Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934 for the fiscal year ended December 31, 2001.
Commission file number 1-11834
UnumProvident Corporation
(Exact name of registrant as specified in its charter)
Delaware 62-1598430
(State of other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1 FOUNTAIN SQUARE
CHATTANOOGA, TENNESSEE 37402
(Address of principal executive offices)
423.755.1011
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common stock, $0.10 par value New York Stock Exchange
6.75% Notes, due 2028 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
As of March 18, 2002, there were 242,861,945 shares of the registrant's common
stock outstanding. The aggregate market value of the shares of common stock,
based on the closing price of those shares on the New York Stock Exchange, Inc.,
held by non-affiliates was approximately $6.1 billion.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the annual meeting of shareholders to be
held May 15, 2002 are incorporated by reference into Part III.
TABLE OF CONTENTS
PART I
Page
Cautionary Statement Regarding Forward-Looking Statements ............ 1
1. Business ............................................................. 2
A. General ......................................................... 2
B. Business Strategies ............................................ 4
C. Reporting Segments ............................................. 5
D. Reinsurance .................................................... 9
E. Reserves ....................................................... 10
F. Investments...................................................... 11
G. Competition .................................................... 11
H. Regulation ..................................................... 11
I. Risk Factors ................................................... 12
J. Selected Data of Segments ...................................... 14
K. Employees ...................................................... 14
2. Properties .......................................................... 15
3. Legal Proceedings ................................................... 15
4. Submission of Matters to a Vote of Security Holders ................. 15
PART II
5. Market for the Registrant's Common Equity and Related Stockholder
Matters ........................................................... 16
6. Selected Financial Data ............................................. 17
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations ............................................. 18
7A. Quantitative and Qualitative Information about Market Risk .......... 42
8. Financial Statements and Supplementary Data ......................... 43
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .............................................. 92
PART III
10. Directors and Executive Officers of the Registrant .................. 93
11. Executive and Director Compensation ................................. 94
12. Security Ownership of Certain Beneficial Owners and Management ...... 94
13. Certain Relationships and Related Transactions ...................... 94
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .... 95
Signatures .......................................................... 96
Index to Exhibits ................................................... 107
PART I
Cautionary Statement Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the Act) provides a
"safe-harbor" for forward-looking statements which are identified as such and
are accompanied by the identification of important factors which could cause
actual results to differ materially from the forward-looking statements.
UnumProvident Corporation (the Company) claims the protection afforded by the
safe harbor in the Act. Certain information contained in this discussion, or in
any other written or oral statements made by the Company, is or may be
considered as forward-looking. Examples of disclosures that contain such
information include, among others, sales estimates, income projections, and
reserves and related assumptions. Forward-looking statements are those not based
on historical information, but rather relate to future operations, strategies,
financial results, or other developments. These statements may be made directly
in this document or may be made part of this document by reference to other
documents filed with the Securities and Exchange Commission by the Company,
which is known as "incorporation by reference." You can find many of these
statements by looking for words such as "may," "should," "believes," "expects,"
"anticipates," "estimates," "intends," "projects," "goals," "objectives," or
similar expressions in this document or in documents incorporated herein.
These forward-looking statements are subject to numerous assumptions, risks, and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by the forward-looking statements include, among others, the
following possibilities:
. Insurance reserve liabilities can fluctuate as a result of changes
in numerous factors, and such fluctuations can have material
positive or negative effects on net income.
. Actual persistency may be lower than projected persistency,
resulting in lower than expected revenue and higher than expected
amortization of deferred policy acquisition costs.
. Incidence and recovery rates may be influenced by, among other
factors, the emergence of new diseases, new trends and developments
in medical treatments, and the effectiveness of risk management
programs.
. Retained risks in the Company's reinsurance operations, including
the credit risk of the reinsurers, are influenced by many factors.
Any material changes in these factors can have material positive or
negative effects on results.
. Effectiveness in supporting new product offerings and providing
customer service may not meet expectations.
. Sales growth may be less than planned, which will impact revenue and
profitability.
. Actual experience may deviate from that assumed in pricing and
underwriting.
. Competitive pressures in the insurance industry may increase
significantly through industry consolidation, competitor
demutualization, or otherwise.
. General economic or business conditions, both domestic and foreign,
may be less favorable than expected, which can impact premium
levels, claims experience, and investment results, including credit
deterioration of investments.
. Legislative or regulatory changes may adversely affect the
businesses in which the Company is engaged.
. Changes in the interest rate environment may adversely affect
reserve and policy assumptions and ultimately profit margins.
. The level and results of claim-related litigation may vary from that
previously experienced by the Company's insurance subsidiaries.
. Events or consequences relating to terrorism and acts of war, both
domestic and foreign, which are in many respects unpredictable, may
adversely affect the Company's business and may also affect the
availability and cost of reinsurance.
For further discussion of risks and uncertainties which could cause actual
results to differ from those contained in the forward-looking statements, see
"Risk Factors" contained herein in Item 1.
All subsequent written and oral forward-looking statements attributable to the
Company or any person acting on its behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to in this section.
The Company does not undertake any obligation to release publicly any revisions
to such forward-looking statements to reflect events or circumstances after the
date of this document or to reflect the occurrence of unanticipated events.
1
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 and Japan. 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, (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 and
return-to-work capabilities 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 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.
2
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.
Through the continued development of Unum Japan Accident Insurance Company
Limited (Unum Japan), 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.
Subsequent to the merger, the Company continued to enter into transactions
designed to more closely focus its operations on its core businesses. During
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 2000, the Company 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. Separately, the
Company reinsured on a 100 percent indemnity coinsurance basis the future claim
payments on long duration group long-term disability claims in Paul Revere Life
which were incurred prior to January 1, 1996. The Company also entered into a
reinsurance agreement under which Unum America now cedes, through a net quota
share reinsurance agreement, 50 percent of the group life volume above Unum
America's aggregate retention limit.
During 2001, the Company entered into an agreement in principle to limit its
liabilities pertaining to the Lloyd's syndicate participations. Separately, the
Company also reinsured 100 percent of the group disability reinsurance reserves
and all future business underwritten and managed by Duncanson and Holt Services,
Inc., a subsidiary of D&H, effective January 1, 2001. In a separate but related
transaction, the Company also sold the reinsurance management operations of
Duncanson and Holt Services, Inc. and divested the remaining assets of that
facility.
In 2001, the Company acquired the assets of EmployeeLife.com, an Internet
Capital Group partner company. This new subsidiary, Benefit Technologies, Inc.
(doing business under the name BenefitAmerica), will enhance customer service by
offering Internet business solutions to help employers efficiently manage and
administer employee benefits. The Company also acquired Resource Opportunities,
Inc. (ROI), a national provider of medical and vocational case management
services. ROI will improve GENEX's ability to service its customers, in turn
benefiting the Company's insurance customers.
Also in 2001, the Company sold Provident National Assurance Company, an inactive
insurance subsidiary. 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.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the "Notes to Consolidated Financial Statements" contained
herein in Items 7 and 8 for further discussion.
3
Business Strategies
The Company's objective is to grow its business and further enhance
profitability by providing:
Comprehensive Solutions for Income Protection and Related Needs
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.
Benefits Emphasizing Return to Work
The Company's organization and range of offerings are designed to help employers
better manage lost time from the workplace and improve productivity.
Impairment-based Claims Management with a Clinical Focus: The Company has
--------------------------------------------------------
made considerable investments in clinical resources and created a
specialty process for handling long-duration claims based on the type of
injury or illness. This process, along with the more than 80 physicians in
14 subspecialties, 300 centralized clinical and vocational specialists,
and 1000 more who are field-based, is designed to promote return-to-work
and absence management.
Return to Work (RTW) Program Planning: The Company offers a combination of
-------------------------------------
web-based resources and access to RTW planners to provide employers
opportunities to impact their workplace productivity by strategically
designing and formalizing RTW programs. Some customers using the Company's
customized RTW program have experienced a significant reduction in lost
work days and medical costs.
Family Medical Leave Act (FMLA) Absence Management: Offering
--------------------------------------------------
administration and compliance for complex FMLA and state leave
regulations, the Company's FMLA services unit can help employers improve
absence management.
Integrated Disability Management: By combining the Company's early
--------------------------------
intervention, rehabilitation, and cost containment resources with the
worker's compensation provider a customer chooses, employers are offered
the benefit of integrated reporting and disability case management.
4
Comparative Reporting and Analysis: With web-based access to the Company's
----------------------------------
private disability database, customers can compare their claim results
with those of peer companies to allow analysis of trends in their claim
experience with others in their industry. This provides them with a tool
to focus on changes in plan design or internal corporate policies needed
to promote return-to-work.
Highly Responsive Service for Customers and their Advisors
The Company is committed to providing a high quality service experience for all
customers and their advisors. Through a variety of technology tools and trained
service professionals, the Company offers a service environment designed to be
responsive, timely, and a committed to service excellence.
A suite of services is in place to support customers and their advisors. For
advisors, the Company offers Internet-based portal access to work in process and
marketing materials. Dedicated service professionals respond to requests for
individual sales proposals. Dedicated account management service professionals
in local sales offices assist both advisors and customers in plan design,
contract implementation, and service delivery. For advisors, the Company offers
technology and call center supported contracting and compensation administration
services that are designed to make it easy to do business.
The Company's employer customers are assigned service professionals in local
sales offices to support and address their implementation and ongoing service
needs. Larger employer customers are also assigned Customer Care (claims
management and return-to-work services) account managers located in the home
office who can provide support for several ongoing programs. There are regional
service teams that manage the administration of the account, including
contracts, booklets, and billing. The Company offers a wide array of electronic
services, including its BenefitManager webpage, electronic booklets and billing,
enrollment options including the Internet and interactive voice response, and
call centers dedicated to enrollment support. Employer customers have access to
a local service specialist regardless of size. Larger cases with more than 2000
insured lives have a wider array of technology tools as well as dedicated
national practice account managers available to service the account in the local
sales office. The national practice account managers are complemented with home
office based account managers when the needs of the customer dictate this
solution. The Company also offers technology enabled call center access to
service professionals who are connected via a common voice technology network.
The Benefit America service offering includes web-enabled, self-service benefit
administration solutions for employers and their employees.
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,
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.
5
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 $2,721.4 million of premium income in 2001. Group
life generated $1,338.7 million of premium income in 2001.
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 begin after a waiting 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.
6
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
$1,647.8 million of premium income in 2001. Individual long-term care premium
income totaled $180.3 million in 2001.
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 waiting 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 during 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.
7
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 a waiting
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
$790.7 million in 2001.
The life insurance products principally include universal life,
interest-sensitive whole life, and term 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, as well as lump sum specified critical illness
coverage. 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 2001, the Company entered
into an agreement to limit its liabilities pertaining to the Lloyd's syndicate
participations. Separately, the Company also reinsured 100 percent of the group
disability reinsurance reserves and all future business underwritten and managed
by Duncanson and Holt Services, Inc. The transaction had an effective date of
January 1, 2001. The Company also sold the reinsurance management operations of
Duncanson and Holt Services, Inc. and divested the remaining assets of that
facility during 2001. See Note 13 of the "Notes to Consolidated Financial
Statements" for further discussion of the reinsurance operations.
8
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. In general, 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.
Furthermore, the Company's catastrophic coverage for the year 2002 limits its
exposure for any accident involving three or more lives in a single event. The
2002 catastrophic reinsurance provides worldwide coverage for all life and
disability insured risks with a $20.0 million deductible. Coverage for 2002
includes risk sharing of 28 percent of direct claims above the $20.0 million
deductible, but less than $50.0 million, 100 percent of direct claims over $50.0
million but less than $100.0 million, and 25 percent of direct claims over
$100.0 million but less than $150.0 million. The coverage is not limited if the
event is caused by acts of war or terrorism. The Company's 2001 catastrophic
coverage had a $2.0 million deductible per event and full loss coverage for up
to $100.0 million of direct claims. Present conditions in the reinsurance market
made it difficult to duplicate in 2002 the catastrophe coverage program in place
for 2001.
The amount of risk retained by the Company on individual disability income
products varies by policy type and year of issue. Other than the catastrophic
coverage, 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, and consideration of the need for collateral, such as letters of
credit or trust agreements. The Company also assumes reinsurance from other
insurers. The reinsurance receivable at December 31, 2001 relates to
approximately 315 reinsurance relationships. Of the seven major relationships
which account for approximately 78 percent of the reinsurance receivable amount
at December 31, 2001, all are with companies rated A or better by A.M. Best
Company or are fully securitized by letters of credit and/or investment-grade
fixed maturity securities held in trust.
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 the Company's
reinsurance activities.
9
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. For further discussion of
reserves, refer to the critical accounting policies in "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and Note 2 of the
"Notes to Consolidated Financial Statements" contained herein in Items 7 and 8.
10
Investments
Investment activities are an integral part of the Company's business, and
profitability is significantly affected by investment results. The Company's
investment portfolio was $28.3 billion, or over 65 percent of total assets, at
December 31, 2001, and in 2001 net investment income was over 21 percent of the
Company's total revenue. Refer to "Risk Factors", the investment section in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", and Notes 4 and 5 of the "Notes to Consolidated Financial
Statements" contained herein in Items 7 and 8 for information on the Company's
investments and derivative financial instruments.
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 2001,
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, and
New York 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, and New York. 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,
2001, were above the ranges that would require regulatory action. See further
discussion under "Risk Factors-Capital Adequacy."
11
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. In 2001 the
NAIC adopted revisions to the individual and group disability RBC formula
associated with the risk of loss from adverse mortality and morbidity
experience. These formula revisions, which were effective December 31, 2001,
resulted in a reduction to the minimum risk-based capital requirements for the
Company's group disability business. The change in the risk-based capital
requirements for individual disability was not significant.
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. 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.
12
Both economic and societal factors can affect claim incidence for disability
insurance. The relationship between these factors and overall incidence is very
complex and will vary due to contract design features and the degree of
expertise within the insuring organization to price, underwrite, and adjudicate
the claims. Within the employee benefits market, pricing and renewal actions can
be taken to react to higher claim rates. However, these actions take time to
implement, and there is a risk that the market will not sustain increased
prices. In addition, changes in economic and external conditions may not
manifest themselves in claims experience for several quarters.
The pricing actions available in the individual disability market differ between
product classes. The nature of that portion of the Company's outstanding
insurance business that consists of individual 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 in-force business due to changes resulting from such factors.
Guaranteed renewable contracts can be repriced to reflect external factors, but
rate changes cannot be implemented as quickly as in the employee benefits
market.
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.
Group Life Insurance
Group life insurance may be affected by many factors, including the
characteristics of the employees insured, the amount of insurance employees may
elect voluntarily, the Company's risk selection process, the ability of the
Company to retain employer groups with lower claim incidence rates, and the
geographical concentration of employees. Claim incidence is also influenced by
events such as the September 11,2001 tragedy, which may impact the availability
of reinsurance coverage. Changes in any of these factors may adversely affect
the results of the Company.
Investments
The Company maintains an investment portfolio that is primarily composed of
fixed income securities. The quality and/or yield of the portfolio may be
impacted by a number of factors, including the general economic environment,
changes in the credit quality of the issuer, changes in market conditions,
changes in interest rates, changes in foreign exchange rates, or regulatory
changes. These securities are issued by both domestic and foreign entities and
are backed either by collateral or the credit of the underlying issuer. Factors
such as an economic downturn or political change in the country of the issuer, a
regulatory change pertaining to the issuer's industry, a significant
deterioration in the cash flows of the issuer, or a change in the issuer's
marketplace may adversely impact the Company's ability to collect principal and
interest from the issuer.
The investments held by the Company's insurance subsidiaries are highly
regulated by specific legislation in each state that governs the type, amount,
and credit quality of allowable investments. Legislative changes could force the
Company to restructure the portfolio in an unfavorable interest rate or credit
environment, with a resulting adverse impact on profitability.
The Company uses derivative instruments that are hedging in nature. The
Company's profitability may be adversely impacted if a counterparty to the
derivative defaults in its payment. This default risk is mitigated by
cross-collateralization agreements.
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.
13
In 1974 Congress passed the Employee Retirement Income Security Act (ERISA). The
purpose of ERISA was to reserve for federal authority the sole power to regulate
the field of employee benefits. ERISA eliminated the threat of conflicting or
inconsistent state and local regulation of employee benefit plans. In doing so,
ERISA pre-empted all state laws except those that specifically regulated the
business of insurance. ERISA also provides an exclusive remedial scheme for any
action brought by ERISA plan participants and beneficiaries. ERISA has allowed
plan administrators and plan fiduciaries to efficiently manage employee benefit
plans in the United States. Most group long-term and short-term disability plans
administered by the Company are governed by ERISA. Changes to ERISA enacted by
Congress or via judicial interpretations could adversely impact the risk of
managing employee benefit plans, increase the premiums associated with such
plans, and ultimately impact their affordability.
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, 2001, the Company had approximately 13,100 full-time employees,
including those in its foreign operations. Some employees in Argentina,
comprising approximately one percent of the Company's total workforce, are
members of a union.
14
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. A parking deck is currently under construction on a
portion of the surrounding 25 acres of land used for employee parking. 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 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. The property in the United Kingdom is located in
Dorking, with approximately 70,000 square feet of office space located on
approximately 55 acres with a portion developed for employee parking. The
facility in Argentina is approximately 23,000 square feet of space within a
condominium in Buenos Aries.
Additionally, the Company leases office space, for periods principally from five
to ten years, for use by its affiliates and sales forces.
ITEM 3. LEGAL PROCEEDINGS
Refer to Item 8 Note 15 of the "Notes to Consolidated Financial Statements" for
information on legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
15
PART II
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. Common stock information is shown as follows:
Market Price
-----------------------
High Low Dividend
----------- --------- -----------
2001
1st Quarter $30.4400 $23.8125 $0.1475
2nd Quarter 33.7500 27.0300 0.1475
3rd Quarter 33.0100 22.2500 0.1475
4th Quarter 27.3500 22.4100 0.1475
2000
1st Quarter $31.9375 $11.9375 $0.1475
2nd Quarter 24.6250 14.8125 0.1475
3rd Quarter 27.6875 19.2500 0.1475
4th Quarter 29.7500 25.4375 0.1475
As of March 18, 2002 there were 21,127 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. More information
and an authorization form may be obtained by writing or calling the Company's
transfer agent, EquiServe Trust Company, N.A. 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."
16
ITEM 6. SELECTED FINANCIAL DATA
2001 2000 1999 1998 1997
----------------------------------------------------------------------
(in millions of dollars, except share data)
Statement of Operations Data
Premium Income $ 7,078.2 $ 7,057.0 $ 6,843.2 $ 6,129.0 $ 5,293.1
Net Investment Income 2,002.9 2,060.4 2,059.7 2,035.4 2,015.7
Net Realized Investment Gain (Loss) (40.6) (14.6) 87.1 55.0 11.5
Other Income 354.3 329.5 339.6 299.9 357.0
----------- ----------- ----------- ----------- -----------
Total Revenue 9,394.8 9,432.3 9,329.6 8,519.3 7,677.3
Benefits and Expenses 8,569.7 8,566.7 9,495.1 7,599.1 6,760.6
----------- ----------- ----------- ----------- -----------
Income (Loss) Before Federal Income Tax
and Extraordinary Loss 825.1 865.6 (165.5) 920.2 916.7
Federal Income Tax 243.0 301.4 17.4 302.8 299.1
----------- ----------- ----------- ----------- -----------
Income (Loss) Before Extraordinary Loss 582.1 564.2 (182.9) 617.4 617.6
Extraordinary Loss, Net of Tax (2.9) -- -- -- --
----------- ----------- ----------- ----------- -----------
Net Income (Loss) $ 579.2 $ 564.2 $ (182.9) $ 617.4 $ 617.6
=========== =========== =========== =========== ===========
Per Common Share Information
Net Income (Loss) - Basic $ 2.40 $ 2.34 $ (0.77) $ 2.60 $ 2.62
Net Income (Loss) - Assuming Dilution $ 2.38 $ 2.33 $ (0.77) $ 2.54 $ 2.57
Common Stockholders' Equity at End of Year $ 24.52 $ 23.12 $ 20.73 $ 25.89 $ 23.46
Cash Dividends $ 0.59 $ 0.59 $ 0.58 $ 0.57 $ 0.55
Weighted Average Common Shares
Outstanding (000s)
- Basic 241,824.9 240,880.4 239,080.6 236,975.2 230,741.2
- Assuming Dilution 243,608.7 242,061.0 239,080.6 242,348.9 235,818.2
Financial Position (at End of Year)
Assets $ 42,442.7 $ 40,363.9 $ 38,447.5 $ 38,602.2 $ 37,040.1
Long-term Debt, Subordinated Debt
Securities, and Preferred Stock $ 2,304.2 $ 1,915.5 $ 1,466.5 $ 1,525.2 $ 1,396.2
Stockholders' Equity $ 5,939.9 $ 5,575.5 $ 4,982.2 $ 6,146.2 $ 5,714.1
17
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.
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 emphasizes integrated selling that combines
employee benefit coverages, individual products, and voluntary workplace
products. The Company has closely linked its various incentive compensation
programs to the achievement of its goals for new sales and persistency.
Critical Accounting Policies
Reserves for Policy and Contract Benefits
The two primary categories of liabilities for policy and contract benefits are
policy reserves for claims not yet incurred and claim reserves for claims that
have been incurred and have future benefits to be paid. Policy reserves equal
the present value of the difference between future policy benefits and expenses
and future premiums, allowing a margin for profit. These reserves are applicable
for the majority of the Company's business, which is traditional non-interest
sensitive in nature. The claim payments are estimated using assumptions
established when the policy was issued. Generally accepted accounting principles
require that these assumptions not be subsequently modified unless the policy
reserves are determined to be inadequate. Throughout the life of the policy, the
reserve is based on the original assumptions used for the policy's issue year.
A claim reserve is established when a claim is incurred or is estimated to have
been incurred but not yet reported to the Company. Policy reserves for a
particular policy continue to be maintained after a claim reserve has been
established. Claim reserves generally equal the Company's estimate, at the
current reporting period, of the present value of the liability for future
benefits to be paid on a claim. A claim reserve for a specific claim is based on
assumptions derived from the Company's actual historical experience as to claim
duration as well as the specific circumstances of the claimant such as benefits
available under the policy, the covered benefit period and the age and
occupation of the claimant. Consideration is given to historical trends in the
Company's experience and to expected deviations from historical experience that
result from changes in benefits available, changes in the Company's risk
management policies and procedures, and other economic, environmental, or
societal factors. Reserves for claims that are estimated to have already been
incurred but that have not yet been reported to the Company are based on factors
such as historical claim reporting patterns, the average cost of claims, and the
expected volumes of incurred claims.
Claim reserves, unlike policy reserves, are subject to revision as current claim
experience and projections of future factors impacting claim experience change.
The Company reviews annually, or more frequently as appropriate, emerging
experience to ensure that its claim reserves provide the Company's current
estimate of adequate and reasonable provision for future benefits. This review
includes the determination of a range of reasonable estimates within which the
reserve must fall.
18
Deferred Policy Acquisition Costs
The Company defers certain costs incurred in acquiring new business and
amortizes (expenses) these costs over the life of the related policies. The
Company uses its own historical experience and expectation of the future
performance of its business in determining the expected life of the policies.
Approximately 94 percent of the Company's deferred policy acquisition costs
relates to traditional non interest-sensitive products, for which the costs are
amortized in proportion to the estimated premium income to be received over the
life of the policies. The estimated premium income in the early years of the
amortization period is higher than in the later years due to anticipated policy
lapses, which results in a greater proportion of the costs being amortized in
the early years of the life of the policy. Amortization of deferred costs on
traditional products is adjusted annually to reflect the actual policy lapse
experience as compared to the anticipated experience. The Company will
experience increased amortization if policies terminate earlier than projected.
Deferred costs related to group and individual disability products are amortized
over a twenty-year period. Approximately 60 percent and 85 percent of the
original deferred costs related to group disability products are expected to be
amortized by years ten and fifteen, respectively. For individual disability
policies, approximately 50 percent and 70 percent of the original deferred costs
are expected to be amortized by years ten and fifteen, respectively. Deferred
costs for group life products are amortized over a fifteen-year period, with
approximately 20 percent of the cost expected to remain at year ten.
Valuation of Fixed Maturity Securities
In determining when a decline in fair value below amortized cost of a fixed
maturity security is other than temporary, the Company evaluates market
conditions, relevant industry conditions and trends, rating agency actions,
offering prices, trends of earnings, and other key measures for the related
security. When a decline in value is determined to be other than temporary, the
Company recognizes an impairment loss in the current period results to the
extent of the decline in value.
Private placement fixed maturity securities with a carrying value of
approximately $4.2 billion, or 17.0 percent of total fixed maturity securities
at December 31, 2001, do not have readily determinable market prices. For these
securities, the Company uses internally prepared valuations combining matrix
pricing with vendor purchased software programs, including valuations based on
estimates of future profitability, to estimate the fair value. All such
investments are classified as available for sale. The Company's ability to
liquidate its positions in some of these securities could be impacted to a
significant degree by the lack of an actively traded market, and the Company may
not be able to dispose of these investments in a timely manner. Although the
Company believes its estimates reasonably reflect the fair value of those
securities, the key assumptions about the risk-free interest rates, risk
premiums, performance of underlying collateral (if any), and other factors may
not reflect those of an active market. The Company believes that generally these
private placement securities carry a credit quality comparable to companies
rated Baa by major credit rating organizations.
As of December 31, 2001, the key assumptions used to estimate the fair value of
private placement fixed maturity securities included the following:
. Risk free interest rates of 4.30 percent for five-year maturities to 5.47
percent for 30-year maturities were derived from the current yield curve
for U.S. Treasury Bonds with similar maturities.
. Current Baa corporate bond spreads ranging from 1.48 percent to 2.99
percent plus an additional 30 basis points were added to the risk free
rate to consider the lack of liquidity.
. An additional ten basis points were added to the risk free rates for
foreign investments.
. Additional basis points were added as deemed appropriate for securities in
certain industries that are considered to be of greater risk.
Historically, the Company's realized gains or losses on dispositions of its
private placement fixed maturity securities have not varied significantly from
amounts estimated under the valuation methodology described above.
19
Reinsurance Receivable
Reinsurance is a contractual agreement whereby the Company's reinsurance
partners assume a defined portion of the risk for future benefits payable under
reinsurance contracts. The reinsurance receivable reported as an asset in the
Company's consolidated statements of financial condition includes amounts due
from the Company's reinsurers on current claims and estimates of amounts that
will be due on future claims. Policy reserves and claim reserves reported in the
Company's consolidated statements of financial condition are not reduced for
reinsurance. The reinsurance receivable is generally equal to the policy
reserves and claim reserves related to the risk being reinsured. The Company
reduces the reinsurance receivable if recovery is not likely due to the
financial position of the reinsurer or if there is disagreement between the
Company and the reinsurer regarding the liability of the reinsurer.
Results of Operations
2001 Significant Transactions and Events
The September 11, 2001 tragedy resulted in a 2001 before-tax charge of $24.0
million, or $15.6 million after tax. This charge included estimated gross
ultimate losses from reported and unreported claims of $65.0 million less an
estimated $41.0 million recoverable from the Company's reinsurers. The charge
did not include any indirect costs which the Company incurred in developing
specialized procedures for filing claims resulting from the attacks and in
providing additional support to impacted policyholders and group clients. The
Company's reinsurance program provides a significant layer of catastrophic
coverage for its individual disability and its group life, accidental death and
dismemberment, travel accident, long-term disability, and short-term disability
lines of business through a group of highly rated major national and
international reinsurance organizations. Because of the quality and level of the
Company's various reinsurance coverages, the Company does not anticipate that
any of its reinsurers will be unable to cover the claims incurred as a result of
the events. Should this occur, however, all of the Company's insurance
subsidiaries are sufficiently capitalized such that each insurance subsidiary
will be able to satisfy these claims and will face no liquidity or risk-based
capital issues. The effects on each line of business are disclosed in the
following discussions of segment operating results.
During 2001, the Company entered into an agreement to limit its liabilities
pertaining to the Lloyd's syndicate participations. Separately, the Company also
reinsured 100 percent of the group disability reinsurance reserves and all
future business underwritten and managed by Duncanson and Holt Services, Inc., a
subsidiary of D&H. The transaction, in which reserves of approximately $323.8
million were ceded to the reinsurer, had an effective date of January 1, 2001.
In a separate but related transaction, the Company also sold the reinsurance
management operations of Duncanson and Holt Services, Inc. and divested the
remaining assets of that facility.
During 2001, the Company reinsured on a 100 percent indemnity coinsurance basis
certain cancer policies written by one of the Company's insurance subsidiaries
and ceded approximately $113.6 million of reserves to the reinsurer. The
transaction had an effective date of November 1, 2001.
In 2001, the Company acquired the assets of EmployeeLife.com, an Internet
Capital Group partner company. This new subsidiary, Benefit Technologies, Inc.
(doing business under the name BenefitAmerica), will enhance customer service by
offering Internet business solutions to help employers efficiently manage and
administer employee benefits. The Company also acquired Resource Opportunities,
Inc. (ROI), a national provider of medical and vocational case management
services. ROI will improve GENEX's ability to service its customers, in turn
benefiting the Company's insurance customers.
Also in 2001, the Company sold Provident National Assurance Company, an inactive
insurance subsidiary. 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.
During 2001, the Company wrote off the remaining goodwill balance related to its
operations in Argentina, resulting in a decrease in before-tax and after-tax
operating income of $5.4 million.
In 2001, the Company recognized a tax benefit of $35.2 million related to its
investment in the foreign reinsurance operations, which lowered the 2001 tax
rate below the U.S. federal statutory rate of 35 percent. Additionally, as a
20
result of tax legislation enacted in the United Kingdom during 2000 that allows
additional group tax relief among companies with common ownership, the Company
began recognizing foreign tax benefits during 2001.
During 2001 the Company redeemed its $172.5 million par value 8.8% monthly
income debt securities (junior subordinated debt), which were due in 2025 but
callable at par in 2000 and thereafter. This early redemption is expected to
lower the Company's financing costs in 2002 through the use of commercial paper
available at lower interest rates. The early extinguishment of debt resulted in
a write-off of the remaining deferred debt cost of $4.5 million associated with
the issuance of the securities. The extraordinary loss, net of a $1.6 million
tax benefit, was $2.9 million.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and
No. 142 (SFAS 142), Goodwill and Other Intangible Assets. In accordance with
SFAS 142, goodwill will no longer be amortized but will be subject to annual
impairment tests. Other intangible assets will continue to be amortized over
their useful lives. The Company adopted the provisions of SFAS 141 and SFAS 142
effective January 1, 2002. Application of the non-amortization provision is
expected to increase 2002 earnings $21.3 million before tax and $20.2 million
after tax. In connection with the initial adoption of SFAS 142, the Company will
perform the required transitional goodwill impairment tests. Any impairment loss
resulting from the transitional goodwill impairment tests will be recognized as
the effect of a change in accounting principle and will be presented as a
separate caption, net of tax, in the income statement. The impairment loss, if
any, is not expected to have a material impact on the Company's financial
position or 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 the Company 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 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 that were incurred prior to January
1, 1996. The agreement was effective January 1, 2000.
During 2000, the Company entered into a reinsurance agreement 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.
During 2000, the Company purchased a single premium annuity for its retirees,
which allowed the release of the related pension plan liability and resulted in
a net before-tax gain of $116.1 million. The pension plan transaction enabled
the Company to provide a higher level of administrative service for its retirees
while also locking in favorable pension plan performance.
Also in 2000, the Company increased reserves $65.6 million in the Company's
long-term disability business and $21.9 million in the reinsurance operations,
wrote off assets and established loss provisions of $15.5 million in the
reinsurance operations, and accrued consolidation and benefit expenses of $9.4
million. See the discussions of segment operating results contained herein for
further information.
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
21
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 of dollars):
North American Reinsurance Operations
Loss on Sale of A&H and LTC Reinsurance Management $ 12.9
Operations (includes write-off of $6.0 million of
goodwill)
Loss on Reinsurance of A&H and LTC Risk Participations 12.7
Provision for Losses on Retained Business 42.1
International Reinsurance Operations
Provision for Losses on Lloyd's of London Syndicate
Participations 186.5
Provision for Losses on Reinsurance Pool
Participations Other than Lloyd's 21.9
Goodwill Impairment Excluding Amount Recognized on Sale 51.7
------
Total Before-tax Charge $327.8
======
22
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
(in millions of dollars)
Year Ended December 31
----------------------------------------------------------------
2001 % Change 2000 % Change 1999
-------- -------- --------
Revenue
Premium Income $7,078.2 0.3% $7,057.0 3.1% $6,843.2
Net Investment Income 2,002.9 (2.8) 2,060.4 -- 2,059.7
Other Income 354.3 7.5 329.5 (3.0) 339.6
-------- -------- --------
Total 9,435.4 (0.1) 9,446.9 2.2 9,242.5
-------- -------- --------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 6,234.3 (2.7) 6,407.5 (5.6) 6,787.6
Commissions 782.8 3.8 754.1 (17.5) 913.6
Interest and Debt Expense 169.6 (6.7) 181.8 31.9 137.8
Deferral of Policy Acquisition Costs (695.9) 16.8 (595.7) (26.4) (809.3)
Amortization of Deferred Policy
Acquisition Costs 432.7 (5.2) 456.5 (3.9) 474.8
Amortization of Value of
Business Acquired 48.4 7.6 45.0 17.5 38.3
Amortization of Goodwill 26.6 19.3 22.3 (73.0) 82.6
Operating Expenses 1,571.2 21.3 1,295.2 (30.7) 1,869.7
-------- -------- --------
Total 8,569.7 -- 8,566.7 (9.8) 9,495.1
-------- -------- --------
Income (Loss) Before Federal
Income Tax, Net Realized
Investment Gain (Loss), and
Extraordinary Loss 865.7 (1.6) 880.2 N.M. (252.6)
Federal Income Tax (Credit) 258.1 (16.0) 307.1 N.M. (12.9)
-------- -------- --------
Income (Loss) Before Net Realized
Investment Gain (Loss) and
Extraordinary Loss 607.6 6.0 573.1 N.M. (239.7)
Net Realized Investment Gain (Loss) (25.5) N.M. (8.9) N.M. 56.8
-------- -------- --------
Income (Loss) Before Extraordinary Loss 582.1 3.2 564.2 N.M. (182.9)
Extraordinary Loss (2.9) N.M. -- N.M. --
-------- -------- --------
Net Income (Loss) $ 579.2 2.7 $ 564.2 N.M. $ (182.9)
======== ======== ========
N.M. = not a meaningful percentage
In the following financial statements and discussions of operating results by
segment, "revenue" includes premium income, net investment income, and other
income. "Income" or "loss" excludes federal income tax, net realized investment
gains and losses, and extraordinary losses.
23
Employee Benefits Segment Operating Results
(in millions of dollars)
Year Ended December 31
----------------------------------------------------------
2001 % Change 2000 % Change 1999
-------- -------- --------
Revenue
Premium Income
Group Long-term Disability $2,151.8 3.3% $2,082.7 2.4% $2,034.7
Group Short-term Disability 569.6 10.7 514.4 8.6 473.7
Group Life 1,338.7 12.0 1,194.8 3.2 1,158.2
Accidental Death &
Dismemberment 206.3 10.1 187.3 (1.8) 190.7
Group Long-term Care 81.1 28.1 63.3 47.6 42.9
-------- -------- --------
Total Premium Income 4,347.5 7.5 4,042.5 3.6 3,900.2
Net Investment Income 761.6 8.5 701.8 16.0 604.9
Other Income 178.8 18.2 151.3 7.9 140.2
-------- -------- --------
Total 5,287.9 8.0 4,895.6 5.4 4,645.3
-------- -------- --------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 3,598.8 5.0 3,426.2 (6.5) 3,663.9
Commissions 343.2 6.4 322.5 (2.0) 329.0
Deferral of Policy Acquisition Costs (293.9) 27.0 (231.4) (7.1) (249.2)
Amortization of Deferred Policy
Acquisition Costs 169.6 15.2 147.2 38.1 106.6
Amortization of Value of
Business Acquired 2.0 (16.7) 2.4 (4.0) 2.5
Operating Expenses 938.4 18.1 794.4 2.8 773.1
-------- -------- --------
Total 4,758.1 6.7 4,461.3 (3.6) 4,625.9
-------- -------- --------
Income Before Federal Income
Tax, Net Realized Investment
Gain (Loss), and Extraordinary Loss $ 529.8 22.0 $ 434.3 N.M. $ 19.4
======== ======== ========
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 Company has adjusted its focus within the Employee Benefits segment to
integrated selling that combines long-term disability, short-term disability,
and group life products. During 2001, 28 percent of all new sales included
long-term disability, short-term disability, and group life combined coverage.
This compares to 32 percent and 26 percent for 2000 and 1999, respectively.
24
Sales for Employee Benefits, on both a submitted and effective date basis, are
as follows:
(in millions of dollars)
Year Ended December 31
---------------------------------------------------------
2001 % Change 2000 % Change 1999
-------- -------- --------
Sales - Submitted Date Basis
Group Long-term Disability $ 398.4 19.4% $ 333.8 (13.3)% $ 385.2
Group Short-term Disability 176.9 19.1 148.5 (13.7) 172.0
Group Life 338.4 12.4 301.0 (1.6) 305.8
Accidental Death & Dismemberment
and Group Long-term Care 85.8 8.1 79.4 (11.3) 89.5
-------- -------- --------
Total $ 999.5 15.9 $ 862.7 (9.4) $ 952.5
======== ======== ========
Sales - Effective Date Basis
Long-term Disability $ 356.2 12.0% $ 318.0 (31.9)% $ 466.9
Short-term Disability 166.7 32.9 125.4 (38.3) 203.1
Group Life 362.9 63.8 221.5 (34.5) 338.3
Accidental Death & Dismemberment
and Group Long-term Care 82.1 2.6 80.0 (10.5) 89.4
-------- -------- --------
Total $ 967.9 29.9 $ 744.9 (32.1) $1,097.7
======== ======== ========
Sales related to employee benefits can fluctuate significantly due to large case
size and timing of sales submissions. The Company implemented a number of
initiatives throughout 2000 which helped maintain the sales momentum achieved
during the last half of 2000 and continuing into 2001, 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
national practice groups that 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.
Persistency during 2001 for group disability, group life, and accidental death
and dismemberment products was generally improved overall from that experienced
in 2000 but was unfavorable for certain issue years when compared to the
persistency expected at the time the business was written, resulting in
additional amortization of $41.5 million. The majority of the unfavorable
persistency occurred in more recently issued business, which has higher
associated unamortized deferred policy acquisition costs. The additional
amortization related to persistency in 2000 and 1999 was $34.1 million and $5.2
million, respectively. It is expected that persistency for the foreseeable
future may continue to be lower than historical levels. The Company's 2001
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 renewal activity will
emerge throughout 2002. 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 the
Company's wholly-owned subsidiaries GENEX Services, Inc. and Options and
Choices, Inc., totaled $150.6 million in 2001, compared to $126.1 million in
2000 and $107.8 million in 1999.
25
Group Disability
Group disability revenue was $3,352.7 million in 2001 compared to $3,200.4
million in 2000. Group disability reported income of $336.9 million for 2001
compared to $211.0 million for 2000. Group disability results for 2001 include
$7.3 million for losses related to September 11, 2001, with estimated gross
ultimate losses from reported and unreported claims of $9.0 million less an
estimated $1.7 million recoverable from the Company's reinsurers. The income for
2000 includes an increase of $65.6 million in group long-term disability claim
reserves, discussed more fully below.
Positive impacts on 2001 income were a $152.3 million revenue increase and a
change in the benefit ratio from 87.1 percent in 2000 to 84.1 percent in 2001,
excluding losses related to September 11 for 2001 and the $65.6 million reserve
increase for 2000. The commission ratio also improved slightly relative to 2000.
Negatively impacting income was an increase in the operating expense ratio in
2001 compared to 2000. The 2001 results include $26.3 million of additional
amortization necessitated by the higher level of group long-term and short-term
disability terminations experienced during 2001 relative to that which was
expected at the time the business was written. The additional amortization
during 2000 was $25.8 million. For both 2001 and 2000, the disability business
retained is relatively more profitable than the business that terminated.
A critical part of the Company's strategy for group disability involves
executing its renewal program and managing persistency, both of which management
expects will have a positive impact on future premium growth and profitability.
The Company has implemented pricing changes in the group disability line wherein
prices may increase or decrease by market segment, as appropriate, to respond to
current claim experience and other factors and assumptions. Persistency during
2001 on the overall block of group disability improved over 2000, with long-term
disability persistency at 84.9 percent compared to 81.6 percent last year and
short-term disability at 82.1 percent versus 80.7 percent in 2000. However,
persistency on business sold in 1999 and 2000 has been unfavorable when compared
to what was expected when the business was sold, resulting in additional
amortization of the deferred policy acquisition costs that have a relatively
high remaining asset balance.
The fundamentals underlying risk results in the group disability line continued
to exhibit overall improvement in 2001, as demonstrated by the lower benefit
ratio. Claim recovery rates in 2001 continued to be above historical levels but
the increase in the claim recovery rates has slowed, as expected, as the Company
has now fully implemented the improvements to its claim processes. Both
submitted and paid claim incidence for long-term disability increased over
recent years, with a portion of the increase attributable to industries impacted
by the weaker economy. However, in comparing 2001 results with 2000, there was
no significant increase in the types of claims normally associated with a weaker
economy.
For short-term disability, both the average claim duration and paid incidence
increased from the prior year. The average weekly indemnity continued to
increase as well, but the premium per life grew at a slightly higher level. The
Company expects to modify its product and pricing strategy in short-term
disability to be more selective in the product options offered in the large case
market, with a focus on self funded or experience rated products.
Group disability revenue was $3,200.4 million in 2000 compared to $3,029.0
million in 1999. The high terminations and slow sales decreased the earned
premium growth compared to that experienced during 1999 and 1998. 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 represented
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." See Note 2 of the "Notes to
Consolidated Financial Statements" for further discussion.
26
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 was higher than in 1999. The paid claim incidence for long-term disability
was lower than 1999 due to lower claim acceptance rates, and the rate of net
claim resolutions continued to increase during 2000. The 2000 submitted claim
incidence rate for long-term disability was higher than the rate for 1999.
The claims disruption charge taken in the fourth quarter of 1998 resulted in a
$50.3 million charge for the group long-term disability line of business 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. 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.
The benefit ratio for short-term disability decreased marginally during 2000
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. The
additional amortization during 1999 was $4.2 million. 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.
Income in 2000 was positively impacted by a 5.7 percent revenue increase and an
improvement in both the commission and operating expense ratios relative to
1999.
As previously disclosed 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.
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 re-priced, 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 disproportionate
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 $179.2 million in 2001 compared to $214.0 million in 2000. Included in
2001 income is additional benefit expense of $6.7 million related to the
September 11, 2001 tragedy.
27
Group life, accidental death and dismemberment, and long-term care reported an
increase in revenue for 2001 compared to 2000 due to increases in both premium
income and net investment income. Premium growth was attributable to strong
sales results in 2001 and improvements in persistency. Persistency for group
life was 84.6 percent in 2001, an increase over the 81.5 percent for 2000. For
accidental death and dismemberment, persistency was 83.0 percent and 79.5
percent for 2001 and 2000, respectively.
Offsetting the 2001 revenue increase was an increase in the benefit ratio and
operating expense ratio when compared to the previous year reporting period. The
amortization of deferred policy acquisition costs for 2001 includes $15.2
million of additional amortization due to the higher level of terminations for
group life and accidental death and dismemberment products experienced than
expected at the time the policies were written. The unfavorable variance of
actual to expected terminations occurred primarily in the group life product
line. The additional amortization during 2000 was $8.3 million.
Group life submitted and paid incidence continued to remain high in 2001,
although the incidence rates during the last six months of the year were lower
than the rates for the first half of 2001. The average paid claim size has also
increased compared to the prior year, and waiver incidence continues to be above
recent levels. The claim recovery rate on waiver claims has increased, somewhat
mitigating the impact of the increase in waiver incidence.
Group life 2001 benefits include estimated gross ultimate losses from reported
and unreported claims of $17.0 million less an estimated $14.0 million
recoverable from the Company's reinsurers, for a net increase in benefits of
$3.0 million related to the September 11, 2001 tragedy.
The Company has implemented several actions in the group life line of business,
including tighter underwriting guidelines and pricing changes, and is developing
case specific remedial plans for under performing business. The Company believes
these actions will improve profitability in group life, but it is uncertain
whether these actions will restore the profitability that this line of business
has historically reported. As a result of the actions implemented, it is
expected that the sales growth rate in this business will slow from that
experienced in recent years. This was evidenced by the rate of growth reported
for group life sales in the fourth quarter of 2001, with a 15.2 percent and 27.0
percent decline, compared to the fourth quarter of 2000, reported for submitted
and effective date basis sales, respectively.
The 2001 benefit ratio for accidental death and dismemberment was higher than
2000 primarily due to a significant increase in the average paid claim amounts.
The rate of claim incidence in 2001 did not change significantly over the prior
year. The 2001 results for accidental death and dismemberment include estimated
gross ultimate losses of $25.0 million less estimated reinsurance recoverables
of $21.3 million, for a net increase in benefits of $3.7 million related to the
September 11, 2001 tragedy. These losses relate to both accidental death and
dismemberment and travel accident coverages.
Group long-term care reported a very slight decrease in the benefit ratio for
2001 compared to 2000, although the last two quarters of 2001 reported
increasing benefit ratios relative to the first half of the year and to prior
year quarters.
The reinsurance transaction entered into during 2000 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 reinsurance transactions.
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. 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 a higher 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 a decrease in paid mortality incidence.
28
The 2000 benefit ratio for accidental death and dismemberment was higher than
1999 due to an increase in the average paid claim size. Submitted incidence for
accidental death and dismemberment improved relative to 1999.
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.
Individual Segment Operating Results
(in millions of dollars)
Year Ended December 31
---------------------------------------------------------------
2001 % Change 2000 % Change 1999
-------- -------- --------
Revenue
Premium Income
Individual Disability $1,647.8 0.3% $1,643.5 5.8% $1,553.5
Individual Long-term Care 180.3 34.9 133.7 45.3 92.0
-------- -------- --------
Total Premium Income 1,828.1 2.9 1,777.2 8.0 1,645.5
Net Investment Income 912.8 8.6 840.3 9.0 771.1
Other Income 86.7 (28.9) 122.0 100.7 60.8
-------- -------- --------
Total 2,827.6 3.2 2,739.5 10.6 2,477.4
-------- -------- --------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 1,932.7 4.0 1,858.4 15.8 1,604.2
Commissions 260.6 2.5 254.3 (7.4) 274.5
Deferral of Policy Acquisition Costs (224.1) 7.5 (208.4) 4.8 (198.8)
Amortization of Deferred Policy
Acquisition Costs 106.4 16.8 91.1 17.2 77.7
Amortization of Value of
Business Acquired 44.1 8.4 40.7 30.9 31.1
Operating Expenses 417.2 2.9 405.3 (6.7) 434.6
-------- -------- --------
Total 2,536.9 3.9 2,441.4 9.8 2,223.3
-------- -------- --------
Income Before Federal Income
Tax, Net Realized Investment
Gain (Loss), and Extraordinary Loss $ 290.7 (2.5) $ 298.1 17.3 $ 254.1
======== ======== ========
The Individual segment includes results from the individual disability and
individual long-term care lines of business.
Individual Disability
New annualized sales in the individual disability line of business were $145.1
million in 2001, compared to $116.1 million in 2000 and $124.1 million in 1999.
The Company developed a new individual disability product portfolio that was
released for sale in approved states early in the fourth quarter of 2000. 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 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." The persistency of individual disability
business continues to be stable.
29
Revenue was $2,615.8 million for 2001 compared to $2,585.6 million in 2000.
Income in the individual disability line of business was $274.8 million in 2001,
a decrease of 3.7 percent over the prior year. Included in the results for 2001
was $14.0 million of estimated gross ultimate losses related to September 11,
2001, less an estimated recoverable from reinsurers of $4.0 million. Excluding
this $10.0 million loss, income would have been essentially level with 2000.
The benefit ratio of 107.7 percent for 2001 was slightly higher than the 2000
ratio of 106.6 percent. The interest adjusted loss ratio was 63.6 percent and
63.4 percent for 2001 and 2000, respectively. Submitted and paid claim incidence
rates for the overall individual disability line of business increased from 2000
and are higher than recent historical incidence rates. The claim recovery rate
for 2001 increased compared to the 2000 results. Individual disability also
benefited from a slightly improved commission ratio for 2001 as compared to
2000, but the operating expense ratio increased.
The overall individual disability results for 2001 were negatively impacted by
the business issued during the mid-1990s and prior years. The interest adjusted
loss ratios for later issue years are significantly below the overall ratio of
63.6 percent, even in the more poorly performing market segments and product
lines. The improvement in the later issue year business reflects the substantial
product, distribution, and underwriting changes made during that time period.
The Company is reviewing internal and external alternatives, including
reinsurance, for improving the overall results in its individual disability line
of business, particularly as related to business issued prior to the mid-1990s.
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.
See Note 2 of the "Notes to Consolidated Financial Statements" for further
discussion.
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 was slightly higher than the average for the year 1999, while paid
incidence improved relative to the prior year. The claim acceptance rate
declined throughout 1999 and 2000, and the net claim resolution rate for 2000
increased from 1999. Offsetting these trends was an increase in reserves for
existing claims. 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.
As noted in the "Employee Benefits Segment Operating Results," claim resolution
rate assumptions 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. 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.
Individual Long-term Care
The individual long-term care line of business reported a 35 percent increase in
premium income for 2001 compared to 2000, primarily due to new sales growth. New
annualized sales for long-term care were $53.8 million for 2001, $47.7 million
for 2000, and $40.0 million for 1999. 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.
30
Income in the individual long-term care line of business was $15.9 million in
2001 compared to $12.8 million for 2000, primarily due to an increase in revenue
and an improvement in the commission and operating expense ratios. The benefit
ratio increased when compared to 2000. The increase over the prior year resulted
primarily from an increase in the active life reserve. Paid incidence was
essentially unchanged from 2000, and the claim recovery rate increased.
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. Income for 2000 was $12.8 million, compared to a
loss of $2.6 million in 1999. The increase in revenue, as well as improvements
in both the benefit ratio and operating expense ratios, contributed to the year
over year increase.
Voluntary Benefits Segment Operating Results
(in millions of dollars)
Year Ended December 31
----------------------------------------------------------
2001 % Change 2000 % Change 1999
------- ------- -------
Revenue
Premium Income $ 790.7 6.9% $ 739.6 6.9% $ 691.6
Net Investment Income 124.6 9.9 113.4 6.4 106.6
Other Income 13.5 N.M. 6.3 -- 6.3
------- ------- -------
Total 928.8 8.1 859.3 6.8 804.5
------- ------- -------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 489.8 9.5 447.2 13.9 392.7
Commissions 173.5 14.3 151.8 9.4 138.7
Deferral of Policy Acquisition Costs (177.6) 16.9 (151.9) 2.8 (147.8)
Amortization of Deferred Policy
Acquisition Costs 126.1 12.3 112.3 (0.6) 113.0
Amortization of Value of
Business Acquired 2.3 -- 2.3 (4.2) 2.4
Operating Expenses 153.6 7.0 143.6 (14.8) 168.5
------- ------- -------
Total 767.7 8.8 705.3 5.7 667.5
------- ------- -------
Income Before Federal Income
Tax, Net Realized Investment
Gain (Loss), and Extraordinary Loss $ 161.1 4.6 $ 154.0 12.4 $ 137.0
======= ======= =======
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 $928.8 million in 2001
from $859.3 million in 2000 primarily due to the increase in premium income
which was attributable to sales growth and favorable persistency. New annualized
sales for 2001 were $296.6 million, an increase of 11.9 percent over the prior
year. Management continues its efforts to increase sales through the sales
initiatives discussed under "Employee Benefits Segment Operating Results."
For 2001, all of the product lines reported an increase in premium income and
net investment income over 2000. The life and disability product lines both
reported a marginal increase in the benefit ratio relative to 2000. The increase
for life was due primarily to an increase in the size of the average paid claim.
Claim payments for disability increased due to an increase in the average
monthly indemnity and a lengthening of the duration of claims, but the incidence
rates remained stable. The benefit ratio for the other line was higher in 2001
compared to 2000 due partially to the poor results from the block of business
which was reinsured in the fourth quarter of 2001 and also due to an increase in
the average claim size for the Company's other cancer products.
31
As previously discussed, during 2001 the Company reinsured on a 100 percent
indemnity coinsurance basis certain cancer policies written by the Company's
subsidiary, Colonial Life & Accident Insurance Company. The transaction closed
during the fourth quarter with an effective date of November 1, 2001. The
Company ceded approximately $113.6 million of reserves to the reinsurer. The
$12.3 million before-tax gain on this transaction was deferred and is being
amortized into income based upon expected future premium income on the policies
ceded. The Company will continue to market its other cancer products.
Revenue in the Voluntary Benefits segment increased to $859.3 million in 2000
from $804.5 million in 1999. 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 and $245.3 million
in 1999. 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 higher than the ratio reported in 1999.
The primary drivers were an increase in benefits in the life product line and an
increase in the incurred and paid loss ratios for the cancer product line.
Other Segment Operating Results
(in millions of dollars)
Year Ended December 31
----------------------------------------------------------------
2001 % Change 2000 % Change 1999
-------- -------- --------
Revenue
Premium Income $ 111.9 (77.5)% $ 497.7 (17.9)% $ 605.9
Net Investment Income 184.2 (51.2) 377.2 (31.4) 549.5
Other Income 50.4 70.8 29.5 (68.0) 92.2
-------- -------- --------
Total 346.5 (61.7) 904.4 (27.5) 1,247.6
-------- -------- --------
Benefits and Expenses
Benefits and Change in Reserves for
Future Benefits 213.0 (68.5) 675.7 (40.0) 1,126.8
Other Expenses 80.2 (56.7) 185.4 (38.1) 299.3
-------- -------- --------
Total 293.2 (66.0) 861.1 (39.6) 1,426.1
-------- -------- --------
Income (Loss) Before Federal Income
Tax, Net Realized Investment
Gain (Loss), and Extraordinary Loss $ 53.3 23.1 $ 43.3 N.M. $ (178.5)
======== ======== ========
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.
32
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 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 unamortized balance of the
deferred gain was $343.9 million at the end of 2001 and $373.5 million at the
end of 2000. 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 for individual life and corporate-owned life insurance was $42.7
million, $236.1 million, and $435.0 million in 2001, 2000, and 1999,
respectively. Income for the same periods was $38.9 million, $49.6 million, and
$65.6 million.
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 2001, the Company entered into an agreement to limit its liabilities
pertaining to the Lloyd's syndicate participations. Separately, the Company also
reinsured 100 percent of the group disability reinsurance reserves and all
future business underwritten and managed by Duncanson and Holt Services, Inc., a
subsidiary of D&H. The transaction, in which reserves of approximately $323.8
million were ceded to the reinsurer, had an effective date of January 1, 2001.
In a separate but related transaction, the Company also sold the reinsurance
management operations of Duncanson and Holt Services, Inc. and divested the
remaining assets of that facility during 2001. See Note 13 of the "Notes to
Consolidated Financial Statements" for further discussion of the reinsurance
operations.
During 2001, the reinsurance pools and management operations reported a gain of
$0.1 million compared to losses of $32.7 million in 2000 and $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 of $270.1 million resulting from its decision to exit
these pools, but at that time there was insufficient information to fully
evaluate all of the exposures. During 2000, additional changes to fund these
exposures and provide for the run-off of its participation resulted in a claim
reserve adjustment of $21.9 million and uncollectible receivables and loss
provisions of $15.5 million.
In 1999, an additional $57.7 million was 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 and 2000 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.
33
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.
Other
Group pension, health insurance, individual annuities, and other closed lines of
business had revenue of $201.3 million, $219.4 million, and $279.1 million in
2001, 2000, and 1999 and income of $14.3 million, $26.4 million, and $35.6
million. Decreases in revenue and income are expected to continue as these lines
of business wind down. Included in these amounts are the Company's operating
results for its operations in Argentina, which produced revenue of $47.1
million, $40.2 million, and $32.9 million in 2001, 2000, and 1999 and income
(losses) of $1.1 million, $2.7 million, and $(0.8) million in each of those
three years. As previously mentioned, the Company in 2001 wrote off the
remaining goodwill balance of $5.4 million related to its operations in
Argentina. The goodwill write-off is included in the Corporate segment operating
results. The net assets related to the Argentina operations were approximately
$9.2 million at December 31, 2001.
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 $44.6 million in 2001, $48.1 million in
2000, and $67.7 million in 1999. 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 $169.2 million in 2001, $49.5 million
in 2000, and $484.6 million in 1999. Interest and debt expense was $169.6
million in 2001, $181.8 million in 2000, and $137.8 million in 1999. The
amortization of goodwill was $26.6 million in 2001, $22.3 million in 2000, and
$82.6 million in 1999. The Company recorded write-downs of goodwill of $5.4
million in 2001 related to its Argentina operations and $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" for further discussion.
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 of dollars):
Employee related expense $ 77.7
Exit activities related to duplicate facilities/asset abandonments 67.4
Investment banking, legal, and accounting fees 39.6
------
Subtotal 184.7
Expense related to the early retirement offer to employees 125.9
------
Subtotal 310.6
Income tax benefit 89.2
------
Total $221.4
======
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.
34
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 cash flows and durations with related expected liability cash flows and
durations and to maximize investment returns, subject to constraints of quality,
liquidity, diversification, and regulatory considerations. See Notes 4 and 5 of
the "Notes to Consolidated Financial Statements" for further discussion of the
Company's investments and derivative financial instruments.
Excluding the net investment income reported in the Other segment, which
continues its expected decline as these product lines are sold, reinsured, or
wind down, 2001 net investment income increased 8.1 percent over the previous
year. The overall yield in the portfolio remains relatively stable at 8.02
percent as of the end of 2001 compared to 8.06 percent at the end of 2000. The
Company is actively marketing its real estate investments and presently
evaluating the possible sale of all or a portion of the mortgage loan portfolio
for replacement with longer duration securities.
The Company reported a before-tax net realized investment loss of $40.6 million
in 2001. The loss was the net of gains of $150.6 million and losses of $191.2
million, including write-downs of $153.8 million recognized as a result of
management's determination that the value of certain fixed maturity securities
had other than temporarily declined.
During 2000, the Company reported a net realized investment loss 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 a net
gain of $51.0 million in 2000 from the sale of fixed maturity and equity
securities. Offsetting this gain was a $94.0 million realized investment loss
recognized because the value of certain fixed maturity securities 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. Policy loans of $2.3
billion and $2.2 billion were ceded as of December 31, 2001 and 2000,
respectively, and the investment income thereon is no longer included in income.
December 31
-----------------
2001 2000
------ ------
Investment-Grade Fixed Maturity Securities 78.1% 78.3%
Below-Investment-Grade Fixed Maturity Securities 8.0 6.6
Equity Securities 0.1 0.1
Mortgage Loans 3.3 4.3
Real Estate 0.2 0.4
Policy Loans 8.9 9.1
Other Invested Assets 1.4 1.2
------ ------
Total 100.0% 100.0%
====== ======
35
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately $3.8
billion and $3.5 billion on an amortized cost basis at December 31, 2001 and
2000, respectively. At December 31, 2001, the mortgage-backed securities had an
average life of 9.5 years and effective duration of 8.5 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, 2001, was $2,261.7 million, representing 8.7 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 $1,760.8 million at December
31, 2000, representing 7.2 percent of invested assets. The year over year
increase resulted from downgrades of existing securities that were previously
investment grade rather than the purchase of additional below-investment-grade
securities.
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. The Company expects
additional downgrades to occur during 2002, with resulting realized investment
losses. The Company does not anticipate any liquidity problem caused by the
investments in below-investment-grade securities, nor does it expect these
investments to adversely affect its ability to hold its other investments to
maturity.
The Company has investments in four special purpose entities whose purposes are
to support the Company's investment objectives. These entities are for asset
collateralization and contain specific investment securities that do not include
the Company's common stock or debt. These investments are described as follows:
During 2001, the Company invested in two special purpose entity trusts
that have underlying assets consisting of unrelated equity securities. The
investments in these trusts qualify as fixed maturity securities under
generally accepted accounting principles and were reported at fair value
in the consolidated statements of financial condition contained herein in
Item 8. The fair value of these investments was derived from the fair
value of the underlying assets based on quoted market prices. The fair
value and amortized cost of these investments were $50.5 million and $58.1
million, respectively, at December 31, 2001.
The Company has an investment in a collateralized bond obligation asset
trust in which it is also the investment manager of the underlying
high-yield securities. This investment was reported at fair value with
fixed maturity securities in the consolidated statements of financial
condition. The fair value of this investment was derived from the fair
value of the underlying assets based on quoted market prices. The fair
value and amortized cost of this investment was $20.4 million and $46.0
million, respectively, at December 31, 2001 and $29.4 million and $51.9
million at December 31, 2000.
At December 31, 2001, the Company had a retained interest in a special
purpose entity trust that was securitized with financial assets consisting
of a United States Treasury bond and several limited partnership equity
interests. This investment was reported at fair value and included with
fixed maturity securities in the consolidated statements of financial
condition. The fair value of this investment was derived from the fair
value of the underlying assets, which are based on quoted market prices as
well as the limited partnership capital balances. The fair value and
amortized cost of this investment was $113.6 million and $122.6 million,
respectively, at December 31, 2001 and $121.8 million and $114.5 million
at December 31, 2000. At December 31, 2001, the Company had capital
commitments of $21.7 million to this special purpose entity trust. These
funds are due upon satisfaction of contractual notice from the trust.
These amounts may or may not be funded during the term of the trust.
36
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $941.2 million and $1,135.6 million at
December 31, 2001 and 2000, respectively. The mortgage loan portfolio is well
diversified geographically and among property types. The incidence of new
problem mortgage loans and foreclosure activity remains low, and 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 2001 and 2000 other than two purchase money mortgages associated with the
sale of real estate.
At December 31, 2001 and 2000, impaired loans totaled $13.1 million and $17.7
million, respectively. Included in the impaired mortgage loans at December 31,
2001 were $6.4 million of loans which had a related, specific investment
valuation allowance of $2.4 million and $6.7 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 $5.7 million and $8.5 million at December
31, 2001 and 2000, respectively, and represent loans that have been refinanced
with terms more favorable to the borrower. Interest lost on restructured loans
was immaterial for 2001 and 2000.
Real estate was $51.8 million and $116.7 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 $7.6 million at December 31, 2001, and $18.3 million at December 31, 2000.
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.
Investment valuation allowances for real estate held for sale are established
based on a review of specific assets. If a decline in value of a mortgage loan
or real estate investment 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 recognized as a realized investment loss.
Management monitors the risk associated with these invested asset portfolios 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 $10.5 million during
2001. The real estate valuation allowance was reduced $5.7 million during 2001
in conjunction with the sale of the associated property. At December 31, 2001,
the balance in the valuation allowance for mortgage loans and real estate was
$2.4 million and $19.9 million, respectively.
Other
The Company's exposure to non-current investments totaled $176.7 million at
December 31, 2001, or 0.7 percent of invested assets excluding ceded policy
loans. 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 has an investment program wherein it simultaneously enters into
repurchase transactions and reverse repurchase transactions with the same party.
The Company nets the related receivables and payables in the consolidated
statements of financial condition as these transactions are with the same party
and include a right of offset. As of December 31, 2001, the Company had $391.7
million face value of these contracts in an open position that were offset.
37
Historically, the Company has utilized 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 future premium income. Positions under the Company's
hedging programs for derivative activity that were open during 2001 involved
current and forward interest rate swaps, as well as currency swaps which are
used to hedge the currency risk of certain foreign currency denominated fixed
income securities. All transactions are hedging in nature and not speculative.
Almost all transactions are associated with the individual and group long-term
care and 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.
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 $1,770.6 million for the
year ended December 31, 2001, as compared to $1,211.5 million and $1,566.7
million for the comparable periods of 2000 and 1999, 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's source of cash could be negatively impacted by a decrease in
demand for the Company's insurance products or an increase in the incidence of
new claims or the duration of existing claims. The Company's policy benefits are
primarily in the form of claim payments, and the Company therefore has minimal
exposure to the policy withdrawal risk associated with deposit products such as
individual life policies or annuities. Cash flow could also be negatively
impacted by a deterioration in the credit market whereby the Company's ability
to liquidate its positions in certain of its fixed maturity securities would be
impacted such that the Company might not be able to dispose of these investments
in a timely manner.
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, 2001, the Company had
outstanding from its insurance subsidiaries a $150.0 million surplus debenture
due in 2006 with a weighted average interest rate during 2001 of 7.85 percent
and a $100.0 million surplus debenture due in 2027 with a weighted average
interest rate during 2001 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 ordinary
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 ten percent of an insurer's statutory surplus
with respect to policyholders as of the preceding year end or the statutory net
gain from operations, excluding realized investment gains and losses, of the
preceding year. Further, pursuant to the 1999 merger of Unum and Provident, the
Company is required to obtain approval from the Maine Bureau of Insurance (Maine
Bureau) regarding payment of ordinary dividends from the Company's Maine
domiciled insurance subsidiary until 2004.
The payment of ordinary dividends to the Company from its insurance subsidiaries
is further limited to the amount of statutory surplus as it relates to
policyholders. Based on the restrictions under current law, during 2002 $384.9
million is available for the payment of ordinary dividends to the Company from
its domestic insurance subsidiaries. Of this amount, $121.8 million is
conditional upon approval from the Maine Bureau.
38
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. Approximately $27.5 million will be available for the payment
of dividends from Unum Limited during 2002.
The amount available during 2001 for the payment of ordinary dividends from the
Company's domestic insurance subsidiaries was $359.9 million, including $149.2
million available with approval from the Maine Bureau. Of the total available,
$148.6 million was utilized, including $50.0 million as requested by the Company
and approved by the Maine Bureau. The amount available during 2001 from Unum
Limited was $20.9 million, none of which was utilized.
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, 2001, the Company had short-term and long-term debt totaling
$161.8 million and $2,004.2 million, respectively. At December 31, 2001,
approximately $403.0 million was available for additional financing under the
Company's revolving credit facilities. The debt to total capital ratio was 29.8
percent at December 31, 2001 compared to 30.2 percent at December 31, 2000.
Contingent upon market conditions and corporate needs, management may refinance
short-term notes payable with longer-term securities.
During 2001 the Company redeemed its $172.5 million par value 8.8% monthly
income debt securities (junior subordinated debt), which were due in 2025 but
callable at par in 2000 and thereafter. This early redemption is expected to
lower the Company's financing costs in 2002 through the use of commercial paper
available at lower interest rates. The early extinguishment of debt resulted in
a write-off of the remaining deferred debt cost of $4.5 million associated with
the issuance of the securities. The extraordinary loss, net of a $1.6 million
tax benefit, was $2.9 million.
During the fourth quarter of 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. The 364-day portion of the credit facilities was renewed as of
October 30, 2001.
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, remaining funding under the shelf registration
will be used to refinance debt on a longer-term basis and/or to fund other
corporate needs.
During the second quarter of 2000, the Company issued $200.0 million of variable
rate notes in a privately negotiated transaction. The notes were used to
refinance other short-term debt and had a weighted average interest rate of 7.52
percent during the first quarter of 2001. The notes matured in April 2001.
39
In 1998, the Company completed a public offering of $200.0 million of 7.25%
senior notes due March 15, 2028. In 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 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.
Contractual debt and Company-obligated mandatorily redeemable preferred
securities commitments are as follows (in millions of dollars):
Payments Due by Period
----------------------------------------------------------------
Less than 1 to 3 4 to 5 After
Total 1 Year Years Years 5 Years
-------- -------- -------- -------- --------
Short-term Debt $ 161.8 $ 161.8 $ -- $ -- $ --
Long-term Debt 2,004.2 470.2 247.0 -- 1,287.0
Company-Obligated Mandatorily
Redeemable Preferred Securities 300.0 -- -- -- 300.0
-------- -------- -------- -------- --------
Total $2,466.0 $ 632.0 $ 247.0 $ -- $1,587.0
======== ======== ======== ======== ========
Commercial paper debt of $470.2 million was classified as long-term at December
31, 2001 because the Company has the ability through the senior revolving credit
facilities to convert this obligation into long-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
current shelf registration statement.
The Company has an agreement with an outside party wherein the Company is
provided computer data processing services and related functions. The contract
expires in 2010, but the Company may cancel this agreement effective August 2005
or later upon payment of applicable cancellation charges. The aggregate
noncancelable contractual obligation remaining under this agreement is $258.8
million at December 31, 2001, with no annual payment expected to exceed $69.9
million.
As previously discussed, at December 31, 2001, the Company had capital
commitments of $21.7 million to fund a special purpose entity trust in which the
Company has a retained interest. The Company also has capital commitments of
$36.6 million to fund certain of its private placement fixed maturity
securities. The funds are due upon satisfaction of contractual notice from the
issuer. These amounts may or may not be funded during the term of the security.
40
Ratings
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's), Fitch,
Inc. (Fitch), 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. If the
Company were to experience negative operating trends, it could result in a
downgrade of the current ratings, which might impact the Company's ability to
sell and retain its business.
The table below reflects the current debt ratings for the Company and the
financial strength ratings for the U.S. domiciled insurance company
subsidiaries.
- ------------------------------------------------------------------------------------------------------------------------
S&P Moody's Fitch AM Best
----------------- ------------------ ----------------- -------------
- ------------------------------------------------------------------------------------------------------------------------
UnumProvident Corporation
- ------------------------------------------------------------------------------------------------------------------------
Senior Debt A- (Strong) Baa1 (Medium Grade) A- (High a- (Strong)
Credit Quality)
- ------------------------------------------------------------------------------------------------------------------------
Commercial Paper A-2 (Good) Prime-2 (Strong F2 (Good AMB-2
Ability) Credit Quality) (Acceptable)
- ------------------------------------------------------------------------------------------------------------------------
U.S. Insurance Subsidiaries
- ------------------------------------------------------------------------------------------------------------------------
Provident Life & Accident AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- ------------------------------------------------------------------------------------------------------------------------
Provident Life & Casualty Not Rated Not Rated Not Rated A (Excellent)
- ------------------------------------------------------------------------------------------------------------------------
Unum Life of America AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- ------------------------------------------------------------------------------------------------------------------------
First Unum Life AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- ------------------------------------------------------------------------------------------------------------------------
Colonial Life & Accident AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- ------------------------------------------------------------------------------------------------------------------------
Paul Revere Life AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- ------------------------------------------------------------------------------------------------------------------------
Paul Revere Variable AA- (Very Strong) A2 (Good Financial AA- (Very Strong) A (Excellent)
Security)
- ------------------------------------------------------------------------------------------------------------------------
41
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 at
December 31, 2001 and 2000. The fair values of mortgage loans, which are
reported in the consolidated statements of financial condition at amortized
cost, would decrease by approximately $50 million and $70 million, respectively,
at December 31, 2001 and 2000. Held-to-maturity securities are also reported at
amortized cost and would decrease by approximately $40 million at December 31,
2000. There were no held-to-maturity securities at December 31, 2001.
At December 31, 2001 and 2000, 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 would increase approximately $125 million and $100 million, respectively,
and the fair values of the company-obligated mandatorily redeemable preferred
securities would increase approximately $40 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 were 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 7.4 percent and 7.7 percent of total
assets at December 31, 2001 and 2000, respectively, and 8.7 percent and 9.7
percent of total revenue for 2001 and 2000, respectively. Assuming foreign
exchange rates decreased 10 percent from the December 31, 2001 and 2000 levels,
year end 2001 and 2000 stockholders' equity would not be materially affected.
42
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, 2001 and 2000,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2001.
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 conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 provide a
reasonable basis for our opinion.
In our opinion, based on our audits, 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,
2001 and 2000, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001 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 of America. Also in our
opinion, based on our audits, 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 6, 2002, except for
Note 15, for which the date is
March 21, 2002
43
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UnumProvident Corporation and Subsidiaries
December 31
2001 2000
(in millions of dollars)
-----------------------------
Assets
Investments
Fixed Maturity Securities
Available-for-Sale - at fair value (amortized cost: $23,821.0; $21,931.2) $24,393.0 $22,242.3
Held-to-Maturity - at amortized cost (fair value: $ -; $369.8) -- 346.6
Equity Securities - at fair value (cost: $9.4; $23.2) 10.9 24.5
Mortgage Loans 941.2 1,135.6
Real Estate 51.8 116.7
Policy Loans 2,517.0 2,426.7
Other Long-term Investments 30.4 32.3
Short-term Investments 379.7 279.4
--------- ---------
Total Investments 28,324.0 26,604.1
Other Assets
Cash and Bank Deposits 123.9 107.1
Accounts and Premiums Receivable 1,789.4 1,851.3
Reinsurance Receivable 6,224.0 6,046.5
Accrued Investment Income 601.3 532.2
Deferred Policy Acquisition Costs 2,674.8 2,424.0
Value of Business Acquired 542.2 591.6
Goodwill 674.7 683.3
Property and Equipment 386.9 387.5
Miscellaneous 1,058.4 1,068.7
Separate Account Assets 43.1 67.6
--------- ---------
Total Assets $42,442.7 $40,363.9
========= =========
See notes to consolidated financial statements.
44
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
December 31
2001 2000
(in millions of dollars)
--------------------------
Liabilities and Stockholders' Equity
Liabilities
Policy and Contract Benefits $ 1,926.1 $ 1,796.8
Reserves for Future Policy and Contract Benefits 27,182.9 25,633.9
Unearned Premiums 328.3 332.8
Other Policyholders' Funds 2,542.5 2,645.1
Federal Income Tax
Current 19.0 68.4
Deferred 509.9 430.8
Short-term Debt 161.8 402.2
Long-term Debt 2,004.2 1,615.5
Other Liabilities 1,485.0 1,495.3
Separate Account Liabilities 43.1 67.6
--------- ---------
Total Liabilities 36,202.8 34,488.4
--------- ---------
Commitments and Contingent Liabilities - Note 15
Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debt Securities of the Company 300.0 300.0
--------- ---------
Stockholders' Equity - Note 11
Common Stock, $0.10 par
Authorized: 725,000,000 shares
Issued: 242,394,996 and 241,310,917 shares 24.2 24.1
Additional Paid-in Capital 1,064.1 1,040.2
Accumulated Other Comprehensive Income (Loss)
Net Unrealized Gain on Securities 61.0 212.8
Net Gain on Cash Flow Hedges - Note 1 78.1 --
Foreign Currency Translation Adjustment (91.1) (72.1)
Retained Earnings 4,816.3 4,379.7
Treasury Stock - at cost: 176,295 shares (9.2) (9.2)
Deferred Compensation (3.5) --
--------- ---------
Total Stockholders' Equity 5,939.9 5,575.5
--------- ---------
Total Liabilities and Stockholders' Equity $42,442.7 $40,363.9
========= =========
See notes to consolidated financial statements.
45
CONSOLIDATED STATEMENTS OF OPERATIONS
UnumProvident Corporation and Subsidiaries
Year Ended December 31
2001 2000 1999
(in millions of dollars, except share data)
------------------------------------------
Revenue
Premium Income $ 7,078.2 $ 7,057.0 $ 6,843.2
Net Investment Income 2,002.9 2,060.4 2,059.7
Net Realized Investment Gain (Loss) (40.6) (14.6) 87.1
Other Income 354.3 329.5 339.6
------------ ------------ ------------
Total Revenue 9,394.8 9,432.3 9,329.6
------------ ------------ ------------
Benefits and Expenses
Benefits and Change in Reserves for Future Benefits 6,234.3 6,407.5 6,787.6
Commissions 782.8 754.1 913.6
Interest and Debt Expense 169.6 181.8 137.8
Deferral of Policy Acquisition Costs (695.9) (595.7) (809.3)
Amortization of Deferred Policy Acquisition Costs 432.7 456.5 474.8
Amortization of Value of Business Acquired and Goodwill 75.0 67.3 120.9
Other Operating Expenses 1,571.2 1,295.2 1,869.7
------------ ------------ ------------
Total Benefits and Expenses 8,569.7 8,566.7 9,495.1
------------ ------------ ------------
Income (Loss) Before Federal Income Tax and Extraordinary
Loss 825.1 865.6 (165.5)
Federal Income Tax (Credit)
Current 139.2 195.7 141.2
Deferred 103.8 105.7 (123.8)
------------ ------------ ------------
Total Federal Income Tax 243.0 301.4 17.4
------------ ------------ ------------
Income (Loss) Before Extraordinary Loss 582.1 564.2 (182.9)
Extraordinary Loss, Net of Tax - Note 9 (2.9) -- --
------------ ------------ ------------
Net Income (Loss) $ 579.2 $ 564.2 $ (182.9)
============ ============ ============
Earnings Per Common Share
Basic
Income (Loss) Before Extraordinary Loss $ 2.41 $ 2.34 $ (0.77)
Net Income (Loss) $ 2.40 $ 2.34 $ (0.77)
Assuming Dilution
Income (Loss) Before Extraordinary Loss $ 2.39 $ 2.33 $ (0.77)
Net Income (Loss) $ 2.38 $ 2.33 $ (0.77)
See notes to consolidated financial statements.
46
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
UnumProvident Corporation and Subsidiaries
Accumulated
Additional Other
Common Paid-in Comprehensive Retained Treasury Deferred
Stock Capital Income (Loss) Earnings Stock Compensation Total
(in millions of dollars)
--------------------------------------------------------------------------------------
Balance at December 31, 1998 $23.8 $959.2 $914.7 $4,279.2 $(9.2) $(21.5) $ 6,146.2
Comprehensive Loss
Net Loss (182.9) (182.9)
Change in Net Unrealized Gain
on Securities (net of tax credit
of $519.5) (949.6) (949.6)
Change in Foreign Currency
Translation Adjustment (net of
tax expense of $11.6) 16.0 16.0
---------
Total Comprehensive Loss (1,116.5)
---------
Common Stock Activity 0.3 69.4 21.5 91.2
Dividends to Stockholders (138.7) (138.7)
----- -------- ------- -------- ----- ------ ---------
Balance at December 31, 1999 24.1 1,028.6 (18.9) 3,957.6 (9.2) -- 4,982.2
Comprehensive Income
Net Income 564.2 564.2
Change in Net Unrealized Gain
on Securities (net of tax expense
of $96.5) 193.0 193.0
Change in Foreign Currency
Translation Adjustment (net of
tax credit of $7.5) (33.4) (33.4)
---------
Total Comprehensive Income 723.8
---------
Common Stock Activity 11.6 11.6
Dividends to Stockholders (142.1) (142.1)
----- -------- ------- -------- ----- ------ ---------
Balance at December 31, 2000 24.1 1,040.2 140.7 4,379.7 (9.2) -- 5,575.5
Comprehensive Income
Net Income 579.2 579.2
Change in Net Unrealized Gain
on Securities (net of tax credit
of $50.8) (76.5) (76.5)
Change in Net Gain on Cash Flow
Hedges (net of tax expense of $1.5) 2.8 2.8
Change in Foreign Currency
Translation Adjustment (net of
tax credit of $11.0) (19.0) (19.0)
---------
Total Comprehensive Income 486.5
---------
Common Stock Activity 0.1 23.9 (3.5) 20.5
Dividends to Stockholders (142.6) (142.6)
----- -------- ------- -------- ----- ------ ---------
Balance at December 31, 2001 $24.2 $1,064.1 $ 48.0 $4,816.3 $(9.2) $ (3.5) $ 5,939.9
===== ======== ======= ======== ===== ====== =========
See notes to consolidated financial statements.
47
CONSOLIDATED STATEMENTS OF CASH FLOWS
UnumProvident Corporation and Subsidiaries
Year Ended December 31
2001 2000 1999
(in millions of dollars)
------------------------------------------
Cash Flows from Operating Activities
Net Income (Loss) $ 579.2 $ 564.2 $ (182.9)
Adjustments to Reconcile Net Income (Loss)
to Net Cash Provided by Operating Activities
Policy Acquisition Costs Capitalized (695.9) (595.7) (809.3)
Amortization of Policy Acquisition Costs 432.7 456.5 474.8
Amortization of Value of Business Acquired and Goodwill 75.0 67.3 120.9
Depreciation 65.3 71.1 58.0
Net Realized Investment (Gain) Loss 40.6 14.6 (87.1)
Reinsurance Receivable (186.3) 386.7 130.1
Insurance Reserves and Liabilities 1,629.9 781.0 2,391.1
Federal Income Tax 79.7 127.6 (189.9)
Other (249.6) (661.8) (339.0)
------------ ------------ ------------
Net Cash Provided by Operating Activities 1,770.6 1,211.5 1,566.7
------------ ------------ ------------
Cash Flows from Investing Activities
Proceeds from Sales of Investments
Available-for-Sale Securities 2,754.9 1,711.3 3,773.9
Proceeds from Maturities of Investments
Available-for-Sale Securities 917.1 805.0 1,023.8
Held-to-Maturity Securities -- 1.3 0.3
Proceeds from Sales and Maturities of Other Investments 416.1 362.8 268.3
Purchase of Investments
Available-for-Sale Securities (5,167.5) (3,149.3) (6,237.5)
Held-to-Maturity Securities -- (23.0) (22.2)
Other Investments (174.7) (385.2) (209.1)
Net Sales (Purchases) of Short-term Investments (101.2) 41.4 (76.8)
Acquisition of Business (19.2) (94.2) --
Disposition of Business (382.9) (78.2) --
Other 20.8 (57.6) (75.3)
------------ ------------ ------------
Net Cash Used by Investing Activities $ (1,736.6) $ (865.7) $ (1,554.6)
------------ ------------ ------------
See notes to consolidated financial statements
48
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
UnumProvident Corporation and Subsidiaries
Year Ended December 31
2001 2000 1999
(in millions of dollars)
------------------------------------------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts $ 6.8 $ 33.8 $ 175.1
Maturities and Benefit Payments from
Policyholder Accounts (49.5) (209.5) (613.0)
Net Short-term Debt and Commercial Paper
(Repayments) Borrowings (254.2) (223.8) 692.6
Issuance of Long-term Debt 575.0 -- --
Long-term Debt Repayments (172.5) -- --
Issuance of Common Stock 20.5 11.6 69.7
Dividends Paid to Stockholders (142.6) (142.1) (138.9)
Other -- -- (18.6)
------------ ------------ ------------
Net Cash (Used) Provided by Financing Activities (16.5) (530.0) 166.9
------------ ------------ ------------
Effect of Foreign Exchange Rate Changes on Cash (0.7) (1.1) 2.2
------------ ------------ ------------
Net (Decrease) Increase in Cash and Bank Deposits 16.8 (185.3) 181.2
Cash and Bank Deposits at Beginning of Year 107.1 292.4 111.2
------------ ------------ ------------
Cash and Bank Deposits at End of Year $ 123.9 $ 107.1 $ 292.4
============ ============ ============
See notes to consolidated financial statements.
49
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 in accordance with accounting principles generally accepted in the
United States of America (GAAP). Such accounting principles differ from
statutory accounting practices (see Note 16). The consolidated financial
statements include the accounts of UnumProvident Corporation and its
subsidiaries (the Company). Material intercompany transactions have been
eliminated.
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.
Many factors influence the assumptions upon which reserves for policy and
contract benefits are based, including historical trends in the Company's
experience and expected deviations from historical experience. Considerable
judgment is required to interpret actual historical experience and to assess the
future factors that are likely to influence the ultimate cost of settling
existing claims. Given that insurance products contain inherent risks and
uncertainties, the ultimate liability may be more or less than such estimates
indicate.
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.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1 - Significant Accounting Policies - Continued
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 other than temporarily 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 $17.8 million and $31.0 million as of December 31, 2001 and 2000,
respectively.
Policy Loans are presented at unpaid balances directly related to policyholders.
Included in policy loans are $2,329.3 million and $2,237.6 million of policy
loans ceded to reinsurers at December 31, 2001 and 2000, respectively.
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.
Changes in the fair value of available-for-sale fixed maturity securities and
equity securities are reported as a component of other comprehensive income.
These amounts are net of federal income tax and valuation adjustments to
reserves for future policy and contract benefits which would have been recorded
had the related unrealized gain or loss 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 collection is uncertain. The Company recognizes
investment income on impaired loans when the income is received.
Derivative Financial Instruments: The Company recognizes all of its derivative
instruments (including certain derivative instruments embedded in other
contracts) as either assets or liabilities in the consolidated statements of
financial condition and measures those instruments at fair value.
The accounting for changes in the fair value (i.e., gain or loss) of a
derivative depends on whether it has been designated and qualifies as part of a
hedging relationship, and further, on the type of hedging relationship. To
qualify as a hedging instrument, a derivative must pass prescribed effectiveness
tests, performed quarterly or on a more frequent basis using both qualitative
and quantitative methods. For those derivatives that are designated and qualify
as hedging instruments, the derivative is designated, based upon the exposure
being hedged, as one of the following:
Fair value hedge. Changes in the fair value of the derivative as well
as the offsetting change in fair value on the hedged item attributable
to the risk being hedged are recognized in current operating earnings
during the period of change in fair value. The gain or loss on the
termination of an effective fair value hedge is recognized in current
operating earnings.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1 - Significant Accounting Policies - Continued
Cash flow hedge. To the extent it is effective, changes in the fair
value of the derivative are reported in other comprehensive income and
reclassified into earnings in the same period or periods during which
the hedged item affects earnings. The ineffective portion of the hedge,
if any, is recognized in current operating earnings during the period
of change in fair value. The gain or loss on the termination of an
effective cash flow hedge is reported in other comprehensive income and
reclassified into earnings in the same period or periods during which
the hedged item affects earnings.
Foreign currency exposure hedge. To the extent it is effective, changes
in the fair value of the derivative are reported in other comprehensive
income as part of the foreign currency translation adjustment and
reclassified into earnings in the same period or periods during which
remeasurement of the hedged foreign currency asset affects earnings.
The ineffective portion of the hedge, if any, is recognized in current
operating earnings during the period of change in fair value. The gain
or loss on the termination of an effective foreign currency exposure
hedge is reported in other comprehensive income as part of the foreign
currency translation adjustment and reclassified into earnings in the
same period or periods during which remeasurement of the hedged foreign
currency asset affects earnings.
Gains or losses on the termination of ineffective hedges are reported in current
operating earnings. In the event a hedged item is disposed of or the anticipated
transaction being hedged is no longer likely to occur, the Company will
terminate the related derivative and recognize the gain or loss on termination
in current operating earnings.
For a derivative not designated as a hedging instrument, the change in fair
value is recognized in current operating earnings during the period of change.
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.
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
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1 - Significant Accounting Policies - Continued
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
$217.1 million and $168.7 million as of December 31, 2001 and 2000,
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, prior to January 1, 2002,
was amortized on a straight-line basis over a period not to exceed 40 years. The
accumulated amortization for goodwill was $101.2 million and $85.9 million as of
December 31, 2001 and 2000, respectively. The carrying amount of goodwill is
reviewed for impairment annually or whenever events or changes in circumstances
indicate that the carrying amount might not be recoverable. If the fair value of
the operations to which the goodwill relates is 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 $352.7 million and $350.1 million as
of December 31, 2001 and 2000, 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.
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.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1 - Significant Accounting Policies - Continued
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 on 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 on 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.
The annual effective interest rate assumptions used to calculate reserves for
future policy and contract benefits are as follows:
December 31
2001 2000
---------------------------------------------
Active Life Reserves - Current Year Issues
Traditional Life 6.00% to 7.25% 6.00% to 7.25%
Individual Disability 6.00% to 9.00% 6.18% to 9.00%
Disabled Lives Reserves - Current Year Claims
Individual Disability 5.50% to 8.00% 6.65% to 8.00%
Group Disability 7.35% 7.35%
Disabled Lives Reserves - Prior Year Claims
Individual Disability 5.50% to 8.00% 6.65% to 8.00%
Group Disability 7.35% 7.35%
Interest assumptions for active life reserves may be graded downward over a
period of years. Reserves for future policy and contract benefits on
interest-sensitive products are principally policyholder account values.
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.
Federal Income Tax: 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.
Deferred Gain or Loss on Reinsurance: The Company is a party to various
reinsurance agreements. Where applicable, gains or losses on these transactions
are deferred and amortized into earnings based upon expected future premium
income for traditional insurance policies and estimated future gross profits for
interest-sensitive insurance policies. The deferred gain on reinsurance included
in other liabilities in the consolidated statements of financial condition at
December 31, 2001 and 2000 was $360.2 million and $373.5 million, respectively.
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
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1 - Significant Accounting Policies - Continued
for sales and administrative fees. Also, the sponsoring companies of the
separate accounts receive management fees 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 or 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 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 PFA was $408.6 million and $361.6 million at
December 31, 2001, and 2000, respectively, and represented approximately 1.0
percent and 0.9 percent of consolidated assets and 1.1 percent and 1.0 percent
of consolidated liabilities for December 31, 2001 and 2000, 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:
Statements of Financial Accounting Standards No. 133 (SFAS 133), Accounting for
Derivative Instruments and Hedging Activities, and No. 138 (SFAS 138),
Accounting for Certain Derivative Instruments and Certain Hedging Activities -
an Amendment of FASB Statement No. 133
Effective January 1, 2001, the Company adopted the provisions SFAS 133 and SFAS
138. SFAS 133 and SFAS 138 establish accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. The provisions of SFAS 133 and SFAS 138 require 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 and
SFAS 138 specify a special method of accounting for certain hedging
transactions, prescribe the type of items and transactions that may be hedged,
and provide the criteria which must be met in order to qualify for hedge
accounting.
At the adoption date of SFAS 133, the Company designated anew all of its hedging
relationships and formally documented these relationships. The Company
reclassified all of its held-to-maturity fixed maturity securities to
available-for-sale fixed maturity securities. These held-to-maturity securities
had an amortized cost of $346.6 million and a fair value of $369.8 million on
the date of reclassification. The resulting before-tax unrealized gain of $23.2
million was reported as a component of accumulated other comprehensive income in
stockholders' equity as a cumulative effect transition adjustment. No transition
adjustment was reported in net income as a result of the adoption of SFAS 133
and SFAS 138. See Note 5.
Prior to the adoption of SFAS 133, the Company accounted for all derivatives as
hedges. The fair values of the derivatives which hedged available-for-sale
securities were reported in the consolidated statements of financial condition
as a component of fixed maturity securities with the corresponding change in
fair value being reported in accumulated other comprehensive income (loss). The
fair values of interest rate swap agreements which hedged liabilities were not
reported in the consolidated statements of financial condition.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 1 - Significant Accounting Policies - Continued
Statement of Financial Accounting Standards No. 140 (SFAS 140), Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities
Effective April 1, 2001, the Company adopted SFAS 140. SFAS 140 revised the
standards for accounting and reporting for transfers and servicing of financial
assets and extinguishment of liabilities. The adoption of SFAS 140 did not have
a material impact on the Company's financial position or results of operations.
Accounting Pronouncements Outstanding:
Statement of Financial Accounting Standards No. 141 (SFAS 141), Business
Combinations
SFAS 141 addresses financial accounting and reporting for business combinations
and requires that all business combinations be accounted for using the purchase
method. SFAS 141 applies to all business combinations initiated after June 30,
2001. The adoption of SFAS 141 will have no immediate effect on the Company but
does prohibit the future use of the pooling of interests method of accounting
for business combinations.
Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and
Other Intangible Assets
SFAS 142 addresses financial accounting and reporting for acquired goodwill and
other intangible assets.
The Company will adopt the provisions of SFAS 142 effective January 1, 2002. In
accordance with SFAS 142, goodwill will no longer be amortized but will be
subject to annual impairment tests. Other intangible assets will continue to be
amortized over their useful lives.
Application of the non-amortization provision is expected to increase 2002
earnings $21.3 million before tax and $20.2 million after tax. At the initial
adoption of SFAS 142, the Company will perform the required transitional
goodwill impairment test. Any impairment loss resulting from the transitional
goodwill impairment test will be recognized as the effect of a change in
accounting principle and will be presented as a separate caption, net of tax, in
the consolidated statements of operations. The impairment loss, if any, is not
expected to have a material impact on the Company's financial position or
results of operations.
Statement of Financial Accounting Standards No. 143 (SFAS 143), Accounting for
Asset Retirement Obligations
SFAS 143 addresses financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. The Company will adopt the provisions of SFAS 143 effective
January 1, 2003. The adoption of this pronouncement is not expected to have a
material impact on the Company's financial position or results of operations.
Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for
the Impairment or Disposal of Long-Lived Assets
SFAS 144 supercedes Statement of Financial Accounting Standards No. 121 (SFAS
121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30 (Opinion 30), Reporting the Results
of Operations - Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.
Two accounting models existed for long-lived assets to be disposed of under SFAS
121 and Opinion 30. SFAS 144 represents a single accounting model for long-lived
assets to be disposed of by sale. The Company will adopt the provisions of SFAS
144 effective January 1, 2002. The adoption of this pronouncement is not
expected to have a material impact on the Company's financial position or
results of operations.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 2 - Merger
On June 30, 1999, Unum merged with and into Provident under the name
UnumProvident Corporation. Merger expenses, accounting policy changes, and
operating results for the six month period prior to the merger are discussed as
follows.
Merger Expenses
During 1999, the Company recognized expenses related to the merger and the early
retirement offer to employees as follows (in millions of dollars):
Employee related expense $ 77.7
Exit activities related to duplicate facilities/asset abandonments 67.4
Investment banking, legal, and accounting fees 39.6
------
Subtotal 184.7
Expense related to the early retirement offer to employees 125.9
------
Subtotal 310.6
Income tax benefit 89.2
------
Total $221.4
======
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.
57
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:
June 30, 1999
---------------------------------------
Current Rates Former Rates
---------------------------------------
Group Long-term Disability (North America) 6.75% 7.74%
Group Long-term Disability and Individual Disability (United Kingdom) 7.45% 8.80%
Individual Disability (North America) 6.88% 7.37%
The unpaid claim reserves for these disability lines as of June 30, 1999 were
$5,318.3 million using the former method for determining reserve discount rates
and $5,559.0 million using the current method. The impact on 1999 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.
58
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 of dollars).
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.
59
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 annual
effective interest 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 period prior to the merger were as follows (in millions of dollars):
Six Months Ended
June 30, 1999
----------------
Revenue
Unum $ 2,557.8
Provident 1,988.9
----------
Combined Revenue $ 4,546.7
==========
Net Income (Loss)
Unum $ (189.7)
Provident 87.8
----------
Combined Net Loss $ (101.9)
==========
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.
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 3 - Fair Values of Financial Instruments
The carrying amounts and fair values of the Company's financial instruments are
as follows:
December 31
(in millions of dollars)
------------------------------------------------------------
2001 2000
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------------------------
Assets
Fixed Maturity Securities
Available-for-Sale $24,352.7 $24,352.7 $22,110.4 $22,110.4
Derivatives Hedging Available-for-Sale 40.3 40.3 131.9 131.9
Held-to-Maturity - - 346.6 369.8
Equity Securities 10.9 10.9 24.5 24.5
Mortgage Loans 941.2 980.6 1,135.6 1,183.0
Policy Loans 2,517.0 2,517.0 2,426.7 2,426.7
Short-term Investments 379.7 379.7 279.4 279.4
Cash and Bank Deposits 123.9 123.9 107.1 107.1
Deposit Assets 608.8 608.8 658.5 658.5
Liabilities
Policyholders' Funds
Deferred Annuity Products 1,481.1 1,481.1 1,665.3 1,665.3
Other 365.8 373.0 386.7 396.6
Short-term Debt 161.8 161.8 402.2 402.2
Long-term Debt 2,004.2 1,982.8 1,615.5 1,465.8
Company-Obligated Mandatorily Redeemable
Preferred Securities 300.0 286.2 300.0 245.9
Derivatives Hedging Liabilities (2.4) (2.4) (4.3) (4.3)
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.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 3 - Fair Values of Financial Instruments - Continued
Policy Loans, Short-term Investments, Cash and Bank Deposits, and Deposit
Assets: Carrying amounts approximate fair value.
Policyholders' Funds: Carrying amounts 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. Carrying amounts for
supplementary contracts without life contingencies approximate fair value.
Fair values for insurance contracts other than investment contracts are not
required to be disclosed. However, the fair values of liabilities under all
insurance contracts are taken into consideration in the Company's overall
management of interest rate risk, which minimizes exposure to changing interest
rates through the matching of investment maturities with amounts due under
insurance contracts.
Short-term Debt: 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.
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4 - Investments
Securities
The amortized cost and fair values of securities by security type are as
follows:
December 31, 2001
(in millions of dollars)
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
---------------------------------------------------------
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 74.2 $ 13.8 $ -- $ 88.0
States, Municipalities, and Political Subdivisions 55.2 2.5 0.1 57.6
Foreign Governments 725.8 122.5 2.0 846.3
Public Utilities 2,705.7 134.6 66.4 2,773.9
Mortgage-backed Securities 3,820.8 267.6 14.2 4,074.2
All Other Corporate Bonds 16,213.0 948.3 827.9 16,333.4
Redeemable Preferred Stocks 226.3 7.0 13.7 219.6
------------ ------------ ------------ ------------
Total Fixed Maturity Securities 23,821.0 1,496.3 924.3 24,393.0
Equity Securities 9.4 1.9 0.4 10.9
------------ ------------ ------------ ------------
Total $ 23,830.4 $ 1,498.2 $ 924.7 $ 24,403.9
============ ============ ============ ============
December 31, 2000
(in millions of dollars)
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
---------------------------------------------------------
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 76.9 $ 14.9 $ -- $ 91.8
States, Municipalities, and Political Subdivisions 155.0 3.5 0.2 158.3
Foreign Governments 752.1 131.7 0.8 883.0
Public Utilities 3,138.1 141.4 47.3 3,232.2
Mortgage-backed Securities 3,159.8 162.9 5.9 3,316.8
All Other Corporate Bonds 14,536.4 772.1 844.0 14,464.5
Redeemable Preferred Stocks 112.9 2.4 19.6 95.7
------------ ------------ ------------ ------------
Total Fixed Maturity Securities 21,931.2 1,228.9 917.8 22,242.3
Equity Securities 23.2 4.0 2.7 24.5
------------ ------------ ------------ ------------
Total $ 21,954.4 $ 1,232.9 $ 920.5 $ 22,266.8
============ ============ ============ ============
Held-to-Maturity Securities
United States Government and
Government Agencies and Authorities $ 6.9 $ 1.6 $ -- $ 8.5
States, Municipalities, and Political Subdivisions 1.5 0.1 -- 1.6
Mortgage-backed Securities 320.7 20.6 -- 341.3
All Other Corporate Bonds 17.5 0.9 -- 18.4
------------ ------------ ------------ ------------
Total $ 346.6 $ 23.2 $ -- $ 369.8
============ ============ ============ ============
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4 - Investments - Continued
The amortized cost and fair values of fixed maturity securities by maturity date
are shown below. The maturity dates have not been adjusted for possible calls or
prepayments.
December 31, 2001
(in millions of dollars)
-----------------------------
Amortized Fair
Cost Value
--------- ---------
Available-for-Sale Securities
1 year or less $ 419.7 $ 466.7
Over 1 year through 5 years 1,993.4 2,097.5
Over 5 years through 10 years 4,576.3 4,426.6
Over 10 years 13,010.8 13,328.0
--------- ---------
20,000.2 20,318.8
Mortgage-backed Securities 3,820.8 4,074.2
--------- ---------
Total $23,821.0 $24,393.0
========= =========
At December 31, 2001, 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 $2,261.7 million or 8.7 percent of invested
assets excluding ceded policy loans. The amortized cost of these securities was
$2,738.3 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 on these securities were $44.2 million and $23.6 million,
respectively, at December 31, 2001 and 2000.
In the normal course of business, the Company both loans securities to broker
dealers and invests in short-term repurchase agreements. For both types of
transactions, the Company requires that a minimum of 102 percent of the fair
value of the securities loaned or securities purchased under repurchase
agreements be maintained as collateral. Generally, cash is received as
collateral under these agreements. In the event that securities are received as
collateral, the Company is not permitted to sell or repledge them.
At December 31, 2001, the Company had a retained interest in a special purpose
entity trust that was securitized with financial assets consisting of a United
States Treasury bond and several limited partnership equity interests. This
investment was reported at fair value and included with fixed maturity
securities in the consolidated statements of financial condition. The fair value
of this investment was derived from the fair value of the underlying assets,
which are based on quoted market prices as well as the limited partnership
capital balances. The fair value and amortized cost of this investment was
$113.6 million and $122.6 million, respectively, at December 31, 2001 and $121.8
million and $114.5 million at December 31, 2000. At December 31, 2001, the
Company had capital commitments of $21.7 million to this special purpose entity
trust. These funds are due upon satisfaction of contractual notice from the
trust. These amounts may or may not be funded during the term of the trust.
At December 31, 2001, the Company had capital commitments of $36.6 million to
fund certain of its private placement fixed maturity securities. The funds are
due upon satisfaction of contractual notice from the issuer. These amounts may
or may not be funded during the term of the security.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4 - Investments - Continued
The components of the change in the net unrealized gain on securities and the
change in the net gain on cash flow hedges included in other comprehensive
income (loss) are as follows:
Year Ended December 31
2001 2000 1999
(in millions of dollars)
---------------------------------------------
Change in Net Unrealized Gain (Loss)
Before Reclassification Adjustment $ 215.1 $ 384.5 $ (2,159.3)
Reclassification Adjustment for Net Realized
Investment (Gain) Loss 40.6 14.6 (87.1)
Cumulative Effect Transition Adjustment for the
Adoption of SFAS 133 and SFAS 138 - Note 1 23.2 -- --
Change in Net Gain on Cash Flow Hedges 4.3 -- --
Change in Net Unrealized Gain on Deposit Assets 20.6 49.5 (237.5)
Change in the Adjustment to Reserves for
Future Policy and Contract Benefits (426.8) (159.1) 1,014.8
Change in Tax Liability 49.3 (96.5) 519.5
------------ ------------ ------------
Total $ (73.7) $ 193.0 $ (949.6)
============ ============ ============
In accordance with the adoption of SFAS 133, the Company reclassified within
accumulated other comprehensive income the beginning of the year balance in 2001
of $75.3 million of after-tax unrealized gains on derivatives from the net
unrealized gain on securities to the net gain on cash flow hedges.
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 $13.1 million and $17.7 million,
respectively, at December 31, 2001 and 2000. Included in the impaired loans at
December 31, 2001 were loans of $6.4 million that had a related allowance for
losses of $2.4 million and loans of $6.7 million that had no related allowance
for losses. Included in the impaired loans at December 31, 2000 were loans of
$6.5 million that had a related allowance for losses of $2.4 million and loans
of $11.2 million which had no related allowance for losses.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 4 - Investments - Continued
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:
Balance at Balance
Beginning at End
of Year Additions Deductions of Year
(in millions of dollars)
-------------------------------------------------
Year Ended December 31, 1999
Mortgage Loans $ 32.8 $ 0.1 $ -- $ 32.9
Real Estate 51.2 -- 13.4 37.8
---------- ---------- ---------- ----------
Total $ 84.0 $ 0.1 $ 13.4 $ 70.7
========== ========== ========== ==========
Year Ended December 31, 2000
Mortgage Loans $ 32.9 $ -- $ 20.0 $ 12.9
Real Estate 37.8 -- 12.2 25.6
---------- ---------- ---------- ----------
Total $ 70.7 $ -- $ 32.2 $ 38.5
========== ========== ========== ==========
Year Ended December 31, 2001
Mortgage Loans $ 12.9 $ -- $ 10.5 $ 2.4
Real Estate 25.6 -- 5.7 19.9
---------- ---------- ---------- ----------
Total $ 38.5 $ -- $ 16.2 $ 22.3
========== ========== ========== ==========
66
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:
Year Ended December 31
2001 2000 1999
(in millions of dollars)
---------------------------------------------
Fixed Maturity Securities $ 1,912.9 $ 1,824.1 $ 1,712.7
Equity Securities 0.1 0.1 0.1
Mortgage Loans 86.1 100.7 111.2
Real Estate 11.7 24.7 37.0
Policy Loans 12.0 120.3 222.3
Other Long-term Investments 10.0 11.2 6.8
Short-term Investments 24.7 27.1 56.0
------------ ------------ ------------
Gross Investment Income 2,057.5 2,108.2 2,146.1
Less Investment Expenses 33.5 24.7 63.0
Less Investment Income on PFA Assets 21.1 23.1 23.4
------------ ------------ ------------
Net Investment Income $ 2,002.9 $ 2,060.4 $ 2,059.7
============ ============ ============
Realized Investment Gain and Loss
Realized investment gains (losses) are as follows:
Year Ended December 31
2001 2000 1999
(in millions of dollars)
---------------------------------------------
Fixed Maturity Securities
Gross Gains $ 85.7 $ 93.4 $ 82.6
Gross Losses (186.6) (197.6) (99.9)
Equity Securities 2.4 9.8 25.8
Mortgage Loans, Real Estate, and Other Invested Assets 52.5 42.9 17.1
Deposit Assets 3.1 25.5 61.4
Derivatives 2.3 11.4 0.1
------------ ------------ ------------
Realized Investment Gain (Loss) $ (40.6) $ (14.6) $ 87.1
============ ============ ============
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.
67
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 $37.0 million at December 31, 2001.
Hedging Activity
The table below summarizes by notional amounts the activity for each category of
derivatives.
Swaps
-----------------------------------
Receive Receive Receive
Variable/ Fixed/Pay Fixed/Pay
Pay Fixed Fixed Variable Forwards Futures Options Total
(in millions of dollars)
----------------------------------------------------------------------------------------
Balance at December 31, 1998 $ -- $ 168.3 $ 1,080.0 $ -- $ 111.0 $ 212.3 $ 1,571.6
Additions 8.2 12.3 406.0 82.9 325.0 459.0 1,293.4
Terminations -- 168.3 320.0 -- 436.0 370.0 1,294.3
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 1999 8.2 12.3 1,166.0 82.9 -- 301.3 1,570.7
Additions -- 15.8 569.0 40.0 283.3 -- 908.1
Terminations 8.2 -- 600.0 122.9 283.3 294.0 1,308.4
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 2000 -- 28.1 1,135.0 -- -- 7.3 1,170.4
Additions 500.0 -- 459.0 126.6 -- -- 1,085.6
Terminations 500.0 10.9 620.0 -- -- -- 1,130.9
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 2001 $ -- $ 17.2 $ 974.0 $ 126.6 $ -- $ 7.3 $ 1,125.1
========== ========== ========== ========== ========== ========== ==========
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, 2001, whereby the Company receives a
fixed rate and pays a variable rate. The weighted average interest rates assume
current market conditions.
2002 2003 2004 2005 2007 Total
(in millions of dollars)
------------------------------------------------------------------------
Receive Fixed/Pay Variable
Notional Value $329.0 $279.0 $149.0 $157.0 $ 60.0 $974.0
Weighted Average Receive Rate 7.55% 7.12% 6.76% 6.83% 13.37% 7.55%
Weighted Average Pay Rate 1.88% 1.88% 1.88% 1.88% 3.60% 1.99%
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 5 - Derivative Financial Instruments - Continued
The Company's derivatives all qualify as hedges and have been designated as cash
flow hedges. The cash flow hedging programs are described as follows.
The Company has executed a series of cash flow hedges in the group disability,
individual disability, group and individual long-term care, and group single
premium annuities portfolios using forward starting interest rate swaps. The
purpose of these hedges is to lock in the reinvestment rates on future
anticipated cash flows through the year 2005 and protect the Company from the
potential adverse impact of declining interest rates on the associated policy
reserves. The Company plans on terminating these forward interest rate swaps at
the time the projected cash flows are used to purchase fixed income securities.
The Company has entered into an interest rate swap whereby it receives a fixed
rate of interest and pays a variable rate of interest. The purpose of this swap
is to hedge the variable cash flows associated with a floating rate security
owned by the Company. The variable rate the Company pays on the swap is offset
by the amount the Company receives on the variable rate security.
The Company has entered into several foreign currency interest rate swaps
whereby it receives a fixed rate of interest denominated in U.S. dollars
(functional currency) and pays a fixed rate of interest denominated in a foreign
currency. The purpose of these derivatives is to eliminate the variability of
functional currency cash flows associated with certain foreign currency
denominated securities owned by the Company. The fixed rate the Company pays on
the swap is offset by the fixed rate it receives on the foreign currency
denominated security.
The Company also used forward starting swaps to hedge the interest rate on its
anticipated issuance of debt. This hedge was initiated in the first quarter of
2001 and was terminated in March 2001 when the debt was issued. The deferred
gain of $2.8 million is being amortized into earnings as a component of interest
expense over the expected remaining life of the hedged debt instrument. See Note
9.
The Company has invested in certain structured fixed maturity securities that
contain embedded derivatives. These embedded derivatives represent forward
contracts and are accounted for as cash flow hedges. The purpose of these
forward contracts is to hedge the risk of changes in cash flows related to the
anticipated purchase of equity securities.
During 2001, the Company recognized net gains of $87.6 million upon the
termination of cash flow hedges and reported $85.6 million of these gains in
other comprehensive income. In 2001, the Company reported $2.0 million in
operating earnings as realized investment gains in conjunction with hedges that
were terminated.
The Company amortized $9.1 million of net deferred gains into earnings during
2001 including the amortization of deferred gains on derivative instruments that
arose prior to the initial application of SFAS 133 and that were previously
added to the carrying amount of recognized hedged assets. The estimated amount
of net deferred gains that will be amortized into operating earnings during 2002
is $10.4 million. The notional amount of derivatives outstanding under the hedge
programs was $1,125.1 million at December 31, 2001.
For the year ended December 31, 2001, there was no material ineffectiveness
related to the Company's derivative holdings, and there was no component of the
derivative instruments' gain or loss excluded from the assessment of hedge
effectiveness.
69
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:
2001 2000 1999
(in millions of dollars)
--------------------------------------------
Balance at January 1 $ 591.6 $ 534.1 $ 570.5
Acquisition of Business -- 138.4 --
Disposition of Business -- (31.2) --
Interest Accrued 41.4 43.8 40.4
Amortization (89.8) (88.8) (78.7)
Change in Foreign Currency Translation Adjustment (1.0) (4.7) 1.9
------------ ------------ ------------
Balance at December 31 $ 542.2 $ 591.6 $ 534.1
============ ============ ============
The estimated net amortization of value of business acquired for each of the
next five years is $43.8 million in 2002, $42.6 million in 2003, $41.0 million
in 2004, $39.5 million in 2005, and $38.0 million in 2006. Acquisition and
disposition activity related to certain reinsurance transactions. See Note 13.
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 7 - Liability for Unpaid Claims and Claim Adjustment Expenses
Changes in the liability for unpaid claims and claim adjustment expenses are as
follows:
2001 2000 1999
(in millions of dollars)
------------------------------------------
Balance at January 1 $ 18,696.8 $ 15,344.5 $ 13,159.1
Less Reinsurance Recoverables 3,964.6 2,087.9 1,614.8
------------ ------------ ------------
Net Balance at January 1 14,732.2 13,256.6 11,544.3
Acquisition of Business - Note 13 -- 602.5 --
Incurred Related to
Current Year 4,366.8 4,565.0 4,853.8
Prior Years
Interest 994.9 872.1 705.4
Incurred 74.7 19.6 757.5
------------ ------------ ------------
Total Incurred 5,436.4 5,456.7 6,316.7
------------ ------------ ------------
Paid Related to
Current Year 1,355.9 1,496.1 1,538.2
Prior Years 3,525.9 3,087.5 3,066.2
------------ ------------ ------------
Total Paid 4,881.8 4,583.6 4,604.4
------------ ------------ ------------
Net Balance at December 31 15,286.8 14,732.2 13,256.6
Plus Reinsurance Recoverables 2,544.5 3,964.6 2,087.9
------------ ------------ ------------
Balance at December 31 $ 17,831.3 $ 18,696.8 $ 15,344.5
============ ============ ============
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 2001,
2000, and 1999. During 1999, unpaid claims incurred for prior years increased
primarily due to changes in reserves as disclosed in Notes 2 and 13.
September 11, 2001
The tragedy of September 11, 2001 resulted in a third quarter 2001 before-tax
charge of $24.0 million, or $15.6 million after tax. This charge includes
estimated gross ultimate losses from reported and unreported claims of $65.0
million less an estimated $41.0 million recoverable from the Company's
reinsurers. The charge does not include any indirect costs which the Company
incurred in developing specialized procedures for filing claims resulting from
the attacks and in providing additional support to impacted policyholders and
group clients. The Company's reinsurance program provides a significant layer of
catastrophic coverage for its individual disability and its group life,
accidental death and dismemberment, travel accident, long-term disability, and
short-term disability lines of business through a group of highly rated major
national and international reinsurance organizations. Because of the quality and
level of the Company's various reinsurance coverages, the Company does not
anticipate that any of its reinsurers will be unable to cover the claims
incurred as a result of the events. Should this occur, however, all of the
Company's insurance subsidiaries are sufficiently capitalized such that each
insurance subsidiary will be able to satisfy these claims and will face no
liquidity or risk-based capital issues.
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 8 - Federal Income Tax
A reconciliation of the income tax (benefit) attributable to continuing
operations computed at U.S. federal statutory tax rates to the income tax
expense as included in the consolidated statements of operations follows:
Year Ended December 31
2001 % 2000 % 1999 %
(in millions of dollars)
-----------------------------------------------------------------------
Statutory Income Tax (Benefit) $ 288.8 35.0% $ 303.0 35.0% $ (57.9) 35.0%
Tax-exempt Investment Income (9.8) (1.2) (13.5) (1.6) (22.0) 13.3
Income Tax Settlements -- -- -- -- (14.2) 8.6
Business Restructuring Charges -- -- -- -- 17.2 (10.4)
Tax Basis in Foreign Subsidiary -- -- (44.5) (5.1) -- --
Change in Valuation Allowance (44.3) (5.4) 42.5 4.9 65.7 (39.7)
Goodwill 8.4 1.0 6.9 0.8 25.9 (15.7)
Other Items, Net (0.1) -- 7.0 0.8 2.7 (1.6)
-------- -------- -------- -------- -------- --------
Effective Tax $ 243.0 29.4% $ 301.4 34.8% $ 17.4 (10.5)%
======== ======== ======== ======== ======== ========
The net deferred income tax liability consists of the following:
December 31
2001 2000
(in millions of dollars)
------------------------
Deferred Tax Liability
Deferred Policy Acquisition Costs $ 603.5 $ 527.1
Net Unrealized Gain on Securities and Cash Flow Hedges 55.6 105.1
Value of Business Acquired 192.1 210.2
Policy Reserve Adjustments 128.3 31.0
Property and Equipment 26.2 18.5
Other Employee Benefits 19.9 19.7
Other 33.2 24.5
---------- ----------
Gross Deferred Tax Liability 1,058.8 936.1
---------- ----------
Deferred Tax Asset
Net Operating Losses 221.7 226.4
Reinsurance Gains and Losses 128.1 131.9
Accrued Liabilities 24.9 27.8
Tax Basis in Foreign Subsidiary 3.9 44.5
Realized Investment Gains and Losses 122.6 88.1
Postretirement Benefits 70.9 68.2
Foreign Currency Translation 33.8 22.8
Other 14.2 11.1
---------- ----------
Gross Deferred Tax Asset 620.1 620.8
Less Valuation Allowance 71.2 115.5
---------- ----------
Net Deferred Tax Asset 548.9 505.3
---------- ----------
Net Deferred Tax Liability $ 509.9 $ 430.8
========== ==========
Prior year amounts have been reclassified to conform to the current year
presentation.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 8 - Federal Income Tax - Continued
Under the Life Insurance Company Tax Act of 1959, life companies were required
to maintain a policyholders' surplus account containing the accumulated portion
of current income which had not been subjected to income tax in the year earned.
The Deficit Reduction Act of 1984 requires that no future amounts be added after
1983 to the policyholders' surplus account. Further, any future distributions
from the account would become subject to federal income tax at the general
corporate federal income tax rate then in effect. The amount of the
policyholders' surplus account at December 31, 2001, is approximately $228.8
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 2002, this would
result in a tax of approximately $80.1 million. No current or deferred federal
income taxes have been provided on these amounts because management considers
the conditions under which such taxes would be paid to be remote.
The Company has not provided for deferred taxes on basis differences in its
foreign subsidiaries that are permanent in duration or on the unremitted
earnings of its domestic subsidiaries which are not expected to result in
taxable or deductible amounts.
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):
Year Ended December 31
2001 2000 1999
(in millions of dollars)
--------------------------------------------
Income (Loss) Before Tax Subject to Foreign Taxation $ 95.2 $ 109.5 $ (213.5)
============ ============ ============
Foreign Income Tax Expense (Credit)
Current $ 7.8 $ 54.3 $ 38.0
Deferred 8.0 (23.6) (40.9)
------------ ------------ ------------
Total Foreign Income Tax Expense (Credit) $ 15.8 $ 30.7 $ (2.9)
============ ============ ============
For most of the Company's subsidiaries, tax years through 1995 are closed to
further assessment by the Internal Revenue Service (IRS). During 2001, the IRS
continued its examination of subsequent tax 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.
During 2001, the Company's valuation allowance decreased by $44.3 million
related to its investment in foreign operations.
The Company's subsidiaries had net operating loss carryforwards of approximately
$627.5 million, alternative minimum tax credit carryforwards of approximately
$2.8 million, and capital loss carryforwards of $5.9 million as of December 31,
2001. The majority of the net operating loss carryforwards will begin to expire,
if not utilized, in 2020; the alternative minimum tax credits do not expire; the
capital loss carryforward, if not utilized, will expire in 2006.
Federal income taxes paid during 2001, 2000, and 1999 were $127.3 million,
$165.6 million, and $77.8 million, respectively.
73
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 (in millions of dollars):
December 31
2001 2000
---------------------------------------------------------------
Weighted Weighted
Average Average
Interest Interest
Balance Rate Balance Rate
---------------------------------------------------------------
Commercial Paper $126.8 3.28% $ -- --%
Current Portion of Medium-term Notes 35.0 7.55 -- --
Private Placements -- -- 400.0 7.2
Other Short-term Debt -- -- 2.2 4.8
------ ------
Total $161.8 $402.2
====== ======
Long-term debt consists of the following:
December 31
2001 2000
(in millions of dollars)
------------------------
Commercial Paper, average interest rate of 3.22% $ 470.2 $ 449.0
and 7.74%
Notes @ 6.75% due 2028, callable at or above par 250.0 250.0
Notes @ 7.25% due 2028, callable at or above par 200.0 200.0
Notes @ 7.0% due 2018, non-callable 200.0 200.0
Notes @ 7.625% due 2011, non-callable 575.0 --
Notes @ 6.375% due 2005, non-callable 200.0 200.0
Monthly Income Debt Securities @ 8.8% due 2025, callable at
par in 2000 and thereafter -- 172.5
Medium-term Notes @ 5.9% to 7.3% due 2003 to 2028, non-callable 109.0 144.0
---------- ----------
Total $ 2,004.2 $ 1,615.5
========== ==========
In 2001 the Company redeemed its $172.5 million par value 8.8% monthly income
debt securities. This early extinguishment of debt resulted in a write-off of
the remaining deferred debt costs of $4.5 million associated with the issuance
of the securities. The write-off is reported as an extraordinary loss, net of a
$1.6 million tax benefit, in 2001.
In 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 364-day
portion of the credit facility was renewed as of October 2001. Interest is
variable based upon a London Interbank Offered Rate (LIBOR) plus a margin or an
alternate base rate. At December 31, 2001, approximately $403.0 million was
available for additional financing under the Company's revolving credit
facilities.
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 9 - Debt and Company-Obligated Mandatorily Redeemable Preferred Securities
- - Continued
Also in 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. In 2001, the Company completed a long-term debt offering, issuing $575.0
million of 7.625% senior notes due March 1, 2011. The proceeds were used to
refinance short-term debt on a long-term basis and to fund other corporate
needs. At December 31, 2001, $425.0 million was available under the shelf
registration.
Commercial paper debt is due within one year, but a portion has been classified
as long term because the Company has the ability through the 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 $2,004.2 million of long-term debt at December 31, 2001, $470.2 million
will mature in 2002, $20.0 million will mature in 2003, $227.0 million will
mature in 2005, and $1,287.0 million will mature in 2011 and thereafter.
Interest paid on short-term and long-term debt during 2001, 2000, and 1999 was
$137.1 million, $156.9 million, and $115.2 million, respectively.
Company-Obligated Mandatorily Redeemable Preferred Securities
In 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 each of the years ended December 31, 2001, 2000,
and 1999 was $22.2 million.
75
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.
Pension Benefits Postretirement Benefits
------------------------------------------------
2001 2000 2001 2000
(in millions of dollars)
------------------------------------------------
Change in Benefit Obligation
Balance at January 1 $ 310.7 $ 651.5 $ 191.8 $ 165.5
Service Cost 11.8 12.0 4.0 4.9
Interest Cost 23.4 45.4 14.1 13.2
Plan Amendments -- (12.4) (15.2) 16.0
Actuarial (Gain) Loss 38.3 (6.3) 35.1 4.1
Benefits Paid (13.7) (36.4) (11.0) (11.9)
Settlement -- (343.1) -- --
--------- --------- --------- ---------
Balance at December 31 370.5 310.7 218.8 191.8
--------- --------- --------- ---------
Change in Fair Value of Plan Assets
Balance at January 1 521.5 927.3 10.9 11.2
Actual Return on Plan Assets (49.2) (33.1) (0.1) --
Contributions 4.6 6.8 10.6 11.6
Benefits Paid (13.7) (36.4) (11.0) (11.9)
Settlement -- (343.1) -- --
--------- --------- --------- ---------
Balance at December 31 463.2 521.5 10.4 10.9
--------- --------- --------- ---------
Funded (Underfunded) Status of the Plans at December 31 92.7 210.8 (208.4) (180.9)
Unrecognized Net Actuarial (Gain) Loss 38.2 (99.4) 36.0 0.8
Unrecognized Prior Service Cost (22.5) (25.2) (21.7) (8.0)
Unrecognized Net Transition Obligation 0.5 0.9 -- --
--------- --------- --------- ---------
Prepaid (Accrued) Benefit Cost $ 108.9 $ 87.1 $ (194.1) $ (188.1)
========= ========= ========= =========
During 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.
At December 31, 2001, the plan assets include 448,784 shares of the Company's
common stock with a fair value of $11.9 million. The amount of dividends paid
during 2001 was immaterial.
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 10 - Pensions and Other Postretirement Benefits - Continued
The weighted average assumptions used in the measurement of the Company's
benefit obligation are as follows:
Pension Benefits Postretirement Benefits
------------------------------------------------
2001 2000 2001 2000
------------------------------------------------
Discount Rate 7.35% 7.60% 7.35% 7.60%
Expected Return on Plan Assets 9.00% 9.00% 6.00% 6.00%
Rate of Compensation Increase 5.00% 4.50% -- --
For measurement purposes at December 31, 2001, the annual rate of increase in
the per capita cost of covered health care benefits assumed for 2002 was 11.0
percent. The rate range was assumed to change gradually to a rate of 5.0 percent
for 2008 and remain at that level thereafter. For measurement purposes at
December 31, 2000, the annual rate of increase in the per capita cost of covered
health care benefits for 2001 was 7.5 percent, and was assumed to gradually
decrease to a rate of 5.5 percent in 2004 and remain at that level thereafter.
A one percent increase or decrease in the assumed health care cost trend rate at
December 31, 2001 and 2000 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.
Year Ended December 31
Pension Benefits Postretirement Benefits
----------------------------------------------------------------------
2001 2000 1999 2001 2000 1999
(in millions of dollars)
----------------------------------------------------------------------
Service Cost $ 11.8 $ 12.0 $ 22.7 $ 4.0 $ 4.9 $ 5.7
Interest Cost 23.4 45.4 46.2 14.1 13.2 11.4
Expected Return on Plan Assets (46.7) (82.6) (79.9) (0.6) (0.7) (0.9)
Net Amortization and Deferral (5.7) (23.3) (12.5) (1.5) (1.9) 2.4
Early Retirement - Note 2 -- -- 95.2 -- -- 30.7
Settlement -- (116.1) -- -- -- --
--------- --------- --------- --------- --------- ---------
Total $ (17.2) $ (164.6) $ 71.7 $ 16.0 $ 15.5 $ 49.3
========= ========= ========= ========= ========= =========
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 11 - Stockholders' Equity and Earnings Per Share
Preferred Stock
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.
Earnings Per Common Share
The computations of earnings per common share and earnings per common share
assuming dilution are as follows:
Year Ended December 31
2001 2000 1999
(in millions of dollars, except share data)
--------------------------------------------
Numerator
Net Income (Loss) $ 579.2 $ 564.2 $ (182.9)
============ ============ ============
Denominator (000s)
Weighted Average Common Shares - Basic 241,824.9 240,880.4 239,080.6
Dilution for Assumed Exercise of Stock Options and Stock 1,783.8 1,180.6 --
------------ ------------ ------------
Weighted Average Common Shares - Assuming Dilution 243,608.7 242,061.0 239,080.6
============ ============ ============
Net Income (Loss) Per Common Share
Basic $ 2.40 $ 2.34 $ (0.77)
Assuming Dilution $ 2.38 $ 2.33 $ (0.77)
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 10.2 million, 10.7 million, and 3.7
million options for the years ended December 31, 2001, 2000 and 1999,
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.
78
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 $27.0 million, $28.8 million, and $6.6 million for
2001, 2000, and 1999, respectively.
Stock Plans
Under the stock plan of 1999, the Company has available up to 17,500,000 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 3,500,000 shares.
The options have a maximum term of ten years after the date of grant. The
Company granted 158,100 shares of restricted stock to certain employees during
2001 with a weighted average grant date value of $27.99 per common share.
Under the broad-based stock plan of 2001, the Company has available up to
2,000,000 shares of common stock for awards to its employees, consultants, and
producers, excluding certain senior officers and directors. For both the stock
plan of 1999 and the broad-based stock plan of 2001, the exercise price for
stock options issued shall not be less than the fair market value of the
Company's stock as of the grant date.
Prior to these stock plans, 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:
2001 2000 1999
-------------------------- -------------------------- -------------------------
Shares Weighted Average Shares Weighted Average Shares Weighted Average
(000s) Exercise Price (000s) Exercise Price (000s) Exercise Price
------ ---------------- ------ ---------------- ------ ----------------
Outstanding at January 1 16,200 $30.53 14,299 $36.04 15,023 $30.43
Granted 3,495 28.12 5,299 15.71 3,795 48.15
Exercised (910) 16.79 (612) 16.04 (3,460) 22.38
Forfeited or Expired (589) 26.95 (2,786) 33.66 (1,059) 44.43
------- ------ -------
Outstanding at December 31 18,196 30.87 16,200 30.53 14,299 36.04
====== ====== ======
December 31, 2001
-------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
---------------------------------------------------------- -------------------------------------
Weighted Average
Range of Shares Remaining Years Weighted Average Shares Weighted Average
Exercise Prices (000s) in Contractual Life Exercise Price (000s) Exercise Price
--------------- ------ ------------------- -------------- ------ --------------
$ 10 to 19 4,014 7.0 $14.70 1,276 $16.74
20 to 29 6,796 6.5 26.74 3,019 25.52
30 to 39 3,488 4.6 34.80 3,453 34.83
40 to 49 1,289 6.8 45.52 1,078 45.55
50 to 59 2,609 6.7 54.01 2,218 53.81
------ ------
Total 18,196 6.3 30.87 11,044 35.06
====== ======
79
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 159,572; 201,626; and 86,497 shares
to employees with a weighted average exercise price of $22.40, $16.73, and
$31.71 in 2001, 2000, and 1999, respectively.
Compensation Cost Under the Fair Value Approach
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 defined in Statement of Financial
Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based
Compensation, 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 2001, 2000 and 1999 are as follows:
Year Ended December 31
2001 2000 1999
-------------------------------------------
Volatility 26.3% 24.2% 24.0%
Risk-free Rate of Return 5.0% 6.6% 5.5%
Dividend Payout Rate Per Share $0.59 $0.59 $0.59
Time of Exercise
Stock Option Plan 6.0 years 6.0 years 5.7 years
ESPP 3 months 3 months 3 months
Weighted Average Fair Value of Awards Granted During the Year
Stock Option Plan $7.87 $2.73 $14.33
ESPP $5.57 $5.20 $10.77
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:
Year Ended December 31
2001 2000 1999
(in millions of dollars, except share data)
-----------------------------------------------------
Net Income (Loss) $566.9 $556.0 $(223.6)
Net Income (Loss) Per Common Share
Basic 2.34 2.31 (0.94)
Assuming Dilution 2.33 2.30 (0.94)
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
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, 2001 relates to approximately 315 reinsurance
relationships. Of the seven major relationships which account for approximately
78 percent of the reinsurance receivable amount at December 31, 2001, 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 benefits and change in reserves for future 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
2001 2000 1999
(in millions of dollars)
----------------------------------------------
Premium Income $ 720.6 $665.3 $508.3
Benefits and Change in Reserves for Future Benefits 1,172.3 820.8 695.5
Premium income assumed was $513.3 million, $618.1 million, and $576.7 million
during 2001, 2000, and 1999, respectively.
During 2001, the Company reinsured on a 100 percent indemnity coinsurance basis
certain cancer policies written by one of the Company's insurance subsidiaries.
The effective date of the transaction was November 1, 2001. Total policy
reserves ceded were approximately $113.6 million. The $12.3 million before-tax
gain on this transaction was deferred and is being amortized into income based
upon expected future premium income on the policies ceded.
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.
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.
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13 - Reinsurance - Continued
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 noncancelable 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, 2001, the attachment point had not been reached.
The following discloses the various layers in the agreement at December 31, 2001
(in millions of dollars):
Net GAAP Reserves $ 843.9
Experience Layer 386.8
----------
Attachment Point 1,230.7
Centre Re's Defined Risk Layer 128.9
----------
Defined Risk Limit $ 1,359.6
==========
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 Standards 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 gain or loss from the sale of assets is reflected as a realized
investment gain or loss in the Company's consolidated statements of operations.
Included in miscellaneous assets in the consolidated statements of financial
condition at December 31, 2001, is a deposit asset for this reinsurance
arrangement of approximately $367.4 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 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
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13 - Reinsurance - Continued
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 2001, the Company entered into an agreement to limit its liabilities
pertaining to the Lloyd's syndicate participations. Separately, the Company also
reinsured 100 percent of the group disability reinsurance reserves and all
future business underwritten and managed by Duncanson and Holt Services, Inc., a
subsidiary of D&H. The transaction, in which reserves of approximately $323.8
million were ceded to the reinsurer, had an effective date of January 1, 2001.
In a separate but related transaction, the Company also sold the reinsurance
management operations of Duncanson and Holt Services, Inc. and divested the
remaining assets of that facility during 2001. The gains on the reinsurance and
sale transactions were immaterial.
The table below summarizes the charges recognized by the Company during 2000 and
1999 related to the reinsurance operations. There were no significant charges
recognized during 2001.
2000 1999
(in millions of dollars)
------------------------
North American Reinsurance Operations
Loss on Sale of A&H and LTC Reinsurance Management Operations $ -- $ 12.9
Loss on Reinsurance of A&H and LTC Risk Participations -- 12.7
Provision for Losses on Retained Business -- 42.1
International Reinsurance Operations
Provision for Losses on Lloyd's of London Syndicate Participations -- 186.5
Provision for Losses on Reinsurance Pool Participations Other than
Lloyd's 37.4 21.9
Goodwill Impairment Excluding Amount Recognized on Sale -- 51.7
--------- ---------
Total Before-tax Charge $ 37.4 $ 327.8
========= =========
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.
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13 - Reinsurance - Continued
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 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.
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 13 - Reinsurance - Continued
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, working with the pool managers in London, 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
Because an event or change in circumstance occurred that indicated the
recoverability of an asset should be assessed for impairment, a
recoverability test was performed to determine if impairment had 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. The tests indicated that future undiscounted cash
flows were insufficient to recover the entire goodwill amount, indicating
that the goodwill was impaired. 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 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, but
has retained certain risks, including the exposure associated with disputes
arising from reinsurance pools disclosed in Note 15.
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 14 - Segment Information
Selected data by segment is as follows:
Year Ended December 31
2001 2000 1999
(in millions of dollars)
--------------------------------------
Premium Income
Employee Benefits $ 4,347.5 $ 4,042.5 $ 3,900.2
Individual 1,828.1 1,777.2 1,645.5
Voluntary Benefits 790.7 739.6 691.6
Other 111.9 497.7 605.9
---------- ---------- ----------
7,078.2 7,057.0 6,843.2
Net Investment Income and Other Income
Employee Benefits 940.4 853.1 745.1
Individual 999.5 962.3 831.9
Voluntary Benefits 138.1 119.7 112.9
Other 234.6 406.7 641.7
Corporate 44.6 48.1 67.7
---------- ---------- ----------
2,357.2 2,389.9 2,399.3
Total Revenue (Excluding Net Realized Investment Gain or Loss)
Employee Benefits 5,287.9 4,895.6 4,645.3
Individual 2,827.6 2,739.5 2,477.4
Voluntary Benefits 928.8 859.3 804.5
Other 346.5 904.4 1,247.6
Corporate 44.6 48.1 67.7
---------- ---------- ----------
9,435.4 9,446.9 9,242.5
Benefits and Expenses
Employee Benefits 4,758.1 4,461.3 4,625.9
Individual 2,536.9 2,441.4 2,223.3
Voluntary Benefits 767.7 705.3 667.5
Other 293.2 861.1 1,426.1
Corporate 213.8 97.6 552.3
---------- ---------- ----------
8,569.7 8,566.7 9,495.1
Income (Loss) Before Net Realized Investment Gain
(Loss), Federal Income Tax, and Extraordinary Loss
Employee Benefits 529.8 434.3 19.4
Individual 290.7 298.1 254.1
Voluntary Benefits 161.1 154.0 137.0
Other 53.3 43.3 (178.5)
Corporate (169.2) (49.5) (484.6)
---------- ---------- ----------
865.7 880.2 (252.6)
Net Realized Investment Gain (Loss) (40.6) (14.6) 87.1
---------- ---------- ----------
Income (Loss) Before Federal Income Tax and Extraordinary Loss 825.1 865.6 (165.5)
Federal Income Tax 243.0 301.4 17.4
---------- ---------- ----------
Income (Loss) Before Extraordinary Loss 582.1 564.2 (182.9)
Extraordinary Loss, Net of Tax (2.9) -- --
---------- ---------- ----------
Net Income (Loss) $ 579.2 $ 564.2 $ (182.9)
========== ========== ==========
86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 14 - Segment Information - Continued
Included in benefits and expenses above is amortization of deferred policy
acquisition costs, value of business acquired, and goodwill. Amortization of
these items by segment is as follows:
Year Ended December 31
2001 2000 1999
(in millions of dollars)
--------------------------------------
Employee Benefits $ 171.6 $ 149.6 $ 109.1
Individual 150.5 131.8 108.8
Voluntary Benefits 128.4 114.6 115.4
Other 30.6 105.5 179.8
Corporate 26.6 22.3 82.6
---------- ---------- ----------
Total $ 507.7 $ 523.8 $ 595.7
========== ========== ==========
Assets by segment are as follows:
December 31
2001 2000
(in millions of dollars)
-----------------------
Employee Benefits $ 12,662.9 $ 11,282.8
Individual 17,243.8 16,162.6
Voluntary Benefits 2,443.2 2,210.4
Other 9,416.4 9,864.8
Corporate 676.4 843.3
---------- ----------
Total $ 42,442.7 $ 40,363.9
========== ==========
In 2001 and prior, goodwill and the amortization thereof was reported in the
Corporate segment. In conjunction with the adoption of SFAS 142, effective
January 1, 2002, the unamortized goodwill balance will be reclassified to the
segments expected to benefit from the originating business combinations. The
reclassification will increase assets $78.2 million, $585.5 million, and $11.0
million in the Employee Benefits, Individual, and Other segments, respectively,
with a corresponding decrease of $674.7 million in the Corporate segment.
Note 15 - Commitments and Contingent Liabilities
Commitments
The Company has an agreement with an outside party wherein the Company is
provided computer data processing services and related functions. The contract
expires in 2010, but the Company may cancel this agreement effective August 2005
or later upon payment of applicable cancellation charges. The aggregate
noncancelable contractual obligation remaining under this agreement is $258.8
million at December 31, 2001, with no annual payment expected to exceed $69.9
million.
Contingent Liabilities
In 1997 two alleged class action lawsuits were filed in Superior Court in
Worcester, Massachusetts (Superior Court) against UnumProvident Corporation
(UnumProvident) and several of its subsidiaries, The Paul Revere Corporation
(Paul Revere), The Paul Revere Life Insurance Company, The Paul Revere Variable
Annuity Insurance Company, The Paul Revere Protective Life Insurance Company,
and Provident Life and Accident Insurance Company. One
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 15 - Commitments and Contingent Liabilities - Continued
purported to represent independent brokers who sold certain individual
disability income policies with benefit riders that were issued by subsidiaries
of Paul Revere. The trial for the independent broker class action commenced in
March 2001. In April 2001, the jury returned a complete defense verdict. The
court subsequently entered judgement on that verdict. The plaintiffs have not
given an indication as to whether or not they will appeal the jury verdict. The
plaintiffs have a pending motion seeking a new trial. Notwithstanding the jury
verdict, the judge is obligated to rule separately on the claim that
UnumProvident and its affiliates violated the Massachusetts Consumer Protection
Act. The bench trial for the alleged violation commenced in October 2001 and
concluded in November 2001 with closing briefs submitted to the judge in
December 2001 and closing arguments heard in January 2002. A decision is
expected by May 2002.
The career agent class action purports to represent all career agents of
subsidiaries of Paul Revere whose employment relationships ended on June 30,
1997 and were offered contracts to sell insurance policies as independent
producers. At the hearing to determine class certification heard in December
1999 in Superior Court, class certification was denied for the career agents.
Summary judgment motions were heard in November 2000 and all motions from
plaintiffs and defendants were denied pertaining to the two class
representatives whose cases survived. The career agent plaintiffs have re-filed
their complaint seeking a class action status by limiting the issues to those in
the certified broker class action. The court has not ruled on the re-filing.
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 (including the career class action representatives)
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 (NASD) 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. In June 2001, the first arbitration was heard before a NASD panel and the
arbitration panel awarded the plaintiffs $190,000 in compensatory damages with
no award for punitive damages, attorney's fees, or interest. The second
arbitration has now been delayed three times at plaintiff's request, and plans
are being made for a new date. Eight of the other cases are tentatively set to
begin trials in 2002, but at this late date it is highly unlikely that more than
two could start. UnumProvident and affiliates believe that they have strong
defenses and plan to vigorously defend their position in these cases. Although
the individual lawsuits described above are in the early stages, management does
not 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 Corporation (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 Companies, Inc. (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.
88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 15 - Commitments and Contingent Liabilities - Continued
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, and (iii) under Section 12(a) of the Securities Act
of 1933 on behalf of purchasers of the Company 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. The Company disputes the claims
alleged in the complaint and denies any liability to plaintiffs.
In October 2001, the parties reached an agreement in principle to settle this
litigation. Under the terms of the settlement, which is subject to, among other
things, final approval by the court, the Company has agreed to pay $45 million
to settle all claims that were or could have been asserted by the class in the
litigation. The parties agreed that, for purposes of the settlement only,
the litigation may be maintained as a class action on behalf of all persons who
exchanged the stock of Unum or Provident for the common stock of the Company
pursuant to the joint proxy/registration statement or otherwise acquired Company
common stock traceable to the joint proxy/registration statement on or before
August 3, 1999, other than the defendants and their officers, directors,
affiliates, and subsidiaries. On January 9, 2002, the district court entered an
order that, among other things, approved preliminarily the terms of the proposed
settlement. On March 21, 2002, the district court held a hearing to determine,
among other things, whether the settlement should be finally approved by the
court. The district court has not yet entered its ruling on the motion to
finally approve the settlement.
The Company has received confirmation from its insurance carriers that, apart
from a $1.0 million deductible, the entire amount to be paid under the proposed
settlement, as well as the attorneys' fees and expenses incurred by the Company
defending the litigation, will be covered under the Company's insurance
policies. Management is of the opinion that, if the settlement is finally
approved by the court, this matter will not have any material adverse affect on
the Company's financial position or results of operations.
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 the reinsurance pools and management section contained
in the segment results discussion in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contained herein in Item 7.
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.
89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 16 - Statutory Financial Information
Statutory Net Income (Loss), Capital and Surplus, and Dividends
The Company's insurance subsidiaries' statutory combined net income (loss), as
reported in conformity with statutory accounting practices, for the years ended
December 31, 2001, 2000, and 1999, was $221.1 million, $353.5 million, and
$(233.7) million, respectively. Statutory combined net gain (loss) from
operations was $353.2 million, $414.8 million, and $(220.7) million for the
years ended December 31, 2001, 2000, and 1999, 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, 2001 and 2000, was $3,378.7 million and
$3,263.0 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. Pursuant to the 1999 merger
of Unum and Provident, the Company is required to obtain approval from the Maine
Bureau of Insurance regarding payment of ordinary dividends from its Maine
domiciled insurance subsidiary to the Company until 2004. Based on the
applicable restrictions, $384.9 million will be available for the payment of
dividends to the Company from its top-tier domestic insurance subsidiaries
during 2002. Of this amount, $121.8 million is conditional upon approval from
the Maine Bureau of Insurance. 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 2002 is
approximately $27.5 million. Regulatory restrictions do not limit the amount of
dividends available for distribution to the Company from its non-insurance
subsidiaries.
Statutory Accounting Practices
The National Association of Insurance Commissioners and the Company's insurance
subsidiaries' states of domicile approved a codification of statutory accounting
practices effective January 1, 2001, which serves as a comprehensive and
standardized guide to statutory accounting principles. The codification changed,
to some extent, the accounting practices that the Company's insurance
subsidiaries used to prepare their statutory financial statements. The
cumulative effect of the changes in accounting principles adopted to conform to
the codification of statutory accounting principles for the Company's insurance
subsidiaries was approximately $45.6 million and was recognized as an increase
to statutory surplus as of January 1, 2001.
Deposits
At December 31, 2001, the Company's insurance subsidiaries had on deposit with
regulatory authorities securities with a book value of $1,313.0 million held for
the protection of policyholders.
90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
UnumProvident Corporation and Subsidiaries
Note 17 - Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations for 2001
and 2000:
2001
---------------------------------------------------------
4th 3rd 2nd 1st
---------------------------------------------------------
(in millions of dollars, except share data)
---------------------------------------------------------
Premium Income $1,769.3 $1,792.2 $1,769.8 $1,746.9
Net Investment Income 492.9 515.5 500.0 494.5
Net Realized Investment Loss (28.8) (9.1) (1.5) (1.2)
Total Revenue 2,313.5 2,377.4 2,363.0 2,340.9
Income Before Federal Income Tax and
Extraordinary Loss 195.5 193.2 210.9 225.5
Net Income 124.0 127.1 146.1 182.0
Net Income Per Common Share
Basic
Income Before Extraordinary Loss .52 .53 .60 .75
Net Income .51 .53 .60 .75
Assuming Dilution
Income Before Extraordinary Loss .52 .52 .60 .75
Net Income .51 .52 .60 .75
2000
---------------------------------------------------------
4th 3rd 2nd 1st
---------------------------------------------------------
(in millions of dollars, except share data)
---------------------------------------------------------
Premium Income $1,731.7 $1,754.6 $1,789.9 $1,780.8
Net Investment Income 482.9 482.4 543.0 552.1
Net Realized Investment Gain (Loss) (2.2) (14.0) 1.8 (0.2)
Total Revenue 2,302.8 2,311.7 2,423.7 2,394.1
Income Before Federal Income Tax 231.1 208.5 219.6 206.4
Net Income 149.6 137.0 143.1 134.5
Net Income Per Common Share
Basic .62 .57 .59 .56
Assuming Dilution .62 .57 .59 .56
91
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
92
PART III
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 15, 2002,
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.
Name Age Position
---- --- --------
J. Harold Chandler 52 Chairman, President, Chief Executive Officer, and
Director
Thomas R. Watjen 47 Executive Vice President, Finance and Risk
Management
F. Dean Copeland 62 Executive Vice President, Legal and
Administrative Affairs, and General Counsel
Robert O. Best 52 Senior Vice President, Customer Loyalty Services,
and Chief Information Officer
Robert C. Greving 50 Senior Vice President, Finance
Ralph W. Mohney 50 Senior Vice President, Return to Work Services
Kevin P. McCarthy 46 Senior Vice President, Underwriting
Joseph R. Foley 46 Senior Vice President, Product and Market
Development
Mr. Chandler is Chairman, President, and Chief Executive Officer. For a
brief period after the merger of Unum and Provident, he was President and Chief
Operating Officer, and became Chairman and Chief Executive Officer on November
1, 1999. Prior to the merger, Mr. Chandler became Chairman of Provident on April
28, 1996 and President and Chief Executive Officer and a Director of Provident's
predecessor, Provident Life and Accident Insurance Company of America (America),
and its principal subsidiaries on November 8, 1993.
Mr. Watjen became Executive Vice President, Finance on June 30, 1999 and
assumed the additional Risk Management responsibilities on November 1, 1999.
Prior to the merger, he was Vice Chairman and Chief Financial Officer of
Provident, positions he assumed on March 26, 1997. He became Executive Vice
President and Chief Financial Officer of America on July 1, 1994.
Mr. Copeland became Executive Vice President and General Counsel of
Provident on May 12, 1997 and following the merger assumed the additional
responsibilities of Executive Vice President, Legal and Administrative Affairs
on June 30, 1999. Prior to joining Provident 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 Loyalty Services, 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 Provident beginning in May 1997. He joined America as Senior Vice
President and Chief Information Officer in July 1994.
93
Mr. Greving became Senior Vice President, Finance in August 2000. He
joined Provident as Senior Vice President and Chief Actuary in April 1997. Prior
to joining Provident, 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, Return to Work Services in March
2002. Prior to that time he served as Senior Vice President, Customer Care from
December 1999. He served as Senior Vice President, Claims from June 1997, and
Vice President, Claims from October 1994. Mr. Mohney originally joined Accident
in 1974.
Mr. McCarthy was named Senior Vice President, Underwriting in November
2001. He served as Senior Vice President, Marketing, Product Development, and
International from December 1999. Prior to that time he served as Senior Vice
President and Managing Director of Unum Japan. He originally joined Unum America
in 1987.
Mr. Foley was named Senior Vice President, Product and Market Development
in November 2001. Prior to that time he served as Senior Vice President,
Reinsurance and Special Operations from December 1999. He was Executive Vice
President, Operations of Unum America from May 1998. Mr. Foley originally joined
Unum America in 1980.
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 15, 2002,
and is incorporated herein by reference.
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 15, 2002, and is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
94
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of Documents filed as part of this report: Page
(1) Financial Statements
The following report and consolidated financial statements of
UnumProvident Corporation and Subsidiaries are included in Item 8.
Report of Ernst & Young LLP, Independent Auditors ........... 43
Consolidated Statements of Financial Condition at
December 31, 2001 and 2000 ................................... 44
Consolidated Statements of Operations for the three
years ended December 31, 2001................................. 46
Consolidated Statements of Stockholders' Equity for the
three years ended December 31, 2001 ........................ 47
Consolidated Statements of Cash Flows for the three
years ended December 31, 2001................................. 48
Notes to Consolidated Financial Statements .................. 50
(2) Schedules Supporting Financial Statements
I. Summary of Investments - Other than Investments in
Related Parties ..................................... 98
II. Condensed Financial Information of Registrant ......... 99
III. Supplementary Insurance Information .................. 103
IV. Reinsurance ........................................... 105
V. Valuation and Qualifying Accounts ..................... 106
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 107 of this report.
(b) Reports on Form 8-K:
Form 8-K filed on November 6, 2001 reporting third quarter 2001
financial results.
95
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, 2002.
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.
Name Title Date
- ------------------------- --------------------------------- --------------
/s/ J. Harold Chandler Chairman, President, and Chief
- ------------------------- Executive Officer and a Director March 28, 2002
J. Harold Chandler
/s/ Thomas R. Watjen Executive Vice President, Finance
- ------------------------- and Risk Management March 28, 2002
Thomas R. Watjen
/s/ Robert C. Greving Senior Vice President, Finance
- -------------------------
Robert C. Greving March 28, 2002
* Director
- -------------------------
William L. Armstrong March 28, 2002
* Director
- -------------------------
Ronald E. Goldsberry March 28, 2002
* Director
- -------------------------
Hugh O. Maclellan, Jr. March 28, 2002
* Director
- -------------------------
A. S. MacMillan, Jr. March 28, 2002
* Director
- -------------------------
George J. Mitchell March 28, 2002
* Director
- -------------------------
Cynthia A. Montgomery March 28, 2002
* Director
- -------------------------
James L. Moody, Jr. March 28, 2002
96
Name Title Date
- ------------------------- --------------------------------- --------------
* Director
- -------------------------
C. William Pollard March 28, 2002
* Director
- -------------------------
Lawrence R. Pugh March 28, 2002
* Director
- -------------------------
Lois D. Rice March 28, 2002
* Director
- -------------------------
John W. Rowe March 28, 2002
* Director
- -------------------------
Burton E. Sorensen March 28, 2002
* By: /s/ Susan N. Roth For all of the Directors
- -------------------------
Susan N. Roth March 28, 2002
Attorney-in-Fact
97
SCHEDULE I--SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
UnumProvident Corporation and Subsidiaries
December 31, 2001
Amount at which
shown in the
Fair statement
Type of Investment Cost Value of financial position
(in millions of dollars)
- --------------------------------------------------------------------------------------------------------------------------
Available-for-Sale Fixed Maturity Securities:
Bonds
United States Government and Government
Agencies and Authorities $ 74.2 $ 88.0 $ 88.0
States, Municipalities, and Political Subdivisions 55.2 57.6 57.6
Foreign Governments 725.8 846.3 846.3
Public Utilities 2,699.4 2,767.8 2,767.8
Mortgage-backed Securities 3,820.8 4,074.2 4,074.2
Convertible Bonds 53.4 39.3 39.3
All Other Corporate Bonds 16,165.9 16,300.2 16,300.2
Redeemable Preferred Stocks 226.3 219.6 219.6
------------ ------------ ------------
Total 23,821.0 $24,393.0 24,393.0
------------ ============ ------------
Equity Securities:
Common Stocks 8.2 $ 10.0 10.0
Nonredeemable Preferred Stocks 1.2 0.9 0.9
------------ ------------ ------------
Total 9.4 $ 10.9 10.9
------------ ============ ------------
Mortgage Loans 943.6 941.2*
Real Estate Acquired in Satisfaction of Debt 36.3 14.2*
Other Real Estate 53.3 37.6*
Policy Loans 2,517.0 2,517.0
Other Long-term Investments 30.4 30.4
Short-term Investments 379.7 379.7
------------ -----------
$ 27,790.7 $ 28,324.0
============ ===========
*Difference between cost and carrying value results from certain valuation
allowances and other temporary declines in value.
98
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UnumProvident Corporation (Parent Company)
STATEMENTS OF FINANCIAL CONDITION
December 31
2001 2000
(in millions of dollars)
------------------------
ASSETS
Fixed Maturity Securities
Available-for-Sale--at fair value (cost: $10.1; $10.1) $ 11.0 $ 10.4
Investment in Subsidiaries 8,293.3 7,835.1
Short-term Notes Receivable from Subsidiaries 180.3 183.6
Surplus Notes of Subsidiaries 250.0 250.0
Other Assets 517.9 472.1
---------- ----------
Total Assets $ 9,252.5 $ 8,751.2
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term Debt from Subsidiaries $ 464.4 $ 491.9
Short-term Debt 161.8 400.0
Long-term Debt 2,004.2 1,615.5
Other Liabilities 382.2 368.3
---------- ----------
Total Liabilities 3,012.6 2,875.7
---------- ----------
Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debt Securities of the Company 300.0 300.0
STOCKHOLDERS' EQUITY
Common Stock 24.2 24.1
Additional Paid-in Capital 1,064.1 1,040.2
Accumulated Other Comprehensive Income 48.0 140.7
Retained Earnings 4,816.3 4,379.7
Treasury Stock (9.2) (9.2)
Deferred Compensation (3.5) --
---------- ----------
Total Stockholders' Equity 5,939.9 5,575.5
---------- ----------
Total Liabilities and Stockholders' Equity $ 9,252.5 $ 8,751.2
========== ==========
See notes to condensed financial information.
99
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
UnumProvident Corporation (Parent Company)
STATEMENTS OF OPERATIONS
Year Ended December 31
2001 2000 1999
(in millions of dollars)
--------------------------------------------
Dividends from Subsidiaries $ 181.6 $ 138.8 $ 97.0
Interest from Subsidiaries 39.4 20.8 24.9
Other Income 55.3 22.8 12.8
------------ ------------ ------------
Total Revenue 276.3 182.4 134.7
------------ ------------ ------------
Interest and Debt Expense 187.4 204.3 110.3
Other Expenses (Credit) 22.8 (101.3) 49.6
------------ ------------ ------------
Total Expenses 210.2 103.0 159.9
------------ ------------ ------------
Income (Loss) Before Federal Income Tax and Equity
in Undistributed Earnings (Losses) of Subsidiaries 66.1 79.4 (25.2)
Federal Income Tax Credit (15.4) (10.7) (38.5)
------------ ------------ ------------
Income Before Equity in Undistributed Earnings (Losses)
of Subsidiaries 81.5 90.1 13.3
Equity in Undistributed Earnings (Losses) of Subsidiaries 497.7 474.1 (196.2)
------------ ------------ ------------
Net Income (Loss) $ 579.2 $ 564.2 $ (182.9)
============ ============ ============
See notes to condensed financial information.
100
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
UnumProvident Corporation (Parent Company)
STATEMENTS OF CASH FLOWS
Year Ended December 31
2001 2000 1999
(in millions of dollars)
--------------------------------------------
CASH PROVIDED BY OPERATING ACTIVITIES $ 21.5 $ 78.3 $ 26.0
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net Sales of Short-term Investments 0.5 2.6 2.8
Cash Distributions to Subsidiaries -- (224.0) (492.3)
Short-term Notes Receivable from Subsidiaries 3.3 31.2 (14.3)
Other (26.5) (22.5) (15.9)
------------ ------------ ------------
CASH USED BY INVESTING ACTIVITIES (22.7) (212.7) (519.7)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net Short-term Borrowings from Subsidiaries (27.5) 465.3 (27.8)
Net Short-term Debt and Commercial Paper
(Repayments) Borrowings (252.0) (210.4) 602.4
Issuance of Long-term Debt 575.0 -- --
Long-term Debt Repayment (172.5) -- --
Issuance of Common Stock 20.5 11.6 69.7
Dividends Paid to Stockholders (142.6) (142.1) (138.9)
------------ ------------ ------------
CASH PROVIDED BY FINANCING ACTIVITIES 0.9 124.4 505.4
------------ ------------ ------------
INCREASE (DECREASE) IN CASH $ (0.3) $ (10.0) $ 11.7
============ ============ ============
See notes to condensed financial information.
101
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, 2001 and 2000, 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 8.3 percent in 2001 and 8.2 percent in 2000 and 1999.
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).
102
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
UnumProvident Corporation and Subsidiaries
Future Policy
Deferred Benefits, Other Policy
Policy Losses, Claims and
Acquisition Claims, and Unearned Benefits
Segment Costs Loss Expenses Premiums Payable
(in millions of dollars)
- ----------------------------------------------------------------------------------------------------
Year Ended December 31, 2001
Employee Benefits $ 1,035.2 $ 6,789.5 $ 20.0 $ 1,230.1
Individual 1,115.4 12,648.2 280.9 326.3
Voluntary Benefits 522.7 1,253.7 12.1 267.8
Other 1.5 6,491.5 15.3 101.9
------------ ------------ ------------ ------------
Total $ 2,674.8 $ 27,182.9 $ 328.3 $ 1,926.1
============ ============ ============ ============
Year Ended December 31, 2000
Employee Benefits $ 907.8 $ 6,197.4 $ 17.5 $ 1,020.4
Individual 1,006.0 11,624.0 274.8 356.2
Voluntary Benefits 477.6 1,302.9 14.8 107.3
Other 32.6 6,509.6 25.7 312.9
------------ ------------ ------------ ------------
Total $ 2,424.0 $ 25,633.9 $ 332.8 $ 1,796.8
============ ============ ============ ============
(Continued on following page)
103
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
UnumProvident Corporation and Subsidiaries
(continued from preceding page)
Benefits, Amortization
Claims, of Deferred
Net Losses and Policy Other
Premium Investment Settlement Acquisition Operating Premiums
Segment Revenue Income (1) Expenses Costs Expenses (2) Written (3)
(in millions of dollars)
- ----------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2001
Employee Benefits $ 4,347.5 $ 761.6 $ 3,598.8 $ 169.6 $ 989.7 $ 3,030.0
Individual 1,828.1 912.8 1,932.7 106.4 497.8 1,847.6
Voluntary Benefits 790.7 124.6 489.8 126.1 151.8 580.9
Other 111.9 184.2 213.0 30.6 49.6 96.0
Corporate -- 19.7 -- -- 213.8
------------ ------------ ------------ ------------ ------------
Total $ 7,078.2 $ 2,002.9 $ 6,234.3 $ 432.7 $ 1,902.7
============ ============ ============ ============ ============
Year Ended December 31, 2000
Employee Benefits $ 4,042.5 $ 701.8 $ 3,426.2 $ 147.2 $ 887.9 $ 2,850.5
Individual 1,777.2 840.3 1,858.4 91.1 491.9 1,780.1
Voluntary Benefits 739.6 113.4 447.2 112.3 145.8 544.7
Other 497.7 377.2 675.7 105.9 79.5 424.6
Corporate -- 27.7 -- -- 97.6
------------ ------------ ------------ ------------ ------------
Total $ 7,057.0 $ 2,060.4 $ 6,407.5 $ 456.5 $ 1,702.7
============ ============ ============ ============ ============
Year Ended December 31, 1999
Employee Benefits $ 3,900.2 $ 604.9 $ 3,663.9 $ 106.6 $ 855.4 $ 2,783.6
Individual 1,645.5 771.1 1,604.2 77.7 541.4 1,660.2
Voluntary Benefits 691.6 106.6 392.7 113.0 161.8 514.3
Other 605.9 549.5 1,126.8 177.5 121.8 495.0
Corporate -- 27.6 -- -- 552.3
------------ ------------ ------------ ------------ ------------
Total $ 6,843.2 $ 2,059.7 $ 6,787.6 $ 474.8 $ 2,232.7
============ ============ ============ ============ ============
(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 in 1999, is now reported in the Other segment. Results
in 1999 have been reclassified to conform to current reporting.
104
SCHEDULE IV--REINSURANCE
UnumProvident Corporation and Subsidiaries
Percentage
Ceded Assumed Amount
Gross to Other from Other Net Assumed
Amount Companies Companies Amount to Net
(in millions of dollars)
- --------------------------------------------------------------------------------------------------
Year Ended December 31, 2001
Life Insurance in Force $641,268.4 $ 47,679.5 $ 1,720.0 $595,308.9 0.3%
========== ========== ========== ==========
Premium Income:
Life Insurance $ 1,779.0 $ 236.4 $ 11.4 $ 1,554.0 0.7%
Accident and Health Insurance 5,506.5 484.2 501.9 5,524.2 9.1%
---------- ---------- ---------- ----------
Total $ 7,285.5 $ 720.6 $ 513.3 $ 7,078.2 7.3%
========== ========== ========== ==========
Year Ended December 31, 2000
Life Insurance in Force $581,765.8 $ 48,099.8 $ 2,081.7 $535,747.7 0.4%
========== ========== ========== ==========
Premium Income:
Life Insurance $ 1,642.6 $ 209.5 $ 15.7 $ 1,448.8 1.1%
Accident and Health Insurance 5,461.6 455.8 602.4 5,608.2 10.7%
---------- ---------- ---------- ----------
Total $ 7,104.2 $ 665.3 $ 618.1 $ 7,057.0 8.8%
========== ========== ========== ==========
Year Ended December 31, 1999
Life Insurance in Force $564,730.4 $ 24,936.0 $ 2,484.5 $542,278.9 0.5%
========== ========== ========== ==========
Premium Income:
Life Insurance $ 1,505.4 $ 69.9 $ 16.9 $ 1,452.4 1.2%
Accident and Health Insurance 5,269.4 438.4 559.8 5,390.8 10.4%
---------- ---------- ---------- ----------
Total $ 6,774.8 $ 508.3 $ 576.7 $ 6,843.2 8.4%
========== ========== ========== ==========
105
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
UnumProvident Corporation and Subsidiaries
Additions Additions
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description of Period Expenses Accounts Deductions (2) Period
(in millions of dollars)
- ------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2001
Mortgage loan loss reserve $ 12.9 $ -- $ -- $ 10.5 $ 2.4
Real estate reserve $ 25.6 $ -- $ -- $ 5.7 $ 19.9
Allowance for doubtful
accounts (deducted from
premiums receivable and
miscellaneous assets) $ 8.5 $ -- $ -- $ 0.2 $ 8.3
Year Ended December 31, 2000
Mortgage loan loss reserve $ 32.9 $ -- $ -- $ 20.0 $ 12.9
Real estate reserve $ 37.8 $ -- $ -- $ 12.2 $ 25.6
Allowance for doubtful
accounts (deducted from
premiums receivable and
miscellaneous assets) $ 3.8 $ 11.7 $ -- $ 7.0 $ 8.5
Year Ended December 31, 1999
Mortgage loan loss reserve (1) $ 32.8 $ 0.1 $ -- $ -- $ 32.9
Real estate reserve $ 51.2 $ -- $ -- $ 13.4 $ 37.8
Allowance for doubtful
accounts (deducted from
premiums receivable and
miscellaneous assets) $ 2.9 $ 0.9 $ -- $ -- $ 3.8
(1) Amounts shown in additions charged to cost and expenses represent realized
investment losses.
(2) Deductions include amounts deemed to reduce exposure of probable losses,
amounts applied to specific loan at time of sale/foreclosure, and amounts
deemed uncollectible.
106
UnumProvident Corporation and Subsidiaries
INDEX TO EXHIBITS
(2.1) Agreementand 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
(incorporated by reference to Exhibit 3.1 of the Company's Form 10-K
filed March 28, 2001).
(3.2) Amended and Restated Bylaws of the Company (incorporated by reference to
Exhibit 3.2 of the Company's Form 10-K filed March 28, 2001).
(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, as amended
by the Compensation Committee on February 8, 2001, and as amended by the
Compensation Committee on February 15, 2002. *
(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.
107
(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 (incorporated by
reference to Exhibit 10.7 of the Company's Form 10-K filed March 28,
2001). *
(10.8) Employee Stock Purchase Plan (of 1995) adopted by stockholders June 13,
1995, as amended by the Compensation Committee on February 15, 2002). *
(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 (incorporated by reference to
Exhibit 10.12 of the Company's Form 10-K filed March 28, 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 (incorporated by reference to Exhibit 10.13 of the
Company's Form 10-K filed March 28, 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 (incorporated by
reference to Exhibit 10.15 of the Company's Form 10-K filed March 28,
2001). *
(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 (incorporated by reference to
Exhibit 10.17 of the Company's Form 10-K filed March 28, 2001). *
(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 (incorporated by reference to Exhibit 10.23
of the Company's Form 10-K filed March 28, 2001). *
(10.24) 1996 Long Term Stock Incentive Plan as amended by the Compensation
Committee February 8, 2001 (incorporated by reference to Exhibit 10.24
of the Company's Form 10-K filed March 28, 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). *
108
(10.26) Supplemental UnumProvident Pension Plan (incorporated by reference to
Exhibit 3.1 of the Company's Form 10-K filed March 28, 2001). *
(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
(incorporated by reference to Exhibit 10.27 of the Company's Form 10-K
filed March 28, 2001).
(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
(incorporated by reference to Exhibit 10.28 of the Company's Form 10-K
filed March 28, 2001).
(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 (incorporated by
reference to Exhibit 10.30 of the Company's Form 10-K filed March 28,
2001).
(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 $500 million 364-Day Credit Agreement (incorporated by
reference to Exhibit 10.31 of the Company's Form 10-K filed March 28,
2001).
(10.32) 2000 Annual Incentive Plan (incorporated by reference to Exhibit 3.1 of
the Company's Form 10-K filed March 28, 2001). *
(10.33) First Amendment to $500 million 364-Day Credit Agreement dated as of
October 31, 2001, among the Company, the Banks listed therein, Citicorp,
USA, Inc. and Wachovia Bank, N.A. as Co-Syndication Agents, Fleet
National Bank as Documentation Agent and Bank of America, N.A., as
Administrative Agent.
(10.34) Separation and Severance Agreement between the Company and John S.
Roberts dated November 12, 2001.*
(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 of Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividends.
(21) Subsidiaries of the Company.
(23) 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.
109