINGENT LIABILITIES
Various lawsuits against the Company have arisen in the normal course of
business. Contingent liabilities that might arise from litigation are not
deemed likely to materially affect the financial position or results of
operations of the Company.
NOTE 5--SALE OF A PORTION OF A LINE OF BUSINESS
On December 20, 1994, the Company entered into an Asset and Stock Purchase
Agreement (the Agreement) with Healthsource, Inc. (Healthsource) whereby
Healthsource agreed to acquire certain assets and assume certain liabilities of
the Company's group medical business. The sale was completed on May 31, 1995
effective April 30, 1995. The Company received $131.0 million in cash and
$100.0 million of a new issue of Healthsource 6.25% preferred stock which is
redeemable at par for two years or exchangeable for marketable securities under
certain circumstances. Pursuant to the Agreement, assets were transferred to
Healthsource which had a carrying value of approximately $297.5 million.
Liabilities assumed by Healthsource in connection with the transferred business
totaled $221.5 million. Total revenue and income before federal income taxes
for the group medical business were $146.2 million and $3.3 million,
respectively, for the four month period ended April 30, 1995. The gain on sale
of the Company's group medical business increased second quarter and
year-to-date operating earnings by $21.8 million ($0.48 per common share)
before taxes and $14.2 million ($0.31 per common share) after taxes.
NOTE 6--RESTATEMENT
The Company restated its first quarter results to correct premium income and
related expenses. This restatement is reflected in year-to-date statements of
income and cash flows and in the segment information. During the process of
separating the group business between the product lines retained by the Company
and the product lines sold as part of the Medical Services business, an error
occurred which resulted in the overstatement of premium income by $6.3 million,
of income before federal income taxes by $6.1 million, of net income by $4.0
million, of income before federal income taxes per common share of $0.14, and
of net income per common share of $0.09.
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INDEPENDENT AUDITORS' REPORT ON REVIEW
OF INTERIM FINANCIAL INFORMATION
Board of Directors and Shareholders
Provident Life and Accident Insurance Company of America
We have reviewed the accompanying condensed consolidated statement of financial
condition of Provident Life and Accident Insurance Company of America and
Subsidiaries as of June 30, 1995, the related condensed consolidated statements
of income for the three and six month periods ended June 30, 1995 and 1994, and
the condensed consolidated statements of cash flows for the six month periods
ended June 30, 1995 and 1994. These financial statements are the
responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, which will be
performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
referred to above for them to be in conformity with generally accepted
accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial condition of Provident Life
and Accident Insurance Company of America and Subsidiaries as of December 31,
1994, and the related consolidated statements of operations, stockholders'
equity and cash flows for the year then ended, not presented herein, and in our
report dated February 6, 1995, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth
in the accompanying condensed consolidated statement of financial condition as
of December 31, 1994, is fairly stated in all material respects in relation to
the consolidated statement of financial condition from which it has been
derived.
ERNST & YOUNG LLP
Chattanooga, Tennessee
August 9, 1995
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Revenue excluding net realized investment gains/losses ("revenue")
decreased $23.2 million, or 3.4 percent, to $668.7 million in the second quarter
of 1995 from $691.9 million in the second quarter of 1994. The decline was the
result of a decrease in revenue in the other operations segment ($46.0 million),
which more than offset higher revenue in the individual life and disability
segment ($16.5 million) and employee benefits segment ($6.3 million).
For the first six months of 1995, revenue increased $0.8 million to
$1,386.4 million from $1,385.6 million in the first six months of 1994. Revenue
in the other operations segment declined $48.5 million, which was offset by
increased revenue in the individual life and disability segment ($33.1 million)
and employee benefits segment ($16.2 million).
Income before net realized gains and losses and federal income taxes
("income") increased $16.2 million, or 26.9 percent, to $76.5 million in the
second quarter of 1995 from $60.3 million in the second quarter of 1994. The
increase was the result of higher income in the individual life and disability
segment ($1.5 million) and other operations segment ($28.6 million), which was
partly offset by decreased income in the employee benefits segment ($13.9
million).
For the first six months of 1995, income declined $19.2 million, or 16.1
percent, to $100.0 million from $119.2 million in the first six months of 1994.
Lower income in the individual life and disability segment ($29.5 million) and
employee benefits segment ($18.5 million) was partly offset by increased income
in the other operations segment ($28.8 million).
INDIVIDUAL LIFE AND DISABILITY
Revenue in this segment increased $16.5 million, or 7.0 percent, to
$251.1 million in the second quarter of 1995 from $234.6 million in the second
quarter of 1994. Increases in both premium income and net investment income
contributed to the higher revenue. Premium income increased $0.2 million, or
0.1 percent, to $159.8 million in the second quarter of 1995 from $159.6 million
in the second quarter of 1994. The increase was the result of higher premium
income in the individual disability income line of business, which increased
$1.0 million, or 0.7 percent, to $144.1 million in the second quarter of 1995
from $143.1 million in the second quarter of 1994. Net investment income for
the segment increased $15.2 million, or 20.7 percent, to $88.5 million in the
second quarter of 1995 from $73.3 million in the second quarter of 1994. The
increase was the result of increased capital and surplus allocated to the
individual disability line of business, the normal growth in reserve liabilities
and related assets held in individual life and disability contracts, and the
growth in investment income related to the deferred deposits in the annuity line
of business.
For the first six months of 1995, revenue increased $33.1 million, or
7.1 percent, to $501.5 million from $468.4 million in the first six months of
1994. Premium income increased $2.2 million, or 0.7 percent, to $320.2 million
in the first six months of 1995 from $318.0 million in the first six months of
1994. Increased premium income in the individual disability income line offset a
decline in premium income from the individual life line of business. Net
investment income increased $28.0 million, or 19.1 percent, to $174.6 million in
the first six months of 1995 from $146.6 million in the first six months of
1994. The increase was the result of increased capital and surplus allocated to
the individual disability line of business, the normal growth in reserve
liabilities and related assets held in individual life and disability contracts,
and the growth in investment income related to the deferred deposits in the
annuity line of business.
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In November 1994, the Company announced its intention to discontinue
selling individual non-cancellable disability income contracts with long-term
own-occupation provisions (other than conversion policies available under
existing contractual arrangements). The Company will focus on replacing the
traditional non-cancellable, long-term own-occupation contracts with "loss of
earnings" contracts which insure income rather than occupation and require the
insured to participate in occupational rehabilitation as appropriate.
During this product transition period, premium income in the individual
disability line is expected to decline as a result of a period of lower sales
and the premium differential that exists between the traditional
non-cancellable, own-occupation contracts and the new loss of earnings
contracts. The magnitude and duration of the expected decline are dependent on
the response of customers and competitors in the industry.
This segment reported income of $17.3 million in the second quarter of
1995 compared to $15.8 million in the second quarter of 1994, an increase of
$1.5 million, or 9.5 percent. The individual disability line of business
produced income of $10.2 million in the second quarter of 1995 compared to
income of $8.1 million in the second quarter of 1994. This line benefited from
improved claim experience in the second quarter of 1995 relative to the year ago
quarter and the first quarter of 1995. Management believes that improved claims
handling procedures, initiated over the past several months, helped produce this
improvement in experience. New claims in the second quarter of 1995 were lower
than the level experienced in the first quarter of 1995, but above the levels of
the year ago quarter.
For the first six months of 1995, the segment reported income of $0.5
million compared to $30.0 million in the first six months of 1994. The decline
is primarily due to the individual disability income line, which produced a loss
of $10.3 million in the first six months of 1995 compared to income of $15.5
million in the first six months of 1994. The loss was a result of adverse claim
experience in the first quarter of 1995 on individual non-cancellable disability
income contracts with own-occupation provisions which were issued between 1983
and 1989. Specifically, the severity of the new claims in the first quarter of
1995 was higher than the average levels experienced in the 1994 first quarter
and for all of 1994, and the level of claim terminations was lower relative to
both periods.
A loss recognition deficiency of $423.0 million on a pre-tax basis was
recorded as an increase in "policy and contract benefits" and "change in
reserves for future policy and contract benefits" in the third quarter of 1993
to reflect the lower interest rates available at the time of the charge compared
to the interest rate assumptions used in pricing the business at earlier dates.
Higher than expected claim experience, caused by the general economic recession
and trends in particular regions of the country toward increasing claims for
certain occupations and types of disabilities, also contributed to the
requirement under generally accepted accounting principles to record the
deficiency. Although interest rates are currently consistent with those
projected at the time of the charge, it is not reasonably possible to determine
at this time exactly what the trends in interest rates will be.
Besides movement of interest rates, changes in expenses and morbidity
can affect results. The loss recognition study performed as of September 30,
1993, also projected that morbidity would improve over time as a result of
stricter policy provisions, tighter underwriting requirements, improved claim
handling procedures (consisting of centralization of the claims-paying function
in the home office and the availability of additional technical resources), the
effects of anti-selection wearing off over time, and general improvement in the
economy. Incidence and termination rate studies have been performed as of
December 31, 1994, to evaluate actual morbidity experience. Morbidity
experience was at somewhat higher levels than expected for 1994, and also the
first quarter of 1995. In the second quarter of 1995, however, actual
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morbidity experience was more in line with expected experience. It is not
possible at this time to predict what actual morbidity will be in the future.
However, if morbidity experience is higher than the levels assumed in the loss
recognition studies, a further adjustment might be required. Since the study
in 1993, expenses have been lower than projected in that study, primarily as a
result of expense control efforts and centralization of the claims-paying
function into the home office.
The Company considers its individual disability income business to be
one block or line of business for purposes of conducting a loss recognition
study. The individual disability income business is analyzed on an ongoing basis
to determine particular geographic areas, occupations, policy provisions, etc.
which may be a factor in the results being experienced. Such reviews have shown
that policies written for medical professionals and for residents of California
and south Florida are more likely to result in claims than those written in
other professions or in other areas of the United States or Canada.
Additionally, policies written during the period 1983 through 1989 have a higher
claim rate than those policies written before or after this time period. The
Company, in intense competition with other companies in this line of business
during this time period, liberalized underwriting standards and policy
provisions without a corresponding increase in premium rates to offset the
increased risk undertaken. Since 1989, however, the Company has been
strengthening its underwriting and policy provisions and adjusting the price on
its new business written to better reflect the risks in this line of business.
Because individual disability income policies are long-term contracts
(with typical effective terms of five to forty years, depending upon the age of
the insured at the time of issue), assumptions as to interest rates and
morbidity, as well as expenses, lapse rates and other variables, used to price
the product and to calculate policyholder liabilities during the term of the
contracts, must be made with a long-term perspective. Fluctuations in actual
experience from such assumptions are normal, especially since these assumptions
are a long-term prediction of future events and conditions. These assumptions
are long-term averages of the experience that the Company expects to realize
over the duration of the policies and do not attempt to predict each short-term
rise or decline in interest rates, morbidity, or other factors. Variations
between actual experience and such long-term averages are monitored through a
variety of ongoing statistical studies. Such variations over a one or two year
period do not necessarily indicate that a change in the long-term assumptions is
necessary or that higher or lower reserves are required. Normally, such
fluctuations between actual experience and assumed experience are included in
income or loss in the current year. However, when these deviations occur in a
magnitude and/or over a time period such that if they continued the sufficiency
of reserves and the recoverability of deferred policy acquisition costs is
questionable, it is prudent to perform a loss recognition study.
In a loss recognition study, the Company uses its best estimates as to
future experience with regard to interest rates, morbidity rates, lapse rates,
expenses, and other factors to update its assumptions. These revised
assumptions are then used to determine if reserves currently held plus the
present value of future cash inflows (primarily from premiums and investment
income) are projected to be sufficient to meet the present value of future cash
outflows (primarily for benefits and expenses) and the amortization of deferred
policy acquisition costs. If they are not sufficient, an additional provision
must be recorded either as a reduction of deferred policy acquisition costs or
as an increase in reserve liabilities.
While claims were higher and interest rates generally lower in 1991 than
in previous years, at that time the Company believed these fluctuations to be
short-term and acceptable variations from the assumptions underlying these
long-term policies. However, in light of a continuing decline in interest rates
and deterioration of morbidity experience during 1992, the Company began such a
loss recognition study on its individual disability income business in December
1992 to determine whether or not a loss recognition deficiency existed at
December 31, 1992. An
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independent actuarial consulting firm was engaged to assist in the development
of a gross premium valuation model appropriate to the Company's business, to
review the reasonableness of the assumptions used by the Company at the time of
the study, and to work with Company employees in the actual performance of the
calculations. The loss recognition study completed in February 1993 showed
that no loss recognition deficiency existed at December 31, 1992, using the
assumptions with respect to morbidity, interest rates, and expenses that
reflected management's best estimates as of that date. Although there is
always uncertainty as to the direction of future morbidity experience and
interest rates, the Company believed the results of the study indicated that
reserves were sufficient as of that date. The Company also believed at that
time that, under its "most likely case" scenario, interest rates would rise in
1993 and morbidity rates would do no worse than remain at 1988-1992 levels.
Through the first half of 1993, however, the interest rates continued to
decline, and the Company experienced further morbidity deterioration related to
this business. As a result, reserves were increased during the first two
quarters of 1993. Also, as part of its normal, ongoing reserve analysis, the
Company performs several detailed actuarial studies, including measuring
morbidity experience over a run-off period of several years. Increased claim
activity experienced in the first two quarters of 1993 and studies performed in
the second and third quarters of 1993, which reflected 1992 morbidity
experience, caused management to revise its December 31, 1992, estimate of
long-term morbidity rates. At the same time, the portfolio of assets related to
this line of business experienced a significant decline in long-term interest
rates combined with increased prepayment of fixed maturity securities, resulting
in a significant decline in the portfolio's future investment returns. The
yields on assets supporting the individual disability business declined to 9.32
percent at the end of the first quarter and to 9.17 percent at the end of the
second quarter, compared to an aggregate yield of 9.57 percent at the end of
1992.
Because of these developments during the first half of 1993, the Company
again evaluated the sufficiency of reserves and the recoverability of deferred
policy acquisition costs. Although a loss recognition study had been scheduled
for year-end 1993 as a follow-up to the study at December 31, 1992, the
deviations between actual experience and assumptions were widening rapidly
enough to warrant accelerating the study to the third quarter of 1993 to
determine if reserves continued to be sufficient in light of these fluctuations.
The specific conditions that precipitated the third quarter 1993 loss
recognition study were:
1. A sharp drop in interest rates as evidenced by the decline in the
rate on 10-year U.S. Treasury Notes from 6.93 percent in December
1992, to 5.23 percent in September 1993. This drop of 170 basis
points was a 25 percent decline in nine months.
2. Prepayment of many fixed maturity securities during this nine-month
period, brought about primarily by the lower interest rate levels,
caused the yield on the portfolio supporting the individual
disability income business to decline 59 basis points in only nine
months.
3. Morbidity studies covering the first and second quarters of 1993
reflected further deterioration in morbidity experience during this
part of 1993 compared with previous morbidity experience.
The September 30, 1993, loss recognition study followed the same
principles as the study performed as of December 31, 1992. The independent
actuarial consulting firm, which assisted in conducting the December 1992 study,
served in a review capacity (rather than as an active participant) in the
performance of the study. Based upon the revised assumptions, which
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represented management's best estimates at the time of the study, a loss
recognition deficiency of $423.0 million on a pre-tax basis was required to be
recognized under generally accepted accounting principles. Management believes
that the required charge taken in the third quarter was a prompt and
appropriate response to these previously unforeseen changes.
The December 31, 1994, study again followed the same principles as the
previous two studies. Based upon the revised assumptions, which represented
management's best estimates at the time of the study, reserves were adequate at
the end of 1994.
The following table shows the new money interest rate assumptions on a
net effective yield rate basis and the portfolio yield interest rate assumptions
which were used in the December 31, 1992, September 30, 1993, and December 31,
1994, loss recognition studies.
The interest rate assumptions in each of the loss recognition studies
represented management's best estimates at the time the studies were performed.
The equivalent level portfolio net effective yield rate represents the effective
yield on the portfolio over a thirty year period, using the actual portfolio
yield at the date of the loss recognition study and the assumed yield rates at
which new money will be invested.
------------------------------------------------------------------------------------------------------------
December 31, 1992 September 30, 1993 December 31, 1994
------------------------------------------------------------------------------------------------------------
New New New
Money Portfolio Money Portfolio Money Portfolio
------------------------------------------------------------------------------------------------------------
1993 8.19% 9.38%
1994 8.92 9.33 6.53% 8.57%
1995 8.92 9.27 6.51 8.46 7.95% 8.40%
1996 8.92 9.24 6.82 8.43 7.64 8.29
1997 8.92 9.21 7.07 8.45 7.64 8.20
1998 8.92 9.18 7.13 8.42 7.64 8.13
Ultimate 8.92 8.92 7.13 7.13 7.64 7.64
Equivalent Level Portfolio
Net Effective Yield Rate: 9.27% 9.27% 7.91% 7.91% 8.19% 8.19%
------------------------------------------------------------------------------------------------------------
Annual net effective interest rates at which new money was actually
invested for the individual disability income business for the year 1992, the
first nine months of 1993, and the year 1994 were 8.82 percent, 7.59 percent,
and 8.17 percent, respectively. The net effective interest rate at which new
money was invested for this line in the second quarter of 1995 was 7.98 percent
and 8.32 percent for the first half of 1995. The overall net effective
portfolio yield rates for invested assets supporting the individual disability
income business were 9.57 percent, 8.98 percent, and 8.64 percent as of
December 31, 1992, September 30, 1993, and December 31, 1994, respectively.
The overall net effective portfolio yield for invested assets supporting this
line was 8.58 percent at June 30, 1995. The September 1993 loss recognition
study projected that morbidity would improve as a result of improved claim
handling procedures (consisting of centralization of the claims-paying function
in the home office and the availability of additional technical resources), the
effects of anti-selection wearing off over time, and general improvement in the
economy. The December 1994 study also projected improved morbidity, with
reduced or delayed improvement, but projected no improvement in the economy.
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In performing a loss recognition study the Company is required to use
its best estimates with regard to assumptions used in the calculation. Using
"best estimates" means that no provision for adverse deviation is included in
the assumptions and the expectation is for a break-even outcome, that is, there
is about an even chance that experience will be better than or worse than the
assumptions. If future experience conforms to assumptions used in the loss
recognition study, no gain or loss would be expected from the line of business
other than (i)investment income relative to the capital and surplus allocated to
that line, and (ii) profit from new individual disability income policies. If
actual experience in a future period is worse than assumed and is expected to
continue, an additional loss would have to be recognized. If actual experience
is better than assumed, the resulting gain will be recognized over future years
as it is actually realized.
On a pre-tax basis, approximately 51 percent of the difference between
the results of the December 1992 and September 1993 loss recognition studies
related to the effects of rapidly declining interest rates during 1993,
including prepayment of fixed maturity securities as well as lower portfolio
yields on both new and reinvested money. Approximately 26 percent of the
difference related to higher morbidity costs and the associated claim
administration expenses. Approximately 11 percent of the difference was related
to the inclusion in the September 1993 loss recognition study of guaranteed
increases in coverage on existing policies. The remaining amount was primarily
attributable to differences in assumptions with respect to expenses, other than
claim administration expenses, and to persistency.
Based on the assumptions used in the September 1993 loss recognition
study, a ten basis point change in the equivalent level interest rates would
result in approximately a $22 million change in reserves, and a one percent
change in actual to assumed morbidity would result in approximately a $29
million change in reserves. Based on the assumptions used in the December 1994
study, a ten basis point change in the equivalent level interest rates would
result in approximately a $29 million change in reserves, and a one percent
change in actual to assumed morbidity would result in approximately a $28
million change in reserves.
It is not possible to predict with certainty whether morbidity, interest
rates, and fixed maturity securities prepayments will continue at a level
consistent with the Company's assumptions, improve, or deteriorate; however, the
current assumptions as to these factors represent management's best estimates in
light of present circumstances. Additional increases to reserves would be
required if there is further material deterioration in morbidity, interest
rates, and fixed maturity securities prepayments from current assumptions. As
part of its ongoing management of this line of business, the Company will
conduct a gross premium valuation annually to validate the continued adequacy of
current reserves.
Income from the individual life line of business declined to $5.8
million in the second quarter of 1995, compared to $7.2 million in the second
quarter of 1994. For the first six months of 1995, income from this line was
$9.5 million compared to $13.5 million in the first six months of 1994. The
decline in the first half was primarily attributable to a $1.9 million
non-recurring expense item recorded in the first quarter of 1995 pertaining to
reinsurance reserves, as well as higher mortality experience and slower revenue
growth in the second quarter of 1995.
Deposits on deferred annuities totaled $19.2 million in the second
quarter of 1995 compared to $24.9 million in the second quarter of 1994. For
the first six months of 1995, deposits totaled $62.1 million compared to $42.7
million for the first six months of 1994.
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EMPLOYEE BENEFITS
Revenue in the employee benefits segment increased $6.3 million, or 4.5
percent, to $146.7 million in the second quarter of 1995 from $140.4 million in
the second quarter of 1994. This increase was primarily the result of an
increase in premium income of $5.4 million, or 4.6 percent, to $123.2 million in
the second quarter of 1995 from $117.8 million in the second quarter of 1994.
Increased premium income in the group long-term disability (LTD), voluntary
benefits, and packaged products lines of business contributed to this increase.
Net investment income declined by $0.2 million, or 0.9 percent, to $21.3 million
in the second quarter of 1995 from $21.5 million in the second quarter of 1994.
For the first six months of 1995, revenue increased $16.2 million, or
5.8 percent, to $297.4 million from $281.2 million in the first six months of
1994. This increase was primarily the result of an increase in premium income
of $16.0 million, or 6.8 percent, to $251.5 million in the first six months of
1995 from $235.5 million in the first six months of 1994. Increased premium
income in the voluntary benefits, packaged products, group life, and group LTD
lines of business contributed to this increase. Net investment income declined
$1.2 million, or 2.8 percent, to $42.4 million in the first six months of 1995
from $43.6 million in the first six months of 1994.
Income in this segment decreased $13.9 million to $8.1 million in the
second quarter of 1995 from $22.0 million in the second quarter of 1994. The
decline is primarily attributable to higher loss ratios in the group LTD and
group life lines of business. The LTD line of business produced a loss of $6.6
million in the second quarter of 1995 compared to income of $1.3 million in the
second quarter of 1994 due to higher claim incidence and severity. During the
first quarter of 1995, the Company notified the existing group LTD customers in
the medical and legal occupational classes that coverages will be terminated
under the terms of the existing contracts, and the Company will no longer accept
proposals for group disability coverage of new medical or legal groups. This
action will impact approximately 15 percent of the group LTD block of business,
which produced $58.9 million of premium income in 1994. Results in the group
LTD line were negatively impacted by $2.2 million in the second quarter and
first six months of 1995 due to an acceleration in the amortization of deferred
policy acquisition costs. The group life line produced income of $4.2 million
in the second quarter of 1995 compared to income of $8.5 million in the second
quarter of 1994. The decline was primarily due to a higher loss ratio.
For the first six months of 1995, income in this segment declined $18.5
million to $20.5 million from $39.0 million in the first six months of 1994. The
decline is primarily attributable to higher loss ratios in the group LTD and
group life lines. Group LTD produced a loss of $10.1 million in the first half
of 1995 compared to income of $2.9 million in the first half of 1994 due to
higher claims and severity. Income from the group life line declined to $7.8
million in the first six months of 1995 from $15.8 million in the first six
months of 1994 due to the poor experience in the second quarter of 1995.
OTHER OPERATIONS
Revenue in the other operations segment declined $46.0 million, or 14.5
percent, to $270.9 million in the second quarter of 1995 from $316.9 million in
the second quarter of 1994. Net investment income declined $11.0 million, or
5.2 percent, to $200.0 million in the second quarter of 1995 from $211.0 million
in the second quarter of 1994. This was a result of the lower investment income
from the corporate (unallocated) capital and assets, which are included in this
segment, due to additional capital being allocated to the individual disability
line of business, and lower investment income in the group pension line due to a
decrease in funds under management. Premium income declined $38.9 million to
$30.1 million in the second quarter of 1995 from $69.0
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million in the second quarter of 1994 due to the sale of the medical services
business to Healthsource, Inc. This segment includes only one month of results
of the medical services line in the second quarter of 1995, due to the sale of
this line effective May 1, 1995. This line of business produced $23.5 million
of premium income and $12.4 million of fee income in April compared to $61.5
million and $34.5 million, respectively, for the second quarter of 1994.
For the first six months of 1995, revenue declined $48.5 million, or 7.6
percent, to $587.5 million from $636.0 million in the first six months of 1994.
Net investment income declined $14.5 million, or 3.4 percent, to $405.8 million
in the first half of 1995 from $420.3 million in the first half of 1994. This
was a result of lower investment income from the corporate (unallocated) capital
and assets, the group pension line, and the inclusion of only four months of net
investment income for the medical services line. Premium income in this segment
declined $39.3 million, or 27.7 percent, to $102.4 million in the first half of
1995 from $141.7 million in the first half of 1994. The decline was primarily
the result of the sale of the medical services business which became effective
May 1, 1995. This line produced $90.9 million of premium in the first four
months of 1995, compared to $127.5 million in the first six months of 1994.
Premium income in this segment was also impacted by the discontinuation of the
sale of group single premium annuities which produced $0.7 million of premium
income in the first half of 1995 compared to $3.0 million in the first six
months of 1994.
Income in this segment increased $28.6 million, or 127.1 percent, to
$51.1 million in the second quarter of 1995 from $22.5 million in the second
quarter of 1994. This segment includes a before-tax gain of $21.8 million from
the sale of the medical services business to Healthsource during the second
quarter of 1995. Within this segment, the group pension line of business
produced income of $17.5 million in the second quarter of 1995, compared to
$11.9 million in the second quarter of 1994. This line of business benefited
from an improvement in the spread between interest credited on contracts and the
interest earned on the invested assets.
During the first half of 1995, income in this segment increased $28.8
million, or 57.4 percent to $79.0 million from $50.2 million in the first half
of 1994. The increase is primarily due to the gain from the medical services
sale and the improved results in the group pension line. Results in the second
quarter and first six months of 1995 were negatively impacted by a $1.9 million
guaranty fund assessment.
The Company announced in December 1994, that it would discontinue the
sale of traditional guaranteed investment contracts (GICs). Traditional GICs
under management declined $1.21 billion, or 16.8 percent, to $6.01 billion at
June 30, 1995, from $7.22 billion at June 30, 1994. Total funds under
management and equivalents decreased $0.15 billion, or 1.5 percent, to $9.91
billion at June 30, 1995 from $10.06 billion at June 30, 1994. Included in this
total are accumulated funds from the sale of synthetic GICs which totaled $2.25
billion at June 30, 1995 compared to $1.21 billion at June 30, 1994. Deposits of
synthetic GICs totaled $418.0 million in the second quarter of 1995, compared to
$250.8 million in the second quarter of 1994. Deposits of synthetic GICs
totaled $620.6 million in the first half of 1995 compared to $574.7 million in
the first half of 1994.
Income from the block of corporate-owned life insurance, included in the
other operations segment, improved to $9.3 million in the first half of 1995
from $8.8 million in the first half of 1994. Improved mortality experience was
a primary source of the higher income in this line of business.
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LIQUIDITY AND CAPITAL RESOURCES
As a holding company, the Company is dependent upon payments from its
wholly-owned subsidiary, Provident Life Capital Corporation ("Capital"), to pay
dividends to its shareholders and to pay its expenses. Capital is also a
holding company and therefore dependent upon payments from its wholly-owned
subsidiary, Provident, to pay dividends, to meet its debt service obligations
and to pay its expenses. These payments by Provident may take the form of
either dividends or interest payments on amounts loaned to Provident by Capital.
State insurance laws generally restrict the ability of insurance
companies to pay cash dividends or make other payments to their affiliates in
excess of certain prescribed limitations. In Tennessee, the Company's state of
domicile, regulatory approval is required if an insurance company seeks to make
loans to affiliates in amounts equal to or in excess of 3 percent of the
insurer's admitted assets, or to pay cash dividends in excess of the greater of
such company's net gains from operations of the preceding year or 10 percent of
its surplus as regards policyholders, as determined at the end of the preceding
year in accordance with prescribed or permitted accounting practices. Under
these regulatory restrictions, up to $80.4 million would be available in 1995
for the payment of dividends or other distributions by the Company without
regulatory approval.
The Company's requirements are met primarily by cash flow provided from
operations, principally in Provident. Cash flow from operations has been
substantial over the past three years. Premium and investment income as well as
maturities and sales of invested assets provide the primary sources of cash.
Cash flows from operations were ample in the first six months of 1995 and 1994.
Premium and investment income as well as maturities and sales of invested assets
provide the primary sources of cash. Cash is applied to the payment of policy
benefits, cost of acquiring new business (principally commissions) and operating
expenses as well as purchases of new investments. The Company has established
an investment strategy that management believes will provide for adequate cash
flow from operations.
The Company expects that the sale of the group medical services business
to Healthsource will have no material adverse effect on its liquidity. The sale
produced an after-tax gain of $14.2 million on a generally accepted accounting
principles (GAAP) basis and an after-tax gain of $86.4 million on a statutory
basis.
The Company expects no material adverse effect on its liquidity as a
result of the strategic decision to discontinue the sale of traditional GICs.
While traditionally the investment strategy for this product line has been to
match the effective asset durations with the related expected liability
durations, the Company has moved toward a cash-matching investment strategy. In
addition, management expects that capital from the GIC business will be
redeployed in other lines of business or used for other business purposes.
INVESTMENTS
The Company is actively exploring transactions which will reduce its
exposure to both restructured mortgage loans and currently performing mortgage
loans either through the outright sale of mortgage loans or the securitization
of part or all of the portfolio. In anticipation of the sale the Company has
used puts on Treasury securities to hedge the expected proceeds from the sale.
On May 10, 1995, the Company sold restructured mortgage loans with a principal
amount of $147.5 million and a book value of $122.6 million. The Company
received $99.5 million in cash for these restructured loans, which resulted in a
before-tax realized investment loss of $23.1 million.
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Prior to 1992, the Company experienced increases in non-current
investments. For the past three years, however, the Company's exposure to such
investments has declined significantly. These non-current investments are
primarily foreclosed real estate investments, mortgage loans which became more
than thirty days past due in their principal and interest payments, and bonds
and preferred stocks in default. Non-current investments at June 30, 1995 were
$104.0 million, or 0.68 percent of invested assets. Non-current investments at
year-end 1994 were $88.5 million, or 0.59 percent of invested assets, compared
to $170.2 million, or 1.13 percent of invested assets, at year-end 1993.
A distribution of the mortgage loan portfolio by state and by property
type as of June 30, 1995 is presented below.
Percent of
Region Amount Mortgage Portfolio
------ ------ ------------------
(in millions)
Pacific $ 336.6 27.2%
South Atlantic 274.4 22.2
East North Central 168.8 13.7
Mountain 136.5 11.0
West North Central 112.2 9.1
West South Central 100.7 8.1
East South Central 97.2 7.9
Middle Atlantic 25.9 2.1
New England 6.2 0.5
Mortgage Loan Loss Reserve (22.2) (1.8)
-------- -----
TOTAL $1,236.3 100.0%
======== =====
Property Percent of
Type Amount Mortgage Portfolio
---- ------ ------------------
(in millions)
Retail $ 401.2 32.5%
Apartment 307.6 24.9
General Office Buildings 188.1 15.2
Industrial & Warehouse 184.4 14.9
Healthcare 142.3 11.5
Hotel/Motel 23.9 1.9
Other 11.0 0.9
Mortgage Loan Loss Reserve (22.2) (1.8)
-------- -----
TOTAL $1,236.3 100.0%
======== =====
The basic types of risk associated with mortgage lending are default
risk (that the borrower will fail to make payments as scheduled), interest rate
risk (that the interest rate charged to a borrower will fall below the lender's
cost of funds), and inflation risk (that the rate of return expected when the
loan was made does not adequately compensate the lender for actual inflation
over the term of the loan). Additionally, the secondary market for certain
types of mortgage loans can be highly illiquid.
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The following chart outlines the mortgage loan portfolio and delinquent
loans, restructured mortgage loans, foreclosed real estate, and bonds and
preferred stocks in default.
June 30, 1995 Dec 31, 1994 Dec 31, 1993
------------- ------------ ------------
($ in millions)
Mortgage Loans $ 1,236.3 $ 1,502.5 $ 1,824.9
Invested Assets 15,258.7 15,017.6 15,009.6
Mortgage Loans as Percent
of Invested Assets 8.1% 10.0% 12.2%
Delinquent Mortgage Loans $ 40.5 $ 25.4 $ 64.7
Restructured Mortgage Loans 66.4 243.5 246.2
Foreclosed Real Estate 32.3 45.2 81.4
Problem Mortgages as Percent
of Invested Assets 0.9% 2.1% 2.6%
Mortgage Loan Reserve $ 22.2 $ 49.0 $ 55.3
Real Estate Reserve - Foreclosed 11.6 10.6 12.0
Real Estates Reserve - Investment 7.0 7.7 0.7
Bonds and Preferred Stocks
in Default $ 31.2 $ 17.9 $ 24.1
Management believes the mortgage loan loss reserve is adequate given the
level of delinquent mortgage loans. Foreclosed real estate is reported at the
lower of cost or fair value.
Management does not expect the non-current mortgage loan and foreclosed
real estate investments to have a material adverse effect on its results of
operations, financial condition, or ability to hold its other investments to
maturity. This is primarily because of the relatively small amount of these
non-current investments compared to total invested assets and to the total of
high quality, liquid investments. Mortgage loans are placed on a non-accrual
status when the loan becomes thirty days past due, and at that time all accruals
on such delinquent mortgage loans are reversed.
In addition, the Company actively manages its non-current investments
through sales and leasing of foreclosed real estate in order to achieve the
highest current return as well as to preserve capital. Write-downs and
provisions for losses on mortgage loans and foreclosed real estate were $16.8
million for the year 1994. During the first half of 1995, the Company increased
the loss provision for $3.0 million and released $31.4 million from the reserve
as actual losses were incurred. The net effect was a realized investment loss
of $3.0 million. These losses are not expected to have a material adverse
impact on the financial condition and results of the Company due to the strong
capitalization of the Company.
During the first six months of 1995, the Company sold six foreclosed
properties with a book value of $11.7 million. During 1994, the Company sold
thirteen foreclosed properties with a book value of $58.9 million at the date of
sale.
The Company's investment in mortgage-backed securities totaled $3.1
billion on an amortized cost basis at June 30, 1995, and $3.3 billion at
December 31, 1994. At June 30, 1995,
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the mortgage-backed securities had an average life of 5.7 years and effective
duration of 3.6 years. The mortgage-backed securities are valued on a monthly
basis using valuations supplied by the brokerage firms that are dealers in
these securities. The primary risk involved in investing in mortgage-backed
securities is the uncertainty of the timing of cash flows from the underlying
loans due to prepayments of principal. The Company uses models which
incorporate economic variables and possible future interest rate scenarios to
predict future prepayment rates. The Company has not invested in
mortgage-backed derivatives, such as interest-only, principal-only, or
residuals, where market values can be highly volatile relative to changes in
interest rates.
As with most other fixed income investments, below-investment-grade
bonds are subject to the effects of changes in the overall level of interest
rates, which can affect both capital and reinvestment return.
Below-investment-grade bonds are inherently more risky than investment-grade
bonds since the risk of default by the issuer, by definition and as exhibited by
bond rating, is higher. Also, the secondary market for certain
below-investment-grade issues can be highly illiquid. Management does not
anticipate any liquidity problem being caused by the investments in
below-investment-grade securities, nor does it expect these investments to
adversely affect its ability to hold its other investments to maturity. Adverse
events occurring in the market for this type of investment in the last 5-10
years are not reasonably expected to have a material adverse effect on results
of operations or the financial condition of the Company primarily because of the
minimal exposure to such investments.
The company's exposure to below-investment-grade fixed maturities at
June 30, 1995, was $841.4 million, representing 5.5 percent of invested assets,
below the internal limit of 7.5 percent of investment assets for this type of
investment. The Company's exposure to below-investment-grade fixed maturities
at December 31, 1994, was $694.8 million, representing 4.6 percent of invested
assets. The Company's holding of $100 million of Healthsource 6.25% preferred
stock, related to the sale of the group medical services business, is included
in this figure at June 30, 1995.
In the fourth quarter of 1994, the Company announced that it would
discontinue the sale of traditional GICs as a part of its overall strategic
review. Subsequently, the decision was made to move to a cash-matched basis
instead of a duration-matched basis. In the fourth quarter of 1994, the
investment portfolio of Provident National Assurance Company ("PNAC"), one of
the Company's subsidiaries through which group pension products are marketed,
was rebalanced. Approximately $220 million of long duration bonds were sold to
fund maturing liabilities, and the balance was reinvested in shorter duration
bonds in order to minimize the exposure to interest rate changes. Approximately
$7 million in capital losses was realized from the sale of longer duration
assets. In addition, the future sales value of approximately $700 million in
assets held by PNAC was hedged by entering into $200 million (notional value) of
futures contracts and $500 million (notional value) of forward interest rate
swaps. The net asset and hedge losses that could potentially be realized over
the next two years are presently estimated to be approximately $30 million
within a range of $3 million to $6 million per quarter, assuming interest rates
do not increase more than 100 basis points and asset spreads do not change
dramatically. In addition, in the fourth quarter of 1994 the Company used
forward interest rate swaps to hedge $300 million of anticipated future asset
sales in the group pension investment portfolio of Provident, the other of the
Company's subsidiaries through which group pension products are marketed.
During 1995, management has continued to adjust the investment
portfolio. GIC contracts totaling $643 million were restructured on a duration
neutral basis, moving maturities from 1996 and 1997 to 1995, 1998, and 1999.
Hedge transactions totaling $300 million were initiated, fixing the sales price
of future asset sales. In addition, $104 million of long maturity bonds were
sold in the Provident group pension portfolio with $69 million of the proceeds
transferred to PNAC in cash in exchange for bonds which mature in 1997 and $35
million
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24
invested in 1997 bonds which mature in 1997. Management has added resources in
the investment area to address modeling and testing all asset and liability
portfolios to improve interest rate risk management.
REVIEW BY INDEPENDENT AUDITORS
The condensed consolidated financial statements at June 30, 1995, and
for the three month and six month periods then ended have been reviewed, prior
to filing, by Ernst & Young LLP, the Company's independent auditors, and their
report is included herein.
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25
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Company conducted its Annual Meeting of Stockholders on June
13, 1995. Proxies for the meeting were solicited pursuant to
Regulation 14 under the Securities Exchange Act of 1934. The
stockholders elected all of management's nominees for the Board of
Directors as listed in the proxy statement and also approved the
Reorganization of the Company (vote FOR: 32,604,236; AGAINST: 296,502;
ABSTAIN: 364,211; NON-VOTE: 8,360,827); a proposal to allow the meeting
to be adjourned if sufficient votes to approve the Reorganization were
not received (vote FOR: 31,870,329; AGAINST: 2,489,042; ABSTAIN:
152,456; NON-VOTE: 7,113,949); an amendment to the Annual Management
Incentive Compensation Plan of 1994 (vote FOR: 30,960,315; AGAINST:
623,256; ABSTAIN: 271,162; NON-VOTE: 5,362,301); amendments to the
Stock Option Plan of 1994 (vote FOR: 26,620,255; AGAINST: 836,247;
ABSTAIN: 267,917; NON-VOTE: 9,492,615); and the Provident Employee
Stock Purchase Plan (vote FOR: 29,197,238; AGAINST: 586,887; ABSTAIN:
258,505; NON-VOTE: 7,174,404); all as described in the Proxy Statement.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 10.1 An amendment to the Annual Management Incentive
Plan of 1994
Exhibit 10.2 Amendments to the Stock Option Plan of 1994
Exhibit 10.3 Employee Stock Purchase Plan
Exhibit 15 Letter re unaudited interim financial
information
Exhibit 27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K June 1, 1995
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26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Provident Life and Accident Insurance
Company of America
Date: August 10, 1995 /s/ J. Harold Chandler
--------------------------------------
J. Harold Chandler
President and Chief Executive Officer
Date: August 10, 1995 /s/ Thomas R. Watjen
--------------------------------------
Thomas R. Watjen
Executive Vice President and
Chief Financial Officer
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27
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
to
FORM 10-Q
PROVIDENT LIFE AND ACCIDENT INSURANCE COMPANY OF AMERICA
Page
Exhibit 10.1 An amendment to Annual Management Incentive Compensation
Plan of 1994 27
Exhibit 10.2 Amendments to Stock Option Plan of 1994 29
Exhibit 10.3 Employee Stock Purchase Plan 31
Exhibit 15 Letter re unaudited interim financial information 38
Exhibit 27 Financial Data Schedule (for SEC use only) 39
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