ITEM 1. BUSINESS
General
The Company, a Delaware general business corporation, is the parent holding company for a group of insurance and non-insurance companies that collectively operate throughout North America and in the United Kingdom, Japan, and Argentina. The Company's principal operating subsidiaries are Unum Life Insurance Company of America (Unum America), Provident Life and Accident Insurance Company (Accident), The Paul Revere Life Insurance Company (Paul Revere Life), and Colonial Life & Accident Insurance Company (Colonial). The Company, through its subsidiaries, is the largest provider of group and individual disability insurance in North America and the United Kingdom. It also provides a complementary portfolio of other insurance products, including long- term care insurance, life insurance, employer- and employee-paid group benefits, and related services.
The Company is the surviving corporation in the merger on June 30, 1999 of Provident Companies Inc. (Provident), the leading individual disability insurance provider in North America, with Unum Corporation (Unum), the leading group disability insurance provider. In the merger, Provident shareholders received 0.73 shares of the Company's common stock for each Provident share, and Unum shareholders received one share of the Company's common stock for each Unum share.
During the years preceding the merger, both Provident and Unum pursued strategies of divesting non-core businesses and leveraging their respective disability insurance expertise.
In Provident's case, this strategy was the continuation of a new business focus initiated by J. Harold Chandler after joining Provident in 1993. Provident successfully undertook a number of major initiatives in pursuing this strategy prior to the merger with Unum. Specifically, Provident (i) sold its group medical business for $231.0 million in cash and stock, (ii) began winding down its guaranteed investment contracts (GICs) business which carried high capital requirements, (iii) reduced the annual dividend on the common stock to preserve capital to fund future growth, (iv) simplified the corporate legal structure and eliminated a dual class of common stock that had special voting rights in order to present a more conventional corporate structure profile to the investing market, (v) sold in six transactions $1.5 billion in commercial mortgage loans as part of repositioning its investment portfolio, (vi) restructured its marketing and distribution channels, along with the support areas of product development, underwriting, and claims, to better reach and serve individual and employee benefits customers, (vii) strengthened its claims management procedures in the disability income insurance business, and (viii) began restructuring its disability income products to discontinue over a reasonable period the sale of policies which combined noncancelable contracts with long-term own-occupation provisions and to offer in their place an income replacement contract with more reasonable limits and better pricing for elective provisions.
In addition, Provident acquired The Paul Revere Corporation (Paul Revere) and GENEX Services, Inc. (GENEX) in early 1997 and disposed of certain non-core lines of business. These actions strengthened Provident's disability insurance capabilities and enabled Provident to offer a comprehensive and well-focused portfolio of products and services to its customers. From 1989 through 1997 Paul Revere was the largest provider of individual disability insurance in North America on the basis of in-force premiums. By combining Paul Revere's operations with those of Provident, Provident realized significant operating efficiencies, including leveraging both companies' knowledge of disability risks, specialized claims and underwriting skills, and sales expertise. Provident also realized cost savings as a result of combining the corporate, administrative, and financial operations of the two companies. GENEX provides specialized skills in disability case management and vocational rehabilitation that advance the goal of providing products that enable disabled policyholders to return to work.
As it continued to assess acquisition opportunities that could complement its core business, Provident also continued to assess and exit non-core lines. In 1997, Provident transferred its dental business to another insurer. During 1998, Provident reinsured, on a 100 percent coinsurance basis, substantially all of its in-force medical stop-loss insurance business. Also during 1998, Provident sold its in-force individual and tax-sheltered annuity business. The transaction did not include Provident's block of GICs or group single premium annuities (SPAs), which continued in a run-off mode.
In the years prior to the merger Unum also pursued a strategy it had adopted after its demutualization in 1986 of focusing on its core disability businesses. In 1993, Unum merged with Colonial Companies, Inc., the parent company of Colonial, a leader in payroll marketing of supplemental insurance, focused on accident, cancer, and a range of life insurance products. In 1996, Unum sold its group tax-sheltered annuity (TSA) business. The contracts were initially reinsured on an indemnity basis. Upon consent of the TSA contractholders and participants, the contracts were reinsured on an assumption basis, legally releasing Unum from future contractual obligation. Consents for assumption reinsurance were received for substantially all assets under management.
Through the continued development of Unum Japan Accident Insurance Company Limited (Unum Japan) and the purchase in 1997 of Boston Compania Argentina de Seguros, SA in Argentina, Unum also furthered its expansion into foreign disability markets that began with the acquisition in 1990 of Unum Limited, the leading disability insurer in the United Kingdom.
In April 1999, Unum decided to exit its reinsurance operations, including the reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk assumption by Unum America, including reinsurance pool participation; direct reinsurance which includes accident and health (A&H), long-term care (LTC), and long-term disability coverages; and Lloyd's of London (Lloyd's) syndicate participations. On December 31, 1999 the Company completed the sale of certain divisions of the North American reinsurance management operations of D&H and the reinsurance of the Company's risk participation in these facilities. The Company also decided to discontinue its accident reinsurance business in London beginning in year 2000. With respect to Lloyd's, the Company implemented a strategy which limited participation in year 2000 underwriting risks, ceased participation in Lloyd's underwriting risks after year 2000, and managed the run-off of its risk participation in open years of account of Lloyd's reinsurance syndicates. During the first quarter of 2001, the Company entered into an agreement in principle to limit its liabilities pertaining to the Lloyd's syndicate participations. See Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of the reinsurance operations.
During 2000, the Company completed a series of strategic transactions designed to more closely focus its operations on its core businesses, increase its financial flexibility, support its present credit and claims-paying ratings, increase the risk-based capital ratios of the insurance subsidiaries involved, and lower its leverage ratios. The primary transaction involved agreements under which Reassure America Life Insurance Company (Reassure America), an affiliate of Swiss Re Life & Health America Inc. (Swiss Re), reinsured on a 100 percent indemnity coinsurance basis substantially all of the individual life insurance and corporate-owned life insurance policies written by the Company's insurance subsidiaries, as well as a small block of individually underwritten group life insurance. Reassure America is also assuming responsibility for the administration of the policies on a phased-in basis over the course of the next year. The reinsurance agreements were effective as of July 1, 2000.
Separately, Paul Revere Life and Max Re Ltd. entered into an agreement whereby Max Re Ltd. reinsured on a 100 percent indemnity coinsurance basis the future claim payments on long duration group long-term disability claims which were incurred prior to January 1, 1996. The agreement was effective January 1, 2000.
During 2000, Unum America entered into a reinsurance agreement with Manulife Reinsurance Limited and SCOR Reinsurance Company under which Unum America will cede through a net quota share reinsurance agreement 50 percent of the group life volume above Unum America's aggregate retention limit. The treaties are five-year quota share treaties ceding 25 percent of premium, life volume, and paid claims to each reinsurer. The reinsurance agreements were effective as of October 1, 2000.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 13 of the "Notes to Consolidated Financial Statements" contained herein in Items 7 and 8 for further discussion of these 2000 reinsurance transactions.
Also in 2000, the Company purchased a single premium annuity for its retirees. The pension plan transaction allowed the Company to provide a higher level of administrative service for its retirees while also locking in favorable pension plan performance. The proceeds from the transaction were partially offset by actions to further strengthen the Company's financial position. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 10 of the "Notes to Consolidated Financial Statements" contained herein in Items 7 and 8 for further discussion of this transaction.
The Company also sold Provident National Assurance Company, an inactive insurance subsidiary, to Allstate Life Insurance Company. Provident National Assurance Company's general account liabilities were reinsured by another subsidiary of the Company, and the excess capital and surplus was transferred to the parent to reduce short-term borrowings. This transaction closed during the first quarter of 2001.
In the first quarter of 2001, the Company entered into a definitive agreement to acquire the assets of EmployeeLife.com, an Internet Capital Group partner company. This new subsidiary will enhance customer service by providing Internet business solutions to help employers efficiently manage and administer employee benefits. Subject to the approval of the shareholders of EmployeeLife.com and other customary closing conditions, the transaction is expected to close during the first half of 2001.
Business Strategies
The Company's objective is to grow its business and improve its profitability by following the three strategies set forth below.
Provide Integrated Product Choices
The Company offers a comprehensive portfolio of income protection products and services. These coverage choices, available in the employee benefit, individual, and voluntary market segments, seek to meet the diverse needs of the marketplace. The Company seeks to achieve a competitive advantage by offering group, individual, and voluntary workplace products that can combine with other coverages to provide integrated product solutions for customers.
Employees are increasingly turning to the workplace for access to quality insurance protection. Through return-to-work expertise and a comprehensive portfolio of basic employee benefits, as well as supplemental, voluntary, and executive product offerings, the Company offers businesses of all sizes highly competitive benefits to protect the incomes and lifestyles of employees and their families. Income protection solutions include integrated short-term and long-term disability income protection plans with flexible coverage and funding options.
The Company's broad portfolio also includes individual income protection products that help protect individual customers and their families from the financial effects of accidents or illnesses. The products feature choices suited to different ages, incomes, family needs, and lifestyles. Also offered is long- term care insurance as a lifestyle protection solution product.
In order to give the appropriate focus to these three primary business markets, the Company has established national practice groups to focus on large employers, executive benefits, and voluntary benefits. These national practice groups partner with the Company's sales force as well as representatives from claims, customer service, and underwriting to present coverage solutions to potential customers and to manage existing customer accounts.
Provide Benefits Emphasizing Returning People to Work and to an Independent Lifestyle
For corporate and individual customers, the Company offers expert resources to help claimants recover their ability to earn an income and regain an independent lifestyle. These resources include the following:
Benefits Management and Client Care
The Company's benefits organization is focused on helping customers who have suffered an accident or illness to return to work and to an independent lifestyle. The Company's extensive resources reflect the significant investments which have been made in this area. This coordinated effort focuses centralized home office knowledge and local case management and support specialists across North America on making the best resources available for each customer's specific situation.
Specialized Support
Once a customer submits a claim, it's immediately assigned to an expert for handling based on the severity and type of condition. Specialized claims representatives, rehabilitation specialists, nurse case managers, and physicians work directly with each claimant and, where appropriate, with the claimant's medical providers and employer. These specialized resources may also be able to assist a claimant's medical provider in developing treatment plans or return-to-work goals for the claimant. When a claimant is ready to return to work, the Company offers reimbursement to employers for eligible workplace accommodations to enable an employee's transition back to work. If a claimant is unable to return to work, the Company can provide employment counseling, vocational assessment, analysis of skills, and assistance with education or retraining to help the claimant find a new career.
Social Security Disability Income Assistance
For those claimants who are not able to return to work for a considerable time, the Company can help initiate the social security application process by working with the claimants in the application and appeals process to help seek benefits for which the claimant might be eligible.
Returning to an Independent Lifestyle
For customers who experience accidents or illnesses and are not able to return to work, the Company offers resources to enable a transition back to the most independent lifestyle possible. The Company provides information resources for customers and family members of those living with disabilities and provides the assistance of claims specialists who fully understand the dynamics of adjusting to life with longer-term impairments.
Integrated Information Services and Pre-Disability Planning
The Company helps employers identify disability patterns and provides insight into how to better manage the total cost of disability, including worker's compensation and other lost time expenses. The Company's managed disability planning process and return-to-work dividend program can help employers reduce absenteeism, increase the number of employees who return to work following a disability, lower employee replacement and retraining costs, reduce premiums for medical benefits, increase productivity, and improve employee morale.
Provide Highly Responsive Service for Customers and their Advisors
The Company is committed to providing customers with easy access to the Company's resources through increased use of technology, such as on-line employee self-service and automated benefits eligibility and enrollment, and through a broad and multi-channel distribution network. The Company also offers workplace enrollment and marketing capabilities and provides advanced sales support to brokers, agents, and other business partners.
For corporate customers, the Company offers programs to help companies better understand the causes, cost, and impacts of disability; creative return-to-work solutions; research initiatives and ongoing studies in the scientific and human aspects of disability; claims professionals trained in the disabling condition affecting the employee, with coordinated resources and information focused on helping the individual return to work; local case management; reimbursement for qualified workplace accommodations; information, support, assistance, and referrals for living with a disabling condition; independent financial counseling to assist family members after the death of an employee; no-cost cash management services for life insurance beneficiaries immediately on payment of a policy benefit; 24 hour access for employees to counselors trained to help with personal problems; and assistance for people who suffer accidents or illnesses away from home.
For individual customers, the Company offers personalized claim service from professionals trained in the disabling condition affecting the claimant; information, support, assistance, and referrals for living with a disabling condition; 24 hour access to information on aging and long-term care; no-cost cash management services for life insurance
beneficiaries immediately on payment of a policy benefit; and research initiatives and ongoing studies in the scientific and human aspects of disability.
Reporting Segments
The Company is organized around its customers, with reporting segments that reflect its major market segments: Employee Benefits, Individual, and Voluntary Benefits. The Other segment includes products that the Company no longer actively markets. The Corporate segment includes investment income 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. The Employee Benefits segment includes group long-term and short-term disability insurance, group life insurance, group long-term care, accidental death and dismemberment coverages, and the results of managed disability. The Company's Individual reporting segment includes individual disability and individual long-term care. The Voluntary Benefits segment includes products sold to employees through payroll deduction at the workplace. 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 individual life (previously reported in the Individual segment) and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained herein in Item 7 for further discussion of the Company's reporting segments.
Employee Benefits
The Employee Benefits segment includes the results of group products sold to employers for the benefit of employees and the results of managed disability, primarily GENEX. Group long-term and short-term disability comprises the majority of the segment, with $2,597.1 million of premium income in 2000. Group life generated $1,194.8 million of premium income in 2000.
Group long-term disability insurance provides employees with insurance coverage for loss of income in the event of extended work absences due to sickness or injury. Services are offered to employers and insureds to encourage and facilitate rehabilitation, retraining, and re-employment. Most policies begin providing benefits following 90 or 180 day waiting periods and continue providing benefits until the employee reaches a certain age between 65 and 70. The benefits are limited to specified maximums as a percentage of income.
Group short-term disability insurance provides coverage from loss of income due to injury or sickness, effective immediately for accidents and after one week for sickness, for up to 26 weeks, limited to specified maximums as a percentage of income. Short-term disability is sold primarily on a basis permitting periodic repricing to address the underlying claims experience.
Premiums for group disability insurance are generally based on expected claims of a pool of similar risks plus provisions for administrative expenses and profit. Some cases carry experience rating provisions. Premiums for experience rated group disability business are based on the expected experience of the client given their industry group, adjusted for the credibility of the specific claim experience of the client. A few accounts are handled on an administrative services only basis with responsibility for funding claim payments remaining with the customer.
Profitability of group disability insurance is affected by deviations of actual claims experience from expected claims experience, investment returns, persistency, and the ability of the Company to control its administrative expenses. Morbidity is an important factor in disability claims experience. Also important is the general state of the economy; for example, during a recession the incidence of claims tends to increase under this type of insurance. In general, experience rated disability coverage for large groups has narrower profit margins and represents less risk to the Company than business of this type sold to small employers. This is because the Company must bear all of the risk of adverse claims experience in small case coverages while larger employers often bear much of this risk themselves. For disability coverages, case management and rehabilitation activities with regard to claims, along with appropriate pricing and expense control, are important factors contributing to profitability.
Group life insurance consists primarily of renewable term life insurance with the coverages frequently linked to employees' wages. Premiums for group life are generally based on expected claims of a pool of similar risks plus provisions for administrative expenses and profit. Profitability is affected by deviations of actual claims experience from expected claims experience, investment returns, persistency, and the ability of the Company to control administrative expenses. The Company also markets several group benefits products and services including accident and sickness indemnity and accidental death and dismemberment policies.
Group long-term care insurance pays a benefit upon the loss of two or more "activities of daily living" (e.g. bathing, dressing, feeding) and the insured's requirement of standby assistance or cognitive impairment. Payment is made on an indemnity basis, regardless of expenses incurred, up to a lifetime maximum. Benefits start after an elimination period, generally 90 days or less. Long-term care insurance is marketed on a guaranteed renewable basis wherein the Company maintains the right to reprice in-force policies, subject to regulatory approval. Profitability is affected by deviations of actual claims experience from expected claims experience, investment returns, persistency, and the ability of the Company to control administrative expenses.
GENEX provides specialized skills in disability case management and vocational rehabilitation to assist disabled claimants to return to work. GENEX provides a full range of disability management services, including workplace injury management, telephonic early intervention services for injured workers, medical case management, vocational rehabilitation, and disability cost analysis, to third party administrators, corporate clients, and insurance companies. In addition to its historical focus on the worker's compensation market, GENEX and the Company are working together to offer customized disability programs for the employee benefits market that are intended to integrate and simplify coverages, control costs, and improve efficiency for employers with significant disability and related claims. GENEX plays an increasingly significant role in helping the Company to manage its own exposure to individual and group disability claims.
Individual
Individual disability comprises the majority of the Individual segment, with $1,643.5 million of premium income in 2000. Individual long-term care premium income totaled $133.7 million in 2000.
Individual disability income insurance provides the insured with a portion of earned income lost as a result of sickness or injury. Under an individual disability income policy, monthly benefits generally are fixed at the time the policy is written. The benefits typically range from 30 percent to 75 percent of the insured's monthly earned income. Various options with respect to length of benefit periods and waiting periods before payment begins are available and permit tailoring of the policy to a specific policyholder's needs. The Company also markets individual disability income policies which include payments for transfer of business ownership and business overhead expenses. Individual disability income products do not provide for the accumulation of cash values.
Premium rates for these products are varied by age, sex, and occupation based on assumptions concerning morbidity, persistency, policy related expenses, and investment income. The Company develops its assumptions based on its own claims experience and published industry tables. The Company's underwriters evaluate the medical and financial condition of prospective policyholders prior to the issuance of a policy.
The majority of the Company's in-force individual disability income insurance was written on a noncancelable basis. Under a noncancelable policy, as long as the insured continues to pay the fixed annual premium for the policy's duration, the policy cannot be canceled by the Company nor can the premium be raised. Due to the noncancelable, fixed premium nature of the policies marketed in the past, profitability of this part of the business is largely dependent upon achieving the pricing assumptions for morbidity, persistency, interest earned rates, and expense levels.
In 1994, the Company began introducing products that insured loss of earnings as opposed to occupations, and these products generally contained more limited benefit periods and longer elimination periods. In contrast to traditional noncancelable own-occupation policies, for which benefits are determined based on whether the insured can work in his or her original occupation, the loss of earnings policy requires the policyholder to satisfy two conditions for benefits to begin: reduced ability to work due to accident or sickness and earnings loss of at least 20 percent. These policies are aimed at repositioning the individual disability income product by making it more attractive to a broader market of individual consumers, including middle to upper income individuals and corporate benefit buyers.
The Company also offers lifelong disability coverage for loss of income due to injury or sickness on a guaranteed renewable basis, with the right to reprice in-force policies subject to regulatory approval. Lifelong disability coverage provides benefits and transitional support for moderate disabilities, with richer benefits for severe disabilities. Common options include additional coverage for catastrophic injury or illness and an option to convert to a long- term care policy at retirement age.
The Company developed a new individual disability product portfolio that was released for sale in approved states early in the fourth quarter of 2000. This product line consolidates the current offerings of the Company's insurance subsidiaries into one new simplified product portfolio. The new portfolio utilizes a modular approach offering customers a range of product options and features. This portfolio was designed to combine the best features from prior Company offerings and includes return-to-work incentives and optional long-term care conversion benefits and/or benefits for catastrophic disabilities.
Individual long-term care is offered on a single customer basis and to smaller employer groups and is marketed on a guaranteed renewable basis. Individual long-term care insurance pays a benefit upon the loss of two or more "activities of daily living" and the insured's requirement of standby assistance or cognitive impairment. Payment is made on an indemnity basis, regardless of expenses incurred, up to a lifetime maximum. Benefits start after an elimination period, generally 90 days or less. Profitability is affected by deviations of actual claims experience from expected claims experience, investment returns, persistency, and the ability of the Company to control administrative expenses.
Voluntary Benefits
The Voluntary Benefits segment includes a broad line of products sold to groups of employees through payroll deduction at the workplace. These products include life insurance and health products. Premium income for this segment totaled $739.6 million in 2000.
The life insurance products principally include universal life, interest- sensitive life, and whole life insurance. The Company markets accident and sickness policies that provide benefit payments for disability income, death, dismemberment, or major injury and are designed to supplement social security, worker's compensation, and other insurance plans. The Company markets cancer insurance policies designed to provide payments for hospitalization and scheduled medical benefits. The accident and health products qualify as fringe benefits that can be purchased with pre-tax employee dollars as part of a flexible benefits program pursuant to Section 125 of the Internal Revenue Code. Flexible benefits programs assist employers in managing benefit and compensation packages and provide policyholders the ability to choose benefits that best meet their needs. Congress could change the laws to limit or eliminate fringe benefits available on a pre-tax basis, eliminating the Company's ability to continue marketing its products this way. However, the Company believes its products provide value to its policyholders, which will remain even if the tax advantages offered by flexible benefit programs are eliminated.
Profitability of voluntary benefits products is affected by the level of employee participation, persistency, deviations of actual morbidity and mortality experience from expected experience, investment returns, and the ability of the Company to control administrative expenses.
Other
The Other operating segment includes results from products no longer actively marketed, including individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities.
During 1999, the Company concluded that the reinsurance pools and management operations were not solidly aligned with the Company's strength in the disability insurance market. The Company decided to exit these operations through a combination of a sale, reinsurance, and/or placing certain components in run-off. In 1999, the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities and reinsured the Company's risk participation in these facilities. The Company also decided to discontinue its accident reinsurance business in London beginning in year 2000. With respect to Lloyd's, the Company implemented a strategy which limited participation in year 2000 underwriting risks, ceased participation in Lloyd's underwriting risks after year 2000, and managed the run-off of its risk participation in open years of account of Lloyd's reinsurance syndicates. During the first quarter of 2001, the Company entered into an agreement in principle to limit its liabilities pertaining to the Lloyd's syndicate participations. See Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of the reinsurance operations.
The Company no longer markets group pension products, but continues to service its block of existing business. The Company previously marketed GICs for use in corporate tax-qualified retirement plans and group SPAs, used primarily as funding vehicles when defined benefit pension plans are terminated. Under SPAs, the Company received a one-time premium payment and in turn agreed to pay a fixed monthly retirement benefit to specified employees.
As previously discussed, the Company reinsured its individual life and corporate-owned life insurance during 2000, its in-force individual and tax- sheltered annuity business during 1998, and its group tax-sheltered annuity business during 1996.
Corporate
The Corporate segment consists of revenue earned on corporate assets, interest expense on corporate debt, amortization of goodwill, and certain corporate expenses not allocated to a line of business.
Reinsurance
The Company routinely reinsures portions of its business with other insurance companies. In a reinsurance transaction a reinsurer agrees to indemnify another insurer for part or all of its liability under a policy or policies it has issued for an agreed upon premium. The maximum amount of risk retained by the Company and not reinsured is $500,000 on any group or individual life policy and $500,000 on group and individual accidental death insurance. The amount of risk retained by the Company on individual disability income products varies by policy type and year of issue. The Company does not reinsure group or individual disability policies issued subsequent to 1999.
For ceded reinsurance agreements wherein the Company is not relieved of its primary liability to the policyholder, the Company has control procedures to evaluate the financial condition of reinsurers and monitor concentration of credit risk to minimize this exposure. These procedures include the exchange and review of financial statements filed with regulatory authorities, exchange of Insurance Regulatory Information System results, review of ratings by A.M. Best Company, determination of states in which the reinsurer is licensed to do business, on-site visits to assess the operations and management of the reinsurer, consideration of the need for collateral, such as letters of credit, and audits of the Company's reinsurance activities by its Internal Audit staff. The Company also assumes reinsurance from other insurers. The reinsurance receivable at December 31, 2000, relates to over 140 reinsurance relationships. Of the five major relationships which account for approximately 75 percent of the reinsurance receivable amount at December 31, 2000, all are with companies rated A or better by A.M. Best Company or are fully securitized by investment- grade fixed maturity securities held in trust.
See Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of the Company's reinsurance activities.
Reserves
The applicable insurance laws under which insurance companies operate require that they report, as liabilities, policy reserves to meet future obligations on their outstanding policies. These reserves are the amounts which, with the additional premiums to be received and interest thereon compounded annually at certain assumed rates, are calculated to be sufficient to meet the various policy and contract obligations as they mature. These laws specify that the reserves shall not be less than reserves calculated using certain specified mortality and morbidity tables, interest rates, and methods of valuation. The reserves reported in the Company's financial statements contained herein are calculated based on generally accepted accounting principles followed in the United States (GAAP) and differ from those specified by the laws of the various states and carried in the statutory financial statements of the life insurance subsidiaries. These differences arise from the use of mortality and morbidity tables and interest assumptions which are believed to be more representative of the actual business than those required for statutory accounting purposes and from differences in actuarial reserving methods.
The consolidated statements of operations include the annual change in reserves for future policy and contract benefits. The change reflects a normal accretion for premium payments and interest buildup and decreases for policy terminations such as lapses, deaths, and benefit payments.
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 GAAP, 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, at June 30, 1999 the Company adopted Provident's method of calculating the discount rate for claim reserves.
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 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.
Subsequent to the merger date, the Company began to integrate the valuation procedures of the two organizations to provide for a more effective linking of pricing and reserving assumptions and to facilitate a more efficient process for adjusting liabilities to emerging trends. Included in this integration activity were a review and an update of assumptions that underlie policy and contract benefit liabilities. The purpose of the study was to confirm or update the assumptions which were viewed as likely to affect the ultimate liability for contract benefits. Accordingly, as a result of the merger, the Company accelerated the performance of its normal reviews of the assumptions underlying reserves to determine the assumptions that the newly merged Company will use in the future for pricing, performance management, and reserving.
The review resulted in an increase in the benefits and reserves for future benefits for the Company's domestic and Canadian group long-term disability unpaid claim liabilities. As a result of the review, the Company increased its policy and contract benefit liabilities $359.2 million, which reduced 1999 earnings $359.2 million before tax and $233.5 million after tax. The increase in policy and contract benefit liabilities primarily resulted from revisions to assumptions in the following three key components: claim termination rates, incurred but not reported factors, and discount rates. See Note 2 of the "Notes to Consolidated Financial Statements" for further discussion of these reserve changes.
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 were expected to be reported during 1999 and were expected to be affected by the claims operations integration activities. The $153.0 million claim reserve increase represented 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 believed the reserve adjustment was required based upon the integration plans it had in place and to which it had 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 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 were distracted from normal claims management activities as a result of planning and implementing the integration of the two companies' claims organizations. In addition, employee turnover and additional training 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.
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, and where feasible, management also planned to obtain additional claims management resources through outsourcing. All such costs were expensed in the period incurred and were 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. The effect of integration activities on new claim resolution rates was not material after December 31, 1999. See Note 7 of the "Notes to Consolidated Financial Statements" for a complete discussion of the claim disruption reserve.
Competition
There is intense competition among insurance companies for the individual and group insurance products of the types sold by the Company. At the end of 2000, there were over 2,000 legal reserve life insurance companies in the United States, many offering one or more insurance products similar to those marketed by the Company. In the individual and group disability markets, the Company competes in the United States and Canada with a limited number of major companies and regionally with other companies offering specialty products. The Company's principal competitors in the voluntary benefits market and in the employee benefits market for group life and long-term care products include the largest insurance companies in the United States.
All areas of the employee benefits markets are highly competitive due to the yearly renewable term nature of the products and the large number of insurance companies offering products in this market. The Company competes with other companies in attracting and retaining independent agents and brokers to actively market its products. The principal competitive factors affecting the Company's business are integrated product choices, price, and quality of customer service and claims management.
Regulation
The Company's insurance subsidiaries are subject to regulation and supervision in jurisdictions in which they do business, primarily for the protection of policyholders. Although the extent of such regulation varies, insurance laws generally establish supervisory agencies with broad administrative powers including: granting and revocation of licenses to transact business; establishing reserve requirements; setting the form, content, and frequency of required financial statements; the licensing of agents; the approval of policy forms; prescribing the type and amount of investments permitted; and, in general, the conduct of all insurance activities. The Company's insurance subsidiaries must meet the standards and tests for investments promulgated by insurance laws and regulations of the jurisdictions in which they are domiciled. Insurance subsidiaries operate under insurance laws which require they establish and carry, as liabilities, statutory reserves to meet obligations on their disability, life, accident and health policies, and annuities. These reserves are verified periodically by various regulators. The Company's domestic insurance subsidiaries are examined periodically by examiners from their states of domicile and by other states in which they are licensed to conduct business. See Note 16 of the "Notes to Consolidated Financial Statements" for a discussion of permitted statutory accounting practices.
The laws of the states of Maine, Tennessee, Massachusetts, South Carolina, New York, and Delaware require the registration of and periodic reporting by insurance companies domiciled within their jurisdiction which control or are controlled by other corporations or persons so as to constitute a holding company system. The Company is registered as a holding company system in Maine, Tennessee, Massachusetts, South Carolina, New York, and Delaware. The holding company statutes require periodic disclosure concerning stock ownership and prior approval of certain intercompany transactions within the holding company system. The Company may from time to time be subject to regulation under the insurance and insurance holding company statutes of one or more additional states.
The risk-based capital (RBC) standards for life insurance companies, as prescribed by the National Association of Insurance Commissioners (NAIC), establish an RBC ratio comparing adjusted surplus to required surplus for United States domiciled insurance companies. If the RBC ratio falls within certain ranges, regulatory action may be taken ranging from increased information requirements to mandatory control by the domiciliary insurance department. The RBC ratios for the Company's insurance subsidiaries, measured at December 31, 2000, were above the ranges that would require regulatory action. See further discussion under "Risk Factors - Capital Adequacy."
Risk Factors
Any one or more of the following factors may cause the Company's actual results for various financial reporting periods to differ materially from those expressed in any forward looking statements made by or on behalf of the Company. See "Cautionary Statement Regarding Forward-Looking Statements" contained herein on page 1.
Reserves
The Company maintains reserves for future policy benefits and unpaid claims expenses which include policy reserves and claim reserves established for its individual disability insurance, group insurance, and individual life insurance products. Policy reserves represent the portion of premiums received which are reserved to provide for future claims. Claim reserves are established for future payments not yet due on claims already incurred, primarily relating to individual disability and group disability insurance products. Reserves, whether calculated under GAAP or statutory accounting practices, do not represent an exact calculation of future benefit liabilities but are instead estimates made by the Company using actuarial and statistical procedures. There can be no assurance that any such reserves would be sufficient to fund future liabilities of the Company in all circumstances. Future loss development could require reserves to be increased, which would adversely affect earnings in current and future periods. Adjustments to reserve amounts may be required in the event of changes from the assumptions regarding future morbidity (the incidence of claims and the rate of recovery, including the effects thereon of inflation and other societal and economic factors), persistency, mortality, and interest rates used in calculating the reserve amounts.
Capital Adequacy
The capacity for an insurance company's growth in premiums is in part a function of its statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by state insurance regulators, is considered important by state insurance regulatory authorities and the private agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, action by state regulatory authorities, or a downgrade by the private rating agencies.
Effective in 1993, the NAIC adopted an RBC formula, which prescribes a system for assessing the adequacy of statutory capital and surplus for all life and health insurers. The basis of the system is a risk-based formula that applies prescribed factors to the various risk elements in a life and health insurer's business to report a minimum capital requirement proportional to the amount of risk assumed by the insurer. The life and health RBC formula is designed to measure annually (i) the risk of loss from asset defaults and asset value fluctuation, (ii) the risk of loss from adverse mortality and morbidity experience, (iii) the risk of loss from mismatching of asset and liability cash flow due to changing interest rates, and (iv) business risks. The formula is to be used as an early warning tool to identify companies that are potentially inadequately capitalized. The formula is intended to be used as a regulatory tool only and is not intended as a means to rank insurers generally.
Disability Insurance
Disability insurance may be affected by a number of social, economic, governmental, competitive, and other factors. Changes in societal attitudes, work ethics, motivation, stability, and mores can significantly affect the demand for and underwriting results from disability products. Economic conditions affect not only the market for disability products, but also significantly affect the claims rates and length of claims. The climate and the nature of competition in disability insurance have also been markedly affected by the growth of social security, worker's compensation, and other governmental programs in the workplace. The nature of that portion of the Company's outstanding insurance business that consists of noncancelable disability policies, whereby the policy is guaranteed to be renewable through the life of the policy at a fixed premium, does not permit the Company to adjust its premiums on business in-force on account of changes resulting from such factors. Disability insurance products are important products for the Company. To the extent that disability products are adversely affected in the future as to sales or claims, the business or results of operations of the Company could be materially adversely affected.
Industry Factors
All of the Company's businesses are highly regulated and competitive. The Company's profitability is affected by a number of factors, including rate competition, frequency and severity of claims, lapse rates, government regulation, interest rates, and general business considerations. There are many insurance companies which actively compete with the Company in its lines of business, some of which are larger and have greater financial resources than the Company, and there is no assurance that the Company will be able to compete effectively against such companies in the future.
The modernization of the financial services industry as a result of the Gramm- Leach-Bliley Act of 1999 is also likely to affect the future prospects of the Company. This legislation eliminates many federal and state barriers to affiliation among banks and securities firms, insurers, and their financial service providers. At the same time, the legislation increases the separation between financial service providers and other non-financial companies. The major impacts, other than the potential for increased competition, include new federal privacy rules, a requirement that states enact uniform laws and regulations governing the licensure of individuals and entities authorized to solicit the purchase of insurance within and outside a state, and authority given to promulgate regulations granted to numerous federal agencies.
Selected Data of Segments
For information regarding the operations of segments, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained herein in Item 7.
Employees
At December 31, 2000, the Company had approximately 12,400 full-time employees, including those in its foreign operations. Some employees in Argentina, comprising less than 1 percent of the Company's total workforce, are members of a union.
ITEM 2.
ITEM 2. PROPERTIES
The Company occupies over 3,000,000 square feet of space at four principal operating centers in Chattanooga, Tennessee; Portland, Maine; Worcester, Massachusetts; and Columbia, South Carolina. The Company occupies two connected buildings totaling 840,000 square feet in Chattanooga, Tennessee. The office building and substantially all of the surrounding 25 acres of land used for employee parking are owned by the Company in fee along with a 27-unit apartment building for corporate use. In addition, approximately 35,000 square feet of office space is leased and occupied in a nearby office building.
The Company occupies facilities in Portland, Maine, which are comprised of eight owned facilities totaling 968,000 square feet of office space and 250 acres of land, a portion of which has been developed for employee parking. In addition, approximately 127,000 square feet of office space is leased and occupied in three buildings with rents totaling $1.5 million per year.
The Company occupies facilities totaling 341,000 square feet in Worcester, Massachusetts, with approximately 5.6 acres of surrounding property used primarily for parking. In addition, the Company leases 15,000 square feet in Springfield, Massachusetts, and 13,000 square feet in Auburn, Massachusetts.
The Company occupies approximately 547,000 square feet of office space in Columbia, South Carolina. The buildings are located on approximately 47 acres with a portion developed for employee parking.
The Company also owns office buildings in the United Kingdom and Argentina, which serve as the home offices of Unum Limited and Boston Compania Argentina de Seguros SA, respectively.
Additionally, the Company leases office space, for periods principally from five to ten years, for use by its affiliates and sales forces.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Refer to Item 8 Note 15 of the "Notes to Consolidated Financial Statements" for information on legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Common stock of UnumProvident Corporation is traded on the New York Stock Exchange. The stock symbol is UNM. Dividends in the following table have been restated to reflect the merger of Unum Corporation and Provident Companies, Inc. as if it had been completed at the beginning of the earliest period presented.
Market Price ----------------------------------- High Low Dividend ----------------- ---------------- --------------- 1/st/ Quarter $31.9375 $11.9375 $0.1475 2/nd/ Quarter 24.6250 14.8125 0.1475 3/rd/ Quarter 27.6875 19.2500 0.1475 4/th/ Quarter 29.7500 25.4375 0.1475
1/st/ Quarter $62.5000 $43.8125 $0.1428 2/nd/ Quarter 59.5000 42.4375 0.1428 3/rd/ Quarter 56.8750 28.3750 0.1475 4/th/ Quarter 36.1875 26.0000 0.1475
As of March 12, 2001 there were 22,086 registered holders of common stock. The Company's dividend reinvestment plan offers shareholders of Company common stock a convenient way to purchase additional shares of common stock without paying brokerage fees, commissions, or other bank service fees. More information and an authorization form may be obtained by writing or calling the Company's transfer agent, First Chicago Trust Company of New York. The toll-free customer service number is 1-800-446-2617.
For information on restrictions relating to the Company's insurance subsidiaries' ability to pay dividends to the Company see "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained herein in Item 7 and Item 8 Note 16 of the "Notes to Consolidated Financial Statements."
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
On June 30, 1999, Unum Corporation (Unum) merged with and 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 Consolidated Financial Statements" for further discussion.
The following should be read in conjunction with the consolidated financial statements and notes thereto contained herein in Item 8.
This discussion of consolidated operating results and operating results by segment excludes net realized investment gains and losses from revenue and income (loss) 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.
The trends in new annualized sales in the Employee Benefits, Individual, and Voluntary Benefits segments are indicators of the Company's potential for growth in its respective markets and the level of market acceptance of price changes and new products. The Company has closely linked its various incentive compensation programs to the achievement of its goals for new sales.
Results of Operations
2000 Significant Transactions and Events
During 2000, the Company completed a series of strategic transactions designed to more closely focus its operations on its core businesses, increase its financial flexibility, support its present credit and claims-paying ratings, increase the risk-based capital ratios of the insurance subsidiaries involved, and lower its leverage ratios. The primary transaction involved agreements under which Reassure America Life Insurance Company (Reassure America), an affiliate of Swiss Re Life & Health America Inc. (Swiss Re), reinsured on a 100 percent indemnity coinsurance basis substantially all of the individual life insurance and corporate-owned life insurance policies written by the Company's insurance subsidiaries, as well as a small block of individually underwritten group life insurance. The reinsurance agreements were effective as of July 1, 2000.
Separately, the Company and Max Re Ltd. entered into an agreement whereby Max Re Ltd. reinsured on a 100 percent indemnity coinsurance basis the future claim payments on one of the Company's insurance subsidiaries' long duration group long-term disability claims which were incurred prior to January 1, 1996. The agreement was effective January 1, 2000.
During 2000, the Company entered into a reinsurance agreement with Manulife Reinsurance Limited and SCOR Reinsurance Company under which one of the Company's insurance subsidiaries will cede through a net quota share reinsurance agreement 50 percent of the group life volume above the aggregate retention limit. The treaties are five-year quota share treaties ceding 25 percent of premium, life volume, and paid claims to each reinsurer. The reinsurance agreements were effective as of October 1, 2000.
Also in 2000, the Company purchased a single premium annuity for its retirees. The pension plan transaction allowed the Company to provide a higher level of administrative service for its retirees while also locking in favorable pension plan performance. The proceeds from the transaction were partially offset by actions to further strengthen the Company's financial position, namely reserve adjustments of $65.6 million in the Company's long-term disability business and $21.9 million in the reinsurance operations, asset write-offs and loss provisions of $15.5 million in the reinsurance operations, and consolidation and benefit accruals of $9.4 million. See the discussions of segment operating results contained herein for further information.
During 2000, tax legislation was enacted in the United Kingdom that allowed additional group tax relief among companies with common ownership. The Company expects to realize foreign tax benefits as a result of this legislation.
1999 Significant Transactions and Events
As a result of the aforementioned merger at June 30, 1999, certain accounting policy changes were made during 1999. The following summarizes these changes as well as the expenses related to the merger and the early retirement offer to employees.
Generally, because of the effort and time involved, reviews and updates of assumptions related to benefit liabilities are periodically undertaken over time and are reflected in the calculation of benefit liabilities as completed. Many factors influence assumptions underlying reserves, and considerable judgment is required to interpret current and historical experience underlying all of the assumptions and to assess the future factors that are likely to influence the ultimate cost of settling existing claims.
Prior to the June 30, 1999 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 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, at June 30, 1999, the Company adopted Provident's method of calculating the discount rate for claim reserves. The impact on 1999 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. The charge was reflected in the Employee Benefits, Individual, and Other segments as an increase in benefits to policyholders of $191.7 million, $38.9 million, and $10.1 million, respectively.
Subsequent to the merger date, the Company began to integrate the valuation procedures of the two organizations to provide for a more effective linking of pricing and reserving assumptions and to facilitate a more efficient process for adjusting liabilities to emerging trends. Included in this integration activity were a review and an update of assumptions that underlie policy and contract benefit liabilities. The purpose of the study was to confirm or update the assumptions which were viewed as likely to affect the ultimate liability for contract benefits. Accordingly, as a result of the merger, the Company accelerated the performance of its normal reviews of the assumptions underlying reserves to determine the assumptions that the newly merged Company will use in the future for pricing, performance management, and reserving.
The review resulted in an increase in the benefits and reserves for future benefits for the Company's domestic group long-term disability unpaid claim liabilities. As a result of the review, the Company increased its policy and contract benefit liabilities $359.2 million in the third quarter of 1999, which reduced 1999 results $359.2 million before tax and $233.5 million after tax.
During 1999, the Company recorded before-tax expenses related to the merger of approximately $184.7 million ($139.6 million after tax) for severance and related costs, exit costs for duplicate facilities and asset abandonments, and investment banking, legal, and accounting fees. The Company also recorded in 1999 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 Segment Operating Results." Additionally, in 1999 the Company expensed $24.7 million ($16.1 million after tax) of incremental costs associated with the merger. These incremental costs consist primarily of compensation, training, integration, and licensing costs.
See Note 2 of the "Notes to Consolidated Financial Statements" for further discussion of these charges and "Liquidity and Capital Resources" for a discussion of capital and financing needs.
During 1999 the Company also recognized $327.8 million of before-tax charges related to its reinsurance operations. These charges were as follows (in millions):
See "Other Segment Operating Results" and Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of these charges and the Company's reinsurance operations.
A portion of the losses recognized in 1999 relating to the Company's reinsurance operations does not receive a tax benefit, which unfavorably impacted the effective tax rate. Additionally, a portion of the 1999 expenses related to the merger was non-deductible for federal income tax purposes, resulting in a 1999 tax rate that was less than the U.S. federal statutory tax rate of 35 percent.
In 1999, the Company recorded refunds from the Internal Revenue Service relating to the final settlement of remaining issues for the 1986 through 1992 tax years. The refund of taxes was $30.4 million, and interest on the refunds was $35.4 million. Overall, including interest and the tax provision thereon, 1999 results increased $36.8 million due to settlements of prior year tax issues.
Consolidated Operating Results
N.M. = not a meaningful percentage
In the following discussions of operating results by segment, "revenue" includes premium income, net investment income, and other income. "Income" or "loss" excludes net realized investment gains and losses and federal income taxes.
Employee Benefits Segment Operating Results
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.
Employee Benefits new annualized sales, on a submitted date basis, decreased 9.4 percent to $862.7 million in 2000 from $952.5 million in 1999 and $981.1 million in 1998. On an effective date basis, sales decreased 32.1 percent to $744.9 million in 2000 from $1,097.7 million in 1999 and $926.3 million in 1998. Although total year over year comparisons show a decrease, submitted sales during the last half of 2000 increased $93.3 million over sales submitted during the last half of 1999. Sales that combine long-term disability, short-term disability, and group life products also increased from prior year, showing continued strong integrated sales and collaboration in the field. During 2000, 32 percent of all new sales were with long-term disability, short-term disability, and group life combined coverage, compared to 26 percent in 1999.
Sales related to employee benefits can fluctuate significantly due to large case size and timing of sales submissions. Several factors contributed to the decrease in 2000 sales compared to 1999 and 1998, including rate increases and turnover in the field sales force during the first half of 2000. The Company has a number of initiatives underway to help maintain the sales momentum achieved during the last half of 2000, including targeted incentive plans, organizational changes to create a greater focus on the customer, and enhanced communication with producers. In order to give the appropriate focus to the Company's primary business markets, the Company has established national practice groups to focus on large employers, executive benefits, and voluntary benefits. These national practice groups partner with the Company's sales force and representatives from claims, customer service, and underwriting to present coverage solutions to potential customers and to manage existing customer accounts. The
Company expects that these actions will continue to favorably impact sales growth, but management intends to maintain pricing discipline to balance sales growth and profitability, which may slow the rate of long-term sales growth.
The Company monitors persistency and reflects adverse changes in persistency in the current period's amortization of deferred policy acquisition costs. Actual persistency experienced during 2000 for group disability, group life, and accidental death and dismemberment products compared unfavorably to the persistency expected, resulting in additional amortization of $34.1 million during 2000. The adverse persistency during 2000 relates primarily to large case terminations and an aggressive 2000 renewal program that was heavily concentrated in the first half of the year. It is expected that persistency for the foreseeable future will continue to be lower than historical levels for group disability as well as group life. The Company's 2000 renewal program was generally successful at retaining business that is relatively more profitable than business that terminated. It is expected that the additional premium and related profits associated with this renewal activity will emerge throughout 2001. The Company intends to maintain a disciplined approach in the re-pricing of renewal business, while balancing the need to maximize persistency and retain producer relationships. This approach may lead to lower profit margins on affected cases than originally planned.
Revenue from the managed disability line of business, which includes GENEX Services, Inc. and Options and Choices, Inc., totaled $126.1 million in 2000 compared to $107.8 million in 1999 and $96.2 million in 1998.
Group Disability
Group disability revenue was $3,200.4 million in 2000 compared to $3,029.0 million in 1999. New annualized sales for group long-term disability on a submitted date basis were $333.8 million in 2000 and $385.2 million in 1999. New annualized sales for group short-term disability were $148.5 million in 2000 compared to $172.0 million in 1999. On an effective date basis, new annualized sales for long-term disability and short-term disability were $318.0 million and $125.4 million in 2000 and $466.9 million and $203.1 million in 1999. A critical part of the Company's strategy for group disability during 2000 involved executing its renewal program and managing persistency, both of which management expects will have a positive impact on future premium growth and profitability. However, the high terminations and slow sales have decreased the earned premium growth compared to that experienced during 1999 and 1998. The Company is implementing pricing changes in the group disability line. Prices will increase or decrease by market segment, as appropriate, to respond to current claim experience and other factors and assumptions. Net investment income is expected to continue to increase due to the increase in the level of invested assets allocated to this line of business and the increased duration on new investments.
Group disability reported income of $211.0 million for 2000 compared to a loss of $225.7 million for 1999. Included in the income for 2000 was an increase of $65.6 million in group long-term disability claim reserves, which represents approximately 1.2 percent of total group long-term disability claim reserves. The increase, which resulted from lengthening the projected average claim duration for certain of the Company's group long-term disability claims, was not a result of deteriorating experience but was believed appropriate based on the Company's assessment of the ultimate settlement of these claims. The 1999 loss of $225.7 million was the result of the $191.7 million charge resulting from lowering the discount rate used to calculate certain of Unum's disability claim reserves to conform with Provident's process and assumptions and the $359.2 million charge resulting from the revision in the underlying assumptions used to estimate the ultimate cost of unpaid group long-term disability claims, as discussed in the preceding "Results of Operations."
Excluding the adjustments to the disability claim liabilities discussed in the preceding paragraph, the benefit ratio for group disability was 83.5 percent in 1999 compared to 87.1 percent in 2000. For long-term disability, the ratio for 2000 compared unfavorably to 1999, but showed slight improvement throughout 2000. The paid claim incidence for long-term disability compares favorably to 1999 due to lower claim acceptance rates, and claim resolution experience continued to improve during 2000. The 2000 submitted claim incidence rate for long-term disability was higher than the rate for 1999.
The benefit ratio for short-term disability decreased marginally from the 1999 ratio. The incidence of submitted claims for short-term disability remained relatively constant throughout 2000 and 1999, declining slightly in 2000 compared to the 1999 rate. Negative impacts on the benefit ratio in 2000 were the average claim duration, which increased to its highest level in recent periods during 2000, and an increase in the average weekly indemnity.
Additionally, the increase in the amortization of deferred policy acquisition costs had a negative impact on 2000 income. This increase resulted from $25.8 million of additional amortization necessitated by the higher level of group long-term and short-term disability terminations experienced during 2000 relative to that which was expected at the time the business was written. However, the disability business retained is relatively more profitable than the business that terminated. The additional amortization during 1999 was $4.2 million.
Income in 2000 was positively impacted by a 5.7 percent revenue increase and an improvement in both the commission and operating expense ratios.
As previously discussed under "Results of Operations," during 2000 the Company entered into a 100 percent indemnity coinsurance agreement to cede the future claim payments on one of its insurance subsidiaries' long duration group long-term disability claims which were incurred prior to January 1, 1996. The agreement was effective January 1, 2000.
Group disability revenue increased to $3,029.0 million in 1999 compared to $2,632.1 million in 1998. Premium income growth was driven primarily by prior period sales. As previously discussed, the rate of growth in new sales declined during 1999. New annualized sales, on a submitted date basis, for group long-term disability were $385.2 million in 1999 compared to $441.7 million in 1998. New annualized sales for group short-term disability were $172.0 million in 1999 as compared to $176.2 million in 1998. On an effective date basis, new annualized sales for long-term disability and short-term disability were $466.9 million and $203.1 million in 1999 and $426.4 million and $159.7 million in 1998.
Net investment income increased during 1999 due to the increase in the level of invested assets allocated to this line of business and also due to the portfolio restructuring which occurred subsequent to the merger.
Group disability reported a loss of $225.7 million for 1999, as compared with $334.4 million of income for 1998. The loss was the result of the $191.7 million second quarter 1999 charge and the $359.2 million third quarter 1999 charge as previously discussed. Excluding the effect of these two charges, this line reported an 83.5 percent benefit ratio for 1999. The benefit ratio for 1998 was 79.4 percent, excluding the effect of the fourth quarter of 1998 claims disruption charge discussed in the following paragraphs. The incidence rates for new claims submitted for long-term disability increased during 1999 over the level experienced in 1998, but new claim incidence rates in the third and fourth quarters of 1999 improved relative to levels experienced in the first half of 1999 and the last half of 1998. Small case business continues to perform well, and large case and mid-size business showed improvement in 1999. The incidence rates for new claims submitted for short-term disability improved during 1999 as compared to 1998.
As explained in more detail below, the actual increase in claims durations during 1999 was greater than the increase assumed in the fourth quarter of 1998 claims disruption charge, resulting in a negative impact on the 1999 benefit ratio. Additionally, the 1998 benefit ratio was positively impacted by the updated factors used in calculating social security offset amounts.
The amortization of deferred policy acquisition costs for 1999 includes $4.2 million of additional amortization due to the higher than expected level of terminations for long-term and short-term disability experienced during the fourth quarter of 1999. Also included in 1999 is $3.3 million of amortization related to the write-off of the unamortized balance of deferred costs related to certain discontinued products in the foreign operations.
In the fourth quarter of 1998, the Company recorded a $50.3 million 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 would be impacted as a result of planning, consolidation, and integration efforts related to the merger. Management expected 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 were 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. 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.
During 1999, the claim operations integration activities progressed as assumed. At December 31, 1998, management assumed the revised group disability claim resolution rates for the first, second, third, and fourth quarters of 1999 to be 90, 90, 81, and 86 percent of assumptions, respectively, before adjusting for the impact of the claim operations integration activities. The actual experience was 89 percent for the first quarter of 1999, 90 percent for the second quarter, 67 percent for the third quarter, and 81 percent for the fourth quarter. If the impact of merger-related claim operations integration activities on claim durations had not been anticipated at December 31, 1998, the 1999 loss for the group long-term disability line of business would have been negatively impacted by $50.3 million. However, the shortfall of the actual 1999 experience below that assumed resulted in a negative effect on 1999 results of $18.1 million. As discussed in Note 2 of the "Notes to Consolidated Financial Statements," claim resolution assumptions underlying existing claim reserves were revised in the third quarter of 1999, resulting in an increase in benefit liabilities of $194.8 million. In selecting the revised claim resolution assumptions, consideration was given to claims operations integration activities referenced here as well as other factors expected to impact the future effectiveness of the claims operations. See Notes 2 and 7 of the "Notes to Consolidated Financial Statements" for further discussion.
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 be worse than expected. Management monitors 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. Given the competitive market conditions for the Company's disability products, it is uncertain whether pricing actions can entirely mitigate the effect.
The Company, similar to all financial institutions, has some exposure if a severe and prolonged recession occurs, but management believes that the Company is well positioned if a weaker economy were to occur. Many of the Company's products can be repriced, which would allow the Company to reflect in its pricing any fundamental change which might occur in the risk associated with a particular industry or company within an industry. The Company has a well diversified book of insurance exposure, with no unusual concentrations of risk in any one industry. Because of improvements made in the claims organization in recent years, the Company believes it can respond to increased levels of submitted claims which might result from a slowing economy.
Group Life, Accidental Death and Dismemberment, and Long-term Care
Group life, accidental death and dismemberment, and long-term care reported income of $214.0 million in 2000 compared to $239.5 million in 1999. New annualized sales on a submitted date basis decreased to $380.4 million in 2000 as compared to $395.3 million in 1999. On an effective date basis, new annualized sales were $301.5 million in 2000 compared to $427.7 million for 1999.
Group life and long-term care both reported an increase in revenue for 2000 compared to 1999 due to increases in premium income and net investment income. Offsetting the revenue increase was an increase in the benefit ratio when compared to 1999. Group life reported an unfavorable benefit ratio in 2000 compared to the prior year due to an increase in the average paid claim size and waiver incidence, partially offset by favorable paid mortality incidence.
The 2000 benefit ratio for accidental death and dismemberment compares unfavorably with 1999. The increase in the average paid claim size contributed to the unfavorable comparison. Submitted incidence for accidental death and dismemberment has improved relative to 1999.
The reinsurance transaction with Reassure America, discussed under Item 1 contained herein, reduced 2000 group life and accidental death and dismemberment premium income and benefits approximately $15.4 million and $11.7 million, respectively.
The reinsurance transaction with Manulife Reinsurance Limited and SCOR Reinsurance Company, under which an insurance subsidiary of the Company cedes through a net quota share reinsurance agreement 50 percent of the group life volume above the aggregate retention limit, does not meet the conditions for reinsurance accounting and is therefore accounted for as a deposit. As such, there is no effect on reported premium income or benefits. The only impact on the income statement is the risk charge paid to the reinsurers.
See Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of the 2000 reinsurance transactions.
Group long-term care reported a higher benefit ratio for 2000 compared to 1999. The long-term care net claim resolution rate for 2000 is below the average rate for 1999, primarily due to a decrease in claim recoveries. The 2000 incidence rates for both submitted and paid claims improved over the prior year.
The amortization of deferred policy acquisition costs for 2000 includes $8.3 million of additional amortization due to the higher level of terminations for group life and accidental death and dismemberment products experienced during 2000 relative to that which was expected at the time the policies were written. Positively impacting 2000 income was an improvement in the commission and operating expense ratios.
Group life, accidental death and dismemberment, and long-term care reported income of $239.5 million in 1999 compared to $197.5 million in 1998. The increase resulted from the growth in premium income, which was driven by strong prior period sales, and a lower operating expense ratio. The results also benefited from higher net investment income and a higher volume of business. There was a slight increase in the benefit ratio, from 72.7 percent in 1998 to 73.3 percent in 1999, primarily due to an increase in the average claim size in the group life line of business.
New annualized sales on a submitted date basis increased to $395.3 million in 1999 compared to $363.2 million in 1998. On an effective date basis, sales were $427.7 million in 1999 and $340.2 million in 1998. Premium persistency for group life in 1999 was lower than historical levels, and subsequently the amortization of deferred policy acquisition costs for 1999 includes $1.0 million of additional amortization due to the higher than expected level of terminations.
Individual Segment Operating Results
(in millions of dollars)
The Individual segment includes results from the individual disability and individual long-term care lines of business. Individual life, which was previously included in the Individual segment, is no longer actively marketed and is now reported in the Other segment. Historical by segment results have been reclassified. See "Other Segment Operating Results" for further discussion of the individual life line of business.
Individual Disability
New annualized sales in the individual disability line of business were $116.1 million in 2000 compared to $124.1 million in 1999 and $136.6 million in 1998. As discussed in the "Employee Benefits Segment Operating Results," several factors have contributed to the decrease in sales. However, persistency of existing individual disability income business remained high during 1999 and 2000. The Company has developed a new individual disability product portfolio which was released for sale in approved states early in the fourth quarter of 2000. This product line consolidates the current offerings of the Company's insurance subsidiaries into one new simplified product portfolio. The new portfolio utilizes a modular approach offering customers a range of product options and features. This portfolio was designed to combine the best features from prior Company offerings and includes return-to-work incentives and optional long-term care conversion benefits and/or benefits for catastrophic disabilities. Management expects that premium income in the individual disability line will grow on a year-over-year basis, contingent on further state approvals of the new product portfolio, as the portfolio transition produces increasing levels of new sales of individual disability products and as a result of an increased focus on integrated disability sales in group and individual, as well as other sales initiatives discussed under "Employee Benefits Segment Operating Results."
Revenue was $2,585.6 million in 2000 compared to $2,371.9 million in 1999. The growth in 2000 revenue was driven primarily by the growth in premium income as well as net investment income and other income. Premium income in 2000 included $96.6 million from an inforce block of individual disability business reinsured effective January 1, 2000. Other income benefited from the income on assets held in trust under this reinsurance arrangement. Net investment income for individual disability increased due to the increase in the level of invested assets allocated to this line of business.
Income in the individual disability line of business was $285.3 million in 2000, an increase of $28.6 million from the prior year. As discussed in the preceding "Results of Operations," in the second quarter of 1999 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 individual disability income by $38.9 million in 1999. Excluding this 1999 adjustment, individual disability income decreased $10.3 million in 2000 compared to 1999. This line reported an increase in the benefit ratio for 2000 compared to last year's ratio, excluding the 1999 discount rate change. Submitted incidence for 2000 is slightly higher than the average for the year 1999, while paid incidence has improved relative to the prior year. The claim acceptance rate has been declining throughout 1999 and 2000, and the net claim resolution rate for 2000 compares favorably with 1999. Offsetting these favorable trends was an increase in reserves for existing claims and claims in dispute. Individual disability benefited from improved commission and operating expense ratios for 2000 as compared to 1999. The amortization of value of business acquired increased in 2000 primarily as a result of the amortization on the block of inforce business reinsured effective January 1, 2000.
Income in the individual disability income line of business increased to $256.7 million in 1999 from $190.0 million in 1998. Excluding the 1999 discount rate change of $38.9 million, this line reported an increase in the benefit ratio in 1999 compared to 1998. The 1999 claim resolution rate compared unfavorably with 1998, but showed improvement throughout 1999. New claims for 1999 were fairly level with 1998. This line benefited from higher net investment income and a favorable operating expense ratio for 1999 as compared to 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 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 individual disability claim resolution rates for the first, second, third, and fourth quarters of 1999 to be 90, 90, 85, and 90 percent of assumptions, before adjusting for the impact of the claim operations integration activities. The actual experience for the Company was 89 percent in the first quarter, 90 percent in the second quarter, 93 percent in the third quarter, and 95 percent in the fourth quarter of 1999. If the impact of merger-related claim operations integration activities on claim durations had not been anticipated at December 31, 1998, income for the individual disability line of business would have been negatively impacted by $100.3 million in 1999. In addition, the excess of the actual 1999 experience over that assumed resulted in a positive effect on income of $25.6 million. See Note 7 of the "Notes to Consolidated Financial Statements" for further discussion.
Individual Long-term Care
The individual long-term care line of business reported increased premium income for both 2000 and 1999 as compared to the previous years, primarily due to continued new sales growth. New annualized sales were $47.7 million in 2000, $40.0 million in 1999, and $23.5 million in 1998. The Company expects the strong sales momentum in individual long-term care to continue. Net investment income continues to increase due to the growth in this line of business.
Income for 2000 was $12.8 million, compared to losses of $2.6 million in 1999 and $2.7 million in 1998. The increase in revenue, as well as improvements in both the benefit ratio and operating expense ratios, contributed to the year over year increases.
Voluntary Benefits Segment Operating Results
(in millions of dollars)
The Voluntary Benefits segment includes the results of products sold to employees through payroll deduction at the workplace. These products include life insurance and health products, primarily disability, accident and sickness, and cancer.
Revenue in the Voluntary Benefits segment increased to $859.3 million in 2000 from $804.5 million in 1999 and $770.4 million in 1998. Sales growth and continued favorable persistency were the primary factors contributing to the increase in premium income. New annualized sales in this segment were $265.0 million in 2000, $245.3 million in 1999, and $233.8 million in 1998. Management continues its efforts to increase sales through the sales initiatives discussed under "Employee Benefits Segment Operating Results." The investment income growth in 2000 as compared to 1999 was due to the repositioning of the investment portfolio subsequent to the merger.
Income for 2000 increased 12.4 percent over 1999, primarily due to revenue growth of $54.8 million. An additional positive impact on 2000 income was a favorable operating expense ratio attributable to costs savings resulting from the merger. The 2000 benefit ratio was unfavorable compared to 1999. The primary drivers were unfavorable results in the life product line and an increase in the incurred and paid loss ratios for the cancer product line.
Income in the Voluntary Benefits segment in 1999 was $137.0 million versus $131.1 million in 1998. The increase in income for 1999 was primarily due to the increase in premium income in all of the product lines and an increase in investment income, partially offset by a slightly higher benefit ratio in the life, accident and sickness, and disability product lines.
Other Segment Operating Results
The Other operating segment includes results from products no longer actively marketed, including individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities. It is expected that revenue and income in this segment will decline over time as these business lines wind down. 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.
Individual Life and Corporate-Owned Life
As previously discussed, during 2000 the Company reinsured substantially all of the individual life and corporate-owned life insurance blocks of business. The Company ceded approximately $3.3 billion of reserves to the reinsurer. The $388.2 million before-tax and $252.3 million after-tax gain on these transactions was deferred and is being amortized into income based upon expected future premium income on the traditional insurance policies ceded and estimated future gross profits on the interest-sensitive insurance policies ceded. The Company recognized a 2000 before-tax realized investment loss of $25.9 million on the fixed maturity securities transferred to the reinsurer. In connection with this realized loss, the Company retrospectively adjusted deferred policy acquisition costs and value of business acquired related to interest-sensitive individual life policies with credits to current period amortization of $9.4 million and $1.5 million, respectively, to reflect investment experience. See "Investments" for further discussion of the realized investment loss.
Total revenue and income for individual life and corporate-owned life insurance was $236.1 million and $49.6 million, respectively, in 2000 compared to $435.0 million in revenue and $65.6 million in income for 1999.
Reinsurance Pools and Management
The Company's reinsurance operations include the reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk assumption, which includes reinsurance pool participation; direct reinsurance which includes accident and health (A&H), long-term care (LTC), and long-term disability coverages; and Lloyd's of London (Lloyd's) syndicate participations. During 1999, the Company concluded that these operations were not solidly aligned with the Company's strength in the disability insurance market and decided to exit these operations through a combination of a sale, reinsurance, and/or placing certain components in run-off. In 1999, the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities and reinsured the Company's risk participation in these facilities. The Company also decided to discontinue its London accident reinsurance pool participation beginning in year 2000. With respect to Lloyd's, the Company implemented a strategy which limited participation in year 2000 underwriting risks, ceased participation in Lloyd's underwriting risks after year 2000, and
managed the run-off of its risk participation in open years of account of Lloyd's reinsurance syndicates. During the first quarter of 2001, the Company entered into an agreement in principle to limit its liabilities pertaining to the Lloyd's syndicate participations. See Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of the reinsurance operations.
During 2000, the reinsurance pools and management operations reported a loss of $32.7 million compared to a loss of $279.7 million in 1999. Included in the 2000 results were $37.4 million of charges related to the Company's London accident reinsurance pool participation. During 1999, the Company recorded charges resulting from its decision to exit these pools, but at that time there was insufficient information to fully evaluate all of the exposures. Working with the pool managers in London, the Company now has a clearer view of the potential cost to fund these exposures and provide for the run-off of its participation. The 2000 charges included a claim reserve adjustment of $21.9 million and uncollectible receivables and loss provisions of $15.5 million.
The reinsurance pools and management reported a loss of $279.7 million in 1999 compared to income of $10.0 million in 1998. The 1999 loss was the result of charges related to the decision to exit the reinsurance operations, as discussed in the preceding paragraphs. These charges totaled $270.1 million in 1999, with an additional $57.7 million recorded in the Corporate segment related to the write-off of goodwill. See "Results of Operations" contained herein in Item 7 and Note 13 of the "Notes to Consolidated Financial Statements" in Item 8 for further discussion of the 1999 charges related to the reinsurance operations.
Also, as previously discussed in the preceding "Results of Operations," during 1999 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 the group long-term disability reinsurance income reported in this line of business by $10.1 million in 1999.
In the fourth quarter of 1998, the Company recorded a $2.4 million 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, 1999 income for the reinsurance pools and management line of business would have been negatively impacted by $2.4 million. See Note 7 of the "Notes to Consolidated Financial Statements" for further discussion.
Individual Annuities
In 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 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 1998 was $12.2 million.
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 income on corporate assets not specifically allocated to a line of business, corporate interest expense, amortization of goodwill, and certain corporate expenses not allocated to a line of business.
Revenue in the Corporate segment was $48.1 million in 2000, $67.7 million in 1999, and $31.7 million in 1998. As previously discussed under "Results of Operations," during 1999 the Company recorded refunds from the Internal Revenue Service relating to the final settlement of remaining issues for the 1986 through 1992 tax years. The interest on the refunds was $35.4 million and is included in 1999 revenue.
The Corporate segment reported losses of $49.5 million in 2000, $484.6 million in 1999, and $125.5 million in 1998. Interest and debt expense was $181.8 million in 2000, $137.8 million in 1999, and $112.0 million in 1998 due to increased corporate borrowings. The amortization of goodwill was $22.3 million in 2000, $82.6 million in 1999, and $28.0 million in 1998. The Company recorded write-downs of goodwill of $57.7 million during 1999 related to its reinsurance operations. See previous discussion under "Other Segment Operating Results" and Note 13 of the "Notes to Consolidated Financial Statements."
Results for 2000 were positively impacted by the gain of $116.1 million on the pension plan transaction, partially offset by consolidation and benefit accruals of $9.4 million. See previous discussion contained herein in "Results of Operations" and Note 10 of the "Notes to Consolidated Financial Statements."
As previously discussed, during 1999 the Company recognized $310.6 million of before-tax expenses related to the merger and the early retirement offer to employees. These expenses are as follows (in millions):
Employee related expense consists of employee severance costs, change in control 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 are involuntarily terminated. Severance benefits and change in control costs were $60.2 million, and costs associated with the vesting of restricted stock were $17.5 million.
Exit activities related to duplicate facilities/asset abandonments consist of closing of duplicate offices and write-off of redundant computer hardware and software. The cost associated with these office closures was approximately $25.6 million, which represents the cost of future minimum lease payments less any estimated amounts recovered under subleases. Also, certain physical assets, primarily computer equipment, redundant systems, and systems incapable of supporting the combined entity, were abandoned as a result of the merger, resulting in a write-down of the assets' book values by approximately $41.8 million.
The exit plan was complete as of June 30, 2000.
In addition to the expenses described above, in 1999 the Company expensed $24.7 million of other incremental costs associated with the merger, $21.8 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. See Note 4 of the "Notes to Consolidated Financial Statements" for further discussion of the Company's investments.
Subsequent to the June 30, 1999 merger and continuing through the first half of 2000, the Company actively pursued its strategy of extending the duration of its investments and shifting the mix of assets for approximately $2.1 billion of its investments in order to reduce vulnerability to interest rate risk in the future and increase investment income. Excluding net investment income attributable to the individual life and corporate-owned life insurance blocks of business ceded effective as of July 1, 2000, net investment income for 2000 increased 8.6 percent over 1999 due to increased yields and growth in the asset base.
During 2000, the Company reported net realized investment losses before tax of $14.6 million, including the realized investment loss of $25.9 million on the investment-grade fixed maturity securities transferred to the reinsurer in connection with the individual life and corporate-owned life reinsurance transactions. The loss on these transferred securities was driven by a change in market interest rates and was not attributable to any credit deterioration. Excluding the reinsurance transaction related loss, the Company reported 2000 net gains of $51.0 million from the sale of fixed maturity and equity securities. Offsetting these gains was a $94.0 million realized investment loss recognized as a result of management's determination that the value of certain fixed maturity investments had other than temporarily declined.
The following table provides the distribution of invested assets for the years indicated. Policy loans are reported on a gross basis in the consolidated statements of financial condition and in the table below. As of December 31, 2000, $2.2 billion of policy loans were ceded, and the investment income thereon is no longer included in income.
December 31 ------------------- 2000 1999 ---- ---- Investment-Grade Fixed Maturity Securities 78.3% 76.1% Below-Investment-Grade Fixed Maturity Securities 6.6 8.1 Equity Securities 0.1 0.2 Mortgage Loans 4.3 4.8 Real Estate 0.4 0.8 Policy Loans 9.1 8.7 Other Invested Assets 1.2 1.3 ----- ----- Total 100.0% 100.0% ===== =====
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately $3.5 billion and $3.1 billion on an amortized cost basis at December 31, 2000 and 1999, respectively. At December 31, 2000, the mortgage-backed securities had an average life of 12.6 years and effective duration of 11.2 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.
The Company's exposure to below-investment-grade fixed maturity securities at December 31, 2000, was $1,760.8 million, representing 7.2 percent of invested assets excluding ceded policy loans, 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 $2,147.4 million at December 31, 1999, representing 8.1 percent of invested assets.
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.
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $1,135.6 million and $1,278.1 million at December 31, 2000 and 1999, 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 an investment valuation allowance for mortgage loans 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 2000 and 1999, reflecting 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. No new mortgage loans were added to the Company's investment portfolio during 2000 other than one purchase money mortgage for $14.8 million associated with the sale of real estate.
At December 31, 2000 and 1999, impaired loans totaled $17.7 million and $18.1 million, respectively. Included in the impaired loans at December 31, 2000 were $6.5 million of loans which had a related, specific investment valuation allowance of $2.4 million and $11.2 million of loans which had no related, specific allowance. 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 $8.5 million and $8.7 million at December 31, 2000 and 1999, respectively, and represent loans that have been refinanced with terms more favorable to the borrower. Interest lost on restructured loans was immaterial for 2000 and 1999.
Real estate was $116.7 million and $211.2 million at December 31, 2000 and 1999. 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 $18.3 million at December 31, 2000, and $79.4 million at December 31, 1999.
Investment valuation allowances for 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. Management monitors the risk associated with the invested asset portfolio and regularly reviews and adjusts the investment valuation allowance. As a result of management's most recent review of the overall mortgage loan portfolio and based on management's expectation that delinquencies and problem loans will remain low, the valuation allowance on mortgage loans was reduced $20.0 million during 2000. At December 31, 2000, the balance in the valuation allowance for mortgage loans and real estate was $12.9 million and $25.6 million, respectively.
Other
The Company's exposure to non-current investments totaled $45.0 million at December 31, 2000, or 0.2 percent of invested assets. These non-current investments are foreclosed real estate held for sale and fixed income securities and mortgage loans that became more than thirty days past due in principal and interest payments.
The Company utilizes interest rate futures contracts, current and forward interest rate swaps, interest rate forward contracts, and options on forward interest rate swaps, forward treasuries, or specific fixed income securities to manage duration and increase yield on cash flows expected from current holdings and products. All transactions are hedging in nature and not speculative. Almost all transactions are associated with the individual and group disability product portfolios. All other product portfolios are periodically reviewed to determine if hedging strategies would be appropriate for risk management purposes. See Note 5 of the "Notes to Consolidated Financial Statements" for further discussion of the Company's derivative financial instruments.
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 $1,211.5 million for the year ended December 31, 2000, as compared to $1,566.7 million and $1,719.3 million for the comparable periods of 1999 and 1998, respectively.
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. As a result of the effect on capital during 1999 of the merger related charges, the Company raised approximately $500 million through the debt markets during the fourth quarter of 1999 by securing $200 million of one-year bank debt and by issuing commercial paper.
The Company is dependent upon payments from its subsidiaries to pay dividends to its stockholders and to pay its expenses. These payments by the Company's insurance and non-insurance subsidiaries may take the form of interest payments on amounts loaned to such subsidiaries by the Company, operating and investment management fees, and/or dividends. At December 31, 2000, the Company had outstanding from its insurance subsidiaries a $150.0 million surplus debenture due in 2006 with a weighted average interest rate during 2000 of 8.20 percent and a $100.0 million surplus debenture due in 2027 with a weighted average interest rate during 2000 of 8.25 percent. Semi-annual interest payments are conditional upon the approval by the insurance department of the state of domicile.
Restrictions under applicable insurance laws limit the amount of dividends that can be paid to the Company from its insurance subsidiaries without prior approval by regulatory authorities. Generally, for life insurance subsidiaries domiciled or commercially domiciled in the United States, that limitation equals the greater of: (i) ten percent of an insurer's statutory surplus with respect to policyholders as of the preceding year end; or (ii) the statutory net gain from operations, excluding realized investment gains and losses, of the preceding year.
The payment of dividends to the Company from its insurance subsidiaries is further limited to the amount of statutory unassigned surplus. The Company also has the ability to draw a dividend from its United Kingdom-based affiliate, Unum Limited. Such dividends are limited in amount, based on insurance company law in the United Kingdom, which requires a minimum solvency margin. Based on these restrictions under current law:
. in 2000, $267.6 million was available for the payment of dividends to the Company from its domestic insurance subsidiaries, and approximately $24.9 million was available for the payment of dividends from Unum Limited, and
. in 2001, $359.9 million will be available for the payment of dividends to the Company from its domestic insurance subsidiaries, and approximately $20.9 million will be available for the payment of dividends from Unum Limited.
The ability of the Company to continue to receive dividends from its insurance subsidiaries without regulatory approval will be dependent upon the level of earnings of its insurance subsidiaries as calculated under law. In addition to regulatory restrictions, the amount of dividends that will be paid by insurance subsidiaries will depend on additional factors, such as risk-based capital ratios, funding growth objectives at an affiliate level, and maintaining appropriate capital adequacy ratios to support the ratings desired by the Company. Regulatory restrictions do not limit the amount of dividends available for distribution to the Company from its non-insurance subsidiaries.
At December 31, 2000, the Company had short-term and long-term debt totaling $402.2 million and $1,615.5 million, respectively. At December 31, 2000, approximately $551.0 million was available for additional financing under the Company's revolving credit facilities. Contingent upon market conditions and corporate needs, management may refinance short-term notes payable for longer-term securities.
In October 2000, the Company entered into $1.0 billion senior revolving credit facilities with a group of banks. The facilities, which are split into five-year revolver and 364-day portions, replaced a 364-day revolver which expired in October 2000 and a five-year revolver which has been canceled. The new facilities are available for general corporate purposes, including support of the Company's $1.0 billion commercial paper program, and contain certain covenants that, among other provisions, include a minimum tangible net worth requirement, a maximum leverage ratio restriction, and a limitation on debt relative to the consolidated statutory earnings of the Company's insurance subsidiaries.
During the third quarter of 2000, the Company filed with the Securities and Exchange Commission a shelf registration on Form S-3 covering the issuance of up to $1.0 billion of securities in order to provide funding alternatives for its maturing debt. The shelf registration became effective in September 2000. In March 2001, the Company completed a long-term debt offering, issuing $575.0 million of 7.625% senior notes due March 1, 2011. Contingent upon market conditions and corporate needs, funding will be used to refinance short-term debt on a long-term basis and to fund other corporate needs.
In April 2000, the Company issued $200.0 million of variable rate notes, due in April 2001, in a privately negotiated transaction. The notes were used to refinance other short-term debt and had a weighted average interest rate of 7.33 percent during 2000. The current interest rate on these notes is 6.49 percent.
In March 1998, the Company completed a public offering of $200.0 million of 7.25% senior notes due March 15, 2028. In March 1998, Provident Financing Trust I, a wholly-owned subsidiary trust of the Company, issued $300.0 million of 7.405% capital securities in a public offering. These capital securities, which mature on March 15, 2038, are fully and unconditionally guaranteed by the Company, have a liquidation value of $1,000 per capital security, and have a mandatory redemption feature under certain circumstances. The Company issued $300.0 million of 7.405% junior subordinated deferrable interest debentures, which mature on March 15, 2038, to the subsidiary trust in connection with the capital securities offering. The sole assets of the subsidiary trust are the junior subordinated debt securities.
In July 1998, the Company completed a public offering of $200.0 million of 6.375% senior notes due July 15, 2005, and $200.0 million of 7.0% senior notes due July 15, 2018. In December 1998, the Company issued $250.0 million of 6.75 % senior notes, which mature in 2028.
In the fourth quarter of 1998, the Company rescinded its stock repurchase program as a result of the pending merger. During 1998, the Company acquired approximately 1.4 million shares of its common stock in the open market at an aggregate cost of $72.7 million.
Ratings
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's), Fitch, Inc. (Fitch), formerly Fitch/Duff & Phelps, 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.
On August 23, 2000, Moody's lowered the senior debt rating of the Company to Baa1 from A3, lowered the financial strength ratings of the Company's insurance subsidiaries to A2 from A1, and confirmed the short-term rating at Prime-2. The Company has not experienced a material impact on its new sales or persistency of existing business as a result of these ratings changes. In March 2001, in connection with the Company's issuance of $575.0 million of 7.625% senior notes due March 1, 2011, S&P, Moody's, and Fitch affirmed the senior debt and financial strength ratings at the existing levels.
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.
ITEM 7A.
ITEM 7A. 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 following discussion regarding the Company's risk management activities includes forward-looking statements that involve risk and uncertainties. Estimates of future performance and economic conditions are reflected assuming certain changes in market rates and prices were to occur (sensitivity analysis). Caution should be used in evaluating the Company's overall market risk from the information presented below, as actual results may differ. The Company employs various derivative programs to manage these material market risks. See Notes 4 and 5 of the "Notes to Consolidated Financial Statements" for further discussions of the qualitative aspects of market risk, including derivative financial instrument activity.
Interest Rate Risk
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, as well as to prepare for disadvantageous outcomes. This analysis is the precursor to the Company's activities in derivative financial instruments. The Company uses interest rate swaps, interest rate forward contracts, exchange-traded interest rate futures contracts, and options to hedge interest rate risks and to match asset durations and cash flows with corresponding liabilities.
Assuming an immediate increase of 100 basis points in interest rates from year end levels, the net hypothetical decrease in stockholders' equity related to financial and derivative instruments was estimated to be $0.8 billion and $0.7 billion at December 31, 2000 and 1999, respectively. The fair values of mortgage loans and held-to-maturity securities, which are reported in the consolidated statements of financial condition at amortized cost, would decrease by approximately $70 million and $40 million, respectively, at December 31, 2000 and by approximately $80 million and $40 million, respectively, at December 31, 1999. The fair values of policy loans, which are also reported at amortized cost, would decrease approximately $200 million at December 31, 1999, assuming an immediate increase of 100 basis points in interest rates. During 2000, over 90 percent of the policy loan portfolio was ceded to a reinsurer on a 100 percent indemnity coinsurance basis (see Notes 1 and 13 of the "Notes to Consolidated Financial Statements"). The impact from interest rate risk on the fair values of policy loans net of ceding was immaterial at December 31, 2000.
At December 31, 2000 and 1999, assuming a 100 basis point decrease in long-term interest rates from year end levels, the fair values of the Company's long-term debt and company-obligated mandatorily redeemable preferred securities would increase approximately $100 million and $30 million, respectively.
The effect of a change in interest rates on asset prices was determined using a matrix pricing system whereby all securities are priced with the resulting market rates and spreads assuming a change of 100 basis points. These hypothetical prices were compared to the actual prices for the period to compute the overall change in market value. The changes in the fair values of long-term debt and company-obligated mandatorily redeemable preferred securities were determined using discounted cash flows analyses. Because the Company actively manages its investments and liabilities, actual changes could be less than those estimated above.
Foreign Currency Risk
The Company is also subject to foreign exchange risk arising from its foreign operations and certain investment securities dominated in those local currencies. Foreign operations represented 7.7 percent and 8.9 percent of total assets at December 31, 2000 and 1999, respectively, and 9.7 percent and 9.4 percent of total revenue for 2000 and 1999, respectively. Assuming foreign exchange rates decreased 10 percent from the December 31, 2000 and 1999 levels, year end 2000 and 1999 stockholders' equity would not be materially affected.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders UnumProvident Corporation and Subsidiaries
We have audited the accompanying consolidated statements of financial condition of UnumProvident Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. The consolidated financial statements give retroactive effect to the merger of Unum Corporation and Provident Companies, Inc. on June 30, 1999, which has been accounted for using the pooling of interests method as described in the notes to the consolidated financial statements. Our audits also included the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We did not audit the financial statements and schedules of the former Unum Corporation which statements reflect total revenues constituting 54% of the related consolidated totals for the year ended December 31, 1998. Those statements and schedules were audited by other auditors whose report has been furnished to us, and our opinion, in so far as it relates to data included for the former Unum Corporation, is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of UnumProvident Corporation and subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 after giving retroactive effect to the merger of Unum Corporation, as described in the notes to the consolidated financial statements, in conformity with accounting principles generally accepted in the United States. Also in our opinion, based on our audits and the report of other auditors, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Chattanooga, Tennessee February 12, 2001, except for Notes 13 and 15, for which the date is February 27, 2001
REPORT OF PRICEWATERHOUSECOOPERS LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders UnumProvident Corporation and Subsidiaries
In our opinion, the consolidated statements of income, comprehensive income, stockholders' equity and cash flows of Unum Corporation and its subsidiaries (not presented separately herein) present fairly, in all material respects, the results of their operations and their cash flows for the year ended December 31, 1998, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Corporation's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. We have not audited any financial statements of the Unum Corporation subsequent to December 31, 1998.
/s/ PRICEWATERHOUSECOOPERS LLP
Portland, Maine February 2, 1999
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UnumProvident Corporation and Subsidiaries
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
UnumProvident Corporation and Subsidiaries
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
UnumProvident Corporation and Subsidiaries
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UnumProvident Corporation and Subsidiaries
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
UnumProvident Corporation and Subsidiaries
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
UnumProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies
Basis of Presentation: The accompanying consolidated financial statements have been prepared on the basis of generally accepted accounting principles (GAAP). Such accounting principles differ from statutory accounting practices prescribed or permitted by state regulatory authorities (see Note 16). The consolidated financial statements include the accounts of UnumProvident Corporation and its subsidiaries (the Company). Material intercompany transactions have been eliminated. Certain prior year amounts have been reclassified to conform to current year presentation.
On June 30, 1999, Unum Corporation (Unum) merged with and into Provident Companies, Inc. (Provident) under the name UnumProvident Corporation. The merger was accounted for as a pooling of interests. The historical financial results presented herein give effect to the merger as if it had been completed at the beginning of the earliest period presented.
Operations: The Company does business primarily in North America and operates principally in the life and health insurance business. The Employee Benefits segment includes group long-term and short-term disability insurance, group life insurance, accidental death and dismemberment coverages, group long-term care, and the results of managed disability. The Individual segment includes results from the individual disability 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 individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities. The Corporate segment includes investment earnings on corporate assets not specifically allocated to a line of business, corporate interest expense, amortization of goodwill, and certain corporate expenses not allocated to a line of business. See Note 14 for further information on the operating segments.
Use of Estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.
Investments: Investments are reported in the consolidated statements of financial condition as follows:
Available-for-Sale Fixed Maturity Securities are reported at fair value.
Held-to-Maturity Fixed Maturity Securities are generally reported at amortized cost.
Equity Securities are reported at fair value.
Mortgage Loans are generally carried at amortized cost less an allowance for probable losses.
Real Estate classified as investment real estate is carried at cost less accumulated depreciation. Real estate acquired through foreclosure is valued at fair value at the date of foreclosure. If investment real estate is determined to be permanently impaired, the carrying amount of the asset is reduced to fair value. Occasionally, investment real estate is reclassified to real estate held for sale when it no longer meets the Company's investment criteria. Real estate held for sale is valued net of a valuation allowance that reduces the carrying value to the lower of cost less accumulated depreciation or fair value less estimated cost to sell. Accumulated depreciation on real estate was $31.0 million and $42.8 million as of December 31, 2000 and 1999, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Policy Loans are presented at unpaid balances directly related to policyholders. Included in policy loans are $2,237.6 million and $35.6 million of policy loans ceded to reinsurers at December 31, 2000 and 1999, respectively. See Note 13.
Other Long-term Investments are carried at cost plus the Company's equity in undistributed net earnings since acquisition.
Short-term Investments are carried at cost.
Fixed maturity securities include bonds and redeemable preferred stocks. Equity securities include common stocks and nonredeemable preferred stocks. Fixed maturity and equity securities not bought and held for the purpose of selling in the near term but for which the Company does not have the positive intent and ability to hold to maturity are classified as available-for-sale. Fixed maturity securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity. The Company determines the appropriate classification of fixed maturity securities at the time of purchase.
Changes in the fair value of available-for-sale fixed maturity securities and equity securities are reported as other comprehensive income (loss). These amounts are net of federal income taxes and valuation adjustments to reserves for future policy and contract benefits which would have been recorded had the related unrealized gains or losses on these securities been realized.
Realized investment gains and losses, which are reported as a component of revenue in the consolidated statements of operations, are based upon specific identification of the investments sold and do not include amounts allocable to separate accounts. At the time a decline in the value of an investment is determined to be other than temporary, a loss is recorded which is included in realized investment gains and losses.
The Company discontinues the accrual of investment income on invested assets when it is determined that collectability is doubtful. The Company recognizes investment income on impaired loans when the income is received.
Derivative Financial Instruments: Interest Rate Swap Agreements are agreements in which two parties agree to exchange, at specified intervals, interest payment streams calculated on an agreed-upon notional principal amount. The underlying notional principal is not exchanged between the parties for agreements other than foreign currency swaps. The Company has certain forward interest rate swap agreements where the exchange of interest payments does not begin until a specified future date. The Company intends to settle the forward interest rate swap agreements prior to the commencement of the exchange of interest payment streams.
The fair values of interest rate swap agreements which hedge available-for-sale securities are reported in the consolidated statements of financial condition as a component of fixed maturity securities. The fair values of interest rate swap agreements which hedge liabilities are not reported in the consolidated statements of financial condition. Amounts to be paid or received pursuant to interest rate swap agreements are accrued and recognized in the consolidated statements of operations as an adjustment to net investment income for asset hedges or as an adjustment to policyholder benefits for liability hedges.
The Company accounts for all of its interest rate swap agreements as hedges. Accordingly, for anticipated transaction hedges, any gains or losses realized on closed or terminated interest rate swap agreements are deferred and amortized to net investment income for asset hedges or policyholder benefits for liability hedges over the expected remaining life of the hedged item. The Company also uses interest rate swap agreements to hedge existing assets. The income payment streams generated by these swaps are recorded in the same manner as the hedged asset income payment streams.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
If the hedged item matures or terminates earlier than anticipated, the remaining unamortized gain or loss is amortized to net investment income or policyholder benefits in the current period. If the hedged asset is disposed, the remaining unamortized gain or loss is recognized as an adjustment to net realized investment gains and losses. Gains or losses realized on interest rate swap agreements which are terminated when the hedged assets are sold or which are terminated because the hedged anticipated transaction is no longer likely to occur are reported in the consolidated statements of operations as a component of net realized investment gains and losses.
The Company regularly monitors the effectiveness of its hedging programs. In the event a hedge becomes ineffective, it is marked-to-market, resulting in a charge or credit to net investment income or policyholder benefits.
Futures and Forwards Contracts are commitments to either purchase or sell a financial instrument at a specific future date for a specified price. Changes in the market value of contracts are generally settled on a daily basis. The notional amounts of futures and forwards contracts represent the extent of the Company's involvement but not the future cash requirements, as the Company intends to close out open positions prior to settlement. All of the Company's futures and forwards contracts are accounted for as hedges.
The fair values of futures and forwards which hedge available-for-sale securities are reported in the consolidated statements of financial condition as a component of fixed maturity securities. The fair values of open futures and forwards which hedge liabilities are reported in the consolidated statements of financial condition as a component of other liabilities. Gains or losses realized on the termination of futures and forwards contracts are accounted for in the same manner as interest rate swap agreements.
Option Contracts give the owner the right, but not the obligation, to buy or sell a financial instrument at an agreed-upon price on or before a specific date. The purchasing counterparty pays a premium to the selling counterparty for this right. The notional amounts of contracts represent the Company's involvement but not the future cash requirements, as the Company intends to close out contracts prior to the expiration date when the market price of the underlying financial instrument exceeds the option price or allow contracts to expire if the option price exceeds the market price. All of the Company's options contracts are accounted for as hedges. The book and fair values of options contracts are reported in the consolidated statements of financial condition in a manner similar to the underlying hedged item. Gains or losses on the termination of options contracts are accounted for in the same manner as interest rate swap agreements.
Reinsurance Receivable: The Company routinely cedes reinsurance to other insurance companies. For ceded reinsurance agreements wherein the Company is not relieved of its legal liability to its policyholders, the Company reports assets and liabilities on a gross basis. Reinsurance receivables include the balances due from reinsurers under the terms of these reinsurance agreements for ceded policy and contract benefits, ceded future policy and contract benefits, and ceded unearned premiums, less ceded policy loans.
Deferred Policy Acquisition Costs: Certain costs of acquiring new business which vary with and are primarily related to the production of new business have been deferred. Such costs include commissions, other agency compensation, certain selection and policy issue expenses, and certain field expenses. Deferred policy acquisition costs are subject to recoverability testing at the time of policy issue and loss recognition testing subsequent to the year of issue.
Deferred policy acquisition costs related to traditional policies are amortized over the premium paying period of the related policies in proportion to the ratio of the present value of annual expected premium income to the present value of total expected premium income. Adjustments are made each year to recognize actual persistency experience as compared to assumed experience.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Deferred policy acquisition costs related to interest-sensitive policies are amortized over the lives of the policies in relation to the present value of estimated gross profits from surrender charges and mortality, investment, and expense margins. Adjustments are made each year to reflect actual experience for assumptions which deviate significantly compared to assumed experience.
Loss recognition is performed when, in the judgment of management, adverse deviations from original assumptions have occurred and may be likely to continue such that recoverability of deferred policy acquisition costs on a line of business is questionable. Insurance contracts are grouped on a basis consistent with the Company's manner of acquiring, servicing, and measuring profitability of the contracts. If loss recognition testing indicates that deferred policy acquisition costs are not recoverable, the deficiency is charged to expense. Once a loss recognition adjustment is required, loss recognition testing is generally performed on an annual basis using then current assumptions until the line of business becomes immaterial or results improve significantly. The assumptions used in loss recognition testing represent management's best estimates of future experience.
Value of Business Acquired: Value of business acquired represents the present value of future profits recorded in connection with the acquisition of a block of insurance policies. The asset is amortized based upon expected future premium income for traditional insurance policies and estimated future gross profits for interest-sensitive insurance policies, with the accrual of interest added to the unamortized balance at interest rates principally ranging from 5.55 percent to 8.13 percent. The accumulated amortization for value of business acquired was $168.7 million and $133.2 million as of December 31, 2000 and 1999, respectively. The Company periodically reviews the carrying amount of value of business acquired using the same methods used to evaluate deferred policy acquisition costs.
Goodwill: Goodwill is the excess of the amount paid to acquire a business over the fair value of the net assets acquired. Goodwill is amortized on a straight- line basis over a period not to exceed 40 years. The accumulated amortization for goodwill was $85.9 million and $64.1 million as of December 31, 2000 and 1999, respectively. The carrying amount of goodwill is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount might not be recoverable. If estimated future undiscounted net cash flows expected to be generated from the operations to which the goodwill relates are less than the carrying amount of the unamortized goodwill, the carrying amount is reduced with a corresponding charge to expense.
Property and Equipment: Property and equipment is depreciated on the straight- line method over its estimated useful life. The accumulated depreciation for property and equipment was $350.1 million and $376.1 million as of December 31, 2000 and 1999, respectively.
Revenue Recognition: Traditional life and accident and health products are long duration contracts, and premium income is recognized as revenue when due from policyholders. If the contracts are experience rated, the estimated ultimate premium is recognized as revenue over the period of the contract. The estimated ultimate premium, which is revised to reflect current experience, is based on estimated claim costs, expenses, and profit margins. For interest-sensitive products, the amounts collected from policyholders are considered deposits, and only the deductions during the period for cost of insurance, policy administration, and surrenders are included in revenue. Policyholders' funds represent funds deposited by contract holders and are not included in revenue.
The Company follows the periodic method of accounting for its Lloyd's of London (Lloyd's) business in which premiums are recognized as revenue over the policy term, and claims, including an estimate of claims incurred but not reported, are recognized as they occur. Premiums for the Lloyd's business are based on participation in the individual syndicate underwriting years that generate premiums over a three year period of time. The Company uses its historical experience and information obtained from its managing agents to estimate revenues, losses, expenses, and the related assets and liabilities. See Note 13.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Policy and Contract Benefits: Policy and contract benefits, principally related to accident and health insurance policies, are based on reported losses and estimates of incurred but not reported losses for traditional life and accident and health products. For interest-sensitive products, benefits are the amounts paid and expected to be paid on insured claims in excess of the policyholders' policy fund balances.
Policy and Contract Benefits Liabilities: Active life reserves for future policy and contract benefits on traditional life and accident and health products have been provided on the net level premium method. The reserves are calculated based upon assumptions as to interest, withdrawal, morbidity, and mortality that were appropriate at the date of issue. Withdrawal assumptions are based on actual Company experience. Morbidity and mortality assumptions are based upon industry standards adjusted as appropriate to reflect actual Company experience. The assumptions vary by plan, year of issue, and policy duration and include a provision for adverse deviation.
Disabled lives reserves for future policy and contract benefits on disability policies are calculated based upon assumptions as to interest and claim termination rates that are currently appropriate. Claim termination rate assumptions are based upon industry standards adjusted as appropriate to reflect actual Company experience. The assumptions vary by year of claim incurral and may include a provision for adverse deviation. The interest rate assumptions used for discounting claim reserves are based on projected portfolio yield rates, after consideration for defaults and investment expenses, for the assets supporting the liabilities for the various product lines. The assets for each product line are selected according to the specific investment strategy for that product line to produce asset cash flows that follow similar timing and amount patterns to those of the anticipated liability payments.
Reserves for future policy and contract benefits on group single premium annuities have been provided on a net single premium method. The reserves are calculated based upon assumptions as to interest, mortality, and retirement that were appropriate at the date of issue. Mortality assumptions are based upon industry standards adjusted as appropriate to reflect actual Company experience. The assumptions vary by year of issue and include a provision for adverse deviation.
The interest rate assumptions used to calculate reserves for future policy and contract benefits are as follows:
Interest assumptions for active life reserves are generally graded downward over a period of years. Reserves for future policy and contract benefits on interest- sensitive products are principally policyholder account values determined on the retrospective deposit method.
Policyholders' Funds: Policyholders' funds represent customer deposits plus interest credited at contract rates. The Company controls its interest rate risk by investing in quality assets which have an aggregate duration that closely matches the expected duration of the liabilities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Liabilities for Restructuring Activities: Liabilities for restructuring activities are recorded when management, prior to the balance sheet date, commits to execute an exit plan that will result in the incurral of costs that have no future economic benefit or approves a plan of termination and communicates sufficient detail of the plan to employees. Liabilities for restructuring activities are included in other liabilities in the consolidated statements of financial condition.
Federal Income Taxes: Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes. Deferred taxes have been measured using enacted statutory income tax rates and laws that are currently in effect. A valuation allowance is established for deferred tax assets when it is more likely than not that an amount will not be realized.
Separate Accounts: The separate account amounts shown in the accompanying consolidated financial statements represent contributions by contract holders to variable-benefits and fixed-benefits pension plans. The contract purchase payments and the assets of the separate accounts are segregated from other Company funds for both investment and administrative purposes. Contract purchase payments received under variable annuity contracts are subject to deductions for sales and administrative fees. Also, the sponsoring companies of the separate accounts receive management fees which are based on the net asset values of the separate accounts.
Translation of Foreign Currency: Revenues and expenses of the Company's foreign operations, principally Canada and the United Kingdom, are translated at average exchange rates. Assets and liabilities are translated at the rate of exchange on the balance sheet date. The translation gain or loss is generally reported in accumulated other comprehensive income (loss), net of deferred tax.
Accounting for Participating Individual Life Insurance: Participating policies issued by one of the Company's subsidiaries prior to its 1986 conversion from a mutual to a stock life insurance company will remain participating as long as the policies remain in force. A Participation Fund Account (PFA) was established for the benefit of all of such individual participating life and annuity policies and contracts. The assets of the PFA provide for the benefit, dividend, and certain expense obligations of the participating individual life insurance policies and annuity contracts. The experience of the PFA and its operations have been excluded from the consolidated statements of operations. The PFA was $361.6 million and $362.2 million at December 31, 2000, and 1999, respectively, and represented approximately 0.9 percent of consolidated assets for both years and 1.0 percent and 1.1 percent of consolidated liabilities for December 31, 2000 and 1999, respectively.
Accounting for Stock-Based Compensation: The Company measures compensation cost for stock-based compensation under the expense recognition provisions of Accounting Principles Board Opinion No. 25 (Opinion 25), Accounting for Stock Issued to Employees and related interpretations. Under this method, compensation cost is the excess, if any, of the quoted market price at grant date or other measurement date over the amount an employee must pay to acquire the stock.
Changes in Accounting Principles:
Statement of Position 98-7 (SOP 98-7), Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk Effective January 1, 2000, the Company adopted the provisions of SOP 98-7 which provide guidance on applying the deposit method of accounting to insurance and reinsurance contracts that do not transfer insurance risk. The effect of the adoption of SOP 98-7 on the Company's financial position and results of operations was immaterial.
Financial Accounting Standards Board Interpretation No. 44 (Interpretation 44), Accounting for Certain Transactions Involving Stock Compensation
Effective July 1, 2000, the Company adopted the provisions of Interpretation 44 which clarify the application of Opinion 25. The adoption of the Interpretation had no effect on the Company's financial position or results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Accounting Pronouncements Outstanding:
Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, and Statement of Financial Accounting Standards No. 138 (SFAS 138), Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No.
In 1998, the FASB issued SFAS 133 which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. SFAS 133 specifies a special method of accounting for certain hedging transactions, prescribes the type of items and transactions that may be hedged, and provides the criteria which must be met in order to qualify for hedge accounting.
The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation as follows:
Fair value hedge. Changes in the fair value of both the derivative and the hedged item attributable to the risk being hedged are recognized in operating earnings.
Cash flow hedge. To the extent it is effective, changes in the fair value of the derivative are recognized as a component of accumulated other comprehensive income in stockholders' equity until the hedged item affects earnings. Any ineffective portion must be recognized in operating earnings at the same time the change in fair value is recognized on the statement of financial condition.
Foreign currency exposures hedge. In a hedge of foreign currency exposures in a net investment in a foreign operation, to the extent the hedge is effective, the change in the fair value of the derivative is treated as a translation gain or loss and recognized in accumulated other comprehensive income offsetting other translation gains and losses arising in consolidation. Any ineffective portion must be recognized in operating earnings at the same time the change in fair value of the derivative is recognized on the statement of financial condition.
For a derivative not designated as a hedging instrument, the gain or loss is recognized in operating earnings in the period of change.
SFAS 138, issued in 2000, addresses several issues that apply to derivative instruments and hedging activities and amends certain accounting and reporting standards of SFAS 133.
The Company will adopt the provisions of SFAS 133 and SFAS 138 effective January 1, 2001. The adoptions of these pronouncements are not expected to have a material impact on the Company's financial position or results of operations.
Statement of Financial Accounting Standards No. 140 (SFAS 140), Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities SFAS 140 was issued in September 2000 and replaces Statement of Financial Accounting Standards No. 125. SFAS 140 revises the standards for accounting and reporting for transfers and servicing of financial assets and extinguishments of liabilities. SFAS 140 is effective for transfers occurring after March 31, 2001. The adoption of SFAS 140 is not expected to have a material impact on the Company's financial position or results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
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 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.
Merger Expenses
During 1999, the Company recognized expenses related to the merger and the early retirement offer to employees as follows (in millions):
Employee related expense consists of employee severance costs, change in control 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 change in control costs were $60.2 million, and costs associated with the vesting of restricted stock were $17.5 million.
Exit activities related to duplicate facilities/asset abandonments consisted of closing of duplicate offices and the write-off of redundant computer hardware and software. The cost associated with these office closures was approximately $25.6 million, which represents the cost of future minimum lease payments less any estimated amounts recovered under subleases. Also, certain physical assets, primarily computer equipment, redundant systems, and systems incapable of supporting the combined entity, were abandoned as a result of the merger, resulting in a write-down of the assets' book values by approximately $41.8 million.
The exit plan was complete as of June 30, 2000.
The expenses related to the merger reduced 1999 earnings $184.7 million before tax and $139.6 million after tax. The expense related to the early retirement offer reduced earnings $125.9 million before tax and $81.8 million after tax.
Additionally during 1999, 0.5 million shares of outstanding restricted stock became unrestricted and stock options on 5.3 million shares became immediately exercisable effective with the merger, in accordance with Unum's and Provident's restricted stock and stock option plan provisions concerning a change in control. The expense related to restricted stock vesting has been included in merger related expenses. The Company applies Opinion 25 and related interpretations in accounting for the stock option plans. Accordingly, no compensation cost was recognized for stock option vesting.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 2--Merger - Continued
Accounting Policy Changes
Generally, because of the effort and time involved, reviews and updates of assumptions related to benefit liabilities are periodically undertaken over time and are reflected in the calculation of benefit liabilities as completed. Many factors influence assumptions underlying reserves, and considerable judgment is required to interpret current and historical experience underlying all of the assumptions and to assess the future factors that are likely to influence the ultimate cost of settling existing claims.
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 GAAP, 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, at June 30, 1999 the Company adopted Provident's method of calculating the discount rate for claim reserves.
The discount rates affected by this change in Unum's methodology were as follows:
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 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 during the second quarter.
Subsequent to the merger date, the Company began to integrate the valuation procedures of the two organizations to provide for a more effective linking of pricing and reserving assumptions and to facilitate a more efficient process for adjusting liabilities to emerging trends. Included in this integration activity were a review and an update of assumptions that underlie policy and contract benefit liabilities. The purpose of the study was to confirm or update the assumptions which were viewed as likely to affect the ultimate liability for contract benefits. Accordingly, as a result of the merger, the Company accelerated the performance of its normal reviews of the assumptions underlying reserves to determine the assumptions that the newly merged Company will use in the future for pricing, performance management, and reserving.
The review resulted in an increase in the benefits and reserves for future benefits for the Company's domestic and Canadian group long-term disability unpaid claim liabilities. As a result of the review, the Company increased its policy and contract benefit liabilities $359.2 million, which reduced 1999 earnings $359.2 million before tax and $233.5 million after tax.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 2--Merger - Continued
The increase in policy and contract benefit liabilities primarily resulted from revisions to assumptions in the following three key components: claim termination rates, incurred but not reported (IBNR) factors, and discount rates. These components and their effect on the reserve increase are summarized and discussed below (in millions).
Claim termination rates $ 372.6 Incurred but not reported factors 101.4 Discount rates (114.8) ------- Net change $ 359.2 =======
The assumptions concerning claim termination rates relate to changes in the estimated average length of time a claim is open (duration) and the ultimate cost of settling claims. Recent trends indicate the duration of a disability claim is increasing. Claim termination rates are based on industry experience adjusted for Company historical and anticipated experience, which considers emerging trends and Company actions that would have a material effect on claim termination rates.
The increase in policy and contract benefit liabilities that results from the revised claim termination rates is attributable to two elements. The first element is the claim resolution assumption, which is the portion of claim terminations related to the disabled returning to work or the expiration of the benefit period. The second element is the mortality assumption, which is the portion of claim terminations that result from death of the disabled. The effect of these two elements on the increase in policy and contract benefit liabilities is discussed below.
Claim resolution assumptions have been determined considering both external trends and the Company's current and planned actions which would have a material effect on claim resolution rates. Due to the high variability in claim resolution rates, considerable judgment is required in setting claim resolution assumptions. Revised claim resolution assumptions have been determined after consideration of the merger integration plans, including the short-term disruption of the claims management process from integration activities. Other factors considered included emerging external trends, such as the developing trend for some claimants to remain on claim longer, current and historical claim resolution experience, industry claim resolution experience, and changes in planned actions, as well as the anticipated future effectiveness of the claims operations in settling existing claims. The revised assumptions for claim resolution rates resulted in an increase in benefit liabilities of approximately $194.8 million. These estimates rely on the Company's ability to complete integration and claims processing changes as planned and those changes having the anticipated impact on claim recovery rates.
The review also examined assumptions for mortality. Revision of mortality assumptions resulted in an increase in benefit liabilities of approximately $177.8 million. Mortality is a critical factor influencing the length of time a claimant receives monthly disability benefits. Mortality has been improving for the general population, and this improvement is now considered permanent. Life expectancy has been extended dramatically for individuals suffering from acquired immune deficiency syndrome (AIDS). Early observations of this trend and related medical literature raised questions concerning the long-term sustainability of the mortality improvements. The Company also assumed that, if the trend did continue, many of the individuals responding positively to treatment could be returned to productive employment.
The previous review of mortality performed by the Company did not indicate a need to change mortality assumptions. However, recent analysis indicates that the improved mortality trend is sustainable and that rehabilitation of afflicted individuals to return to work has been minimally successful to date. AIDS related disabilities are approximately 2 percent of the Company's total disability claims. In addition to the AIDS mortality trend, the recent review demonstrates that survival from other frequently fatal diseases such as cancer and heart disease has improved over recent periods and is now judged to be more permanent due to advances in medical sciences and treatments. While the treatment advances have lengthened life expectancies, they do not always result in the claimant being able to return to work; thus, the ultimate level of payments to be made on a disability claim increases. Of the total increase in benefit liabilities for revised mortality assumptions, $85.4 million is related to AIDS related disabilities and $92.4 million to cancer and other disabilities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 2--Merger - Continued
The second component of the increase in benefit liabilities is the provision for claims incurred but not yet reported, which resulted in an increase in benefit liabilities of $101.4 million. This provision is an estimate of the outstanding liability related to claims that have been incurred by individual insureds as of the valuation date, but the claims have not yet been reported to the Company. This liability is affected by the estimate of the number of outstanding claims. Because of the long elimination periods, generally 90 to 180 days or longer, the development of the factors must cover a period of sufficient length to mitigate the effects of random fluctuations and to establish the presence of trends. Recent trends indicate an increase in new claim rates which results in an increase in the estimate of outstanding claims. Another item affecting this liability is the estimate of the average cost of each outstanding claim. The lengthening of time a claimant receives monthly benefits resulting from the factors noted above also results in an increase in the estimate of the average cost of each claim.
The third component of the change in benefit liabilities is the change in the rate used to discount claim reserves, including IBNR reserves, which resulted in a decrease of $114.8 million in benefit liabilities. Subsequent to the merger, the Company significantly restructured the investment portfolio backing these liabilities with the objective of improving asset and liability management and improving yield. As part of this strategy, during the third quarter of 1999, the Company sold $426.1 million of assets with a book yield of 5.98 percent and purchased $546.6 million of assets with a yield of 8.87 percent, improving the overall yield on the assets backing liabilities. As a result of this investment restructuring and consistent with its policy, the Company increased the rate used to discount claim reserves to 7.35 percent, resulting in a decrease of $114.8 million in benefit liabilities.
Results of Operations
The results of operations for the separate companies and the combined amounts for the periods prior to the merger were as follows:
Included in Unum's net loss for the 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 loss 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 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 3--Fair Values of Financial Instruments
The carrying amounts and fair values of the Company's financial instruments are as follows:
The following methods and assumptions were used by the Company in estimating the fair values of its financial instruments:
Fixed Maturity Securities: Fair values are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments. See Note 4 for the amortized cost and fair values of securities by security type and by maturity date.
Equity Securities: Fair values are based on quoted market prices.
Mortgage Loans: Fair values are estimated using discounted cash flow analyses, using interest rates currently being offered for similar mortgage loans to borrowers with similar credit ratings and maturities. Mortgage loans with similar characteristics are aggregated for purposes of the calculations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 3--Fair Values of Financial Instruments - Continued
Policy Loans: At December 31, 2000, the carrying amounts approximate fair value. At December 31, 1999, fair values were estimated using discounted cash flow analyses based on interest rates current at that time.
Short-term Investments, Cash and Bank Deposits, and Deposit Assets: Carrying amounts approximate fair value.
Policyholders' Funds: The carrying amount for deferred annuity products approximate fair value. Other policyholders' funds include guaranteed investment contacts (GICs) and supplementary contracts without life contingencies. Fair values for GICs are estimated using discounted cash flow calculations, based on current market interest rates available for similar contracts with maturities consistent with those remaining for the contracts being valued. The carrying amount for supplementary contracts without life contingencies approximates fair value.
Fair values for insurance contracts other than investment contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.
Short-term Debt: The carrying amounts approximate fair value.
Long-term Debt and Company-Obligated Mandatorily Redeemable Preferred Securities: Fair values were obtained from independent pricing services or discounted cash flow analyses based on current incremental borrowing rates for similar types of borrowing arrangements.
Derivatives: Fair values are based on market quotes or pricing models and represent the net amount of cash the Company would have received or paid if the contracts had been settled or closed on December 31.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4--Investments
Securities
The amortized cost and fair values of securities by security type are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4--Investments - Continued
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4--Investments - Continued
The amortized cost and fair values of fixed maturity securities by maturity date are shown below. The maturity dates have not been adjusted for possible calls or prepayments.
At December 31, 2000, the total investment in below-investment-grade fixed maturity securities (securities rated below Baa3 by Moody's Investors Service or an equivalent internal rating) was $1,760.8 million or 6.6 percent of invested assets. The amortized cost of these securities was $2,161.1 million.
Deposit assets in the form of marketable securities held in trust are reported in miscellaneous assets in the consolidated statements of financial condition. Unrealized gains (losses) on these securities were $23.6 million and $(25.9) million, respectively, at December 31, 2000 and 1999.
Adjustments to reserves for future policy and contract benefits that would have been necessary if the unrealized investment gains and losses related to the available-for-sale securities had been realized as of December 31, 2000 and 1999, were $36.0 million and $(123.1) million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4--Investments - Continued
The components of the change in net unrealized gains on securities included in other comprehensive income (loss) are as follows:
Mortgage Loans
Mortgage loans are impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The reported investment in mortgage loans considered to be impaired was $17.7 million and $18.1 million, respectively, at December 31, 2000 and 1999. Included in the impaired loans at December 31, 2000 were loans of $6.5 million which had a related allowance for losses of $2.4 million and loans of $11.2 million which had no related allowance for losses. Included in the impaired loans at December 31, 1999 were loans of $6.6 million which had a related allowance for losses of $2.4 million and loans of $11.5 million which had no related allowance for losses.
Investment Valuation Allowances
Additions to the investment valuation allowances represent realized investment losses, and deductions represent the allowance released upon disposal or restructuring of the related asset. Changes are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4--Investments - Continued
Net Investment Income
Sources for net investment income are as follows:
Note 5--Derivative Financial Instruments
The Company uses swaps, forwards, futures, and options to hedge interest rate and currency risks and to match assets with its insurance liabilities.
Derivative Risks
The basic types of risks associated with derivatives are market risk (that the value of the derivative will be adversely impacted by changes in the market, primarily the change in interest and exchange rates) and credit risk (that the counterparty will not perform according to the terms of the contract). The market risk of the derivatives should generally offset the market risk associated with the hedged financial instrument or liability.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 5--Derivative Financial Instruments - Continued
To help limit the credit exposure of the derivatives, the Company has entered into master netting agreements with its counterparties whereby contracts in a gain position can be offset against contracts in a loss position. The Company also typically enters into bilateral, cross-collateralization agreements with its counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a loss position to submit acceptable collateral with the other counterparty in the event the net loss position meets or exceeds an agreed upon amount. The Company's current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position, was $73.8 million at December 31, 2000.
Hedging Activity
The table below summarizes by notional amounts the activity for each category of derivatives.
Additions and terminations reported above for futures and options include roll activity, which is the closing out of an old contract and initiation of a new one when a contract is about to mature but the need for it still exists.
The following table summarizes the timing of anticipated settlements of interest rate swaps outstanding at December 31, 2000, whereby the Company receives a fixed rate and pays a variable rate. The weighted average interest rates assume current market conditions.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 5--Derivative Financial Instruments - Continued
Hedging programs for derivative activity are as follows:
Program 1
The Company has executed a series of cash flow hedges in the group disability, individual disability, and group single premium annuities portfolios using interest rate swaps, forwards, futures, and options. The purpose of these hedges is to lock in the reinvestment rates on future cash flows and protect the Company from the potential adverse impact of declining interest rates on the associated policy reserves. The Company uses futures contracts to partially offset hedges on fixed maturity securities purchased prior to the termination date of interest rate swaps and forwards. The Company also uses futures contracts to replace terminated forwards and interest rate swaps in order to maintain hedges until the fixed maturity securities are purchased. The notional amount outstanding for these cash flow hedges was $1,075.0 million, $1,482.9 million, and $1,285.0 million at December 31, 2000, 1999, and 1998, respectively. The deferred gain on these contracts was $82.3 million, $94.0 million, and $63.7 million, at December 31, 2000, 1999, and 1998, respectively.
In 2000, 1999, and 1998, the Company amortized into net investment income $3.5 million, $3.1 million, and $1.9 million, respectively, of the deferred gains from this program. Realized investment gains from this program during 2000 were $6.3 million. Realized investment gains and losses from this program during 1999 and 1998 were immaterial.
At December 31, 2000 and 1999, the Company had an unrealized gain of $123.1 million and $0.3 million, respectively, on the open interest rate swaps, forwards, and futures. These derivatives are scheduled to be terminated in the years 2000 through 2003 as assets are purchased with the future anticipated cash flows.
Future contracts to hedge anticipated cash flows have also been utilized for other product portfolios. At December 31, 2000, the Company had no open contracts for other product portfolios.
Program 2
In 1998 and 1997, the Company sold indexed annuity products whereby a portion of the crediting rate on the annuity was based on the performance of the S&P 500 stock index. In order to hedge this fluctuating credit rate, the Company purchased options with the S&P 500 stock index as the underlying item. These options will be settled with a net cash payment to the Company at the expiration date if the S&P 500 index moves above the option contract's strike price; otherwise, no cash payment will take place at expiration. At December 31, 2000 and 1999, the outstanding notional amount of these options was $7.3 million for both years, and the fair values and carrying amounts were $4.3 million and $5.9 million, respectively.
Program 3
In 1999, the Company entered into a foreign currency interest rate swap to hedge its currency risk in Japan. The notional amount of this swap was $8.2 million and terminated as scheduled in 2000. Additionally, the Company entered into several foreign currency interest rate swaps to hedge the currency risk of certain foreign currency denominated fixed income securities purchased in 1999 and 2000. The notional amount outstanding for these currency hedges was $28.1 million and $12.3 million, at December 31, 2000 and 1999, respectively. The derivatives are scheduled for termination in the years 2006 through 2010. The unrealized gain on these swaps at December 31, 2000 and 1999 was $4.1 million and $0.2 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 5--Derivative Financial Instruments - Continued
Program 3 - Continued
In 1997, the Company borrowed $168.3 million through a private placement with an investor in the United Kingdom. Upon issuance of the borrowing, the Company entered into foreign currency and interest rate swap agreements that converted the principal amount to U.S. dollars and the interest obligation on the debt from a pound sterling based fixed rate to a U.S. dollar fixed rate. The private placement issue was settled in 1999, and the hedging arrangement was terminated.
Program 4
In 1999, the Company entered into an interest rate swap to convert a variable rate security into a fixed rate security. The notional amount for this interest rate swap is $60.0 million and is scheduled for termination in 2007. Income from settlements of payment streams on this interest rate swap agreement was $0.2 million and $0.8 million for 2000 and 1999, respectively. At December 31, 2000 and 1999, the Company had an unrealized gain of $4.7 million and an unrealized loss of $2.9 million, respectively, on this swap.
Program 5
In 1998 and 1997, the Company opened interest rate futures contracts and wrote options on interest rate futures in order to hedge the borrowing rate on the anticipated refinancing of long-term debt. The Company realized a $10.3 million before-tax investment loss when these contracts were terminated. The loss on these contracts was deferred and is being amortized as an adjustment to interest and debt expense.
At December 31, 2000, the Company had no open contracts under this program.
Program 6
The Company routinely uses forwards and futures to protect margins by reducing the risk of changes in interest rates between the time of asset purchase and the associated sale of an asset or sale of new business.
Gains or losses on termination of these forwards and futures are deferred and reported as an adjustment of the carrying amount of the hedged asset or liability and amortized into earnings over the lives of the hedged items. The net deferred gain associated with this activity was $25.4 million and $26.7 million at December 31, 2000 and 1999, respectively.
The deferred gain amortized into earnings was $1.3 million for each of the years ended December 31, 2000, 1999, and 1998.
At December 31, 2000, the Company had no open contracts under this program.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 6--Value of Business Acquired
A reconciliation of value of business acquired is as follows:
The estimated net amortization of value of business acquired for each of the next five years is $45.6 million in 2001, $44.2 million in 2002, $42.8 million in 2003, $41.2 million in 2004, and $39.8 million in 2005. Acquisition and disposition activity relates to certain reinsurance transactions. See Note 13.
Note 7--Liability for Unpaid Claims and Claim Adjustment Expenses
Changes in the liability for unpaid claims and claim adjustment expenses are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 7--Liability for Unpaid Claims and Claim Adjustment Expenses - Continued
The majority of the net balances are related to disabled lives claims with long- tail payouts on which interest earned on assets backing liabilities is an integral part of pricing and reserving. Interest accrued on prior year reserves has been calculated on the opening reserve balance less one-half year's cash payments at the average reserve discount rate used by the Company during 2000, 1999, and 1998. During 1999, unpaid claims incurred for prior years increased primarily due to changes in reserves as disclosed in Notes 2 and 13.
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 were expected to be reported during 1999 and were expected to be affected by the claims operations integration activities. The $153.0 million claim reserve increase represented 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 believed the reserve adjustment was required based upon the integration plans it had in place and to which it had 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 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 were distracted from normal claims management activities as a result of planning and implementing the integration of the two companies' claims organizations. In addition, employee turnover and additional training 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. Prior to the merger, during the first six months of 1999 approximately 90 claims managers and benefit specialists spent nearly 40 percent of their time developing the detailed integration plans. Effective with the merger, virtually all claims personnel were involved in the process of implementing the new work processes and required training. Implementation and related systems conversions continued into the second quarter of 2000. However, due to actions taken by management to mitigate effects on resolution rates, the effect on new claim resolution rates was not material after the end of 1999.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 7--Liability for Unpaid Claims and Claim Adjustment Expenses - Continued
Actions by management to mitigate the effect on resolution rates included 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 is modified 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 were expensed in the period incurred and were 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), were 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 were lower than the first and second quarters because all claims personnel were expected to be involved in the implementation and training efforts. The effect of integration activities on new claim resolution rates was not material after 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 showed 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 were very different from the Paul Revere acquisition, the claims integration activities were similar, and the Paul Revere experience was relevant. The primary circumstances that created claims disruption for Paul Revere were the initial lack of clarity of the organization, process, and structure, the need to plan for a significant transition to new claims processes, and the training and implementation related to those changes. All of those elements impacted the Company as a result of the merger. One primary difference was that the duration of the potential disruption in the merger was 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 provided 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 would not change. The historical experience of Paul Revere provided a statistical reference for the expected experience for the Company when adjusted for the projected effects of the claims integration plans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 7--Liability for Unpaid Claims and Claim Adjustment Expenses - Continued
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 included $153.0 million as the estimated value of projected additional claim payments resulting from these claims operations integration activities. This 1998 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. Quarterly information concerning the estimated and actual impact of the claims operations integration activities is shown below. The $7.5 million favorable variance from assumptions for the year was reflected in 1999 earnings.
Note 8--Federal Income Taxes
A reconciliation of the income tax (benefit) attributable to continuing operations computed at U.S. federal statutory tax rates to the income tax expense (credit) as included in the consolidated statements of operations follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 8--Federal Income Taxes - Continued
Deferred income tax liabilities consist of the following:
Under the Life Insurance Company Tax Act of 1959, life companies were required to maintain a policyholders' surplus account containing the accumulated portion of current income which had not been subjected to income tax in the year earned. The Deficit Reduction Act of 1984 requires that no future amounts be added after 1983 to the policyholders' surplus account. Further, any future distributions from the account would become subject to federal income taxes at the general corporate federal income tax rate then in effect. The amount of the policyholders' surplus account at December 31, 2000, is approximately $233.4 million. Future distributions from the policyholders' surplus account are deemed to occur if a statutorily prescribed maximum for the account is less than the value of the account or if dividend distributions exceed the total amount accumulated as currently taxable income in the year earned. If the entire policyholders' surplus account were deemed distributed in 2001, this would result in a tax of approximately $81.7 million. No current or deferred federal income taxes have been provided on these amounts because management considers the conditions under which such taxes would be paid to be remote.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 8--Federal Income Taxes - Continued
The Company's consolidated statements of operations include the following amounts of income (loss) subject to foreign taxation and the related foreign income tax expense (credit):
For most of the Company's subsidiaries, tax years through 1995 are closed to further assessment by the Internal Revenue Service (IRS). During 2000, the IRS continued its examination of subsequent years. Management believes any future adjustments that may result from IRS examinations of tax returns will not have a material impact on the financial position, liquidity, or results of operations of the Company.
During 1999, the Company reached a settlement with the IRS relating to its federal income tax liability for the 1986 through 1992 tax years. Results for the year ended December 31, 1999 increased $36.8 million due to settlements of these prior year tax issues.
The Company's subsidiaries had net operating loss carryforwards of approximately $641.7 million, alternative minimum tax credit carryforwards of approximately $11.7 million, and capital loss carryforwards of $1.9 million as of December 31, 2000. The majority of the net operating loss carryforwards will begin to expire, if not utilized, in 2015; the alternative minimum tax credits do not expire; the capital loss carryforwards begin expiring in 2005.
Federal income taxes paid during 2000, 1999, and 1998 were $165.6 million, $77.8 million, and $104.8 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 9--Debt and Company-Obligated Mandatorily Redeemable Preferred Securities
Debt
Short-term debt consists of the following at December 31 (in millions):
In April 2000, the Company issued $200.0 million of variable rate notes in a privately negotiated transaction. The notes are due in April 2001 and were used to refinance other short-term debt and had a weighted average interest rate of 7.33 percent during 2000.
Long-term debt consists of the following:
In October 2000, the Company entered into $1.0 billion senior revolving credit facilities with a group of banks. The facilities, which are split into five-year revolver and 364-day portions, replaced a 364-day revolver which expired in October 2000 and a five-year revolver which has been canceled. Interest is variable based upon a London Interbank Offered Rate (LIBOR) plus a margin or an alternate base rate. At December 31, 2000, approximately $551.0 million was available for additional financing under the Company's revolving credit facilities.
In August 2000, the Company filed with the Securities and Exchange Commission a shelf registration statement on Form S-3 covering the issuance of up to $1.0 billion of securities in order to provide funding alternatives for its maturing debt. The shelf registration became effective in September 2000, but as of December 31, 2000, no securities had been issued.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 9--Debt and Company-Obligated Mandatorily Redeemable Preferred Securities - Continued
Commercial paper debt is due within one year, but has been classified as long- term at December 31, 2000 because the Company has the ability through the new senior revolving credit facilities to convert this obligation into longer-term debt. The Company intends to refinance the commercial paper either by issuing additional commercial paper or by replacing commercial paper debt with long-term debt issued under the currently effective shelf registration statement.
Of the $1,615.5 million of long-term debt at December 31, 2000, $449.0 million will mature in 2001, $35.0 million will mature in 2002, $20.0 million will mature in 2003, and $1,111.5 million will mature in 2005 and thereafter.
Interest paid on short-term and long-term debt during 2000, 1999, and 1998 was $156.9 million, $115.2 million, and $100.5 million, respectively.
Company-Obligated Mandatorily Redeemable Preferred Securities
In March 1998, Provident Financing Trust I, a wholly-owned subsidiary trust of the Company, issued $300.0 million of 7.405% capital securities in a public offering. These capital securities, which mature on March 15, 2038, are fully and unconditionally guaranteed by the Company, have a liquidation value of $1,000 per capital security, and have a mandatory redemption feature under certain circumstances. The Company issued $300.0 million of 7.405% junior subordinated deferrable interest debentures which mature on March 15, 2038, to the subsidiary trust in connection with the capital securities offering. The sole assets of the subsidiary trust are the junior subordinated debt securities.
Interest costs related to these securities are reported in the consolidated statements of operations as a component of interest and debt expense. Interest paid on these securities during 2000, 1999, and 1998 was $22.2 million, $22.2 million, and $11.1 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 10--Pensions and Other Postretirement Benefits
The Company sponsors several defined benefit pension and postretirement plans for its employees, including non-qualified pension plans. The following tables provide the changes in the benefit obligation and fair value of plan assets and statements of the funded status of the plans.
During the fourth quarter of 2000, the Company, through its defined benefit pension plan, purchased a single premium annuity to fund the Company's retirement benefit obligation for approximately 3,000 retirees. This transaction resulted in a gain of $116.1 million before tax, or $75.5 million after tax.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 10--Pensions and Other Postretirement Benefits - Continued
At December 31, 2000, the plan assets include 448,784 shares of the Company's common stock with a fair value of $12.1 million. The amount of dividends paid during 2000 was not material.
The weighted average assumptions used in the measurement of the Company's benefit obligation are as follows:
For measurement purposes, the annual rate of increase in the per capita cost of covered health care benefits assumed for 2001 was 7.5 percent. The rate range was assumed to change gradually to a rate of 5.5 percent for 2004 and remain at that level thereafter.
A one percent increase or decrease in the assumed health care cost trend rate at December 31, 2000 and 1999 would have an insignificant impact on the net periodic postretirement benefit cost and postretirement benefit obligation.
The following table provides the components of the net periodic benefit cost (credit) and early retirement cost for the plans described above.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 11--Stockholders' Equity and Earnings Per Share
Preferred Stock
In accordance with the restated certificate of incorporation, the Company has 25,000,000 shares of preferred stock authorized with a par value of $0.10 per share. No preferred shares have been issued to date.
During February 1998, the Company redeemed its 8.10% cumulative preferred stock outstanding of $156.2 million.
Earnings Per Common Share
The computations of earnings per common share and earnings per common share assuming dilution are as follows:
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 results would be antidilutive, such as when a net loss is reported or if options are out of the money. Approximately 10.7 million, 3.7 million, and 2.4 million options for the years ended December 31, 2000, 1999 and 1998, respectively, were not considered dilutive due to the options being out of the money. In-the-money options to purchase approximately 3.1 million common shares for the year ended December 31, 1999, were not considered dilutive due to net losses being reported for the period.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 12--Incentive Compensation and Stock Purchase Plans
Annual Incentive Compensation
The Company has several annual incentive plans for certain employees and executive officers that are designed to encourage achievement of certain goals. Compensation cost recognized in the consolidated statements of operations for annual incentive plans is $28.8 million, $6.6 million, and $38.1 million for 2000, 1999, and 1998, respectively.
Stock Plans
Under the Stock Plan of 1999 (Stock Plan), the Company has available up to 7,500,000 shares of common stock for awards to its employees, officers, producers, and directors. Awards may be in the form of stock options, stock appreciation rights, restricted stock awards, dividend equivalent awards, or any other right or interest relating to stock. The number of shares available to be issued as restricted stock or unrestricted stock awards is limited to 2,250,000 shares. The exercise price for stock options issued under the Stock Plan shall not be less than the fair market value of the Company's stock as of the grant date. The options have a maximum term of ten years after the date of grant.
Prior to the Stock Plan, the Company had various stock option and stock award programs. For all stock option plans the exercise price of each option was not less than the fair market value of the Company's stock at the date of grant. In accordance with stock plan provisions, outstanding stock options and restricted stock became immediately exercisable as a result of a change in control (see Note 2).
Summaries of the Company's stock options issued under the various plans are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 12--Incentive Compensation and Stock Purchase Plans - Continued
Employee Stock Purchase Plan (ESPP)
Substantially all of the Company's employees are eligible to participate in an ESPP. Under the plan, up to 1,460,000 shares of the Company's common stock are authorized for issuance. Stock may be purchased at the end of each financial quarter at a purchase price of 85 percent of the lower of its beginning or end of quarter market prices. The Company sold 201,626; 86,497; and 75,575 shares to employees with a weighted average exercise price of $16.73, $31.71, and $39.00 in 2000, 1999, and 1998, respectively.
Compensation Cost Under the Fair Value Approach (SFAS 123)
The Company applies Opinion 25 and related interpretations in accounting for the stock option plans and ESPP. Accordingly, no compensation cost has been recognized for these plans. Compensation cost for the Company's stock option plans and ESPP under the fair value approach was estimated as of the grant date using Black-Scholes option pricing models.
The weighted average assumptions used in estimating compensation cost for the Company during 2000 and 1999 and for the Provident plans in 1998 are as follows:
Assumptions used in estimating compensation cost for Unum plans in 1998 are as follows:
Volatility 23.8% to 26.4% Risk-free Rate of Return 4.2% to 5.3% Dividend Payout Rate 1.0% Time of Exercise 4 to 8 years Weighted Average Fair Value of Options Granted During the Year $12.88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 12--Incentive Compensation and Stock Purchase Plans - Continued
Had compensation cost for these plans been determined in accordance with the provisions of SFAS 123, the Company's net income (loss) and net income (loss) per common share would have been as follows:
Note 13--Reinsurance
In the normal course of business, the Company assumes reinsurance from and cedes reinsurance to other insurance companies. The primary purpose of ceded reinsurance is to limit losses from large exposures; however, if the assuming reinsurer is unable to meet its obligations, the Company remains contingently liable. The Company evaluates the financial condition of reinsurers and monitors concentration of credit risk to minimize this exposure. The reinsurance receivable at December 31, 2000, relates to over 140 reinsurance relationships. Of the five major relationships which account for approximately 75 percent of the reinsurance receivable amount at December 31, 2000, all are with companies rated A or better by A.M. Best Company or are fully securitized by investment-grade fixed maturity securities held in trust.
Reinsurance activity is accounted for on a basis consistent with the terms of the reinsurance contracts and the accounting used for the original policies issued. Premium income and policyholder benefits are presented in the consolidated statements of operations net of reinsurance ceded. The total amounts deducted for reinsurance ceded are as follows:
Year Ended December 31 2000 1999 1998 (in millions of dollars) -----------------------------------------
Premium Income $665.3 $508.3 $544.5 Policyholder Benefits 820.8 695.5 575.2
Premium income assumed was $618.1 million, $576.7 million, and $489.0 million during 2000, 1999, and 1998, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
Effective January 1, 2000, an insurance subsidiary of the Company reinsured the inforce individual disability income block of business of the New York Life Insurance Company through a 100 percent indemnity modified coinsurance agreement. The Company paid a ceding commission of $88.0 million which is being amortized as earnings emerge from the business assumed.
During 2000 the Company entered into a 100 percent indemnity coinsurance agreement to cede the future claim payments on one of its insurance subsidiaries' long duration group long-term disability claims which were incurred prior to January 1, 1996. Total policy reserves ceded were approximately $177.9 million. The agreement was effective January 1, 2000. The gain on the transaction was immaterial.
Effective July 1, 2000, the Company entered into various reinsurance agreements with Reassure America Life Insurance Company (Reassure America), an affiliate of Swiss Re Life & Health America Inc., under which Reassure America reinsured on a 100 percent indemnity coinsurance basis substantially all of the individual life insurance and corporate-owned life insurance policies written by the Company's insurance subsidiaries, as well as a small block of individually underwritten group life insurance. Reassure America has a current A.M. Best rating of A++ (superior). In consideration of the transfer of reserves, the Company received a ceding commission of $601.0 million. Total liabilities of $3,346.8 million and policy loans of $2,040.9 million were assumed by Reassure America. The $388.2 million before-tax and $252.3 million after-tax gain on these transactions was deferred and is being amortized into income based upon expected future premium income on the traditional insurance policies ceded and estimated future gross profits on the interest-sensitive insurance policies ceded.
Centre Life Reinsurance Limited
In 1996, the Company executed a definitive reinsurance agreement with Centre Life Reinsurance Limited (Centre Re), a Bermuda-based reinsurance specialist, for reinsurance coverage of the existing United States non-cancellable individual disability active life reserves of one of the Company's insurance subsidiaries, Unum Life Insurance Company of America. This agreement reinsures all claims incurred on or after January 1, 1996. The Company has the right, but no obligation, to recapture the business after six years without penalty. Under the agreement, Centre Re has an obligation to absorb losses within a defined risk layer. The Company retains the risk for all experience up to Centre Re's defined risk layer, or attachment point. Once the attachment point is reached, Centre Re assumes the risk for all experience up to a contractually defined risk limit. Any experience above Centre Re's defined risk limit reverts back to the Company. As of December 31, 2000, the attachment point had not been reached.
The following discloses the various layers in the agreement at December 31, 2000 (in millions):
Net GAAP Reserves $ 713.2 Experience Layer 385.0 ---------- Attachment Point 1,098.2 Centre Re's Defined Risk Layer 145.4 ---------- Defined Risk Limit $1,243.6 =========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
Under this agreement, the Company funds a trust account equal to the amount of the Company's exposure. This trust account provides security for amounts due by the Company prior to reaching the attachment point. The Company controls the management of the business, including premium collection and claims management, under this agreement. All premiums, less amounts for management expenses and claim payments, are transferred to the trust account on a quarterly basis. The Company also acts as the investment manager for 80 percent of the assets in the trust with Centre Re managing the remaining 20 percent.
This reinsurance agreement transfers risk and is accounted for as a long-duration reinsurance contract in accordance with the provisions of Statement of Financial Accounting Standard No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. The underlying operating results of this contract are reflected in other income, and any realized gains or losses from sales of assets are reflected as realized investment gains and losses in the Company's consolidated statements of operations.
Included in miscellaneous assets in the consolidated statements of financial condition at December 31, 2000, is a deposit asset for this reinsurance arrangement of approximately $410.6 million. The deposit asset is comprised of the Company's experience layer and unrealized gains or losses on the marketable securities held in the trust. Unrealized gains or losses on marketable securities held in the trust and the related effects on claim reserves are included in other comprehensive income (loss) in the equity section of the Company's consolidated statements of financial condition.
Other Reinsurance Operations
The Company's reinsurance operations include the reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk assumption, which includes reinsurance pool participation; direct reinsurance which includes accident and health (A&H), long-term care (LTC), and long-term disability coverages; and Lloyd's syndicate participations. During 1999, the Company concluded that these operations were not solidly aligned with the Company's strength in the disability insurance market. The Company decided to exit these operations through a combination of a sale, reinsurance, and/or placing certain components in run-off. In 1999, the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities and reinsured the Company's risk participation in these facilities. The Company also decided to discontinue its London accident reinsurance pool participation beginning in year 2000. With respect to Lloyd's, the Company implemented a strategy which limited participation in year 2000 underwriting risks, ceased participation in Lloyd's underwriting risks after year 2000, and managed the run-off of its risk participation in open years of account of Lloyd's reinsurance syndicates. During the first quarter of 2001, the Company entered into an agreement in principle to limit its liabilities pertaining to the Lloyd's syndicate participations.
The table below summarizes the charges recognized by the Company during 2000 and 1999 related to the reinsurance operations (in millions).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
A discussion of these charges is as follows:
North American Reinsurance Operations
Loss on Sale of A&H and LTC Reinsurance Management Operations
In 1999 the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities to American United Life Insurance Company (AUL) and also reinsured the Company's risk participation in these facilities with AUL (see below). Certain risks related to prior operations were not assumed by AUL. The terms of the sale required the Company to continue to participate in certain of the reinsurance facilities in year 2000, thereby assuming underwriting risks. A before-tax loss of $12.9 million, including the write-off of $6.0 million of goodwill related to this portion of the operations, was recognized during 1999.
Loss on Reinsurance of A&H and LTC Risk Participations
The Company entered into a separate indemnity reinsurance agreement with AUL whereby AUL would assume the Company's existing risk participation in the A&H and LTC reinsurance facilities. As a result, the Company recognized a 1999 before-tax loss of $12.7 million.
Provision for Losses on Retained Business
The reinsurance pool business consists of more than 20 different pool facilities, the majority of which are managed by D&H and a few pools 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 $39.1 million during 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.
Also included in the 1999 charge was $3.0 million to recognize the estimated cost of potential uncollectible reinsurance recoveries for two reinsurers who reinsure certain of the Company's reinsurance facilities and who, as the losses have increased, have experienced financial difficulties.
International Reinsurance Operations
Provision for Losses on Lloyd's of London Syndicate Participations
The periodic method of accounting is followed for Lloyd's syndicate participation, which requires premiums to be recognized as revenue over the policy term and claims, including the estimate of claims incurred but not reported, to be recognized as incurred. Throughout 1999, the Company received updated estimates and information about the Lloyd's market from various sources, including managing agents and underwriters of syndicates and published information from Moody's Investors Service. Consistent with overall market trends, the information and loss estimates received indicated significant deterioration in the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
loss experience of open years of account. The deterioration in loss experience related primarily 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. The Company also 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. Market conditions were not expected to improve dramatically in the near term.
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 or 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 $185.0 million was reflected in the Company's income during 1999 for the open years of account 1996 through 1999.
In addition to the risk participation charge, during 1999 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.
As previously stated, during the first quarter of 2001, the Company entered into an agreement in principle to limit its liabilities pertaining to the Lloyd's syndicate participations.
Provision for Losses on Reinsurance Pool Participations Other than Lloyd's
In connection with the development of the cost of exiting the reinsurance operations, during 1999 the Company updated its review of reserves related to non-Lloyd's reinsurance operations as well as future costs associated with managing the run-off of the retained reinsurance pools liabilities. Based upon this review, the Company increased reserves related to its participation in certain managed and non-managed reinsurance facilities by $21.9 million in 1999.
During 2000, the Company recognized $37.4 million of additional charges related to the run-off of the Company's London accident reinsurance pool participation. During 1999, the Company recorded charges resulting from its decision to exit these pools, but at that time there was insufficient information to fully evaluate all of the exposures. Working with the pool managers in London, the Company revised its estimates to reflect current and expected trends in claims experience and expenses. The 2000 charge included an increase of $21.9 million in claim reserves for certain of the reinsurance pools and $15.5 million related to uncollectible receivables and loss provisions.
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 impairment has occurred. Following the poor results of the reinsurance operations in the first quarter of 1999, the Company updated the goodwill recoverability test using the most current results and forecasts. The goodwill recoverability test used the held-for-use model that compares the undiscounted cash flows of these operations to determine whether those cash flows can recover the unamortized goodwill. After factoring in the first quarter 1999 results and the revised forecasts current at that time, future undiscounted cash flows were insufficient to recover the entire goodwill amount, indicating that the goodwill was impaired. Goodwill recoverability testing of these operations performed prior to March 31, 1999 had indicated that the goodwill was not impaired.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13--Reinsurance - Continued
As a result of the impairment, the Company calculated the estimated fair value of these operations. 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. The estimated fair value was compared to the 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 management operations using the held-for-sale model, which compares the carrying value of the asset with the fair value less costs to sell. This resulted in an additional write-down of goodwill in the amount of $2.0 million.
Following the write-downs of $27.0 million and $2.0 million, the Company's remaining unamortized goodwill related to its reinsurance operations was $53.7 million. Of the $31.0 million unamortized balance attributable to the A&H and LTC business being sold, $6.0 million was determined to be unrecoverable and was written off and included in the $12.9 million loss on the sale reported above. The balance of $25.0 million was recovered through the sales proceeds when the sale closed. The remaining unamortized balance of $22.7 million was determined to be unrecoverable based on revised earnings forecasts for the reinsurance operations and was written off during the third quarter of 1999. The total write-down of goodwill was $51.7 million during 1999, exclusive of the $6.0 million included in the loss on the sale.
Retained Risks
The Company has provided its best estimate of the cost of known losses. Under this exit strategy, the Company retained certain risks, including the exposure associated with disputes arising from reinsurance pools disclosed in Note 15.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 14--Segment Information
Selected data by segment is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 14--Segment Information - Continued
Included in benefits and expenses above is amortization of deferred policy acquisition costs, value of business acquired, and goodwill. Amortization of these items by segment is as follows:
Note 15--Commitments and Contingent Liabilities
Commitments
During 2000, the Company entered into an agreement to sell Provident National Assurance Company, an inactive subsidiary of the Company. The transaction, which was subject to regulatory approval, closed in the first quarter of 2001.
Contingent Liabilities
In 1997 two alleged class action lawsuits were filed in Superior Court in Worcester, Massachusetts (Superior Court) against UnumProvident and several of its subsidiaries, The Paul Revere Corporation, The Paul Revere Life Insurance Company, The Paul Revere Variable Annuity Insurance Company, The Paul Revere Protective Life Insurance Company, and the Company. One of the lawsuits purports to represent all career agents of subsidiaries of The Paul Revere Corporation (Paul Revere) whose employment relationships ended on June 30, 1997 and were offered contracts to sell insurance policies as independent producers. The other purports to represent independent brokers who sold certain Paul Revere individual disability income policies with benefit riders. Motions filed by UnumProvident and affiliates to dismiss most of the counts in the complaints, which allege various breach of contract and statutory claims, have been denied. A hearing to determine class certification was heard on December 20, 1999 in Superior Court. The court certified a class for the independent brokers and has denied class certification for the career agents. UnumProvident and affiliates appealed the class certification for the independent brokers, but the appeal was denied. Summary judgment motions were heard on November 10, 2000, and all motions from plaintiffs and defendants were denied. A trial date for the class action is set for March 26, 2001. UnumProvident and affiliates have filed a conditional counterclaim in the class action which requests a substantial return of commissions should the Superior Court agree with the plaintiffs' interpretation of the contracts. The career agent plaintiffs have re-filed, but not served, their complaint seeking class
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 15--Commitments and Contingent Liabilities - Continued
action status by limiting the issues to those in the certified broker class action. UnumProvident and affiliates believe that they have strong defenses to both lawsuits and plans to vigorously defend their position.
In addition, the same plaintiffs' attorney who had initially filed the class action lawsuits has filed 50 individual lawsuits on behalf of current and former Paul Revere sales managers alleging various breach of contract claims. UnumProvident and affiliates filed a motion in federal court to compel arbitration for 17 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 federal court denied 15 of those motions and granted two. UnumProvident and affiliates appealed the denial of the 15 motions before the First Circuit Court of Appeals, but the District Court decision was affirmed. The two cases set for arbitration should be heard in 2001, but plaintiffs have appealed the arbitration ruling to the First Circuit Court of Appeals. Oral argument has been set for March 7, 2001. Eight of the other cases are tentatively set to begin trials in 2002. UnumProvident and affiliates believe that they have strong defenses and plans to vigorously defend their position in these cases. Although the individual lawsuits described above 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.
During September and October 1999, the Company and several of its officers were named as defendants in five class action lawsuits filed in the United States District Court for the District of Maine. On January 3, 2000, the Maine district court appointed a lead class action plaintiff and ordered plaintiffs to file a consolidated amended complaint. On January 27, 2000, a sixth complaint against the same defendants was filed in the Southern District of New York. On March 7, 2000, the sixth action was transferred to the District of Maine, and that action was voluntarily dismissed by the plaintiff on June 12, 2000. On February 23, 2000, two consolidated amended class action complaints were filed against the same defendants. The first amended class action complaint asserts a variety of claims under the Securities Exchange Act of 1934, as amended, on behalf of a putative class of shareholders who purchased or otherwise acquired stock in the Company or Unum between February 4, 1998 and February 9, 2000. The second amended complaint asserts a variety of claims under the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended, on behalf of a putative class of shareholders who exchanged the common stock of Unum or Provident for the Company's stock pursuant to the joint proxy/registration statement issued in connection with the merger between Unum and Provident. The complaints allege that the defendants made false and misleading public statements concerning, among other things, Unum's and the Company's reserves for disability insurance and pricing policies, the Company's merger costs, and the adequacy of the due diligence reviews performed in connection with the merger. The complaints seek money damages on behalf of all persons who purchased or otherwise acquired Company or Unum stock in the class period or who were issued Company stock pursuant to the merger.
On April 10, 2000, the defendants filed a motion to dismiss the complaints. On January 8, 2001, the district court affirmed a Recommended Decision by the Magistrate Judge, entered November 8, 2000, that granted in part, and denied in part, the motion. The district court granted the motion to dismiss plaintiff's claims (i) under Section 10(b) of the Securities Exchange Act of 1934, (ii) under Section 14(a) of the Securities Exchange Act of 1934 on behalf of the former shareholders of Unum Corporation, and (iii) under Section 12(a) of the Securities Act of 1933 on behalf of purchasers of UnumProvident stock after the merger. The district court also dismissed plaintiff's claims relating to disclosures regarding the costs associated with Unum's exit from its reinsurance business, but otherwise denied defendants' motion to dismiss plaintiff's claims under Sections 11 and 12(a) (2) of the Securities Act of 1933 and the claim under Section 14(a) of the Securities Exchange Act of 1934.
On February 16, 2001, each defendant answered the complaint by denying generally the material allegations of the complaint. On January 30, 2001, the district court issued an Amended Scheduling Order that, among other things, ordered all discovery to be complete by July 10, 2001, and directed that the case be prepared for trial in November 2001. Pre-trial discovery is now underway. The Company disputes the claims alleged in the complaint and plans to vigorously contest them.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 15--Commitments and Contingent Liabilities - Continued
In certain reinsurance pools associated with the Company's reinsurance businesses there are disputes among the pool members and reinsurance participants concerning the scope of their obligations and liabilities within the complex pool arrangements, including pools for which subsidiaries of the Company acted either as pool managers or underwriting agents, as pool members or as reinsurers. The Company or the Company's subsidiaries either have been or may in the future be brought into disputes, arbitration proceedings, or litigation with other pool members or reinsurers of the pools in the process of resolving the various claims. See Note 13 for further discussion regarding reinsurance pool participation.
Various other lawsuits against the Company have arisen in the normal course of its business. Contingent liabilities that might arise from such other litigation are not deemed likely to materially affect the financial position or results of operations of the Company.
Note 16--Statutory Financial Information
Statutory Net Income (Loss), Capital and Surplus, and Dividends
The Company's insurance subsidiaries' statutory net income (loss), as reported in conformity with statutory accounting practices prescribed by state regulatory authorities, for the years ended December 31, 2000, 1999, and 1998, was $353.5 million, $(233.7) million, and $227.0 million, respectively. Statutory net gain (loss) from operations was $414.8 million, $(220.7) million, and $266.2 million for the years ended December 31, 2000, 1999, and 1998, respectively. Excluding the expenses related to the merger and early retirement offer and the changes in reserves as discussed in Note 2, the federal income tax refund activity, and the reinsurance operations charges, the Company's insurance subsidiaries' statutory net gain from operations was $21.0 million for the year ended 1999. Statutory capital and surplus at December 31, 2000 and 1999, was $3,263.0 million and $2,718.1 million, respectively.
Regulatory restrictions limit the amount of dividends available for distribution to the Company from its insurance subsidiaries without prior approval by regulatory authorities. Generally, that limitation equals the greater of ten percent of an insurer's statutory surplus as regards policyholders as of the preceding year end or the statutory net gain from operations, excluding realized investment gains and losses, of the preceding year. Based on the applicable restrictions, $359.9 million will be available for the payment of dividends to the Company from its top-tier domestic insurance subsidiaries during 2001. The Company also has the ability to draw a dividend from its United Kingdom subsidiary, Unum Limited. Such dividends are limited based on insurance company legislation in the United Kingdom, which requires a minimum solvency margin. The amount available under current law for payment of dividends to the Company from Unum Limited during 2001 is approximately $20.9 million. Regulatory restrictions do not limit the amount of dividends available for distribution to the Company from its non-insurance subsidiaries.
Permitted Statutory Accounting Practices
The Company's insurance subsidiaries prepare their statutory-basis financial statements in accordance with accounting practices prescribed or permitted by the National Association of Insurance Commissioners (NAIC) and the applicable state regulatory authorities. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the NAIC. Currently, permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, may differ from company to company within a state, and may change in the future. At December 31, 2000, the Company had not applied any permitted accounting practices that differed from prescribed statutory accounting practices that had a material impact on the financial position or results of operations of the insurance subsidiaries.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 16--Statutory Financial Information - Continued
The NAIC and the insurance subsidiaries' states of domicile have approved a codification of statutory accounting practices effective January 1, 2001, which will serve as a comprehensive and standardized guide to statutory accounting principles. The codification changes, to some extent, the accounting practices that the Company's insurance subsidiaries use to prepare their statutory financial statements. The cumulative effect of changes in accounting principles adopted to conform to the codification of statutory accounting principles will be reported as an adjustment to statutory surplus as of January 1, 2001. Based on preliminary estimates, the Company believes that these accounting changes will have a positive impact on consolidated statutory surplus for the Company's insurance subsidiaries.
Deposits
At December 31, 2000, the Company's insurance subsidiaries had on deposit with regulatory authorities securities with a book value of $1,407.6 million held for the protection of policyholders.
Note 17--Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations for 2000 and 1999:
During the third quarter of 1999, the Company incurred net charges of $592.2 million before tax ($436.2 million after tax) related to reserve increases, reinsurance operation activities, and merger costs, partially offset by interest income on a federal income tax refund. During the second quarter of 1999, the Company incurred net charges of $508.8 million before tax ($350.3 million after tax) related to reserve increases and merger and early retirement
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 17--Quarterly Results of Operations (Unaudited) - Continued
costs. During the first quarter of 1999, the Company incurred net charges of $101.1 million before tax ($88.0 million after tax) related to reserve increases and reinsurance operation activities. See notes preceding for further discussion.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors
The information required by this Item with respect to directors is included under the caption "Information Concerning the Nominees" of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held May 10, 2001, and is incorporated herein by reference.
Executive Officers of the Registrant
The executive officers of the Company, all of whom are also executive officers of certain principal subsidiaries, were elected to serve for one year or until their successors are chosen and qualified.
Mr. Chandler originally became Chairman of the Company on April 28, 1996, and President and Chief Executive Officer of the Company's predecessor, Provident Life and Accident Insurance Company of America, effective November 8, 1993. On June 30, 1999, in connection with the merger with Unum, he became President and Chief Operating Officer of the Company, relinquishing the offices of Chairman and CEO. He reassumed the offices of Chairman and CEO of the Company on November 1, 1999 following the retirement of James F. Orr, III.
Mr. Watjen became Executive Vice President, Finance, of the Company on June 30, 1999 and assumed the additional Risk Management responsibilities on November 1, 1999. Prior to the merger with Unum, he was Vice Chairman and Chief Financial Officer of the Company, positions he assumed on March 26, 1997. He became Executive Vice President and Chief Financial Officer on July 1, 1994. Prior to joining the Company, he served as a Managing Director of the insurance practice of the investment banking firm, Morgan Stanley & Co., which he joined in 1987.
Mr. Copeland became Executive Vice President and General Counsel of the Company on May 12, 1997 and assumed the additional responsibilities of Executive Vice President, Legal and Administrative Affairs, on June 30, 1999. Prior to joining the Company in May 1997, he was a partner since 1972 in the law firm of Alston & Bird, where he concentrated primarily on matters related to consolidation within the financial services industry.
Mr. Best became Senior Vice President, Customer Service, and Chief Information Officer in March 2000. Following the merger with Unum he became Senior Vice President, Customer Service in June 1999. Prior to the merger he served as Executive Vice President, Customer Service, and Chief Information Officer of the Company beginning in May 1997. He joined the Company as Senior Vice President and Chief Information Officer in July 1994.
Mr. Greving became Senior Vice President, Finance, and Chief Actuary in August 2000. He joined the Company as Senior Vice President and Chief Actuary in April 1997. Prior to joining the Company, he was Executive Vice President and Chief Actuary of Southwestern Financial Services, Corp. from June 1990 until March 1997.
Mr. Mohney became Senior Vice President, Customer Care in December 1999. He had served as Senior Vice President, Claims from June 1997, and Vice President, Claims from October 1994. Mr. Mohney originally joined Accident in 1974.
Mr. Roberts was named Senior Vice President, Underwriting following the merger with Unum. He had served as Executive Vice President of Unum America since 1998. In 1997 he was named Senior Vice President of Unum America's Product Center Group. Prior to that time he had served as Senior Vice President of Long- term Disability for Unum America since 1994. He originally joined Unum America in 1977.
ITEM 11.
ITEM 11. EXECUTIVE AND DIRECTOR COMPENSATION
The information required by this Item is included under the captions "Compensation of Directors" and "Executive Compensation" of the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held May 10, 2001, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is included under the caption "Beneficial Ownership of Company Securities" and under the caption "Security Ownership of Directors and Officers" of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held May 10, 2001, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is included under the caption "Certain Transactions" of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held May 10, 2001, and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
Schedules not referred to have been omitted as inapplicable or because they are not required by Regulation S-X.
(3) Exhibits
See Index to Exhibits on page 108 of this report.
(b) Reports on Form 8-K:
Form 8-K filed on January 3, 2001, reporting changing role for Elaine D. Rosen. Form 8-K filed on February 12 2001, reporting fourth quarter 2000 financial results. Form 8-K filed on March 2, 2001, reporting issuance of 7.625% senior notes.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on March 28, 2001.
UnumProvident Corporation (Registrant)
/s/ J.Harold Chandler ----------------------------------- J. Harold Chandler Chairman, President, and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SCHEDULE I--SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES
UnumProvident Corporation and Subsidiaries
December 31, 2000
*Difference between cost and carrying value results from certain valuation allowances and other temporary declines in value.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UnumProvident Corporation (Parent Company)
STATEMENTS OF FINANCIAL CONDITION
See notes to condensed financial information.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
UnumProvident Corporation (Parent Company)
STATEMENTS OF OPERATIONS
See notes to condensed financial information.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
UnumProvident Corporation (Parent Company)
STATEMENTS OF CASH FLOWS
See notes to condensed financial information.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
UnumProvident Corporation (Parent Company)
NOTES TO CONDENSED FINANCIAL INFORMATION
Note 1--Basis of Presentation
The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of UnumProvident Corporation and Subsidiaries.
Note 2--Surplus Notes of Subsidiaries
At December 31, 2000 and 1999, UnumProvident Corporation (Parent Company) held from its insurance subsidiaries a $150.0 million surplus debenture due in 2006 and a $100.0 million surplus debenture due in 2027. Semi-annual interest payments are conditional upon the approval by the insurance departments of the subsidiaries' states of domicile. The weighted average interest rate for surplus notes of subsidiaries was 8.2 percent in 2000 and 1999, and 8.1 percent in 1998.
Note 3--Other Expenses (Credit)
As reported in Note 10 of the consolidated financial statements of UnumProvident Corporation and Subsidiaries, during 2000 UnumProvident Corporation, through its defined benefit pension plan, purchased a single premium annuity to fund its retirement benefit obligation. This transaction resulted in a gain of $116.1 million and is reported in other expenses (credit).
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
UnumProvident Corporation and Subsidiaries
(Continued on following page)
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
UnumProvident Corporation and Subsidiaries
(continued from preceding page)
(1) Net investment income is allocated based upon segmentation. Each segment has its own specifically identified assets and receives the investment income generated by those assets.
(2) Other operating expenses are allocated to each segment based on activity levels, time information, and usage statistics.
(3) Excludes life insurance.
(4) The individual life line of business, which was previously reported in the Individual segment, is now reported in the Other segment. Prior period results have been reclassified to conform to current reporting.
SCHEDULE IV--REINSURANCE
UnumProvident Corporation and Subsidiaries
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
UnumProvident Corporation and Subsidiaries
(1) Amounts shown in additions charged to cost and expenses represent realized investment losses.
UnumProvident Corporation and Subsidiaries
INDEX TO EXHIBITS
(2.1) Agreement and Plan of Share Exchange between Provident Companies, Inc. (Provident) and Provident Life and Accident Insurance Company of America (America) (incorporated by reference to Exhibit 2.1 of Provident's Form 10-K filed for fiscal year ended December 31, 1995).
(2.2) Amended and Restated Agreement and Plan of Merger dated as of April 29, 1996 by and among Patriot Acquisition Corporation, The Paul Revere Corporation, and Provident (including exhibits thereto), (incorporated by reference to Exhibit 2.1 of Provident's Form 10-Q and Form 10-Q/A filed for fiscal quarter ended September 30, 1996).
(2.3) Agreement and Plan of Merger, dated as of November 22, 1998, between Unum Corporation (Unum) and Provident (incorporated by reference to Exhibit 1 of Provident's Form 8-K filed November 24, 1998).
(3.1) Restated Certificate of Incorporation of UnumProvident Corporation.
(3.2) Amended and Restated Bylaws of the Company.
(4.1) Articles of Share Exchange (incorporated by reference to Provident's Form 10-K for fiscal year ended December 31, 1995).
(10.1) Asset and Stock Purchase Agreement by and between Healthsource and America and its subsidiaries dated December 21, 1994. (incorporated by reference to Exhibit 10.3 of Provident's Form 10-K for fiscal year ended December 31, 1995).
(10.2) Annual Management Incentive Compensation Plan (MICP), adopted by stockholders May 4, 1994, as amended by stockholders May 1, 1996 and May 7, 1997, as restated and amended by stockholders May 6, 1998, and as amended by the Compensation Committee on February 8, 2001.*
(10.3) Stock Option Plan, adopted by stockholders May 3, 1989, as amended by the Compensation Committee on January 10, 1990, and October 29, 1991 (incorporated by reference to Exhibit 10.6 of America's Form 10-K for fiscal year ended December 31, 1991); and as amended by the Compensation Committee on March 17, 1992 and by the stockholders on May 6, 1992 (incorporated by reference to the registrant's Form 10-K filed for the fiscal year ended December 31, 1992). Terminated effective December 31, 1993.
(10.4) Provident Life and Accident Insurance Company (Accident) and Subsidiaries Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.8 of Provident Life Capital Corporation (Capital's) Registration Statement on Form S-1, Registration No. 33-17017). *
(10.5) Form of Surplus Note, dated December 1, 1996, in the amount of $150.0 million executed by Accident in favor of Provident (incorporated by reference to Exhibit 10.7 of Provident's Form 10-K filed for fiscal year ended December 31, 1996).
(10.6) Description of Compensation Plan for Non-Employee Directors Plan (incorporated by reference to Amendment No. 1 to registrant's Form 10-K filed January 27, 1993 on Form 8), and amended by the Board of Directors on February 8, 1994 (incorporated by reference to Exhibit 10.15 of America's Form 10-K filed for fiscal year ended December 31, 1993). Discontinued May 1998.
(10.7) Stock Plan of 1994, originally adopted by stockholders May 5, 1993, as amended by stockholders on May 1, 1996 and on May 7, 1997 and as amended by the Compensation Committee on February 8, 2001. *
(10.8) Employee Stock Purchase Plan (of 1995) adopted by stockholders June 13, 1995 (incorporated by reference to Provident's Form 10-K for fiscal year ended December 31, 1995). *
(10.9) Amended and Restated common stock Purchase Agreement between Provident and Zurich Insurance Company dated as of May 31, 1996 Plan (incorporated by reference to Exhibit 10.15 of Provident's Form 10-K for fiscal year ended December 31, 1996).
(10.10) Amended and Restated Relationship Agreement between Provident and Zurich Insurance Company dated as of May 31, 1996 Plan (incorporated by reference to Exhibit 10.16 of Provident's Form 10-K for fiscal year ended December 31, 1996).
(10.11) Amended and Restated Registration Rights Agreement between Provident and Zurich Insurance Company dated as of May 31, 1996 (incorporated by reference to Exhibit 10.17 of Provident's Form 10-K for fiscal year ended December 31, 1996.)
(10.12) UnumProvident Stock Plan of 1999, adopted by stockholders May 6, 1998, as amended by stockholders June 30, 1999 and as amended by the Compensation Committee on February 8, 2001. *
(10.13) UnumProvident Non-Employee Director Compensation Plan of 1998, adopted by stockholders May 6, 1998 and as amended by the Compensation Committee on February 8, 2001. *
(10.14) Agreement between Provident and certain subsidiaries and American General Corporation and certain subsidiaries dated as of December 8, 1997 (incorporated by reference to Exhibit 3.2 of Provident's Form 10-Q for fiscal quarter ended September 30, 1998).
(10.15) Employment Agreement between the Company and J. Harold Chandler as amended by the Agreement dated November 10, 2000. *
(10.16) Employment Agreement between the Company and F. Dean Copeland (incorporated by reference to Exhibit 10.3 of the Company's Form 10-Q for fiscal quarter ended June 30, 1999). *
(10.17) Employment Agreement between the Company and Elaine D. Rosen as amended by the Agreement dated December 12, 2000. *
(10.18) Employment Agreement between the Company and Thomas R. Watjen (incorporated by reference to Exhibit 10.5 of the Company's Form 10-Q for fiscal quarter ended June 30, 1999). *
(10.19) Employment Agreement between the Company and James F. Orr, III (incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q for fiscal quarter ended June 30, 1999) as amended by the Agreement dated November 1, 1999 between the Company and Mr. Orr (incorporated by reference to the Company's Form 10-K for fiscal year ended December 31, 1999). *
(10.20) Form of Change in Control Severance Agreement (incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q for fiscal quarter ended September 30, 1999). *
(10.21) Unum Deferred Compensation Plan (incorporated by reference to Exhibit 10.1 of Unum's Form 10-K for fiscal year ended December 31, 1995). *
(10.22) Incentive Compensation Plan for Designated Executive Officers (incorporated by reference to Exhibit 10.2 of Unum's Form 10-K for fiscal year ended December 31, 1996). *
(10.23) 1990 Unum Long Term Stock Incentive Plan as amended by the Compensation Committee February 8, 2001. *
(10.24) 1996 Long Term Stock Incentive Plan as amended by the Compensation Committee February 8, 2001. *
(10.25) Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.4 to Unum's Registration Statement on Form S-1 dated June 18, 1986). *
(10.26) UnumProvident Supplemental Pension Plan. *
(10.27) $500 million Five Year Credit Agreement dated as of October 31, 2000 among the Company, Bank of America, N.A. as Administrative Agent, Citicorp, USA, Inc. and Wachovia Bank, N.A. as Co-Syndication Agents, Fleet National Bank as Documentation Agent and the Banks listed therein.
(10.28) $500 million 364-Day Credit Agreement dated as of October 31, 2000 among the Company, Bank of America, N.A. as Administrative Agent, Citicorp, USA, Inc. and Wachovia Bank, N.A. as Co-Syndication Agents, Fleet National Bank as Documentation Agent and the Banks listed therein.
(10.29) Administrative Reinsurance Agreement between Provident Life and Accident Insurance Company and Reassure America Life Insurance Company dated to be effective July1, 2000 (incorporated by reference to the Company's Form 8-K filed March 2, 2001).
(10.30) Augmenting Agreement dated November 6, 2000 among the Company, Bank of America, N.A. as Administrative Agent, and the Royal Bank of Canada relating to $500 million Five Year Credit Agreement.
(10.31) Augmenting Agreement dated November 6, 2000 among the Company, Bank of America, N.A. as Administrative Agent, and the Royal Bank of Canada relating to $364-Day Credit Agreement.
(10.32) 2000 Annual Incentive Plan.*
(11) Statement re computation of per share earnings (incorporated herein by reference to "Note 11 of the Notes to Consolidated Financial Statements").
(12.1) Statement Regarding Computation of Ratio of Earnings to Fixed Charges.
(12.2) Statement Regarding Computation on Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends.
(21) Subsidiaries of the Company.
(23.1) Consent of Independent Auditors.
(23.2) Consent of Independent Auditors.
(24) Powers of Attorney
- -------------------------- * Management contract or compensatory plan required to be filed as an exhibit to this form pursuant to Item 14(c) of Form 10-K.
The total amount of securities authorized pursuant to any instrument defining rights of holders of long-term debt of the Company does not exceed 10 percent of the total assets of the Company and its consolidated subsidiaries. The Company will furnish copies of any such instrument to the Securities and Exchange Commission upon request.