Document/Exhibit Description Pages Size
1: 10-Q Quarterly Report 43 221K
2: EX-3.1 Restated Certificate of Incorporation 8 36K
3: EX-3.2 Amended and Restated Bylaws 17 80K
4: EX-10.1 Employment Agreement for James F. Orr Iii 18 68K
5: EX-10.2 Employment Agreement for J. Harold Chandler 16 64K
6: EX-10.3 Employment Agreement for F. Dean Copeland 15 67K
7: EX-10.4 Employment Agreement for Robert W. Crispin 15 69K
8: EX-10.5 Employment Agreement for Elaine D. Rosen 15 68K
9: EX-10.6 Employment Agreement for Thomas R. Watjen 15 68K
10: EX-15 Letter Re: Unaudited Financial Information 1 8K
11: EX-18 Letter Re: Change in Accounting Principles 1 9K
12: EX-27.1 Financial Data Schedule (12 Months) 2 12K
13: EX-27.2 Financial Data Schedule (6 Months 6/30/99) 2 12K
14: EX-27.3 Financial Data Schedule (6 Months 6/30/98) 2 12K
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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, 1999.
Commission file number 1-11834
UNUMPROVIDENT CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 62-1598430
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2211 CONGRESS STREET
PORTLAND, MAINE 04122
(Address of principal executive offices)
(Zip Code)
(207) 770-2211
(Registrant's telephone number, including area code)
Provident Companies, Inc., 1 Fountain Square, Chattanooga, Tennessee 37402
(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.
[Download Table]
Class Outstanding at June 30, 1999
----- ----------------------------
Common Stock, $0.10 Par Value 238,790,635
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
UNUMPROVIDENT CORPORATION
INDEX
[Download Table]
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial Condition
at June 30, 1999 and December 31, 1998................. 3
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 1999 and 1998...... 4
Condensed Consolidated Statements of Stockholders'
Equity for the Six Months Ended June 30, 1999 and
1998................................................... 5
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended
June 30, 1999 and 1998................................. 6
Notes to Condensed Consolidated Financial Statements.... 7
Independent Auditors' Review Report..................... 20
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 21
Item 3. Quantitative and Qualitative Disclosures About Market
Risk................................................... 36
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders..... 38
Item 6. Exhibits and Reports on Form 8-K........................ 40
2
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
UNUMPROVIDENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
[Download Table]
June 30 December 31
1999 1998
--------- -----------
(in millions of
dollars)
Assets
Investments:
Fixed Maturity Securities:
Available-for-Sale.................................. $21,807.0 $22,732.2
Held-to-Maturity.................................... 319.2 307.0
Mortgage Loans........................................ 1,328.1 1,321.2
Real Estate........................................... 314.4 309.8
Policy Loans.......................................... 2,239.8 2,227.2
Short-term Investments................................ 196.3 245.1
Other Investments..................................... 42.4 43.5
--------- ---------
Total Investments................................. 26,247.2 27,186.0
Cash and Bank Deposits................................. 186.8 111.2
Premiums Receivable.................................... 749.4 570.1
Reinsurance Receivable................................. 4,893.8 4,871.0
Accrued Investment Income.............................. 523.6 502.5
Deferred Policy Acquisition Costs...................... 2,256.6 2,060.5
Value of Business Acquired............................. 552.5 570.5
Goodwill............................................... 772.3 814.7
Other Assets........................................... 1,295.3 1,502.7
Separate Account Assets................................ 439.8 413.0
--------- ---------
Total Assets...................................... $37,917.3 $38,602.2
========= =========
Liabilities and Stockholders' Equity
Policy and Contract Benefits........................... $ 1,469.5 $ 1,384.9
Reserves for Future Policy and Contract Benefits and
Unearned Premiums..................................... 22,870.8 22,490.7
Other Policyholders' Funds............................. 3,634.1 4,102.7
Federal Income Tax..................................... 489.7 969.8
Short-term Debt........................................ 490.0 323.7
Long-term Debt......................................... 1,226.5 1,225.2
Other Liabilities...................................... 1,605.2 1,246.0
Separate Account Liabilities........................... 439.8 413.0
--------- ---------
Total Liabilities................................. 32,225.6 32,156.0
--------- ---------
Commitments and Contingent Liabilities--Note 10
Company-Obligated Mandatorily Redeemable Preferred
Securities
of Subsidiary Trust Holding Solely Junior Subordinated
Debt Securities of the Company........................ 300.0 300.0
--------- ---------
Stockholders' Equity
Common Stock, $0.10 par Authorized: 725,000,000 shares
Issued: 238,966,930 and 237,802,647 shares............ 23.9 23.8
Additional Paid-in Capital............................. 1,002.5 959.2
Accumulated Other Comprehensive Income................. 265.3 914.7
Retained Earnings...................................... 4,109.2 4,279.2
Treasury Stock at Cost: 176,295 shares................. (9.2) (9.2)
Deferred Compensation.................................. -- (21.5)
--------- ---------
Total Stockholders' Equity........................ 5,391.7 6,146.2
--------- ---------
Total Liabilities and Stockholders' Equity........ $37,917.3 $38,602.2
========= =========
See notes to condensed consolidated financial statements.
3
UNUMPROVIDENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
[Download Table]
Three Months Six Months Ended
Ended June 30 June 30
------------------ ------------------
1999 1998 1999 1998
-------- -------- -------- --------
(in millions of dollars, except
share data)
Revenue
Premium Income....................... $1,687.4 $1,506.1 $3,368.9 $2,998.7
Net Investment Income................ 518.0 513.5 1,017.6 1,038.6
Net Realized Investment Gains........ 4.2 5.1 11.4 14.4
Other Income......................... 68.0 82.4 148.8 157.5
-------- -------- -------- --------
Total Revenue...................... 2,277.6 2,107.1 4,546.7 4,209.2
-------- -------- -------- --------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits..................... 1,690.7 1,304.7 3,192.8 2,618.5
Commissions.......................... 219.6 206.2 462.1 439.6
Interest and Debt Expense............ 33.6 30.7 66.5 58.0
Deferral of Policy Acquisition
Costs............................... (189.0) (158.7) (420.2) (347.7)
Amortization of Deferred Policy
Acquisition Costs................... 111.4 90.0 224.6 178.2
Amortization of Value of Business
Acquired and Goodwill............... 17.5 16.9 60.2 33.8
Other Operating Expenses............. 668.4 351.8 1,072.1 716.0
-------- -------- -------- --------
Total Benefits and Expenses........ 2,552.2 1,841.6 4,658.1 3,696.4
-------- -------- -------- --------
Income (Loss) Before Federal Income
Taxes................................. (274.6) 265.5 (111.4) 512.8
Federal Income Taxes (Credit).......... (83.4) 92.0 (9.5) 174.7
-------- -------- -------- --------
Net Income (Loss)...................... $ (191.2) $ 173.5 $ (101.9) $ 338.1
======== ======== ======== ========
Net Income (Loss) Per Common Share
Basic................................ $ (0.80) $ 0.73 $ (0.43) $ 1.42
Assuming Dilution.................... $ (0.80) $ 0.71 $ (0.43) $ 1.39
Dividends Per Common Share............. $ 0.14 $ 0.14 $ 0.28 $ 0.28
See notes to condensed consolidated financial statements.
4
UNUMPROVIDENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
[Enlarge/Download Table]
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,
1997................... $ 156.2 $23.7 $ 954.8 $ 799.0 $3,797.7 $(1.5) $(15.8) $5,714.1
Comprehensive Income,
Net of Tax
Net Income............. 338.1 338.1
Change in Net
Unrealized Gain on
Securities............ 138.8 138.8
Change in Foreign
Currency Translation
Adjustment............ (6.3) (6.3)
--------
Total Comprehensive
Income................ 470.6
--------
Common Stock Activity... (19.0) (7.7) (2.7) (29.4)
Preferred Stock
Redeemed............... (156.2) (156.2)
Dividends to
Stockholders........... (67.9) (67.9)
------- ----- -------- ------- -------- ----- ------ --------
Balance at June 30,
1998................... $ -- $23.7 $ 935.8 $ 931.5 $4,067.9 $(9.2) $(18.5) $5,931.2
======= ===== ======== ======= ======== ===== ====== ========
Balance at December 31,
1998................... $ -- $23.8 $ 959.2 $ 914.7 $4,279.2 $(9.2) $(21.5) $6,146.2
Comprehensive Loss, Net
of Tax Net Loss........ (101.9) (101.9)
Change in Net
Unrealized Gain on
Securities............ (657.0) (657.0)
Change in Foreign
Currency Translation
Adjustment............ 7.6 7.6
--------
Total Comprehensive
Loss.................. (751.3)
--------
Common Stock Activity... 0.1 43.3 21.5 64.9
Dividends to
Stockholders........... (68.1) (68.1)
------- ----- -------- ------- -------- ----- ------ --------
Balance at June 30,
1999................... $ -- $23.9 $1,002.5 $ 265.3 $4,109.2 $(9.2) $ -- $5,391.7
======= ===== ======== ======= ======== ===== ====== ========
See notes to condensed consolidated financial statements.
5
UNUMPROVIDENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
[Download Table]
Six Months Ended
June 30
--------------------
1999 1998
--------- ---------
(in millions of
dollars)
Net Cash Provided by Operating Activities................ $ 740.1 $ 633.8
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments..................... 1,472.9 1,268.4
Proceeds from Maturities of Investments................ 705.7 868.9
Purchase of Investments................................ (2,579.5) (2,201.5)
Net Purchases of Short-term Investments................ 48.1 20.5
Disposition of Business................................ -- 58.0
Other.................................................. (48.8) (41.9)
--------- ---------
Net Cash Provided Used by Investing Activities........... (401.6) (27.6)
--------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts...................... 78.1 150.6
Maturities and Benefit Payments from Policyholder
Accounts.............................................. (480.5) (790.7)
Net Short-term Borrowings.............................. 149.5 548.6
Issuance of Long-term Debt............................. 200.0 250.0
Long-term Debt Repayments.............................. (183.3) (763.0)
Issuance of Company-Obligated Mandatorily Redeemable
Preferred Securities.................................. -- 300.0
Redemption of Preferred Stock.......................... -- (156.2)
Dividends Paid to Stockholders......................... (68.1) (71.1)
Repurchase of Common Stock............................. -- (70.8)
Other.................................................. 42.1 19.7
--------- ---------
Net Cash Used by Financing Activities.................... (262.2) (582.9)
--------- ---------
Effect of Foreign Exchange Rate on Cash.................. (0.7) (0.4)
--------- ---------
Net Increase in Cash and Bank Deposits................... 75.6 22.9
Cash and Bank Deposits at Beginning of Period............ 111.2 94.5
--------- ---------
Cash and Bank Deposits at End of Period.................. $ 186.8 $ 117.4
========= =========
See notes to condensed consolidated financial statements.
6
UNUMPROVIDENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1--Basis of Presentation
On June 30, 1999, UNUM Corporation (UNUM) merged into Provident Companies,
Inc. (Provident) under the name UNUMProvident Corporation (the Company). The
merger was accounted for as a pooling of interests. The historical financial
results presented herein and the unaudited combined condensed statement of
financial condition as of December 31, 1998, 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. Certain additional reclassification
adjustments have been made to conform the companies' presentations in the
condensed consolidated financial statements.
The condensed consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three month and six month periods ended
June 30, 1999, are not necessarily indicative of the results that may be
expected for the year ended December 31, 1999. These results are also not
necessarily indicative of the results of operations that would have been
realized had the merger been completed prior to June 30, 1999. For further
information, refer to the consolidated financial statements and footnotes
thereto included in Provident's and UNUM's reports on Form 10-Q for the six
months ended June 30, 1998, Form 10-K/A for the year ended December 31, 1998,
and Form 10-Q/A for the three months ended March 31, 1999.
Note 2--Merger
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 Provident common stock and 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 these items.
7
In the second quarter of 1999 the Company recorded expenses related to the
merger and the early retirement offer to employees as follows (in millions):
[Download Table]
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 earnings $142.2 million before
tax and $112.0 million after tax ($0.47 per common share). The expense related
to the early retirement offer reduced earnings $125.9 million before tax and
$81.8 million after tax ($0.34 per common share).
In accordance with Provident's and UNUM's restricted stock and stock option
plan provisions concerning a change in control, 546,362 shares of outstanding
restricted stock became unrestricted and stock options on 5,301,683 shares
became immediately exercisable effective with the merger. The expense related
to restricted stock vesting has been included in merger-related expenses. 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.
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.
8
The discount rates affected by this change in UNUM's methodology are as
follows:
[Download Table]
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 impact on 1999 second
quarter earnings related to the change in method of calculating the discount
rate for claim reserves was $240.7 million before tax and $156.5 million after
tax ($0.66 per common share).
The Company continues to review 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 adjust the financial statements to change to those accounting policies,
practices, and classifications that are determined to be most appropriate. The
reviews are expected to be completed by year end 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:
[Download Table]
Three Months Six Months Ended
Ended June 30 June 30
------------------ ------------------
1999 1998 1999 1998
-------- -------- -------- --------
(in millions of dollars)
Revenue
UNUM................................... $1,277.1 $1,124.1 $2,557.8 $2,232.6
Provident.............................. 1,000.5 983.0 1,988.9 1,976.6
-------- -------- -------- --------
Combined Revenue..................... $2,277.6 $2,107.1 $4,546.7 $4,209.2
======== ======== ======== ========
Net Income (Loss)
UNUM................................... $ (205.2) $ 98.7 $ (189.7) $ 192.2
Provident.............................. 14.0 74.8 87.8 145.9
-------- -------- -------- --------
Combined Net Income (Loss)........... $ (191.2) $ 173.5 $ (101.9) $ 338.1
======== ======== ======== ========
Included in UNUM's net income for the three and six months ended June 30,
1999, is $131.8 million after tax for expenses related to the merger and the
early retirement offer to employees and $156.5 million after tax for the
reserve discount rate change. UNUM's net income for the six months ended June
30, 1999 also includes an after-tax first quarter charge of $88.0 million
related to its reinsurance businesses. Included in Provident's net income for
the three and six months ended June 30, 1999, is $62.0 million after tax for
expenses related to the merger and the early retirement offer to employees.
9
The balance sheets for the separate companies and the combined amounts are
as follows:
[Download Table]
June 30, 1999
-----------------------------
UNUM Provident Combined
--------- --------- ---------
(in millions of dollars)
Assets
Total Investments................................ $ 9,821.5 $16,425.7 $26,247.2
Reinsurance Receivable........................... 1,862.5 3,031.3 4,893.8
All Other Assets................................. 3,612.3 3,164.0 6,776.3
--------- --------- ---------
Total Assets................................... $15,296.3 $22,621.0 $37,917.3
========= ========= =========
Liabilities and Stockholders' Equity
Policy and Contract Benefits, Reserves for Future
Policy
and Contract Benefits, and Unearned Premiums.... $ 9,594.3 $14,746.0 $24,340.3
Other Policyholders' Funds....................... 878.8 2,755.3 3,634.1
All Other Liabilities............................ 2,417.6 1,833.6 4,251.2
--------- --------- ---------
Total Liabilities.............................. 12,890.7 19,334.9 32,225.6
--------- --------- ---------
Company--Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary Trust Holding
Solely Junior Subordinated Debt Securities of
the Company..................................... -- 300.0 300.0
--------- --------- ---------
Stockholders' Equity............................. 2,405.6 2,986.1 5,391.7
--------- --------- ---------
Total Liabilities and Stockholders' Equity..... $15,296.3 $22,621.0 $37,917.3
========= ========= =========
Note 3--Liability for Unpaid Claims and Claim Adjustment Expenses
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.
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
10
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 over the next 18 months. 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.
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
11
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. 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.
Quarterly information concerning the estimated and actual impact of the
claims operations integration activities are as follows:
[Download Table]
1999
---------------------------
1st 2nd 3rd 4th
------ ----- ----- -----
(in millions of dollars)
Revised Claim Resolution Rates at December 31,
1998............................................. 90% 90% 84% 89%
Actual Claim Resolution Rates for the Period...... 89% 90%
Estimated Effect of Lower Claim Resolution Rates
at December 31, 1998............................. $ 36.2 $36.2 $47.6 $33.0
Actual Effect of Lower Claim Resolution Rates for
the Period....................................... $ 39.2 $36.2
Further Increases (Decreases) to the Estimated
Liability at December 31, 1998 Recorded During
the Period....................................... $ -- $ --
Liability Remaining for Claims Operation
Integration Activities at End of Period.......... $116.8 $80.6
12
Management expects the remaining claims operations integration activities to
impact claim reserves as anticipated at December 31, 1998. Management will
continue to evaluate the impact of the merger on disability claims experience
and the assumptions related to expected claim resolutions.
Note 4--Reinsurance Businesses
During the first quarter of 1999, the Company 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 of London (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 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
13
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 discount 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.
In the second quarter of 1999, the Company 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.
Recent information 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.
Note 5--Debt
On December 4, 1997, the Company borrowed $168.3 million through a private
placement. Under the terms of the agreement, the investor 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. The notes are due in June of 2000 and had an
interest rate of 5.135% at June 30, 1999.
Note 6--Federal Income Taxes
A portion of the losses recognized in the first quarter of 1999 relating to
the Company's reinsurance businesses does not receive a tax benefit, which
unfavorably impacted the effective tax rate in the first quarter of 1999.
Additionally, a portion of the second quarter 1999 expenses related to the
merger was non-deductible for federal income tax purposes, resulting in a tax
rate for the quarter and year-to-date that was less than the U.S. federal
statutory tax rate of 35 percent. It is expected that the tax rate will move
closer to the statutory rate by the end of the year.
In the second quarter of 1999, the Company reached a settlement agreement
with the Internal Revenue Service related to an issue in dispute for the 1992
tax year. The Company recorded a tax benefit of $5.1 million and related
interest of $1.4 million.
14
Note 7--Stockholders' Equity and Earnings Per Common Share
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. At June 30, 1999, no preferred stock had been issued.
Earnings per common share are determined as follows:
[Download Table]
Three Months Ended Six Months Ended
June 30 June 30
---------------------- ----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(in millions of dollars, except share data)
Numerator:
Net Income (Loss).............. $ (191.2) $ 173.5 $ (101.9) $ 338.1
Preferred Stock Dividends...... -- -- -- 1.9
---------- ---------- ---------- ----------
$ (191.2) $ 173.5 $ (101.9) $ 336.2
========== ========== ========== ==========
Denominator (000s):
Weighted Average Common
Shares--Basic................. 238,438.4 237,021.2 238,108.9 236,824.0
Dilutive Securities............ -- 5,813.7 -- 5,906.4
---------- ---------- ---------- ----------
Weighted Average Common
Shares--Assuming Dilution..... 238,438.4 242,834.9 238,108.9 242,730.4
========== ========== ========== ==========
In computing earnings per share assuming dilution, only potential common
shares that are dilutive (those that reduce earnings per share) are included.
Potential common shares are not used when computing earnings per share assuming
dilution if the result would be antidilutive, such as when a net loss is
reported or if options are out-of-the-money. In-the-money options to purchase
approximately 4.3 million common shares for both the three and six month
periods ended June 30, 1999, were not considered dilutive due to net losses
being reported for the periods. Options which were not considered dilutive due
to the options being out-of-the-money were immaterial for the three and six
month periods ended June 30, 1999 and 1998.
Note 8--Comprehensive Income (Loss)
The components of other comprehensive income, net of deferred tax, are as
follows:
[Download Table]
June 30 December 31
1999 1998
------------ ---------------
(in millions of dollars)
Net Unrealized Gain on Securities................ $ 312.4 $ 969.4
Foreign Currency Translation Adjustment.......... (47.1) (54.7)
------------ ------------
Accumulated Other Comprehensive Income........... $ 265.3 $ 914.7
============ ============
15
The components of comprehensive income (loss) and the related deferred tax
(credit) are as follows:
[Download Table]
Three Months Six Months
Ended June 30 Ended June 30
--------------- ---------------
1999 1998 1999 1998
------- ------ ------- ------
(in millions of dollars)
Net Income (Loss)............................. $(191.2) $173.5 $(101.9) $338.1
------- ------ ------- ------
Change in Net Unrealized Gain on Securities:
Change Before Reclassification Adjustment... (478.2) 202.6 (974.5) 226.6
Reclassification Adjustment for Net Realized
Investment Gains Included in Net Income
(Loss)..................................... (4.2) (5.1) (11.4) (14.4)
Change in Foreign Currency Translation
Adjustment................................... 12.2 (16.8) 15.1 (9.3)
------- ------ ------- ------
(470.2) 180.7 (970.8) 202.9
Change in Deferred Tax (Credit)............... (146.7) 63.8 (321.4) 70.4
------- ------ ------- ------
Other Comprehensive Income (Loss)............. (323.5) 116.9 (649.4) 132.5
------- ------ ------- ------
Comprehensive Income (Loss)................... $(514.7) $290.4 $(751.3) $470.6
======= ====== ======= ======
16
Note 9--Segment Information
Selected data by segment is as follows:
[Download Table]
Three Months Ended Six Months Ended
June 30 June 30
-------------------- ------------------
1999 1998 1999 1998
--------- --------- -------- --------
(in millions of dollars)
Premium Income
Employee Benefits................. $ 960.7 $ 827.2 $1,914.0 $1,633.6
Individual........................ 427.3 414.4 860.4 836.9
Voluntary Benefits................ 173.1 166.8 344.3 331.3
Other............................. 126.3 97.7 250.2 196.9
--------- --------- -------- --------
1,687.4 1,506.1 3,368.9 2,998.7
Net Investment Income and Other
Income
Employee Benefits................. 183.5 166.2 360.3 328.2
Individual........................ 233.8 223.6 461.3 442.7
Voluntary Benefits................ 26.8 24.8 53.4 49.9
Other............................. 135.0 168.4 276.4 358.5
Corporate......................... 6.9 12.9 15.0 16.8
--------- --------- -------- --------
586.0 595.9 1,166.4 1,196.1
Total Revenue (Excluding Net
Realized
Investment Gains and Losses)
Employee Benefits................. 1,144.2 993.4 2,274.3 1,961.8
Individual........................ 661.1 638.0 1,321.7 1,279.6
Voluntary Benefits................ 199.9 191.6 397.7 381.2
Other............................. 261.3 266.1 526.6 555.4
Corporate......................... 6.9 12.9 15.0 16.8
--------- --------- -------- --------
2,273.4 2,102.0 4,535.3 4,194.8
Benefits and Expenses
Employee Benefits................. 1,191.5 847.3 2,156.1 1,677.1
Individual........................ 614.1 557.2 1,194.0 1,119.8
Voluntary Benefits................ 168.8 160.7 335.1 323.0
Other............................. 253.6 229.5 580.0 498.7
Corporate......................... 324.2 46.9 392.9 77.8
--------- --------- -------- --------
2,552.2 1,841.6 4,658.1 3,696.4
Income (Loss) Before Net Realized
Investment
Gains and Losses and Federal Income
Taxes
Employee Benefits................. (47.3) 146.1 118.2 284.7
Individual........................ 47.0 80.8 127.7 159.8
Voluntary Benefits................ 31.1 30.9 62.6 58.2
Other............................. 7.7 36.6 (53.4) 56.7
Corporate......................... (317.3) (34.0) (377.9) (61.0)
--------- --------- -------- --------
(278.8) 260.4 (122.8) 498.4
Net Realized Investment Gains....... 4.2 5.1 11.4 14.4
--------- --------- -------- --------
Income (Loss) Before Federal Income
Taxes.............................. (274.6) 265.5 (111.4) 512.8
Federal Income Taxes (Credit)....... (83.4) 92.0 (9.5) 174.7
--------- --------- -------- --------
Net Income (Loss)................... $ (191.2) $ 173.5 $ (101.9) $ 338.1
========= ========= ======== ========
17
[Download Table]
June 30 December 31
--------- -----------
1999 1998
--------- -----------
(in millions of
dollars)
Assets
Employee Benefits........................................ $ 9,503.8 $ 9,275.7
Individual............................................... 15,671.5 15,887.7
Voluntary Benefits....................................... 2,058.4 2,057.3
Other.................................................... 9,151.0 9,610.2
Corporate................................................ 1,532.6 1,771.3
--------- ---------
$37,917.3 $38,602.2
========= =========
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 products no longer actively marketed,
including corporate-owned life insurance, group pension, health insurance,
individual annuities, and reinsurance pools and management. 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.
Note 10--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 subsidiaries of Paul Revere whose employment
relationships ended on June 30, 1997 and were offered contracts to sell
insurance policies as independent producers and the other purporting to
represent independent brokers who sold certain Paul Revere individual
disability income policies with benefit riders. Motions filed by the Company to
dismiss most of the counts in the complaints, which allege various breach of
contract and statutory claims, have been denied, but the cases remain at a
preliminary stage. To date no class has been certified in either lawsuit. The
Company has filed a conditional counterclaim in each action which requests a
substantial return of commissions should the Court agree with the plaintiff's
interpretation of the contract. The Company has strong defenses to both
lawsuits and will vigorously defend its position and resist certification of
the classes. In addition, the same plaintiff's attorney who has filed the
purported class action lawsuits has filed 44 individual lawsuits on behalf of
current and former Paul Revere sales managers alleging various breach of
contract claims. The Company has filed a motion in federal court to compel
arbitration for 16 of the plaintiffs who are licensed by the National
Association of Securities Dealers and have executed the Uniform Application for
Registration or Transfer in the Securities Industry (Form U-4). The Company has
strong defenses and will vigorously defend its position in these cases as well.
Although the alleged class action lawsuits and the 44 individual lawsuits are
in the early stages, management does not currently expect these suits to
materially affect the financial position or results of operations of the
Company.
Various lawsuits against the Company have arisen in the normal course of
business. Contingent liabilities that might arise from litigation are not
deemed likely to materially affect the financial position or results of
operations of the Company.
Note 11--Changes in Accounting Principles and Accounting Pronouncement
Outstanding
Effective January 1, 1999, the Company adopted the provisions of Statement
of Position 97-3 (SOP 97-3), Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments. SOP 97-3 provides guidance for determining when
an entity should recognize a liability or an asset for insurance-related
assessments and how to measure these items. UNUM and Provident adopted the
provisions of Statement of
18
Position 98-1 (SOP 98-1), Accounting for the Costs of Computer Software
Developed for or Obtained for Internal Use, effective January 1, 1998 and
January 1, 1999, respectively. SOP 98-1 requires the capitalization of certain
costs incurred in connection with developing or obtaining software for internal
use. The effect of the adoptions of SOP 97-3 and SOP 98-1 on the Company's
financial position and results of operations was immaterial.
In June 1999, 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. SFAS 137 defers for
one year the effective date of Statement of Financial Accounting Standards
No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging
Activities. 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.
19
Independent Auditors' Review Report
Board of Directors and Shareholders
UNUMProvident Corporation
We have reviewed the accompanying condensed consolidated statement of
financial condition of UNUMProvident Corporation and Subsidiaries as of June
30, 1999, and the related condensed consolidated statements of operations for
the three and six month periods ended June 30, 1999 and 1998, and the condensed
consolidated statements of stockholders' equity and cash flows for the six
month periods ended June 30, 1999 and 1998. These financial statements are the
responsibility of the Company's management.
We were furnished with the report of other accountants on their review of
the interim information of the former UNUM Corporation and Subsidiaries whose
total assets as of June 30, 1999, and whose revenues for the three-month and
six-month periods then ended constituted 40 percent, 56 percent, and 56
percent, respectively, of the related consolidated totals.
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 and the report of other accountants, we are not aware
of any material modifications that should be made to the accompanying financial
statements for them to be in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Chattanooga, Tennessee
August 2, 1999
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cautionary Statement Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the Act) provides a
"safe-harbor" for forward-looking statements which are identified as such and
are accompanied by the identification of important factors which could cause
actual results to differ materially from the forward-looking statements.
UNUMProvident Corporation (the Company) claims the protection afforded by the
safe harbor in the Act. Certain information contained in this discussion, or in
any other written or oral statements made by the Company, is or may be
considered as forward-looking. Examples of disclosures that contain such
information include, among others, sales estimates, income projections,
reserves and related assumptions, and the year 2000 date conversion. Forward-
looking statements are those not based on historical information, but rather
relate to future operations, strategies, financial results, or other
developments. These statements may be made directly in this document or may be
made part of this document by reference to other documents filed with the
Securities and Exchange Commission by the Company, which is known as
"incorporation by reference". You can find many of these statements by looking
for words such as "may," "should," "believes," "expects," "anticipates,"
"estimates," "intends," "projects," "goals," "objectives," or similar
expressions in this document or in documents incorporated herein.
These forward-looking statements are subject to numerous assumptions, risks,
and uncertainties. Factors that may cause actual results to differ materially
from those contemplated by the forward-looking statements include, among
others, the following possibilities:
. Competitive pressures in the insurance industry may increase
significantly through industry consolidation, competitor
demutualization, or otherwise.
. General economic or business conditions, both domestic and foreign,
whether relating to the economy as a whole or to particular sectors, may
be less favorable than expected, resulting in, among other things, lower
than expected revenues, and the Company could experience higher than
expected claims or claims with longer duration than expected.
. Insurance reserve liabilities can fluctuate as a result of changes in
numerous factors, and such fluctuations can have material positive or
negative effects on net income.
. Costs or difficulties related to the integration of the business of the
Company following the merger may be greater than expected, including
with respect to the management of claims.
. Legislative or regulatory changes may adversely affect the businesses in
which the Company is engaged.
. Necessary technological changes, including changes to address year 2000
data systems issues, may be more difficult or expensive to make than
anticipated, and year 2000 issues at other companies may adversely
affect operations.
. Adverse changes may occur in the securities market.
. Changes in the interest rate environment may adversely affect profit
margins and the Company's investment portfolio.
. The rate of customer bankruptcies may increase.
. Incidence and recovery rates may be influenced by, among others, the
emergence of new diseases, new trends and developments in medical
treatments, and the effectiveness of risk management programs.
For further discussion of risks and uncertainties which could cause actual
results to differ from those contained in the forward-looking statements, see
"Forward-Looking Information" in UNUM Corporation's
21
Form 10-K/A and "Cautionary Statement Regarding Forward-Looking Statements" and
"Risk Factors" in Provident Companies Inc.'s Form 10-K/A, in each case for the
fiscal year ended December 31, 1998.
All subsequent written and oral forward-looking statements attributable to
the Company or any person acting on its behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to in this section.
The Company does not undertake any obligation to release publicly any revisions
to such forward-looking statements to reflect events or circumstances after the
date of this document or to reflect the occurrence of unanticipated events.
Introduction
On June 30, 1999, UNUM Corporation (UNUM) merged into Provident Companies,
Inc. (Provident) under the name UNUMProvident Corporation. The merger was
accounted for as a pooling of interests. The historical financial results
discussed herein give effect to the merger as if it had been completed at the
beginning of the earliest period presented. See Notes 1 and 2 of the "Notes to
Condensed Consolidated Financial Statements" for further discussion.
The following should be read in conjunction with the condensed consolidated
financial statements and notes thereto in Part I, Item 1 contained herein and
with the discussion, analysis, and consolidated financial statements and notes
thereto in Part I, Item 1 and Part II, Items 6, 7, 7A, and 8 of Provident's and
UNUM's Annual Reports on Form 10-K/A.
This discussion of consolidated operating results and operating results by
segment excludes net realized investment gains and losses from revenue and
income before taxes. The Company's investment focus has been on investment
income to support its insurance liabilities as opposed to the generation of
realized investment gains. Due to the nature of the Company's business, a long-
term focus is necessary to maintain profitability over the life of the
business. The realization of investment gains and losses will impact future
earnings levels as the underlying business is long-term in nature and requires
that the Company be able to sustain the assumed interest rates in its
liabilities. However, income excluding realized investment gains and losses
does not replace net income as a measure of the Company's profitability.
Management believes that the trends in new annualized sales in the Employee
Benefits, Individual, and Voluntary Benefits segments are important for
investors to assess in their analysis of the Company's results of operations.
The trends in new sales are indicators of the level of market acceptance of new
products, particularly in the individual disability income line of business,
and the Company's potential for growth in its respective markets. The Company
has closely linked its various incentive compensation plans for management and
employees to the achievement of its goals for new sales. Management's goals,
over time, are to achieve sales growth of 15 percent and premium growth of over
10 percent.
Accounting Policy Changes, Financial Statement Reclassifications, and Merger
Expenses
As a result of the merger, certain accounting policy changes and
reclassification adjustments were made. The following summarizes these changes
and reclassifications as well as the expenses related to the merger and the
early retirement offer to employees that were recorded in the second quarter.
In the second quarter of 1999, the Company recorded a before-tax charge of
$240.7 million ($156.5 million after tax) as a result of changing the method of
calculating the discount rate for claim reserves on certain of the Company's
disability businesses. 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 for calculating the discount rate for disability claim reserves 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 these policies for similar
products. The previous UNUM methodology used the same investment strategy for
assets
22
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 combined entity. Accordingly, UNUM adopted Provident's method
of calculating the discount rate for claim reserves. The impact of the charge
in the second quarter of 1999 was a $191.7 million, $38.9 million, and $10.1
million increase in benefits to policyholders reflected in the Employee
Benefits, Individual, and Other segments, respectively. See Note 2 of the
"Notes to Condensed Consolidated Financial Statements" for further discussion.
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 Company continues to review 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 adjust the financial statements to change to those accounting policies,
practices, and classifications that are determined to be most appropriate. The
reviews include within their scope the assumptions underlying liabilities for
current and future policy and contract benefits and will compare assumptions as
well as consider the expected effect of current and future trends in morbidity
and mortality on the assumptions underlying pricing and reserves.
In addition, the Company is implementing pricing changes in the group
disability line of business to improve its profitability. Price changes will be
increases or decreases by market segment, as appropriate, to respond to current
claim experience and various other factors and assumptions. Considering these
changes, the Company is also reviewing the period over which it will amortize
deferred policy acquisition costs related to future new business.
The reviews are expected to be completed by year end and may 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 Company is also reviewing its method of reporting new annualized sales
for Employee Benefits. New sales in this segment are currently reported based
on the date the application is submitted to the Company rather than the
effective date of the policy. The Company is evaluating whether to adopt the
effective date as the date to report a new sale. Premiums are recognized as
premium income over the premium paying period; therefore, a change in new sales
reporting policy will have no impact on reported premium income or reported
income.
On the date the merger was completed, the Company recorded before-tax
expenses related to the merger of approximately $142.2 million ($112.0 million
after tax) for severance and related costs, exit costs for duplicative
facilities and asset abandonments, and investment banking, legal, and
accounting fees. The Company also recorded in the second quarter a before-tax
expense of approximately $125.9 million ($81.8 million after tax) related to
the early retirement offer to the Company's employees. These expenses are
reported in the Corporate segment as other operating expenses and are further
discussed in the section "Corporate
23
Segment Operating Results." Additionally, in the three and six months ended
June 30, 1999 the Company expensed $20.0 million ($13.0 million after tax) of
incremental costs associated with the merger. These incremental costs consist
primarily of compensation, training, integration, and licensing costs.
Consolidated Operating Results
[Download Table]
Three Months Ended June 30 Six Months Ended June 30
--------------------------- ---------------------------
1999 1998 % Change 1999 1998 % Change
-------- -------- -------- -------- -------- --------
(in millions of dollars)
Premium Income.......... $1,687.4 $1,506.1 12.0% $3,368.9 $2,998.7 12.3%
Net Investment Income... 518.0 513.5 0.9 1,017.6 1,038.6 (2.0)
Other Income............ 68.0 82.4 (17.5) 148.8 157.5 (5.5)
-------- -------- -------- --------
Total Revenue........... 2,273.4 2,102.0 8.2 4,535.3 4,194.8 8.1
Benefits and Expenses... 2,552.2 1,841.6 38.6 4,658.1 3,696.4 26.0
-------- -------- -------- --------
Income (Loss) Before
Federal Income Taxes
and Net Realized
Investment Gains....... (278.8) 260.4 (122.8) 498.4
Federal Income Taxes
(Credit)............... (84.9) 90.3 (13.5) 169.9
-------- -------- -------- --------
Income (Loss) Before Net
Realized Investment
Gains.................. (193.9) 170.1 (109.3) 328.5
Net Realized Investment
Gains.................. 2.7 3.4 (20.6) 7.4 9.6 (22.9)
-------- -------- -------- --------
Net Income (Loss)....... $ (191.2) $ 173.5 $ (101.9) $ 338.1
======== ======== ======== ========
During the first quarter of 1999, the Company recognized a before-tax charge
of $101.1 million ($88.0 million after tax) related to its reinsurance
businesses. The charge included $45.5 million related to the Lloyd's of London
managed and non-managed syndicates. Included in the $45.5 million was $44.0
million related to the Company's risk participation in various Lloyd's of
London syndicates, which primarily consisted of the recognition of estimated
losses for all open syndicate years.
The remaining $1.5 million represented a reduction of profit commissions
related to the reinsurance management company operations. The charge also
included a reserve increase of $28.6 million for expected ultimate losses in
certain reinsurance pools in which the Company participates and a $27.0 million
write-down to recognize goodwill impairment on the Company's reinsurance
management company. Based upon the poor results to date and revisions to future
expected earnings from these businesses, management determined that the
goodwill associated with the reinsurance management company was not recoverable
when measured using the estimated future undiscounted cash flows. The
impairment represented the difference between the carrying value of the
reinsurance management company and the estimated fair value using both an
earnings valuation model and a discounted free cash flow valuation model. A
portion of these losses does not receive a tax benefit, which unfavorably
impacted the effective tax rate in the first quarter of 1999. The impact of the
charge in the first quarter of 1999 was a $72.6 million reserve increase in the
provision for future benefits and a $1.5 million reduction in other income,
both of which were reflected in the Other segment, and a $27.0 million increase
in other operating expenses reflected in the Corporate segment.
In the second quarter of 1999, the Company 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. This valuation resulted in an
additional before-tax write-down of goodwill of $2.0 million ($2.0 million
after tax), reflected in the Corporate segment. The $2.0 million additional
write-down is an estimate of the costs to sell as required when performing a
valuation using the held-for-sale model. Management continues to work with
interested buyers. See Note 4 of the "Notes to Condensed Consolidated Financial
Statements" for further discussion.
As noted above, the Company recorded before-tax expenses related to the
merger of approximately $142.2 million in the second quarter of 1999. A portion
of these expenses is non-deductible for federal income
24
tax purposes, resulting in a tax rate for the quarter that was less than the
U.S. federal statutory tax rate of 35 percent. It is expected that the tax rate
will move closer to the statutory rate by the end of the year.
In the second quarter of 1999, the Company reached a settlement agreement
with the Internal Revenue Service related to an issue in dispute for the 1992
tax year. The Company recorded a tax benefit of $5.1 million and related
interest of $1.4 million.
In the following discussion of operating results by segment, "revenue"
includes premium income, net investment income, and other income. "Income"
excludes net realized investment gains and losses and federal income taxes.
Employee Benefits Segment Operating Results
[Download Table]
Three Months Ended June
30 Six Months Ended June 30
------------------------ ------------------------
1999 1998 % Change 1999 1998 % Change
------- ------ -------- ------- ------- --------
(in millions of dollars)
Premium Income
Group Long-term
Disability................ $ 499.0 $441.9 12.9% $ 997.1 $ 874.2 14.1%
Group Short-term
Disability................ 115.9 90.2 28.5 227.1 176.1 29.0
Group Life................. 288.8 244.8 18.0 575.8 479.5 20.1
Accidental Death &
Dismemberment............. 46.2 43.8 5.5 93.9 90.4 3.9
Group Long-term Care....... 10.8 6.5 66.2 20.1 13.4 50.0
------- ------ ------- -------
Total Premium Income......... 960.7 827.2 16.1 1,914.0 1,633.6 17.2
Net Investment Income........ 148.7 136.5 8.9 292.7 269.1 8.8
Other Income................. 34.8 29.7 17.2 67.6 59.1 14.4
------- ------ ------- -------
Total Revenue................ 1,144.2 993.4 15.2 2,274.3 1,961.8 15.9
Benefits and Expenses........ 1,191.5 847.3 40.6 2,156.1 1,677.1 28.6
------- ------ ------- -------
Income (Loss) Before Federal
Income Taxes and Net
Realized Investment Gains... $ (47.3) $146.1 $ 118.2 $ 284.7 (58.5)
======= ====== ======= =======
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 increases in premium income result from strong sales trends over the
past several quarters. Employee Benefits new annualized sales increased 29.6
percent to $262.6 million in the second quarter of 1999 from $202.6 million in
the second quarter of 1998. New annualized sales for this segment increased
31.9 percent to $510.9 million for the first six months of 1999 from $387.3
million in the same period of 1998. Sales related to employee benefits can
fluctuate significantly from quarter to quarter due to large case size and
timing of sales submissions. Because of this fluctuation and the pricing
changes which are being implemented, management expects that the rate of growth
in new annualized group disability and other employee benefit sales will
moderate during the balance of 1999.
Revenue from the managed disability line of business, which includes GENEX
Services, Inc. and Options and Choices, Inc., totaled $27.4 million in the
second quarter of 1999 compared to $24.4 million in the second quarter of 1998.
On a year-to-date basis, this revenue was $53.2 million in 1999 compared to
$47.7 million in 1998.
Group Disability
Group disability revenue increased to $743.0 million in the second quarter
of 1999 versus $649.3 million in 1998. Premium growth for group long-term
disability was driven by favorable persistency, prior period sales,
25
and strong new annualized sales, which were $101.4 million in the second
quarter of 1999 compared to $90.9 million in the same period of 1998. New
annualized sales for group short-term disability increased 20.3 percent to
$50.3 million in the second quarter of 1999 as compared to the second quarter
of 1998, reflecting management's continuing efforts to cross-sell group short-
term disability products with other employee benefits products.
Group disability reported a loss of $109.6 million for the second quarter of
1999, as compared with $100.0 million of income for the same period in 1998. As
discussed in the preceding "Accounting Policy Changes, Financial Statement
Reclassifications, and Merger Expenses," the Company lowered the discount rate
used to calculate certain of UNUM's disability claim reserves to conform with
Provident's process and assumptions, which decreased group disability before-
tax earnings by $191.7 million for the quarter and year-to-date. Excluding the
effect of the discount rate change, this line reported a higher benefit ratio
for its domestic business in the second quarter of 1999 as compared with 1998,
primarily due to higher new claims incidence and the lengthening duration of
claims incurred in 1999 in both long-term and short-term disability. Also
contributing to the 1999 versus 1998 increase in the benefit ratio was the
positive impact in the second quarter of 1998 of updated factors used in
calculating social security offset amounts. The higher incidence level, which
was noted in the first quarter of 1999, continued through the second quarter of
1999. The higher level of incidence for long-term disability was noted in the
health services and manufacturing sectors. The health services sector has
experienced higher incidence levels in recent quarters. This higher level of
claim incidence is being taken into account in the pricing of new business and
renewal of existing cases.
Group disability reported a loss of $4.1 million for the first six months of
1999, as compared with $196.1 million of income for the same period in 1998.
New annualized sales for the first six months of 1999 were $207.0 million and
$94.9 million for group long-term and short-term disability, respectively,
compared to $175.5 million and $78.0 million for the comparable period in 1998.
As discussed under "Cautionary Statement Regarding Forward-Looking
Statements," certain risks and uncertainties are inherent in the Company's
business. Components of claims experience, including but not limited to,
incidence levels and claims duration, may continue for some period of time at
or above the higher levels experienced in 1998. Therefore, management continues
to monitor claims experience in group disability and responds to changes by
periodically adjusting prices, refining underwriting guidelines, changing
product features, and strengthening risk management policies and procedures.
The Company expects to price new business and re-price existing business, at
contract renewal dates, in an attempt to mitigate the effect of these and other
factors, including interest rates, on new claim liabilities. However, given the
competitive market conditions for the Company's disability products, it is
uncertain whether pricing actions can mitigate the entire effect.
In the fourth quarter of 1998, the Company recorded a $50.3 million before-
tax charge for the group long-term disability line of business in the Employee
Benefits segment for the expected increase in claims durations due to
management's expectation that productivity in the claims organization will be
impacted as a result of planning, consolidation, and integration efforts
related to the merger. Management expects the claims integration efforts to
have some benefits, primarily related to claims incurred in future periods, as
well as the potential for improved customer satisfaction and lower ultimate
claim costs as best practices in return-to-work and claims management are
implemented. As benefits related to the integration become known, reserve
assumptions will be revised, if appropriate. Insurance policies that are
impacted by the temporary change in claim resolution rates will not perform as
anticipated when priced. However, since the cause of the additional claim cost
is of a temporary nature, it is not anticipated to have an effect on future
policy pricing. The $50.3 million reserve increase is not considered material
from a capital adequacy position.
During the first and second quarters of 1999, those claim operations
integration activities progressed as assumed. At December 31, 1998, management
assumed the revised claim resolution rates for the first and second quarters of
1999 to be 90 percent of assumptions, before adjusting for the impact of the
claim operations integration activities. The actual experience was 89 percent
for the first quarter of 1999 and 90 percent for the second quarter. If the
impact of merger-related claim operations integration activities on claim
26
durations had not been anticipated at December 31, 1998, second quarter and six
months 1999 before-tax income for the group long-term disability line of
business would have been negatively impacted by $11.8 million and $23.6
million, respectively. Management expects the remaining claim operations
integration activities to impact claim reserves as anticipated at December 31,
1998. Management will continue to evaluate the impact of the merger on
disability claims experience and the assumptions related to expected claim
resolutions. If the claim operations integration activities take longer than
expected to implement or if they result in unforeseen difficulties, claim
durations could continue to increase and income could be adversely affected.
See Note 3 of the "Notes to Condensed Consolidated Financial Statements" for
further discussion.
Group Life, Accidental Death and Dismemberment, and Long-term Care
Group life, accidental death and dismemberment, and long-term care reported
income of $61.0 million in the second quarter of 1999 compared to $44.7 million
in the second quarter of 1998. The increase resulted from the growth in premium
income, which was driven by strong sales, and a favorable benefit ratio in the
accidental death and dismemberment line. New annualized sales increased 58.7
percent to $110.9 million in the second quarter of 1999. Year-to-date 1999
income was $119.5 million versus $86.3 million in 1998. Year-to-date new
annualized sales were $209.0 million in 1999 compared to $133.8 million in
1998.
Individual Segment Operating Results
[Download Table]
Three Months Ended June 30 Six Months Ended June 30
------------------------------- ------------------------
1999 1998 % Change 1999 1998 % Change
--------- --------- ----------- ------- ------- --------
(in millions of dollars)
Premium Income
Individual Disability.. $ 383.9 $ 377.8 1.6% $ 775.2 $ 765.2 1.3%
Individual Life....... 21.8 22.2 (1.8) 44.4 44.0 0.9
Individual Long-term
Care................. 21.6 14.4 50.0 40.8 27.7 47.3
--------- --------- ------- -------
Total Premium Income.... 427.3 414.4 3.1 860.4 836.9 2.8
Net Investment Income... 222.7 205.7 8.3 432.0 405.0 6.7
Other Income............ 11.1 17.9 (38.0) 29.3 37.7 (22.3)
--------- --------- ------- -------
Total Revenue........... 661.1 638.0 3.6 1,321.7 1,279.6 3.3
Benefits and Expenses... 614.1 557.2 10.2 1,194.0 1,119.8 6.6
--------- --------- ------- -------
Income Before Federal
Income Taxes and Net
Realized Investment
Gains.................. $ 47.0 $ 80.8 (41.8) $ 127.7 $ 159.8 (20.1)
========= ========= ======= =======
The Individual segment includes results from the individual disability,
individual life, and individual long-term care lines of business.
Individual Disability
New annualized sales in the individual disability income line of business
were up 4.3 percent in the second quarter of 1999, rising to $31.4 million from
$30.1 million in the second quarter of 1998. Excluding discontinued products,
new annualized sales increased 17.8 percent to $27.8 million in the second
quarter of 1999 from $23.6 million in the comparable year ago period. Year-to-
date new annualized sales were $65.3 million, an 11.8 percent increase over the
comparable period of 1998. The persistency of existing individual disability
income business continued to be favorable. Management expects that premium
income in the individual disability income line will grow on a year-over-year
basis as the product transition produces increasing levels of new sales of
individual disability products. Income in the individual disability income line
of business decreased to $35.2 million in the second quarter of 1999 from $69.3
million in the second quarter of 1998. On a year-to-date basis, income was
$106.8 million in 1999 and $141.1 million in 1998. As discussed in the
preceding "Accounting Policy Changes, Financial Statement Reclassifications,
and Merger Expenses," the Company lowered the discount rate used to calculate
certain of UNUM's disability claim reserves to
27
conform with Provident's process and assumptions, which decreased individual
disability before-tax earnings by $38.9 million for the quarter and six months.
Excluding the effect of the discount rate change, this line reported an
increase in the benefit ratio compared to the second quarter of 1998, primarily
due to a decrease in claim resolutions on claims incurred in 1999. However,
when compared to the prior three quarters, the claim resolution rate has
improved. Individual disability experienced slightly lower new claim levels for
the quarter as compared to second quarter 1998.
As noted in the "Employee Benefits Segment Operating Results," claim
resolution rates were revised downward in the fourth quarter of 1998 for claim
operations integration activities related to the merger. The Company recorded a
$100.3 million before-tax charge in the fourth quarter of 1998 in the
Individual segment related to the revised claim resolution rates for individual
disability. At December 31, 1998, management assumed the revised claim
resolution rates for the first and second quarters of 1999 to be 90 percent of
assumptions, before adjusting for the impact of the claim operations
integration activities. The actual experience for the Company in the first and
second quarters of 1999 was 89 percent and 90 percent, respectively. If the
impact of merger-related claim operations integration activities on claim
durations had not been anticipated at December 31, 1998, second quarter and
year-to-date 1999 before-tax operating income for the individual disability
line of business would have been negatively impacted by $23.8 million and
$47.6 million, respectively. The $100.3 million reserve increase in the
Individual segment is not considered material from a capital adequacy position.
See Note 3 of the "Notes to Condensed Consolidated Financial Statements" for
further discussion.
Individual Life and Long-term Care
The individual long-term care line of business reported increased premium
income for the quarter and year-to-date, primarily due to new sales growth. New
annualized sales were $10.5 million and $18.1 million for the quarter and year-
to-date, an increase of 150.0 percent and 144.6 percent, respectively. The
Company expects the strong sales momentum in individual long-term care to
continue.
Income in the individual life and long-term care lines of business increased
to $11.8 million in the second quarter of 1999 from $11.5 million in the second
quarter of 1998. Year-to-date income was $20.9 million or 11.8 percent higher
than the first six months of 1998, due primarily to the increase in premium
income and an improvement in the individual life benefit ratio.
Voluntary Benefits Segment Operating Results
[Download Table]
Six Months Ended
Three Months Ended June 30 June 30
-----------------------------------------------------
1999 1998 % Change 1999 1998 % Change
--------- --------- ----------------- ------ --------
(in millions of dollars)
Premium Income.......... $ 173.1 $ 166.8 3.8% $344.3 $331.3 3.9%
Net Investment Income... 25.2 23.2 8.6 50.1 45.4 10.4
Other Income............ 1.6 1.6 -- 3.3 4.5 (26.7)
--------- --------- ------ ------
Total Revenue........... 199.9 191.6 4.3 397.7 381.2 4.3
Benefits and Expenses... 168.8 160.7 5.0 335.1 323.0 3.7
--------- --------- ------ ------
Income Before Federal
Income Taxes and Net
Realized Investment
Gains.................. $ 31.1 $ 30.9 0.6 $ 62.6 $ 58.2 7.6
========= ========= ====== ======
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.
Revenue in the Voluntary Benefits segment increased to $199.9 million in the
second quarter of 1999 from $191.6 million in the second quarter of 1998. On a
year-to-date basis, revenue for 1999 was $397.7 million compared to $381.2
million in 1998. The increase in premium income is driven by sales growth and
favorable
28
persistency. New annualized sales in this segment increased 10.6 percent to
$58.3 million in the second quarter of 1999 from $52.7 million in the
comparable period of 1998. For the six months, new annualized sales were $117.1
million in 1999 and $104.2 million in 1998. These sales are not necessarily
indicative of the levels that may be attained in the future. Management
continues its efforts to increase sales through the realignment of the sales
organization and the enhancement of collaborative sales. Income in the
Voluntary Benefits segment in the second quarter of 1999 was $31.1 million
versus $30.9 million in 1998. For the first six months, income was $62.6
million in 1999 and $58.2 million in 1998. The increase in income is primarily
due to the increase in premium income in all of the product lines, partially
offset by a slightly higher benefit ratio in the accident, sickness, and
disability product line.
Other Segment Operating Results
[Download Table]
Three Months Ended Six Months Ended
June 30 June 30
--------------------- -----------------------
1999 1998 % Change 1999 1998 % Change
------ ----- -------- ------ ------ --------
(in millions of dollars)
Premium Income................... $126.3 $97.7 29.3% $250.2 $196.9 27.1%
Net Investment Income............ 114.5 135.6 (15.6) 228.0 302.8 (24.7)
Other Income..................... 20.5 32.8 (37.5) 48.4 55.7 (13.1)
------ ----- ------ ------
Total Revenue.................... 261.3 266.1 (1.8) 526.6 555.4 (5.2)
Benefits and Expenses............ 253.6 229.5 10.5 580.0 498.7 16.3
------ ----- ------ ------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains................ $ 7.7 $36.6 (79.0) $(53.4) $ 56.7
====== ===== ====== ======
The Other operating segment includes results from products no longer
actively marketed, including corporate-owned life insurance, group pension,
health insurance, individual annuities, and reinsurance pools and management.
It is expected that revenue and earnings in this segment will decline over time
as these business lines wind down. The run-off of the group pension line
results in a decline in assets under management and, in turn, a continued
decline in the net investment income produced by the assets. Management expects
to reinvest the capital supporting these lines of business in the future growth
of the Employee Benefits, Individual, and Voluntary Benefits segments. The
closed blocks of business have been segregated for reporting and monitoring
purposes.
Corporate-Owned Life
Income from this line of business increased to $9.6 million in the second
quarter of 1999 compared to $5.6 million in the same period of 1998. Income was
$14.2 million in the first six months of 1999 versus $11.0 million in 1998.
These results reflect better mortality experience in the second quarter of 1999
and wider spreads between interest earned and credited rates.
Group Pension
Income in the group pension line of business was $9.7 million in the second
quarter of 1999 versus $6.7 million in the second quarter of 1998. For the
first six months, income was $14.5 million in 1999 compared to $14.4 million in
1998. The increase in income in the second quarter of 1999 over the second
quarter of 1998 is the result of higher investment income than required for
crediting purposes. On a year-to-date basis, the 1998 results were lower due to
a $1.9 million charge for guaranty fund assessments.
Individual Annuities
In the second quarter of 1998, the Company closed the sale of Provident's
in-force individual and tax-sheltered annuity business to affiliates of
American General Corporation (American General). The sale was effected by
reinsurance in the form of 100 percent coinsurance agreements. The in-force
business sold
29
consisted primarily of individual fixed annuities and tax-sheltered annuities.
In addition, American General acquired a number of miscellaneous group pension
lines of business sold in the 1970s and 1980s which were no longer actively
marketed. The sale did not include Provident's block of guaranteed investment
contracts or group single premium annuities, which will continue in a run-off
mode. In consideration for the transfer of the approximately $2.4 billion of
statutory reserves, American General paid the Company a ceding commission of
approximately $58.0 million. The before-tax gain included in other income for
the second quarter of 1998 was $12.2 million.
Reinsurance Pools and Management
Premium income increased $25.2 million and $59.1 million for the three and
six months, respectively, to $99.8 million and $203.6 million due primarily to
increased participation in the Lloyd's of London syndicates. The reinsurance
pools and management reported a loss of $12.6 million in the second quarter of
1999 compared to income of $4.2 million in the second quarter of 1998. As
discussed in the preceding "Accounting Policy Changes, Financial Statement
Reclassifications, and Merger Expenses," the Company lowered the discount rate
used to calculate certain of UNUM's disability claim reserves to conform with
Provident's process and assumptions, which decreased group long-term disability
reinsurance second quarter 1999 before-tax earnings by $10.1 million.
The reinsurance pools and management reported a loss of $86.6 million in the
first six months of 1999 compared to income of $9.9 million in 1998. During the
first quarter of 1999, the Company conducted a comprehensive strategic review
of its reinsurance businesses to determine the appropriateness of their fit
within the context of the merged entity. These businesses include the
reinsurance management operations and the risk assumption (reinsurance pool
participation, direct reinsurance, and Lloyd's of London syndicate
participation). In the second quarter of 1999, the Company concluded that these
businesses were not solidly aligned with its strength in the disability
insurance market and stated its intent to sell its reinsurance management
operations assuming the transaction would achieve the Company's financial
objectives. Year-to-date earnings in the reinsurance pools and management line
decreased $74.1 million due to the first quarter charge related to the
reinsurance businesses. See previous discussion under "Consolidated Operating
Results" and Note 4 of the "Notes to Condensed Consolidated Financial
Statements."
In the fourth quarter of 1998, the Company recorded a $2.4 million before-
tax charge related to the revised claim resolution rates for group long-term
disability reinsurance. If the impact of merger-related claim operations
integration activities on claim duration had not been anticipated at December
31, 1998, second quarter and six months 1999 before-tax earnings for the
reinsurance pools and management line of business would have been negatively
impacted by $0.6 million and $1.2 million, respectively. See Note 3 of the
"Notes to Condensed Consolidated Financial Statements" for further discussion.
Other
Effective January 1, 1998, the Company entered into an agreement with
Connecticut General Life Insurance Company (Connecticut General) for
Connecticut General to reinsure, on a 100 percent coinsurance basis, its in-
force medical stop-loss insurance coverages sold to clients of CIGNA Healthcare
and its affiliates (CIGNA). This reinsured block constitutes substantially all
of the Company's medical stop-loss insurance business. The small portion
remaining consists of medical stop-loss coverages sold to clients other than
those of CIGNA. The medical stop-loss business produced revenue of $14.1
million in 1998.
Corporate Segment Operating Results
The Corporate segment includes investment earnings on corporate assets not
specifically allocated to a line of business, corporate interest expense,
amortization of goodwill, and certain corporate expenses not allocated to a
line of business.
30
Revenue in the Corporate segment was $6.9 million in the second quarter of
1999 and $12.9 million in the second quarter of 1998. For the first six months,
revenue was $15.0 million in 1999 and $16.8 million in 1998. The Corporate
segment reported a loss of $317.3 million in the second quarter of 1999
compared to a loss of $34.0 million in the second quarter of 1998. On a year-
to-date basis, the losses were $377.9 million for 1999 and $61.0 million for
1998. Interest and debt expense increased to $33.6 million and $66.5 million
for the second quarter and six months of 1999 compared to $27.7 million and
$55.0 million for the comparable periods of 1998 due to a higher average debt
balance. In addition, the Company recorded a before-tax write-down of goodwill
of $27.0 million and $2.0 million in the 1999 first quarter and second quarter,
respectively. As discussed in the preceding section "Accounting Policy Changes,
Financial Statement Reclassifications, and Merger Expenses," in the second
quarter of 1999 the Company recorded before-tax expenses related to the merger
of approximately $142.2 million and a before-tax expense of approximately
$125.9 million related to the early retirement offer to the Company's
employees.
The expenses related to the merger and to the early retirement offer to
employees consist of the following (in millions):
[Download Table]
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. As further opportunities for cost
reductions are identified, there may be additional expenses for severance costs
and exit activities.
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.
These expenses are $35.1 million higher on a before-tax basis than the
estimated expenses disclosed in the Joint Proxy Statement/Prospectus of UNUM
and Provident dated June 2, 1999, primarily because the actual number of
employees who accepted the early retirement offer was approximately 350
employees higher than estimated, resulting in additional before-tax expense of
approximately $32.0 million. Partially offsetting this increase was a reduction
in employee severance and outplacement costs in that fewer positions will be
involuntarily terminated due to the early retirement election.
The financial statements do not reflect any benefit expected from revenue
enhancements or derived from potential cost savings related to the merger.
Although management anticipates revenue enhancements and costs
31
savings will result from the merger, there can be no assurance that these items
will be achieved. Economies of scale, the elimination of duplicative
expenditures, and the consistent use of the best practices of Provident and
UNUM are expected to enable the Company to achieve annual cost savings of
approximately $130 million in 2000.
In addition to the expenses described above, in the three and six months
ended June 30, 1999, the Company has expensed $20.0 million of other
incremental costs associated with the merger, $17.1 million of which are
included in the Corporate segment. These expenses consist primarily of
compensation, training, integration, and licensing costs.
Investments
Investment activities are an integral part of the Company's business, and
profitability is significantly affected by investment results. Invested assets
are segmented into portfolios, which support the various product lines.
Generally, the investment strategy for the portfolios is to match the effective
asset durations with related expected liability durations and to maximize
investment returns, subject to constraints of quality, liquidity,
diversification, and regulatory considerations. The Company is reviewing its
investment strategies in the context of the combined entity and is extending
the duration of its investments and shifting the mix of assets in the portfolio
by repositioning approximately $2.0 billion of its investments. Management
believes this strategy will reduce its vulnerability to interest rate risk in
the future and anticipates that, as a result, investment income may increase on
an annualized basis approximately $30.0 million.
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately
$1.9 billion on an amortized cost basis at June 30, 1999, and $2.1 billion at
December 31, 1998. At June 30, 1999, the mortgage-backed securities had an
average life of 11.5 years and effective duration of 8.9 years. The mortgage-
backed securities are valued on a monthly basis using valuations supplied by
the brokerage firms that are dealers in these securities. The primary risk
involved in investing in mortgage-backed securities is the uncertainty of the
timing of cash flows from the underlying loans due to prepayment of principal.
The Company uses models which incorporate economic variables and possible
future interest rate scenarios to predict future prepayment rates. The Company
has not invested in mortgage-backed derivatives, such as interest-only,
principal-only or residuals, where market values can be highly volatile
relative to changes in interest rates.
Below-investment-grade bonds are inherently more risky than investment-grade
bonds since the risk of default by the issuer, by definition and as exhibited
by bond rating, is higher. Also, the secondary market for certain below-
investment-grade issues can be highly illiquid. Management does not anticipate
any liquidity problem caused by the investments in below-investment-grade
securities, nor does it expect these investments to adversely affect its
ability to hold its other investments to maturity.
The Company's exposure to below-investment-grade fixed maturity securities
at June 30, 1999, was $1,601.7 million, representing 6.1 percent of invested
assets, below the Company's internal limit of 10.0 percent of invested assets
for this type of investment. The Company's exposure to below-investment-grade
fixed maturities totaled $1,452.6 million at December 31, 1998, representing
5.3 percent of invested assets.
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $1,328.1 million and $1,321.2
million at June 30, 1999, and December 31, 1998, respectively. The Company uses
a comprehensive rating system to evaluate the investment and credit risk of
each mortgage loan and to identify specific properties for inspection and
reevaluation. The Company establishes allowances for probable mortgage loan
losses based on a review of individual loans and the overall loan portfolio,
considering the value of the underlying collateral.
The mortgage loan portfolio is well diversified geographically and among
property types. The incidence of new problem mortgage loans and foreclosure
activity has remained low in 1999 and 1998, reflecting
32
improvements in overall economic activity and improving real estate markets in
the geographic areas where the Company has mortgage loans. Management expects
the level of delinquencies and problem loans to remain low in the future.
At June 30, 1999, and December 31, 1998, impaired loans totaled $18.3
million and $20.7 million, respectively. Included in the impaired loans at June
30 were $6.7 million of loans which had a related, specific allowance for
probable losses of $2.4 million and $11.6 million of loans which had no
related, specific allowance for probable losses. Impaired mortgage loans are
not expected to have a material impact on the Company's liquidity, financial
position, or results of operations.
Restructured mortgage loans totaled $12.3 million at June 30, 1999, compared
to $14.5 million at December 31, 1998, and represent loans that have been
refinanced with terms more favorable to the borrower. Interest lost on
restructured loans was immaterial for the six and twelve month periods ended
June 30, 1999, and December 31, 1998.
Real estate was $314.4 million and $309.8 million at June 30, 1999, and
December 31, 1998. 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 and may be classified as investment real estate if
it meets the Company's investment criteria. 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, which is valued net of a valuation
allowance that reduces the carrying value to the lower of cost or fair value
less estimated cost to sell, amounted to $114.5 million at June 30, 1999, and
$15.6 million at December 31, 1998. The Company reasonably expects to sell this
real estate during 1999. The sale is not expected to have a material impact on
the Company's liquidity, financial position, or results of operations.
Allowances for probable losses on mortgage loans and real estate held for
sale are established based on a review of specific assets as well as on an
overall portfolio basis, considering the value of the underlying assets and
collateral. If a decline in value is considered to be other than temporary or
if the asset is deemed permanently impaired, the investment is reduced to
estimated net realizable value, and the reduction is recorded as a realized
investment loss. The allowance for probable losses on mortgage loans and real
estate was $32.9 million and $53.0 million, respectively, at June 30, 1999.
Management monitors the risk associated with the invested asset portfolio and
regularly reviews and adjusts the allowance for probable losses.
Other
The Company's exposure to non-current investments totaled $15.1 million at
June 30, 1999, or 0.05 percent of invested assets. These non-current
investments are mortgage loans that became more than thirty days past due in
principal and interest payments.
The Company utilizes forward interest rate swaps, forward treasury
purchases, and options on forward interest rate swaps or forward treasuries to
manage duration and increase yield on cash flows expected from current
holdings. All transactions are hedging in nature and not speculative. Almost
all transactions are associated with the individual disability product
portfolio. All other product portfolios are periodically reviewed to determine
if hedging strategies would be appropriate for risk management purposes.
Liquidity and Capital Resources
The Company's liquidity requirements are met primarily by cash flows
provided from operations, principally in its insurance subsidiaries. Premium
and investment income, as well as maturities and sales of invested assets,
provide the primary sources of cash. Cash is applied to the payment of policy
benefits, costs of acquiring new business (principally commissions) and
operating expenses as well as purchases of new investments. The Company has
established an investment strategy that management believes will provide for
adequate cash flows from operations. Cash flows from operations were $740.1
million for the six months ended June 30, 1999, as compared to $633.8 million
in the comparable period in 1998.
33
The Company believes the cash flows from its operations will be sufficient
to meet its operating and financial cash flow requirements excluding the strain
placed on capital as a result of the charges recorded in connection with the
merger and the early retirement program. As a result of the effect of the
reserve increase, the merger related expenses, and the cost of the early
retirement program on capital as well as refinancing requirements, the Company
will need to raise approximately $500 million in capital during the remainder
of 1999. Approximately half of this is incremental to the June 30, 1999
balance. The Company expects to raise the capital for its insurance
subsidiaries through the debt markets and is currently exploring the
alternatives available. The Company intends to file a shelf registration later
this year in order to provide funding flexibility through the issuance of debt
or equity securities. The funding will be used to finance, among other
requirements, the capital need referenced above and to fund internal expansion,
acquisitions, investment opportunities, and the retirement of the Company's
debt and equity.
At June 30, 1999, the Company had short-term and long-term debt totaling
$490.0 million and $1,226.5 million, respectively. Included in the short-term
debt was $150.6 million used to finance investment activities. At June 30,
1999, approximately $308.8 million was available for additional financing under
the existing revolving credit facility. Contingent upon market conditions and
corporate needs, management may refinance short-term notes payable for longer-
term securities. In the normal course of business, the Company enters into
letters of credit, primarily to satisfy capital requirements related to certain
subsidiary transactions. The Company had outstanding letters of credit of
$156.8 million at June 30, 1999.
In the fourth quarter of 1997, the Company borrowed $168.3 million through a
private placement. Under the terms of the agreement, the investor 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.
In 1998, the Company rescinded its stock repurchase program as a result of
the pending merger. As a result, no shares of common stock were repurchased
during the first six months of 1999. During the first six months of 1998, the
Company acquired approximately 1.3 million shares of its common stock in the
open market at an aggregate cost of $70.8 million. At the completion of the
merger, UNUM common stock held in treasury was retired.
Ratings
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's),
and A.M. Best Company (AM Best) are among the third parties that provide the
Company assessments of its overall financial position. Ratings from these
agencies for financial strength are available for the individual U.S. domiciled
insurance company subsidiaries. Financial strength ratings are based primarily
on U.S. statutory financial information for the individual U.S. domiciled
insurance companies. Debt ratings for the Company are based primarily on
consolidated financial information prepared using generally accepted accounting
principles. Both financial strength ratings and debt ratings incorporate
qualitative analyses by rating agencies on an ongoing basis.
34
The rating agencies reviewed and, in some instances, revised their ratings
to reflect the completion of the merger. The table below reflects the most
recent debt ratings for the Company and the financial strength ratings for the
U.S. domiciled insurance company subsidiaries.
[Download Table]
S&P Moody's AM Best
---------------- ------------------------- ------------
UNUMProvident
Corporation
Senior Debt........... A (Strong) A2 (Upper Medium Grade) Not Rated
Junior Subordinated
Debt................. BBB+ (Good) A3 (Upper Medium Grade) Not Rated
Commercial Paper...... A-1 (Strong) Prime-1 (Superior Ability) Not Rated
U.S. Insurance
Subsidiaries
Provident Life &
Accident............. AA- (Very Strong) Aa3 (Excellent) A+ (Superior)
Provident Life &
Casualty............. Not Rated Not Rated A+ (Superior)
Provident National
Assurance............ Not Rated Aa3 (Excellent) A+ (Superior)
UNUM Life of America.. AA- (Very Strong) Aa3 (Excellent) A+ (Superior)
First UNUM Life....... AA- (Very Strong) Aa3 (Excellent) A+ (Superior)
Colonial Life &
Accident............. AA- (Very Strong) Aa3 (Excellent) A+ (Superior)
Paul Revere Life...... AA- (Very Strong) Aa3 (Excellent) A+ (Superior)
Paul Revere Variable.. AA- (Very Strong) Aa3 (Excellent) A+ (Superior)
Paul Revere
Protective........... AA- (Very Strong) Aa3 (Excellent) A+ (Superior)
Year 2000 Date Conversion
As are many other businesses in this country and abroad, the Company is
affected in numerous ways, both by its own computer information systems and by
third parties with which it has business relationships, in the processing of
date data relating to the year 2000 and beyond. Failure to adequately address
and substantially resolve year 2000 issues could, and as to mission critical
systems in certain circumstances would, have a material adverse effect on the
Company's business, results of operations, or financial condition. While there
can be no assurance as to its success, the Company has a project underway which
is intended and designed to avoid and/or mitigate any such material adverse
effect from year 2000 issues.
The Company's program for the year 2000 is organized into a number of phases
for rectifying its internal computer systems, including assessment, code
remediation, testing and deployment. As of June 30, 1999, the Company had
completed the assessment and code remediation phases for all of its critical
and non-critical business systems with over 90 percent completing the
compliance testing phase. Deployment is substantially completed for most
critical and non-critical systems. As previously discussed in Provident's and
UNUM's Annual Reports on Form 10-K/A, management continues to expect completion
of all phases by the end of 1999.
There are numerous instances in which third parties having a relationship
with the Company have year 2000 issues to address and resolve. These include,
among others, vendors of hardware and software, holders of group insurance
policies, issuers of investment securities, financial institutions,
governmental agencies, and suppliers. An aspect of the Company's year 2000
program has been to assess its critical external dependencies and, as part of
its due diligence efforts, to contact certain third parties seeking written
assurance as to their expectancy to be year 2000 compliant. The nature of the
Company's follow up to its written requests to third parties depends upon its
assessment of the response and of the materiality of the effect of non-
compliance by the third party on the Company. In some instances the Company is
performing site visits to certain third party businesses and testing their
systems for compliance. In addition, the Company is testing external electronic
interfaces with certain critical business partners. To date, no significant
issues from critical external dependencies have been identified; however, there
can be no guarantee that the computer systems of these third parties will be
year 2000 compliant. The Company is developing contingency plans to alleviate
the potential business impact of third parties not being year 2000 compliant.
Management expects these plans to be finalized and ready for implementation in
third quarter 1999. The effort of internal business and systems personnel
35
devoted to the project has been considerable. Temporary personnel and subject
matter consultants have been utilized, when appropriate, to assist full time
personnel in some phases or aspects of the project. The Company has utilized
compensation programs to retain project personnel in order to keep the project
on schedule. While the project has required systems management to more closely
scrutinize the prioritization of information technology projects, it is not
believed that any deferral of information technology projects has had a
material impact on the Company. The Company has also had occasional contact
with certain peer companies comparing approaches to year 2000 issues.
Given the range of possibilities that may occur in connection with non-
compliance with year 2000 that could affect the Company, particularly as a
consequence of third parties, the Company is unable to provide an estimate of
the impact of such non-compliance on its business, results of operations, or
financial condition. With regard to non-compliance resulting from the Company's
systems, which the Company believes to be less likely than that resulting from
third parties, the Company would devote its financial and personnel resources
to remediate the problem as soon as possible. With regard to non-compliance
resulting from third party failure, the Company is finalizing appropriate
contingency arrangements that will minimize such impact; however, given the
range of possibilities, no assurance can be given that the Company's efforts
will be successful. In addition, the Company is developing detailed plans for
activities for managing the year-end rollover period. This includes plans for
appropriate backup of data, year-end processing schedules, limiting
installations of new code, and the availability of special response teams
tasked with identifying and resolving any issues which might occur during the
rollover period. These teams include both information technology and business
professionals.
The foregoing discussion of the year 2000 issue contains forward-looking
statements relating to such matters as financial performance and the business
of the Company. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor for forward-looking statements. In order for the Company to comply
with the terms of the safe harbor, the Company notes that a variety of factors
could cause the Company's actual results and experience relating to compliance
with year 2000 to differ materially from the anticipated results or other
expectations expressed in the Company's forward-looking statements concerning
year 2000 issues, which involve certain risks and uncertainties. These factors
include (i) the unanticipated material impact of a system fault of the Company
relating to year 2000, (ii) the failure to successfully remediate, in spite of
testing, material systems of the Company, (iii) the time it may take to
successfully remediate a failure once it occurs, as well as the resulting costs
and loss of revenues, and (iv) the failure of third parties to properly
remediate material year 2000 problems.
Since inception of the project, the Company has expensed approximately $29.4
million through June 30, 1999, in connection with incremental cost of the year
2000 project and estimates an additional $3.0 million to complete the project.
The costs of the project and the date on which the Company plans to complete
year 2000 modifications are based on management's best estimates, derived using
numerous assumptions about future events. However, there can be no guarantee
that these estimates will be achieved, and actual results could differ
materially from those plans. See Part II, Item 7 of Provident's and UNUM's
Annual Reports on Form 10-K/A for further discussion of the year 2000 issues.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is subject to various market risk exposures including interest
rate risk and foreign exchange rate risk. The Company employs various
derivative programs to manage these material market risks. The operations of
the Company are subject to risk resulting from interest rate fluctuations,
primarily long-term U.S. interest rates. Changes in interest rates and
individuals' behavior affect the amount and timing of asset and liability cash
flows. Management continually models and tests asset and liability portfolios
to improve interest rate risk management and net yields. Testing the asset and
liability portfolios under various interest rate and economic scenarios allows
management to choose the most appropriate investment strategy within acceptable
risk tolerances. This analysis is the precursor to the Company's activities in
derivative financial instruments.
36
The Company uses interest rate swaps, interest rate forward contracts,
exchange-traded interest rate futures contracts, and options to hedge interest
rate risks and to match asset durations and cash flows with corresponding
liabilities.
The Company is also subject to foreign exchange risk arising from its
foreign operations and certain foreign dollar denominated investment
securities. Foreign operations represent 6.6 percent and 6.5 percent of total
assets at June 30, 1999 and December 31, 1998, respectively, and 9.3 percent
and 9.9 percent of total revenue for the six month periods ended June 30, 1999
and 1998, respectively. At June 30, 1999, there were no outstanding derivatives
hedging this foreign currency risk.
See Part II, Items 7, 7A, and 8 of Provident's and UNUM's Annual Reports on
Form 10-K/A for further discussion of the qualitative and quantitative aspects
of market risk, including derivative financial instrument activity. During the
first six months of 1999, there was no substantive change to the Company's
market risk.
37
PART II--OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of the Stockholders of Provident held at 8:30 a.m. on
June 30, 1999, Provident stockholders elected all of management's nominees for
the Board of Directors as listed in the proxy statement and set forth below and
approved the following proposals:
[Download Table]
Votes in Votes
Favor Withheld
----------- --------
1. Election of Directors
William L. Armstrong..................................... 122,289,161 372,751
William H. Bolinder...................................... 122,289,150 372,762
J. Harold Chandler....................................... 122,258,709 403,203
Charlotte M. Heffner..................................... 122,285,850 376,062
Hugh B. Jacks............................................ 122,285,974 375,938
Hugh O. Maclellan, Jr.................................... 122,286,452 375,460
A.S. MacMillan........................................... 122,289,510 372,402
C. William Pollard....................................... 122,289,915 371,997
Steven S Reinemund....................................... 122,287,801 374,111
Burton E. Sorensen....................................... 122,284,824 377,088
Thomas R. Watjen......................................... 122,287,370 374,542
[Download Table]
Votes Votes
Votes For Against Abstaining Broker Non-votes
----------- --------- ---------- ----------------
2. Adoption of Agreement and
Plan of Merger............ 116,541,445 106,410 330,400 5,683,657
3. Approval of Amendment to
the Amended and Restated
Certificate of
Incorporation............. 116,455,548 171,557 351,150 5,683,657
4. Approval of Amendment to
Stock Plan of 1999........ 116,688,387 5,555,781 417,744 0
Effective upon the merger with UNUM, Messrs. Bolinder, Jacks, and Watjen and
Ms. Heffner resigned from the board, and the following persons, each of whom
was a director of UNUM immediately prior to the merger were appointed to fill
vacancies on the Board:
[Download Table]
James F. Orr III Cynthia A. Montgomery Lois Dickson Rice
Ronald E. Goldsberry James L. Moody, Jr. John W. Rowe
George J. Mitchell Lawrence R. Pugh
38
REVIEW BY INDEPENDENT AUDITORS
The condensed consolidated financial statements at June 30, 1999, 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.
39
PART II--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
[Enlarge/Download Table]
(a)Exhibit 3.1 Restated Certificate of Incorporation
Exhibit 3.2 Amended and Restated Bylaws
Exhibit 10.1 Employment Agreement between the Company and James F. Orr III
Exhibit 10.2 Employment Agreement between the Company and J. Harold Chandler
Exhibit 10.3 Employment Agreement between the Company and F. Dean Copeland
Exhibit 10.4 Employment Agreement between the Company and Robert W. Crispin
Exhibit 10.5 Employment Agreement between the Company and Elaine D. Rosen
Exhibit 10.6 Employment Agreement between the Company and Thomas R. Watjen
Exhibit 15 Letter re unaudited interim financial information
Exhibit 18 Letter re change in accounting principles
Exhibit 27 Financial data schedules (for SEC use only)
(b)Reports on Form 8-K:
Form 8-K filed on June 30, 1999, relating to the completion of the merger with UNUM
Corporation.
40
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.
UNUMProvident Corporation
(Registrant)
Date: August 12, 1999
/s/ J. Harold Chandler
_____________________________________
J. Harold Chandler
President and Chief Operating
Officer
Date: August 12, 1999
/s/ Thomas R. Watjen
_____________________________________
Thomas R. Watjen
Executive Vice President--Finance
(principal financial officer)
Date: August 12, 1999
/s/ Robert E. Broatch
_____________________________________
Robert E. Broatch
Senior Vice President and Chief
Financial Officer (chief
accounting officer)
41
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
EXHIBITS
TO
FORM 10-Q
----------------
UNUMPROVIDENT CORPORATION
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
42
INDEX OF EXHIBITS
[Download Table]
EXHIBIT PAGE
------- ----
Exhibit 3.1 Restated Certificate of Incorporation.....................
Exhibit 3.2 Amended and Restated Bylaws...............................
Exhibit 10.1 Employment Agreement between the Company and James F. Orr
III.......................................................
Exhibit 10.2 Employment Agreement between the Company and J. Harold
Chandler..................................................
Exhibit 10.3 Employment Agreement between the Company and F. Dean
Copeland..................................................
Exhibit 10.4 Employment Agreement between the Company and Robert W.
Crispin...................................................
Exhibit 10.5 Employment Agreement between the Company and Elaine D.
Rosen.....................................................
Exhibit 10.6 Employment Agreement between the Company and Thomas R.
Watjen....................................................
Exhibit 15 Letter re unaudited interim financial information.........
Exhibit 18 Letter re change in accounting principles.................
Exhibit 27 Financial data schedules (for SEC use only)...............
43
Dates Referenced Herein and Documents Incorporated by Reference
| Referenced-On Page |
|---|
| This ‘10-Q’ Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 1/1/01 | | 19 |
| | 12/31/99 | | 7 | | 11 | | | 10-K, 5/A, NT 11-K |
| Filed on: | | 8/13/99 |
| | 8/12/99 | | 41 |
| | 8/2/99 | | 20 | | | | | 8-K |
| For Period End: | | 6/30/99 | | 1 | | 40 | | | 8-A12B/A, 8-K, S-8 |
| | 6/2/99 | | 31 | | | | | 10-K/A, 10-Q/A, DEFA14A, S-4 |
| | 3/31/99 | | 7 | | 14 | | | 10-K, 10-Q, 10-Q/A |
| | 1/1/99 | | 18 | | 19 |
| | 12/31/98 | | 2 | | 37 | | | 10-K, 10-K/A |
| | 6/30/98 | | 2 | | 37 | | | 10-Q |
| | 1/1/98 | | 19 | | 30 |
| | 12/31/97 | | 5 | | | | | 10-K |
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Filing Submission 0000931763-99-002380 – Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)
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