<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): March 27, 1997
----------------
PROVIDENT COMPANIES, INC.
-------------------------
(Exact Name of Registrant as Specified in Charter)
Delaware 1-11834 62-1598430
---------------- ------------- -------------
(State or Other (Commission (IRS Employer
Jurisdiction of File Number) Identification No.)
Incorporation)
One Fountain Square, Chattanooga, Tennessee 37402
-------------------------------------------------
(Addresses of Principal Executive Offices, including Zip Code)
(615) 755-1011
------------------------------------
(Registrant's Telephone Number, including Area Code)
<PAGE> 2
<PAGE> 3
ITEM 5. OTHER EVENTS
Provident Companies, Inc. ("Provident") is filing financial statements and
pro forma financial information for The Paul Revere Corporation ("Paul Revere"),
including its subsidiaries which are being acquired by Provident pursuant to the
merger of Patriot Acquisition Corporation ("Newco"), a wholly owned subsidiary
of Provident, with and into Paul Revere, pursuant to an Amended and Restated
Agreement and Plan of Merger, dated as of April 29, 1996 by and among Paul
Revere, Newco and Provident.
In accordance with the terms of the Merger Agreement, at the effective
time of the Merger, (a) each share of the $1.00 par value common stock of Paul
Revere (the "Paul Revere Common Stock") (other than shares held by Textron Inc.
("Textron")) will be canceled and extinguished and converted into the right to
receive, at the election of the holder of such share, either (i) $26.00 in
cash, without interest thereon (the "Cash Consideration"), (ii) 0.767 of a
share of the $1.00 par value common stock of Provident (the "Provident Common
Stock") (the "Stock Consideration"), or (iii) $20.00 in cash plus 0.177 of a
share of Provident Common Stock (the "Mixed Consideration"), and (b) each share
of Paul Revere Common Stock held by Textron will be converted into the right to
receive $20.00 in cash plus 0.1578 of a share of Provident Common Stock (the
"Textron Consideration" and, together with the Cash Consideration, the Stock
Consideration and the Mixed Consideration, the "Merger Consideration").
The pro forma financial information presented herein assumes that all Paul
Revere shareholders (other than Textron) make Mixed Elections and that Textron
receives the Textron Consideration. Such pro forma financial information does
not reflect any payments by Textron to Provident in respect of sales of
Provident Common Stock received by Textron in the Merger.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION, AND EXHIBITS.
A. Financial Statements of Businesses to be Acquired
Financial statements of Paul Revere for the years ended December 31, 1996
and 1995, with auditors report thereon, are set forth in Exhibit 99.1 and
incorporated herein by reference.
B. Pro Forma Financial Information
Pro forma financial information reflecting consummation of the Merger are
set forth in Exhibit 99.2 and incorporated herein by reference.
C. Exhibits
<TABLE>
<S> <C>
23.1 Consent of Ernst & Young, LLP.
99.1 Audited financial statements of The Paul Revere Corporation for
the years ended December 31, 1996 and 1995, with auditors report
thereon.
99.2 Pro forma financial information reflecting consummation of the
acquisition of The Paul Revere Corporation by Provident Companies,
Inc.
</TABLE>
2
<PAGE> 4
<PAGE> 5
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
PROVIDENT COMPANIES, INC.
(REGISTRANT)
/s/ Susan N. Roth
--------------------------------
Name: Susan N. Roth
--------------------------
Title: Corporate Secretary
-------------------------
Date: March 26, 1997
3
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Form 8-K of Provident
Companies, Inc. and Subsidiaries of our report dated January 23, 1997 with
respect to the consolidated financial statements of The Paul Revere Corporation
for the year ended December 31, 1996.
We also consent to the incorporation by reference in the Registration
Statements (Form S-8 No. 33-47551, Form S-8 No. 33-88108 and Form S-8 No.
33-62231) pertaining to the Provident Life and Accident Insurance Company
MoneyMaker, a Long-Term 401(K) Retirement Savings Plan, the Provident Life and
Accident Insurance Company Stock Option Plan of 1994 and the Provident Life and
Accident Insurance Company Employee Stock Purchase Plan of 1995 and in the
Registration Statement (Form S-3 No. 333-17849) of our report dated January 27,
1997 with respect to the consolidated financial statements incorporated herein
by reference.
/s/ Ernst & Young LLP
----------------------
ERNST & YOUNG LLP
Boston, Massachusetts
March 27, 1997
<PAGE> 1
<PAGE> 2
EXHIBIT 99.1
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS
THE PAUL REVERE CORPORATION
We have audited the accompanying consolidated balance sheets of The Paul
Revere Corporation as of December 31, 1996 and 1995, and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of The Paul
Revere Corporation at December 31, 1996 and 1995, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
As described in Note 1 to the consolidated financial statements, in 1994,
the Company changed its method of accounting for certain investments in debt
and equity securities.
/s/ Ernst & Young LLP
Boston, Massachusetts
January 23, 1997
<PAGE> 3
THE PAUL REVERE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- -----
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
REVENUES
Premiums, policy and contract charges and fees $ 1,135,584 $ 1,055,293 $ 944,884
Net investment income 405,647 389,710 364,940
Net realized investment gains 48,646 89,035 37,555
----------- ----------- -----------
TOTAL REVENUES 1,589,877 1,534,038 1,347,379
----------- ----------- -----------
BENEFITS, CLAIMS AND EXPENSES
Benefits to policyholders, net of reinsurance
ceded of $50,032 in 1996, $24,828 in 1995
and $9,235 in 1994 1,456,139 1,039,293 863,984
Commissions and other expenses 311,387 291,389 282,397
Amortization of deferred costs:
Deferred policy acquisition costs 56,492 51,924 38,437
Value assigned purchased insurance
in-force 5,478 5,899 7,000
Goodwill amortization 8,272 8,272 8,272
----------- ----------- -----------
TOTAL BENEFITS, CLAIMS AND EXPENSES 1,837,768 1,396,777 1,200,090
----------- ----------- -----------
Income (loss) before income taxes (247,891) 137,261 147,289
INCOME TAX EXPENSE (BENEFIT)
Current 36,210 (11,912) 17,130
Deferred (121,248) 63,867 38,405
----------- ----------- -----------
TOTAL INCOME TAX EXPENSE (BENEFIT) (85,038) 51,955 55,535
----------- ----------- -----------
NET INCOME (LOSS) $ (162,853) $ 85,306 $ 91,754
=========== =========== ===========
NET INCOME (LOSS) PER COMMON SHARE $ (3.62) $ 1.90 $ 2.04
=========== =========== ===========
Weighted average number of common
shares outstanding 45,000,000 45,000,000 45,000,000
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 4
THE PAUL REVERE CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1996 1995
---- ----
<S> <C> <C>
ASSETS (IN THOUSANDS)
Investments:
Available for sale:
Fixed maturities $ 5,003,432 $ 4,619,841
Equity securities 49,050 32,744
Investment in Textron common stock 39,974 57,257
Short-term investments 239,741 71,326
Mortgage loans 329,020 309,046
Real estate 2,696 9,291
Policy loans 73,816 73,933
Other invested assets 32,657 31,604
----------- -----------
Total investments 5,770,386 5,205,042
Cash -- 14,970
Accrued investment income 85,093 80,993
Premiums due 22,462 21,396
Deferred policy acquisition costs 878,888 775,651
Value assigned purchased insurance in force 60,230 66,894
Reinsurance recoverable 466,561 494,313
Goodwill, net of accumulated amortization of $99,264 in 1996
and $90,992 in 1995 107,536 115,808
Property and equipment, net of accumulated depreciation
of $72,638 in 1996 and $66,612 in 1995 31,994 35,386
Other assets 82,611 190,031
Assets held in separate accounts 23,178 43,201
----------- -----------
TOTAL ASSETS $ 7,528,939 $ 7,043,685
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Future policy benefits $ 1,656,671 $ 1,371,297
Unpaid claims and claim expenses 2,363,894 1,852,298
Other policyholder funds 1,973,118 1,876,324
Notes payable 134,707 38,020
Income taxes 164,208 366,094
Other liabilities 115,320 103,072
Liabilities related to separate accounts 23,178 43,201
----------- -----------
TOTAL LIABILITIES 6,431,096 5,650,306
----------- -----------
SHAREHOLDERS' EQUITY
Common stock, par value $1.00 per share, 100,000,000
shares authorized; 45,000,000 shares issued and
outstanding 45,000 45,000
Additional paid-in capital 560,134 560,134
Securities valuation adjustment 78,264 197,090
Foreign currency translation adjustment (14,744) (11,687)
Retained earnings 429,189 602,842
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 1,097,843 1,393,379
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,528,939 $ 7,043,685
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE> 5
THE PAUL REVERE CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON FOREIGN
STOCK ADDITIONAL SECURITIES CURRENCY
$1.00 PAID - IN VALUATION TRANSLATION RETAINED
PAR VALUE CAPITAL ADJUSTMENT ADJUSTMENT EARNINGS TOTAL
--------- ------- ---------- ---------- -------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1994 $ 45,000 $560,134 $ 58,362 $(12,009) $ 447,382 $1,098,869
Adjustment to beginning
balance for change in
accounting method, net 92,441 92,441
Net income 91,754 91,754
Securities valuation
adjustment, net (172,218) (172,218)
Foreign currency translation
adjustment (5,431) (5,431)
Dividends to shareholders
($0.24 per common share) (10,800) (10,800)
-------- -------- --------- -------- --------- ----------
BALANCE AT DECEMBER 31, 1994 45,000 560,134 (21,415) (17,440) 528,336 1,094,615
Net income 85,306 85,306
Securities valuation
adjustment, net 218,505 218,505
Foreign currency translation
adjustment 5,753 5,753
Dividends to shareholders
($0.24 per common share) (10,800) (10,800)
-------- -------- --------- -------- --------- ----------
BALANCE AT DECEMBER 31, 1995 45,000 560,134 197,090 (11,687) 602,842 1,393,379
Net loss (162,853) (162,853)
Securities valuation
adjustment, net (118,826) (118,826)
Foreign currency translation
adjustment (3,057) (3,057)
Dividends to shareholders
($0.24 per common share) (10,800) (10,800)
-------- -------- --------- -------- --------- ----------
BALANCE AT DECEMBER 31, 1996 $ 45,000 $560,134 $ 78,264 $(14,744) $ 429,189 $1,097,843
======== ======== ========= ======== ========= ==========
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE> 6
THE PAUL REVERE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (162,853) $ 85,306 $ 91,754
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Increase in future policy benefits, unpaid claims and
other policyholder funds 935,097 589,711 417,290
Amortization and depreciation 16,343 20,050 18,539
Additions to deferred policy acquisition costs (145,506) (174,132) (161,843)
Increase (decrease) in income tax liability (135,911) 78,335 24,852
Increase (decrease) in other assets/other liabilities 37,852 (161,422) (25,220)
Net realized investment gains (48,646) (89,035) (37,555)
Decrease (increase) in accrued investment income (4,165) 1,190 (5,651)
Other, net (735) (1,891) (4,193)
---------- ---------- ---------
Net cash provided by operating activities 491,476 348,112 317,973
---------- ---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities held to maturity:
Proceeds from sales -- 8,768 10,060
Proceeds from maturities and calls -- 34,454 49,012
Purchases -- (157,281) (849,046)
Fixed maturities, marketable equity securities and
short-term investments available for sale:
Proceeds from sales 848,706 978,695 717,978
Proceeds from maturities and calls 239,994 133,691 440,212
Purchases (1,681,215) (1,265,923) (877,867)
Increase in mortgage loans, net (20,702) (120,419) (11,681)
(Increase) decrease in other, net 13,905 (1,396) 38,460
(Increase) decrease in policy loans, net 117 (4,129) (4,332)
Capital expenditures (3,960) (3,607) (8,128)
---------- ---------- ---------
Net cash used in investing activities (603,155) (397,147) (495,332)
---------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in cash overdraft 28,195 (2,280) (10,320)
Dividends to shareholders (10,800) (10,800) (10,800)
Increase in notes payable 96,500 16,000 22,000
Receipts from interest-sensitive products 204,334 289,870 294,974
Return of account balances on interest-sensitive products (217,789) (233,312) (125,931)
---------- ---------- ---------
Net cash provided by financing activities 100,440 59,478 169,923
Effect of foreign exchange rate changes on cash (3,731) 4,527 7,436
---------- ---------- ---------
Net (decrease) increase in cash (14,970) 14,970 --
Cash at beginning of year 14,970 -- --
---------- ---------- ---------
Cash at end of year $ -- $ 14,970 $ --
========== ========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 7
THE PAUL REVERE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
The Paul Revere Corporation (the "Company") (an 83%-owned subsidiary of
Textron Inc.) was incorporated on December 16, 1992 for the purpose of owning
all of the outstanding shares of The Paul Revere Life Insurance Company ("Paul
Revere"). In connection with its formation, the Company issued 1,000 shares of
common stock in exchange for substantially all of the net assets of PRHC, Inc.
(a wholly-owned subsidiary of Textron Inc.), which included all of the
outstanding shares of Paul Revere. Since both the Company and PRHC, Inc. were
wholly-owned subsidiaries of Textron Inc. ("Textron"), this transfer of assets
was accounted for on the basis of historical cost.
PRHC, Inc. was incorporated on May 17, 1990 and was also established for
the purpose of owning the outstanding shares of Paul Revere. During 1990,
PRHC, Inc. issued to Textron 1,000 shares of common stock in exchange for all
of the outstanding shares of Paul Revere (1,960,000 shares). Since PRHC, Inc.
was a wholly-owned subsidiary of Textron, there was no change in ownership as a
result of this transaction and accordingly, the transfer was accounted for on
the basis of historical cost.
On August 12, 1993, the Company declared a 45,000-for-1 stock split,
effective August 16, 1993, which has been retroactively reflected in the
historical financial statements. In addition, 5,000,000 shares of preferred
stock (the terms of which are to be established prior to issuance) were
authorized for future issuance by the Company's Board of Directors. On October
26, 1993, Textron sold to the public, 17% of the Company in an underwritten
offering registered under the Securities Act of 1933. Prior to the offering,
Textron made a capital contribution of $100,000,000 to the Company.
On April 29, 1996, the Company and Provident Companies, Inc.
("Provident") announced they had signed a definitive merger agreement pursuant
to which Patriot Acquisition Corporation, a wholly owned subsidiary of
Provident will merge with and into the Company with the Company as the
surviving corporation. On November 6, 1996, the Company and Provident
announced that they had amended and restated the merger agreement to, among
other things, extend the date as of which the parties would be entitled to
terminate the agreement and to adjust the exchange ratio to be used in
determining the number of shares of Provident common stock that Textron will
receive in the transaction (as amended, the "Merger Agreement"). The
transaction has been approved by the Boards of Directors and the shareholders
of both companies. The transaction remains subject to the satisfaction of
certain customary closing conditions.
Basis of Presentation
The accompanying consolidated financial statements of the Company have
been prepared on the basis of generally accepted accounting principles (GAAP)
for stock life insurance companies.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported
in those statements and accompanying notes. Actual results may differ from
such estimates.
<PAGE> 8
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company; its wholly-owned subsidiary, Paul Revere and its wholly-owned
subsidiaries, including The Paul Revere Variable Annuity Insurance Company
("PRV") and The Paul Revere Protective Life Insurance Company ("PRP"). All
significant intercompany transactions are eliminated.
Investments
Prior to January 1, 1994, the Company classified fixed maturities in
accordance with the then existing accounting standards, and, accordingly, fixed
maturities held to maturity were carried at amortized cost. A portion of the
Company's portfolio of fixed maturities was considered available for sale and
carried at the lower of aggregate amortized cost or market. Adjustments for
other than temporary declines in the value of publicly traded bonds were
recorded as a direct adjustment to the securities' carrying value. Such
adjustments for other fixed maturities were reflected through the establishment
of allowances.
Effective January 1, 1994, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("FAS 115"). In accordance with FAS
115, prior period financial statements were not restated to reflect the change
in accounting principle. The adoption of FAS 115 had no effect on the Company's
net income. The net unrealized gains of $92,441,000 (net of applicable income
taxes and related adjustments to DAC), relating to the debt securities
classified in the available for sale category of the Company's investment
portfolio as of January 1, 1994, were recorded as an increase to shareholders'
equity.
In November 1995, the Financial Accounting Standards Board ("FASB")
staff issued "A Guide to Implementation of FAS 115" which offered companies a
one-time opportunity to reclassify securities among its investment categories,
without calling into question the intent to hold other debt securities to
maturity in the future. The Company subsequently reviewed its portfolio and on
December 1, 1995, transferred debt securities with an amortized cost and market
value of $2,610,928,000 and $2,858,251,000, respectively, from the held to
maturity category to the available for sale category of its investment
portfolio.
The Company's investment strategies place an emphasis on matching
investment maturities with the timing of amounts estimated to be payable under
insurance contracts.
The available for sale category of the Company's investment portfolio
includes marketable equity securities, short-term investments and fixed
maturities not classified as held to maturity. While these securities are not
held with the specific intention to sell them, they may be sold prior to
maturity to support the Company's investment strategies and, accordingly, are
carried at fair value in accordance with FAS 115. Investments in marketable
equity securities, including the Company's investment in Textron common stock,
are based on the last sales prices as reported on national securities exchanges
or the closing bid prices for unlisted securities as reported by investment
dealers.
Subsequent to January 1, 1994, all securities purchased are designated
for inclusion in either the available for sale or held to maturity categories
based on the Company's intent and the nature of the securities purchased.
Further, adjustments for other than temporary declines in the value of all fixed
maturities are recorded as a direct adjustment to the securities' carrying
value.
The Company's fixed maturities classified as available for sale include
mortgage-backed securities, a substantial portion of which is guaranteed by the
U.S. Government or U.S. Government agencies. Future investment income from
mortgage-backed securities may be affected by the timing of principal payments
and the yields on reinvestment alternatives available at the time of such
payments. To minimize the risk associated with the timing of principal
payments, the Company has purchased certain
<PAGE> 9
mortgage-backed securities which are structured to reduce the sensitivity of
principal payments to fluctuating interest rates.
The amortized cost of fixed maturities classified as available for sale
is adjusted for amortization of premiums and accretion of discounts to maturity,
or, in the case of mortgage-backed securities, over the estimated life of the
security. To the extent that the estimated lives of mortgage-backed securities
change as a result of changes in prepayment rates, the accumulated amortization
of premiums and the accretion of discounts is adjusted retrospectively with a
charge or credit to current operations.
Changes in fair values of securities classified as available for sale,
after adjustment for DAC and applicable income taxes, are reported as a
securities valuation adjustment in a separate component of shareholders' equity
and, accordingly, have no effect on net income.
Effective January 1, 1995, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan" ("FAS 114"), as amended by Statement of Financial
Accounting Standards No. 118, "Accounting by Creditors for Impairment of a
Loan - Income Recognition and Disclosures" ("FAS 118"). FAS 114 and FAS 118
require that an impaired mortgage loan's fair value be measured based on the
present value of future cash flows discounted at the loan's effective interest
rate, at the loan's observable market price, or at the fair value of the
collateral if the loan is collateral dependent. If the fair value of a
mortgage loan is less than the recorded investment in the loan, the difference
is recorded as an allowance for mortgage loan losses. The change in the
allowance for mortgage loan losses is reported with realized gains or losses on
investments. Interest income on impaired loans is accrued on the net reported
value of the impaired loans; changes in actual or estimated cash flows are
charged or credited to the allowance for mortgage loan losses. The impact of
FAS 114 and FAS 118 on the Company's net income and financial condition was not
material.
Net realized investment gains or losses, resulting from sales or calls
of investments and the losses resulting from declines in fair values of
investments in mortgage loans, real estate and other investments that are other
than temporary, are stated separately in the consolidated statements of
operations. The cost of securities sold is determined primarily on the
specific identification method.
Short-term financial instruments, including investments with original
maturities of three months or less at acquisition, are included as investing
activities in the consolidated statements of cash flows.
Other investments are reported as follows:
- Mortgage loans-amortized cost less allowance for other than
temporary declines in value.
- Real estate held for sale-lower of cost or fair value less
estimated costs to sell.
- Real estate held for investment ($0 in 1996 and $3,201,000 in
1995) at cost less accumulated depreciation.
- Policy loans-unpaid principal balance.
- Other invested assets (primarily joint ventures and real estate
limited partnerships) at cost adjusted for the Company's equity
in undistributed net earnings or losses since acquisition, less
allowances for other than temporary declines in value.
<PAGE> 10
Derivative Financial Instruments
Gains or losses on hedges of existing assets are deferred and included
in the carrying amounts of those assets. Gains or losses related to qualifying
hedges of firm commitments or anticipated transactions are also deferred and
recognized in the carrying amount of the underlying asset when the hedged
transaction occurs.
Fair Value of Financial Instruments
The fair values of financial instruments presented in Note 14 are
estimates of the fair values at a specific point in time using available market
information and appropriate valuation methodologies. These estimates are
subjective in nature and involve uncertainties and significant judgment in the
interpretation of current market data. Therefore, the fair values presented
are not necessarily indicative of amounts the Company could realize or settle
currently. The Company does not necessarily intend to dispose of or liquidate
such instruments prior to maturity.
Cash Overdraft
The Company operates a cash management program which, at times, results
in book cash overdrafts supported by its short-term investments. Included in
other liabilities at December 31, 1996 is a cash overdraft of $28,195,000.
Recognition of Premium Revenues and Policy Benefits for Individual Disability
Insurance, Traditional Life Products and Group Insurance
Premiums from individual disability insurance and traditional life
insurance products are recognized in revenues when due. Group insurance
premiums are recognized as income over the period to which the premiums relate.
Benefits and expenses relating to those businesses are recognized over the
life of the contracts through the establishment of reserves for future policy
benefits and the amortization of deferred policy acquisition costs. Benefits
to policyholders include benefits paid or accrued, changes in reserves for
future policy benefits and surrenders.
Recognition of Revenues, Contract Benefits and Expenses for Investment and
Interest-Sensitive Life Products
For investment and interest-sensitive life products, revenues consist of
policy and surrender charges assessed during the year. Benefits and expenses
for these products include amounts incurred during the year for benefit claims
in excess of related account balances, policy maintenance expenses, interest
credited and amortization of deferred policy acquisition costs.
Deferred Policy Acquisition Costs
Costs, which vary with, and are related primarily to, the production of
new business, have been deferred to the extent such costs are deemed
recoverable from future profits. Such costs include commissions, selling,
selection and policy issue expenses. For individual disability insurance,
group long-term disability and traditional life insurance products, these costs
are amortized in proportion to premiums over the estimated lives of the
policies. For interest-sensitive life and investment products, these costs are
amortized in proportion to estimated gross profits from interest, mortality and
other margins under the contracts. Each year, actual and assumed experience
are compared and adjustments are made to this asset, if necessary, and
reflected in current income. Deferred policy acquisition costs are also
adjusted to reflect the effects that the unrealized gains or losses on
investments classified as available for sale would have had if such gains or
losses had actually been realized.
<PAGE> 11
Value Assigned Purchased Insurance In-Force
Value assigned purchased insurance in-force represents the present value
of the future profits of the insurance in-force at the date the Company was
acquired by Textron. This asset is being amortized over the estimated life of
the insurance in-force at the date of acquisition in proportion to the expected
future premium cash flows of the business acquired. Each year, actual and
assumed experience are compared and adjustments are made to this asset, if
necessary, and reflected in current income.
Goodwill
Goodwill represents the excess of Textron's purchase price over the fair
value of assets and liabilities of the Company at the date the Company was
acquired. Goodwill is being amortized using the straight-line method over 25
years.
Property and Equipment
Property and equipment are depreciated using the straight-line method
over their estimated useful lives.
Separate Accounts
The Paul Revere Variable Annuity Contract Accumulation Fund (the "Fund")
is the separate account through which PRV sets aside, separate and apart from
its general assets, assets attributable to its variable annuity contracts. The
Fund is an open-end diversified investment company registered under the
Investment Company Act of 1940. PRV serves as investment advisor to the Fund.
Separate account assets, which are stated at fair value based on quoted market
prices, and separate account liabilities are shown separately in the
consolidated balance sheets. Operating results of the separate account are not
included in the consolidated statements of income. Prior to April, 1996 PRV's
separate accounts also included Paul Revere Separate Account One ("Separate
Account One"). Separate Account One was a unit investment trust registered
under the Investment Company Act of 1940. Separate Account One invested in
underlying investment portfolios managed by various unrelated investment
advisors. PRV was the principal underwriter of variable annuity contracts sold
through Separate Account One. In April, 1996 Separate Account One ceased
accepting new deposits and all existing deposits, with interest, were returned
to contractholders.
Insurance Reserves and Liabilities
Reserves for future policy benefits and unpaid claims and claim expenses
include policy reserves, claim reserves and claim liabilities established for
the Company's individual disability, group and individual life insurance
products.
Policy reserves represent the portion of premiums received, accumulated
with interest, to provide for future claims. Policy reserves for individual
disability insurance and traditional life insurance products are based on the
Company's withdrawal, morbidity and mortality experience at interest rates
ranging from 7.5% to 9.0% in 1996 and 6.5% to 9.4% in 1995 for individual
disability insurance and 3.5% to 10.5% in 1996 and 1995 for traditional life
insurance. Policy reserves for group insurance consist primarily of group life
waiver of premium reserves. Policy reserves for interest-sensitive life
insurance products are determined based on the accumulated policy account
value.
Claim reserves are established for future payments not yet due on claims
already incurred, primarily relating to individual disability insurance and
group long-term disability insurance products. These reserves are established
based on past experience and are continuously reviewed and updated. Any
resulting adjustments are reflected in current operations. For individual
disability insurance benefits,
<PAGE> 12
interest rates used to determine claim reserves ranged from 7.0% to 8.7% in
1996 and 7.0% to 10.0% in 1995. For group disability benefits, interest rates
ranged from 3.9% to 8.9% in 1996 and 1995.
Claim liabilities represent policy benefits currently due but unpaid at
year end.
Other policyholder funds represent amounts accumulated under deferred
contracts to provide annuities in the future. During 1996, 1995 and 1994,
daily interest was credited at effective annual rates ranging from 4.1% to
9.0%, 4.0% to 9.0% and 4.0% to 9.5%, respectively.
The establishment of insurance reserves requires making assumptions
relating to mortality, morbidity and interest rates, as well as expenses and
lapse rates used to calculate policyholder liabilities during the term of the
policies. These estimates are made when the policy is issued or when a claim is
incurred, based on facts and circumstances then known. Other less predictable
variables such as the number and length of disability claims, may vary as the
result of changes in societal attitudes and the economy. While the Company
believes that its policy and claim reserves have been determined on reasonable
bases and are adequate, there are no assurances that the Company's reserves
will be sufficient to fund future liabilities in all circumstances (see Note
7).
Reinsurance
In the normal course of business, the Company, through its life
insurance subsidiaries, is involved in both the cession and assumption of
reinsurance with other companies. For individual life and group insurance, the
Company seeks to limit its exposure to loss on a single insured and to recover a
portion of benefits paid by ceding reinsurance to other insurance enterprises
or reinsurers under excess coverage and coinsurance contracts. The Company
retains a maximum of $500,000 and $250,000 of coverage per individual life and
group life, respectively.
Amounts paid or deemed to have been paid for reinsurance contracts are
recorded as reinsurance receivables. Deferred reinsurance costs and amounts
recoverable related to long-duration contracts are accounted for over the life
of the underlying reinsured policies using assumptions consistent with those
used to account for the underlying policies.
Income Taxes
The Company and its subsidiaries are included in a life/non-life federal
income tax return with Textron. Paul Revere and its subsidiaries file their
own state income tax returns. Paul Revere also files a tax return for its
foreign branch operations in Canada.
Effective in 1993, Textron and the Company (for itself and on behalf of
its subsidiaries) entered into a new tax-sharing agreement under which
consolidated income taxes are allocated to the Company in an amount equal to
the taxes that the Company would otherwise have to pay if the Company and its
subsidiaries were to file separate federal, state or local income tax returns.
Amounts recoverable from Textron under the terms of the tax-sharing agreement
were $16,277,000 and $13,726,000 at December 31, 1996 and 1995, respectively.
In accordance with Statement of Financial Accounting Standards, No. 109,
"Accounting for Income Taxes", deferred income taxes have been recognized for
temporary differences between the financial reporting basis and income tax
basis of assets and liabilities based on enacted tax rates expected to be in
effect when such amounts are expected to be realized or settled.
<PAGE> 13
Postretirement Benefits Other Than Pensions
The Company recognizes the cost of its retiree health care and life
insurance benefits using the accrual method of accounting over the employees'
years of service in accordance with Statement of Financial Accounting Standards
No. 106, "Employers' Accounting for Postretirement Benefits Other than
Pensions".
Foreign Currency Translation
The financial statements of the Company's Canadian operations have been
translated into United States dollars in accordance with Statement of Financial
Accounting Standards No. 52, "Foreign Currency Translation". All balance sheet
accounts have been translated using the exchange rates in effect at the balance
sheet date. Income statement amounts have been translated using the average
exchange rate for the year. The gains and losses resulting from the change in
exchange rates from year to year have been reported separately as a component
of shareholders' equity. The effect on the consolidated statements of
operations of transaction losses totaled $8,846,000, $15,465,000 and
$12,926,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
Income (Loss) Per Common Share
Income (loss) per common share is computed by dividing income (loss)
applicable to common shares by the weighted average number of common shares
outstanding during each period. The weighted average common shares used in the
determination of per share amounts have been adjusted in all years presented to
give retroactive effect to the 45,000-for-1 stock split which was authorized
August 12, 1993, and was effective August 16, 1993.
NOTE 2. INVESTMENTS
The following information summarizes the components of net investment
income and net realized investment gains:
Net Investment Income
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturities $365,259 $349,713 $332,114
Equity securities 2,702 2,983 3,834
Mortgage loans 29,364 22,160 17,629
Real estate 289 310 4,356
Policy loans 5,005 5,064 4,324
Other invested assets 5,392 9,316 6,575
Short-term investments 3,506 4,547 1,126
-------- -------- --------
Gross investment income 411,517 394,093 369,958
Less investment expenses 5,870 4,383 5,018
-------- -------- --------
Net investment income $405,647 $389,710 $364,940
======== ======== ========
</TABLE>
Net Realized Investment Gains (Losses)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturities $ 3,760 $56,294 $ 2,768
Equity securities 47,529 42,344 37,453
Mortgage loans, real estate and other investments (2,643) (9,603) (2,666)
------- ------- -------
Net realized investment gains $48,646 $89,035 $37,555
======= ======= =======
</TABLE>
<PAGE> 14
The increase (decrease) in the Company's unrealized gains and losses on
fixed maturities available for sale was $(194,392,000), $496,554,000 and
($129,376,000) in 1996, 1995 and 1994, respectively; the corresponding amounts
for equity securities were $(9,685,000), ($11,915,000) and ($35,492,000).
Fixed maturities available for sale with an amortized cost of $860,000
mortgage loans with an amortized cost of $450,000 and other invested assets
with an amortized cost of $2,696,000 were non-income producing at December 31,
1996. Investments are placed on non-accrual status once interest is sixty days
past due. Management may, at its discretion, put an investment on non-accrual
status earlier if substantial doubt exists regarding the collectibility of
interest.
The following is a summary of available for sale securities at December
31, 1996 and 1995:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
1996 COST GAINS LOSSES VALUE
- ---- ---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
U.S. Government and agencies $ 332,356 $ 35,406 $13,933 $ 353,829
States and municipalities 7,049 1,022 88 7,983
Foreign governments 246,716 47,494 368 293,842
Public utilities 716,864 30,772 4,202 743,434
Corporate securities 2,924,943 133,931 38,865 3,020,009
Mortgage-backed securities 568,492 21,078 5,235 584,335
---------- -------- ------- ----------
Total fixed maturities 4,796,420 269,703 62,691 5,003,432
Equity securities 47,094 2,776 820 49,050
Investment in Textron common stock 9,795 30,179 -- 39,974
Short-term investments 239,741 -- -- 239,741
---------- -------- ------- ----------
Total available for sale $5,093,050 $302,658 $63,511 $5,332,197
========== ======== ======= ==========
<CAPTION>
1995
- ----
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
U.S. Government and agencies $ 295,590 $ 65,811 $ -- $ 361,401
States and municipalities 8,775 1,104 79 9,800
Foreign governments 216,869 29,300 365 245,804
Public utilities 648,086 57,672 187 705,571
Corporate securities 2,486,887 225,590 11,160 2,701,317
Mortgage-backed securities 562,230 34,804 1,086 595,948
---------- -------- ------- ----------
Total fixed maturities 4,218,437 414,281 12,877 4,619,841
Equity securities 28,370 4,621 247 32,744
Investment in Textron common stock 19,811 37,446 57,257
Short-term investments 71,326 71,326
---------- -------- ------- ----------
Total available for sale $4,337,944 $456,348 $13,124 $4,781,168
========== ======== ======= ==========
</TABLE>
During 1995, the Company sold, from the held to maturity category of its
investment portfolio, fixed maturities with an amortized cost of $8,000,000,
resulting in realized investment gains of $768,000, due to significant
deteriorations in the creditworthiness of the issuers.
<PAGE> 15
At December 31, 1996, $87,281,000 of fixed maturities available for sale
were below investment grade. These securities represented 1.5% of the
Company's total investments.
The amortized cost and fair value of securities at December 31, 1996, by
contractual maturity date, are presented below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
---- -----
(IN THOUSANDS)
<S> <C> <C>
Fixed maturities available for sale:
Due in one year or less $ 22,721 $ 23,518
Due after one year through five years 210,914 225,208
Due after five years through ten years 1,081,026 1,112,214
Due after ten years 2,913,267 3,058,157
Mortgage-backed securities 568,492 584,335
---------- ----------
4,796,420 5,003,432
Equity securities 47,094 49,050
Investment in Textron common stock 9,795 39,974
Short-term investments 239,741 239,741
---------- ----------
Total $5,093,050 $5,332,197
========== ==========
</TABLE>
During 1996 and 1995, fixed maturities and marketable equity securities
classified as available for sale, with a fair value of $616,976,000 and
$1,201,008,000, respectively, as of the date of the sale, were sold. The gross
realized investment gains on such sales totaled $62,363,000 and $112,477,000,
in 1996 and 1995, respectively. The gross realized investment losses on such
sales totaled $21,314,000 and $11,323,000, in 1996 and 1995, respectively.
The Company invests in mortgage loans principally involving commercial
real estate. Mortgage loans have original repayment terms ranging from 10 to
30 years. The mortgages are secured by the underlying property and
non-participating mortgages are generally limited to 75% of the appraised value
of established properties at the date of the loans with sufficient cash flows
to meet debt service requirements.
<PAGE> 16
Changes in the allowance for other than temporary declines in the value
of fixed maturities (not subject to direct adjustment), mortgage loans, real
estate and other investments were as follows:
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING END
OF YEAR ADDITIONS DEDUCTIONS OF YEAR
------- --------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Fixed maturities $ -- $ -- $ -- $ --
Mortgage loans 3,400 1,050 3,400 1,050
Real estate 4,041 1,060 2,926 2,175
Other investments 13,400 2,502 9,000 6,902
------- --------- ---------- -------
Total $20,841 $ 4,612 $ 15,326 $10,127
======= ========= ========== =======
Year ended December 31, 1995:
Fixed maturities $ -- $ -- $ -- $ --
Mortgage loans 6,995 -- 3,595 3,400
Real estate 5,538 773 2,270 4,041
Other investments 2,439 11,136 175 13,400
------- --------- ---------- -------
Total $14,972 $ 11,909 $ 6,040 $20,841
======= ========= ========== =======
Year ended December 31, 1994:
Fixed maturities $16,781 $ -- $ 16,781 $ --
Mortgage loans 5,980 3,165 2,150 6,995
Real estate 5,012 1,526 1,000 5,538
Other investments 2,573 1,686 1,820 2,439
------- --------- ---------- -------
Total $30,346 $ 6,377 $ 21,751 $14,972
======= ========= ========== =======
</TABLE>
Additions represent charges to net realized investment losses and
deductions represent reserves released upon disposal or restructuring of the
related assets. The net change in the reserve is included as an increase or
decrease in net realized investment gains or losses in the consolidated
statements of operations. Adjustments for other than temporary declines in the
value of all fixed maturities are recorded as a direct adjustment to the
securities' carrying value.
Net investment income recorded on problem investments was $3,016,000,
$1,322,000 and $1,778,000 in 1996, 1995 and 1994, respectively. Interest not
recognized on non-accrual securities and loans was $232,000, $946,000 and
$3,447,000 in 1996, 1995 and 1994, respectively.
Restructured securities and loans aggregated $14,435,000 and $26,483,000
as of December 31, 1996 and 1995, respectively. The amount of interest
foregone on restructured securities and loans was $1,519,000, $2,007,000 and
$2,902,000 in 1996, 1995 and 1994, respectively.
The Company had no loan commitments at December 31, 1996.
No investment position exceeded 10% of the Company's shareholders'
equity at December 31, 1996.
<PAGE> 17
NOTE 3. DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses common derivative financial instruments such as futures
and forward settling contracts to hedge certain risks associated with future
investments. These derivative financial instruments are used as part of its
overall interest rate risk management strategy. Exchange traded futures are
used to hedge the interest rate risk associated with holding cash positions
until suitable long term investments can be found. The Company uses forward
settling US Treasury locks to hedge expected cash flows in the next two years
against the adverse risk of declining interest rates on the individual
disability insurance reserves. In using these instruments, the Company is
subject to the off-balance-sheet risk that counterparties to the transactions
will fail to completely perform as contracted. The Company manages this risk
by only entering into contracts with highly rated institutions and listed
exchanges. The Company also enters into bilateral cross-collateralization
agreements with its counterparties to help limit the credit exposure of the
derivatives. The Company does not intend to hold derivative financial
instruments for the purpose of trading.
The table below summarizes by notional amounts the activity for each
category of derivatives:
<TABLE>
<CAPTION>
FORWARDS FUTURES TOTAL
-------- ------- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at December 31, 1995 $ -- $ -- $ --
Additions 300,000 175,000 475,000
Terminations 92,500 92,500
-------- --------- --------
Balance at December 31, 1996 $300,000 $ 82,500 $382,500
</TABLE>
Gains or losses on termination of the futures are deferred and reported
as an adjustment of the carrying amount of the hedged asset and amortized into
earnings over the lives of the hedged items. The net deferred gain associated
with this activity was $1,900,000 at December 31, 1996. At December 31, 1996,
the Company had an unrealized loss of $500,000 on its open futures contracts.
During 1996, the Company executed a series of cash flow hedges in the
individual disability income portfolio, hedging $300,000,000 of expected cash
flows in the years 1997 and 1998 using forward settling US Treasury locks. The
purpose of this action is to lock in the reinvestment rates on future cash
flows and protect the Company from the potential adverse impact of declining
interest rates on the individual disability income reserves. At December 31,
1996, the Company had an unrealized gain of $9,600,000 on these forward locks.
These forward locks are scheduled to be terminated in 1997 and 1998 as assets
are purchased with the future anticipated cash flows.
NOTE 4. VALUE ASSIGNED PURCHASED INSURANCE IN-FORCE
Value assigned purchased insurance in-force is amortized with interest
based upon expected future premium cash flows of the business acquired.
Interest has been accrued on the unamortized balance at 9% during 1996 and
1995.
An analysis of the value assigned purchased insurance in-force for each
of the three years in the period ended December 31, 1996 is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Value assigned purchased insurance in-force at beginning of year $ 66,894 $ 72,478 $ 80,172
Amortization (10,961) (11,896) (12,980)
Interest accrued 5,483 5,997 5,980
Impact from sale of Canadian life insurance portfolio (1,146) -- --
Foreign translation gain (loss) (40) 315 (694)
-------- -------- --------
Value assigned purchased insurance in-force at end of year $ 60,230 $ 66,894 $ 72,478
======== ======== ========
</TABLE>
<PAGE> 18
The estimated amortization of value assigned purchased insurance
in-force (in thousands) for each of the next five years is as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 $10,377
1998 9,342
1999 8,357
2000 7,372
2001 6,698
</TABLE>
NOTE 5. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to the Company; consequently, allowances are established for amounts
deemed uncollectible. The Company evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk arising from similar
geographic regions, activities, or economic characteristics of the reinsurers
to minimize its exposure to significant losses from reinsurer insolvencies.
In September 1995, the Company finalized and received regulatory
approval for a reinsurance agreement providing for the coinsurance of certain
individual disability claims in its U.S. individual disability insurance block
of business. Under the agreement, effective July 1, 1995, 80% of the Company's
liability on United States claims open as of June 30, 1995 with dates of
disability prior to July 1, 1993 was reinsured with an unaffiliated reinsurer
on a quota share basis. In connection with this transaction, the Company
transferred certain assets with a market value of $560,968,000 into a
reinsurance trust account managed by the reinsurer. This transaction is
considered a non-cash item in the consolidated statement of cash flows for the
year ended December 31, 1995. The Company will continue to manage the claims
for an agreed upon fee.
At December 31, 1996 and 1995, reinsurance recoverables of $448,488,000
and $474,848,000, other assets of $75,191,000 and $77,665,000 representing the
present value of future experience credits and the cost of reinsurance were
associated with this agreement. Also in connection with this agreement, the
Company amortized the cost of reinsurance totaling $2,474,000 and $2,101,000 in
1996 and 1995, respectively.
The effect of reinsurance on premiums and amounts earned is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Direct premiums and amounts assessed
against policyholders $ 981,279 $ 901,164 $ 809,619
Reinsurance assumed 162,997 162,297 147,956
Reinsurance ceded (8,692) (8,168) (12,691)
---------- ---------- ---------
Net premiums and amounts earned $1,135,584 $1,055,293 $ 944,884
========== ========== =========
</TABLE>
NOTE 6. DEBT AND CREDIT ARRANGEMENTS
In September 1994, the Company restructured its existing $75,000,000
bankers acceptance credit facility with a bank into a $100,000,000 multi-bank
revolving credit facility, consisting of a bankers acceptance portion as well
as revolving loans at either a prime or Eurodollar rate of interest. In
September 1995, the limit of the facility was extended through September 30,
1998, with a single one-year option remaining. The facility limit is
permanently reducible at the Company's option.
<PAGE> 19
Under the terms of the bankers acceptance portion, the insurance
companies may invest in bankers acceptances of the bank group. The face amount
of such investments was $80,000,000 at December 31, 1996 and $75,000,000 at
December 31, 1995 and 1994. At December 31, 1996, 1995 and 1994, the Company
had advances totaling $76,241,000, $71,548,000 and $73,359,000, respectively,
outstanding under this provision of the facility, including accrued interest of
$720,000, $1,135,000 and $1,185,000, respectively; the maximum amounts
outstanding in each year were $76,241,000, $75,000,000 and $73,359,000,
respectively. The weighted average interest rate on outstanding advances was
6.62%, 6.48% and 6.67% at December 31, 1996, 1995 and 1994, respectively.
Interest incurred on the outstanding advances varies based upon the date the
advance was made and interest rates then in effect. Interest expense incurred
on this debt was approximately $4,664,000, $4,690,000, and $4,391,000 in 1996,
1995 and 1994, respectively, and is included in commissions and other expenses.
Interest paid was $5,080,000, $4,740,000 and $7,159,000 in 1996, 1995 and
1994, respectively. The average amounts outstanding under the bankers
acceptance portion for 1996, 1995 and 1994, calculated by averaging the
beginning and ending monthly outstanding balances, were $73,867,000,
$73,189,000 and $73,316,000, respectively.
The bankers acceptance portion contains a right of offset clause which
allows the Company to offset any obligations with respect to the bankers
acceptance portion against the acceptance obligation of the bank to the
insurance companies. As a result, the total obligation of the Company was
offset against the total carrying value of the bankers acceptances of
approximately $76,476,000 and $71,696,000 at December 31, 1996 and 1995,
respectively. The fair value of this net credit facility approximates the net
amount recorded in the consolidated financial statements. While individual
borrowings by the Company have interim maturities of $75,521,000 in 1997, the
credit facility guarantees the Company the right to renew these borrowings up
to the limit of the facility.
In addition, under the terms of the revolving loan portion of this
agreement, at December 31, 1996 and 1995, the Company had outstanding
Eurodollar borrowings of $17,136,000 and $17,006,000, respectively, including
accrued interest of $136,000 and $6,000, respectively. Interest paid on these
borrowings was $853,000 and $485,000 in 1996 and 1995, respectively. These
borrowings are unsecured and interest is payable quarterly. The borrowings
mature in 1997, but are renewable for the life of the facility. The weighted
average interest rate for the facility during the years ended December 31,
1996, 1995 and 1994, calculated by dividing the interest expense incurred by
the average outstanding balance, was 6.25%, 6.43% and 6.00%, respectively.
In addition to its multi-bank revolving credit facility, in November
1995, the Company established a $25,000,000 revolving credit agreement with a
single bank. Unsecured Eurodollar borrowings of $4,501,000 and $21,014,000,
including accrued interest of $1,000 and $14,000, respectively, were
outstanding at December 31, 1996 and 1995, respectively. Interest paid on these
borrowings was $400,000 in 1996, there was no interest paid in 1995. The
maximum amounts outstanding, including accrued interest, in 1996 and 1995 were
$21,313,000 and $21,014,000, respectively. The interest rates on outstanding
advances at December 31, 1996 and 1995 were 6.03% and 6.04% respectively.
In addition to its other credit facilities, in December 1996, the
Company established a $180,000,000 revolving credit agreement with a single
bank. Repayment of borrowings under this agreement is guaranteed by Textron.
Borrowings of $113,070,000, including accrued interest, were outstanding under
this agreement at December 31, 1996. The interest rate on borrowings
outstanding at December 31, 1996 was 5.90%.
NOTE 7. CHANGE IN ACCOUNTING ESTIMATES
Under GAAP, a liability for future policy benefits relating to
individual disability insurance policies is established when premium
revenue is recognized. The liability, which represents the present value
of future benefits to be paid and related expenses less the present value
of future net premiums, is estimated using actuarial methods that include
assumptions, such as expected investment yields, morbidity (the incidence of
claims and the rate of recovery, including the effects
<PAGE> 20
thereon of inflation, and other societal and economic factors), lapse rates,
expenses and margins for adverse deviation and future profits, applicable at
the time the insurance contracts are made. Individual disability insurance
policies are complex long-term contracts with typical effective terms of 30
years or more, depending upon the age of the insured at the time of issue. As
such, the effort required to establish and support the original set of reserve
assumptions (i.e., those established when the policy is issued) is
extensive.
GAAP requires that original assumptions continue to be used in
subsequent accounting periods to determine changes in the liability for future
policy benefits unless a premium deficiency exists. However, actual experience
with respect to investment yields, morbidity, lapse rates or expenses may
indicate that the recorded contract liabilities are not sufficient. In such
circumstances, a reserve study is conducted to determine the extent, if any, of
the premium deficiency and whether the original assumptions should be changed,
or "unlocked."
In a reserve study, current best estimates as to future experience with
regard to investment yields, morbidity, lapse rates and expenses are used to
determine if reserves currently held plus the present value of future cash
inflows are projected to be sufficient to meet the present value of future cash
outflows and the amortization of deferred policy acquisition costs. The effort
required to support a change in reserve assumptions is at least as extensive
and comprehensive as the process to establish the original assumptions.
If a premium deficiency exists, GAAP requires that it be recorded as a
reduction in unamortized deferred acquisition costs and value assigned
purchased insurance business in force or an increase in the liability for
future policy benefits. Future changes in the liability are then based on the
revised assumptions. A premium deficiency reserve represents a provision for
the present value of future losses, and therefore, no premium deficiency should
be recorded currently if it would result in creating future income.
Claim reserves are established for future payments not yet due on claims
already incurred. These reserves are based on the estimated ultimate cost of
settling the claims and the rate of interest used to discount future claim
payments. The ultimate cost of the adjudication process is primarily affected
by the rate of recovery, which depends on inflation, other societal and
economic factors and the effectiveness of the claim adjudication process. The
assumptions are based upon past experience adjusted for current trends, and any
other factors that would modify past experience. Changes in estimates of claim
costs resulting from the continuous review process and differences between
estimates and payments for claims are recognized in income during the period in
which the estimates are changed or payments are made.
The Company has traditionally maintained two separate lines of business
within the individual disability insurance segment, the core individual
disability insurance line of business (which generated 1996 premiums of
$763,566,000) and the excess-risk reinsurance line of business (which generated
1996 premiums of $25,566,000). The core line of business includes products
sold through a brokerage system, the Company's own career agency system and its
National Accounts program.
On an ongoing basis, actual and originally expected experience are
compared and an assessment is made regarding the continued appropriateness of
the underlying policy and claim reserve assumptions. As a result of this
ongoing analysis, the Company commenced a comprehensive reserve study in the
fourth quarter of 1995. The study, which was completed in late January 1996,
resulted in a $59,000,000 reserve strengthening in the Company's excess-risk
line of business which was reflected in the Company's financial statements for
the period ended December 31, 1995.
Consistent with its practice of ongoing analysis, the Company considered
the deteriorating morbidity experience in 1996, as compared to the assumptions
used in the 1995 study. Based on this ongoing analysis, the Company determined
in June 1996 to update the comprehensive reserve study using detailed
experience data through June 30, 1996, and considering experience and trends
during the third quarter of 1996 and, if necessary, the fourth quarter of 1996.
<PAGE> 21
The core individual disability insurance line's results have been
severely affected by a higher incidence of new claims and lower claim recovery
rates on policies issued from 1985 through 1989. In addition, business in the
core line issued to physicians has performed below expectations. The quarterly
benefit ratios (benefits divided by premiums earned) for the core disability
insurance line of business were as follows for 1993, 1994 and 1995:
<TABLE>
<CAPTION>
DISABILITY INSURANCE LINE BENEFIT RATIOS 1993-1995
--------------------------------------------------
1993 1994 1995
---- ---- ----
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3* Q4
- -- -- -- -- -- -- -- -- -- -- --- --
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
70.9 74.3 71.9 70.9 70.9 77.5 84.1 88.6 88.0 85.3 78.9 78.4
</TABLE>
* During the third quarter of 1995, the Company entered into a
reinsurance agreement providing for the coinsurance of certain individual
disability claims. Under the agreement, effective July 1, 1995, 80% of the
Company's liability on United States claims open as of June 30, 1995 with dates
of disability prior to July 1, 1993 was reinsured with an unaffiliated reinsurer
on a quota share basis. This transaction results in reducing both benefit
expense and investment income for the policies and related assets affected by
the reinsurance agreement beginning in the third quarter of 1995. The effect
for the third quarter of 1995 was to reduce the benefit ratio by 4 points.
Excess-risk reinsurance includes business assumed from other insurers
relating to individual, non-cancellable disability insurance products issued by
them, including coinsurance, extended elimination period and yearly renewable
term. The underlying products in this line of business are designed,
distributed and administered by other companies. The quarterly benefit ratios
(benefits divided by premiums earned) for the excess-risk reinsurance line of
business were as follows for 1993, 1994 and 1995:
<TABLE>
<CAPTION>
EXCESS RISK REINSURANCE LINE BENEFIT RATIOS 1993-1995
-----------------------------------------------------
1993 1994 1995
---- ---- ----
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-- -- -- -- -- -- -- -- -- -- -- --
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
107.8 48.4 88.0 126.6 201.2 172.1 112.3 178.3 124.7 137.3 187.1 169.4*
</TABLE>
* Exclusive of $59,000,000 of reserve strengthening.
The Company conducted a comprehensive reserve study as of December 31,
1995 of both its excess-risk reinsurance and its core disability lines of
business. As a result of the 1995 reserve study, the Company concluded that a
$59,000,000 reserve strengthening adjustment was warranted in the excess-risk
reinsurance line of business and that no reserve adjustments were warranted in
the core individual disability insurance line of business. At December 31,
1995 these conclusions were based upon the following factors:
- The Company's assessment that the morbidity experience for the
excess-risk line of business would continue to perform worse than
originally expected at the time the reserves were established.
- The Company's belief that the improving morbidity trend on a
quarter-by-quarter basis of the core individual disability line
of business experienced during 1995 would continue into the future,
but at a more modest level. This was predicated on (i) extensive
<PAGE> 22
measures undertaken by the Company, including more restrictive
product provisions and underwriting practices implemented during
the period 1990-1995, (ii) improvements in claims management
processes and staffing and (iii) the Company's belief that changes
in economic factors affecting physician experience would cause that
experience to improve.
- The Company's view that reinvestment yields would generally be more
reflective of current portfolio yields.
- The Company's expectation that it would continue to realize
economies of scale and productivity enhancements.
During the first quarter of 1996, in connection with the potential
sale of the Company, Textron retained the actuarial consulting firm of Milliman
& Robertson, Inc. ("M&R") to serve as Textron's actuarial advisor. In this
capacity, M&R was requested to prepare an appraisal of the Company's business,
evaluate the Company's reserving practices, identify potential issues which
might be raised by prospective buyers and generally assist Textron in the
course of negotiating the transaction. M&R summarized its work for Textron in
a report dated April 23, 1996, which included an estimate of a reserve
deficiency on a GAAP basis with respect to the Company's disability business of
$110,000,000 as of December 31, 1995. (This figure excludes the present value
of projected overhead costs of $54,000,000 which, in accordance with GAAP, are
excluded in determining reserve deficiencies. Overhead costs are general
corporate costs not attributable to policy acquisition, maintenance or claims
adjudication.) The Company was aware of M&R's work and reconciled M&R's
results to the Company's 1995 comprehensive reserve study. The principal
differences between the Company's 1995 study, which produced an estimated
reserve sufficiency of $252,000,000, and the M&R analysis resulted from
differing views regarding future trends in morbidity (a difference of
$334,000,000) and interest rates (a difference of $50,000,000), partially
offset by more favorable expense levels (a difference of $22,000,000). These
differences resulted primarily from differing judgments regarding the following
factors:
- M&R generally assumed that morbidity in the foreseeable future
would be level with that experienced during 1995. The Company
assumed that the gradual quarter-by-quarter improvement experienced
in 1995 would continue into the foreseeable future, but at a more
modest level. Factors that the Company utilized in developing its
assumptions included (i) that experience for business issued in
1985-1989 would begin to improve and (ii) that the extensive
measures undertaken by the Company, including more restrictive
product provisions and underwriting practices implemented during
the period 1990-1995, and improvements in claims management
processes and staffing, had a positive effect contributing to the
quarter-by-quarter trend in 1995 and that this would continue into
the foreseeable future. Additionally, the Company believed that
physician experience would gradually improve as a result of an
improvement in physicians' outlook with respect to their
professional prospects, which previously had been adversely
affected by the federal healthcare reform initiatives and the move
toward managed care and industry consolidation.
- While both M&R and the Company assumed an investment strategy
consistent with the Company's historical investment policy, M&R
assumed a net new investment rate of a level 6.9% while the Company
assumed a new investment rate which increased from 7% to 8% over
ten years. M&R assumed a beginning portfolio yield of 7.85% and
the Company assumed a beginning portfolio yield of 8.25%.
- M&R assumed slightly lower expenses as compared to the Company.
Based on its analysis of the results of M&R's work, the Company
concluded that its views regarding the future trends in morbidity, expense
levels and interest rates continued to be reasonable and that the results of
its 1995 reserve study continued to be appropriate. Although M&R's judgments,
<PAGE> 23
primarily as to future morbidity, were different from those of the Company,
the M&R study was based on the same historical morbidity experience and
utilized the same projection methodology as employed by the Company. As a
result, the Company determined that it was not appropriate to initiate a new
reserve study and unlock the original reserve assumptions. However, the
Company determined that it would continue to closely monitor morbidity and
interest experience, as well as other factors.
In connection with the pending merger of the Company with a wholly-owned
subsidiary of Provident ("the merger"), Provident retained the actuarial
consulting firm of Tillinghast - Towers Perrin ("Tillinghast") to assist
Provident's management in its due diligence investigation of the Company and to
develop information to assist Provident in refining its bid and enhancing its
negotiating position. On April 28, 1996, Tillinghast presented its conclusions
to the Provident Board of Directors, based upon its review of information
provided by the Company to Provident during due diligence as well as
Provident's independently derived assumptions about future experience, which
conclusions included Tillinghast's estimate that the Company's statutory
reserves should be increased by approximately $161,000,000. Provident has
informed the Company that Tillinghast's conclusions concerning statutory
reserves assumed that such conclusions would be used by Provident as a basis
for developing GAAP benefit reserves in Provident's GAAP pro forma financials
to be included in the Joint Proxy Statement/Prospectus of the Company and
Provident to be delivered to the companies' respective shareholders in
connection with the merger. See "Liquidity and Capital Resources section".
Tillinghast noted for the Provident Board of Directors that it relied upon
financial information as of December 31, 1995 furnished by the Company without
independent verification, that the work was developed using a limited amount of
data and that a more complete analysis could change its conclusions and that
its estimate was not intended to be a GAAP valuation of the Company's reserves.
The Company subsequently became aware of Tillinghast's conclusions, but was
not provided sufficient information to understand the assumptions or
methodologies employed by Tillinghast in arriving at its conclusions, which
would be necessary for the Company to make an informed evaluation of the
reasonableness of Tillinghast's conclusions. For these reasons, the Company
could not utilize Tillinghast's conclusions regarding the Company's statutory
reserves in determining the reasonableness of the reserves recorded for GAAP
reporting purposes.
During the first two quarters of 1996, the Company experienced a
deterioration in core individual disability insurance benefit ratios (88.2% for
the six months ended June 30, 1996, and 82.7% and 93.9% for the first and
second quarters, respectively), in contrast with quarter-by-quarter
improvements in benefit ratios experienced in 1995 and with the assumed
improvement in benefit ratios anticipated in the 1995 reserve study.
The Company closely monitored this morbidity experience and carefully
considered its potential impact on reserve adequacy in connection with the
preparation of both the first and second quarter financial statements. The
Company considered, among other factors: (i) the long-term nature of this
product; (ii) the results of the 1995 reserve study completed in January 1996;
(iii) the volatility of recent quarterly results and the difficulty of
predicting future morbidity trends therefrom; (iv) the impact of the pending
merger on the effectiveness of the claims operation and implementation of the
extensive measures undertaken by the Company, including more restrictive
product provisions and underwriting practices implemented during the period
1990-1995, and improvements in claims management processes and staffing; and
(v) the impact of the addition of 1996 business to the block of business being
analyzed. After considering the foregoing and the recent experience with
respect to benefit ratios, the Company did not believe that the first six
months' results were conclusive enough to warrant an adjustment to the
long-term trends encompassed in the Company's 1995 comprehensive reserve study
completed in January 1996.
Although the Company concluded that the reserves at June 30, 1996 were
fairly stated, the deterioration in morbidity experience in 1996, due primarily
to lower than expected claim recovery rates, led to a determination by the
Company in June 1996 to initiate a comprehensive reserve study to consider the
effect of experience through September 30, 1996 on recorded reserves. As a
result of the interrelationship of the morbidity assumptions underlying both
the claim and policy reserves, the comprehensive reserve study would consider
both policy and claim reserves.
<PAGE> 24
The Company completed the comprehensive reserve study in October 1996.
The continued adverse morbidity experience of the core individual disability
insurance line of business through the end of the third quarter of 1996 led the
Company to revise its outlook for morbidity trends in the future from those
which were used in the 1995 study, particularly with respect to business issued
to physicians and business underwritten from 1985 through 1989.
As a result of the 1996 comprehensive reserve study, the Company has
strengthened policy and claim reserves by $380,000,000. The differences
between the 1995 reserve study, which produced a reserve sufficiency of
$252,000,000, and the 1996 reserve study, which produced a reserve deficiency
of $380,000,000, include $577,000,000 derived from a change in the morbidity
assumptions, $48,000,000 derived from a change in the interest rate assumptions
and an aggregate of $7,000,000 from changes in other assumptions. The change
in morbidity assumptions, including claim recovery rates, resulted in revised
estimates of future benefit ratios for the core individual disability insurance
line of business. The 1995 study assumptions resulted in a future benefit
ratio in the first year (i.e., 1996) of 78.9% and the 1996 study assumptions
resulted in a future benefit ratio in the first year (i.e., 1997) of 84.9%.
The 1995 study also differed from the 1996 study in that it resulted in an
approximate 2.4% compound annual rate of improvement in benefit ratios for the
first nine years after the first year, after adjustment for interest (a
continuation of the improving trend in benefit ratios actually experienced in
1995), while the 1996 study resulted in relatively flat benefit ratios for the
first nine years after the first year, after adjustment for interest. Both the
1995 and 1996 reserve studies assumed gradual, moderate improvement after ten
years. The 1995 study also assumed claim recovery rates at levels experienced
on the average for the past four years which anticipated improved recovery
rates relative to the most recently observed experience. The 1996 study
eliminated this anticipated improvement, giving greater weight to experience in
the past year.
Following is a summary of the most significant factors considered by the
Company in determining to change its morbidity assumptions:
- Through the end of the third quarter of 1996, despite the
1995-1996 claims management initiatives, there had been a general
deterioration in claim recovery rates.
- Through the end of the third quarter of 1996, physician experience
and experience for policies issued in 1985-1989 deteriorated
rather than improved as assumed in the 1995 comprehensive reserve
study.
This additional experience is reflected in the 1996 study, which assumes
generally level morbidity experience, in contrast to the 1995 study, which
assumed moderate improvement in morbidity. These revised assumptions as to
future trends are based upon the fact that uncertainties regarding changes in
the healthcare industry and physician prospects continue in the near-term, and
that the Company's claims management initiatives have not materially decreased
claim recovery rates.
The 1995 study assumed a beginning portfolio yield of 8.25% and a new
investment rate which increased from 7% to 8% over ten years, while the 1996
study assumed a beginning portfolio yield of 7.8% and a new investment rate of
a level 7.8%.
In August 1996, the Company engaged M&R to provide assistance in its
actuarial studies, including the analysis of the adequacy of the Company's
benefit and claim reserves with respect to its individual disability business.
M&R concluded in its actuarial report dated November 6, 1996, that the net
individual disability reserves of $2.2 billion reported by the Company at
September 30, 1996, which reflect a reserve strengthening adjustment of
$380,000,000, were adequate. M&R's actuarial report dated November 6, 1996,
which contains numerous explanations and limitations, must be read in its
entirety to be understood and relied upon. This report may be obtained upon
request from the Clerk of the Company.
<PAGE> 25
While the Company believes that, after the reserve strengthening
referred to above, its policy and claim reserves are adequate, there can be no
assurance that the Company's reserves will be sufficient to fund future
liabilities in all circumstances. The establishment of insurance reserves
requires making assumptions relating to expected investment yields, morbidity
(the incidence of claims and the rate of recovery, including the effects
thereon of inflation, and other societal and economic factors), lapse rates,
expenses and margins for adverse deviation and future profits, applicable at
the time the insurance contracts are made. These estimates are made when the
policy is issued or when a claim is incurred or subsequent to recognition of a
premium deficiency, based on the facts and circumstances then known. Because
of the long-term nature of these products and the significance of the
assumptions selected, reserve estimates are highly sensitive to slight changes
in reserve assumptions. For example, if the Company assumed an increase of
five percentage points in projected benefit ratios each year into the future,
a decrease of 100 basis points in assumed new investment rate or an increase of
five percent in future expenses, then the required reserve strengthening would
be increased by $229,000,000, $50,000,000 or $22,000,000, respectively.
Although the Company believes the assumptions which form the basis of
the 1996 reserve study are reasonable, there can be no assurance that actual
experience will conform to these assumptions. The Company believes it is
highly probable that actual experience will differ from that assumed. If
actual experience develops on a less favorable basis than that assumed, reserve
deficiencies will result and additional reserve strengthening may be necessary.
If actual experience develops on a more favorable basis than that assumed,
reserve sufficiencies will result.
The Company will closely monitor actual experience with respect to
morbidity, interest rates and expenses compared to assumptions used in the 1996
reserve study completed in October 1996. In the fourth quarter of 1996 (i.e.,
the first quarter after completion of the 1996 reserve study), interest rates
and expenses performed substantially as anticipated in the 1996 reserve study,
however, morbidity experience was slightly worse than expected in the reserve
study. Considering the long-term nature of this product, the volatility of
quarterly morbidity results and the difficulty of predicting future morbidity
trends therefrom, the Company determined that no adjustment to the assumptions
used in the reserve study were appropriate.
<PAGE> 26
NOTE 8. LIABILITY FOR UNPAID CLAIMS AND CLAIM EXPENSES
The following table provides a reconciliation of the beginning and
ending reserve balances for unpaid claims and claim expenses:
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at January 1 $1,852,298 $1,576,084 $1,356,070
Less reinsurance recoverables 463,899 26,116 21,780
---------- ---------- ----------
Net Balance at January 1 1,388,399 1,549,968 1,334,290
========== ========== ==========
Incurred related to:
Current year 708,248 554,766 515,004
Prior years
Interest 86,933 87,003 89,622
Incurred 193,360 56,431 4,100
---------- ---------- ----------
Total incurred 988,541 698,200 608,726
---------- ---------- ----------
Paid related to:
Current year 112,897 111,254 114,664
Prior years 338,760 290,995 278,384
---------- ---------- ----------
Total paid 451,657 402,249 393,048
---------- ---------- ----------
Reinsurance transactions -- (457,520) --
---------- ---------- ----------
Net Balance at December 31 1,925,283 1,388,399 1,549,968
Plus reinsurance recoverables 438,611 463,899 26,116
---------- ---------- ----------
Balance at December 31 $2,363,894 $1,852,298 $1,576,084
========== ========== ==========
</TABLE>
As discussed in Note 5 to these financial statements, the reinsurance
item is primarily attributable to the ceding of individual disability insurance
incurred claims.
Approximately $89,980,000 of the increase in prior years' incurrals and
$106,863,000 of current year incurrals in 1996 were related to changes in
reserve estimates and assumptions of morbidity, mortality and expense costs of
the individual disability insurance reserves, which were affected by the third
quarter 1996 reserve strengthening.
The development in 1995 and 1994 prior years' reserves was primarily the
result of higher incidence of new claims and lower claim termination rates on
policies issued during 1985-1989, especially in Florida and California. In
addition, business issued to physicians performed below expectations.
Interest accrued on prior year reserves has been calculated on the
opening reserve balance less one half year's cash payments at the average rate
at which the Company's reserves were discounted during 1996, 1995 and 1994.
<PAGE> 27
NOTE 9. RENT EXPENSE AND LEASE COMMITMENTS
The Company leases certain equipment and buildings under non-cancellable
operating leases that expire in various years through 2006. These leases may
be renewed for periods ranging from one to five years.
Future minimum payments under non-cancellable operating leases with
initial terms of one year or more (in thousands) consisted of the following at
December 31, 1996:
<TABLE>
<S> <C>
1997 $ 8,792
1998 6,996
1999 5,252
2000 4,091
2001 1,897
Thereafter 4,212
</TABLE>
Total rent expense was approximately $14,659,000, $15,243,000 and
$15,575,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
NOTE 10. EMPLOYEE BENEFIT PLANS
Pension Plans
The Company has two noncontributory defined benefit pension plans
covering substantially all U.S. and Canadian employees. The plans provide
benefits based on the employee's years of service and compensation during the
highest five years of employment. The Company funds the plans in accordance
with the requirements of the Employee Retirement Income Security Act of 1974,
as amended ("ERISA"). Prior to 1995, plan assets consisted of deposit
administration and variable annuity contracts issued by the Company. Effective
October 1, 1995, the Company began funding the plan covering U.S. Home Office
employees through an unrelated trust consisting of approximately 40% bonds and
60% equities. The plans provide, among other things and subject to certain
conditions, that in the event of plan termination or withdrawal of assets
without a termination within three years following a change in control of
Textron (as defined in the plans), assets in excess of termination liabilities
shall be applied to increase the benefits of participants who are active
employees immediately before the change in control. Additionally, in the event
of any plan merger, consolidation or transfer within such three-year period,
the accrued benefit of each such affected participant and beneficiary must be
vested, increased as provided by the terms of the plans and satisfied by the
purchase of a guaranteed annuity contract.
Net pension expense included the following components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Service cost - benefits earned during the year $ 3,387 $ 2,547 $ 2,777
Interest cost on projected benefit obligation 6,746 5,852 5,539
Actual return on plan assets (7,628) (11,040) (5,106)
Amortization of unrecognized net transition asset -- (585) (585)
Net accretion (amortization) and deferral of actuarial losses (411) 3,533 (2,045)
------- -------- -------
Net pension expense $ 2,094 $ 307 $ 580
======= ======== =======
</TABLE>
<PAGE> 28
The funded status of the plans and amounts recognized in the Company's
consolidated balance sheets, as determined by the plans' actuary, were as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996 1995
---- -----
(IN THOUSANDS)
<S> <C> <C>
Actuarial present value of benefit obligation - vested $ 71,734 $ 61,492
======== ========
Accumulated benefit obligation $ 74,581 $ 64,453
======== ========
Projected benefit obligation $ 95,464 $ 85,059
Plan assets at fair value 93,720 86,019
-------- --------
Projected benefit obligation (in excess of) less than plan assets (1,744) 960
Unrecognized net actuarial losses 8,488 8,498
Unrecognized prior service benefit (1,421) (1,545)
Unrecognized net transition asset (2,933) (3,517)
-------- --------
Net pension asset recognized on the consolidated balance sheets $ 2,390 $ 4,396
======== ========
</TABLE>
Major assumptions used in accounting for the defined benefit pension
plans are shown in the following table. Net pension expense is determined using
these factors as of the end of the prior year; the funded status of the plans
is determined using the discount rate and rate of compensation increase as of
the end of the current year.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994 1993
---- ---- ---- ----
<S> <C> <C> <C> <C>
Discount rate 7.25% 7.25% 8.25% 7.25%
Weighted average long-term rate of compensation
increase 5.00 5.00 5.00 5.00
Long-term rate of return on plan assets 9.00 9.00 9.00 9.00
</TABLE>
The Company has two defined contribution pension plans covering
substantially all its sales force. Contributions are calculated based upon the
compensation for each participant. Expenses recognized for these plans were
approximately $1,217,000, $799,000 and $1,531,000 for 1996, 1995 and 1994,
respectively.
Postretirement Benefits Other Than Pensions
The Company provides certain health care and life insurance benefits for
eligible retired employees. These benefits and similar benefits for active
employees are administered by insurance companies or other providers who
determine premiums for insured plans and expected costs to be paid during the
year under self-insured plans.
<PAGE> 29
In accordance with Statement of Financial Accounting Standards No. 106,
"Employers' Accounting for Postretirement Benefits Other than Pensions", the
Company recognizes the cost of its retiree health care and life insurance
benefits using the accrual method of accounting over the employees' years of
service. Postretirement benefit costs other than those related to pensions for
the Company's plans included the following components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Service cost - benefits earned during the year $ 27 $ 29 $ 31
Interest cost on accumulated postretirement benefit obligation 975 1,221 1,294
Net amortization and deferral of actuarial losses (207) (148) --
Amortization of prior service cost 13 13 13
------ ------ ------
Postretirement benefit costs $ 808 $1,115 $1,338
====== ====== ======
</TABLE>
The Company's postretirement benefit plans other than pensions currently
are not funded. The following table sets forth the status of the Company's
retiree health care and life insurance plans:
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1996 1995
---- ----
(IN THOUSANDS)
<S> <C> <C>
Actuarial present value of benefits attributed to:
Retirees $ 12,912 $ 14,314
Fully eligible active plan participants 780 1,903
Other active plan participants 207 237
Unrecognized net actuarial gain 5,720 3,171
Unrecognized prior service cost (150) (163)
-------- --------
Postretirement benefit liability recognized in the
consolidated balance sheets $ 19,469 $ 19,462
======== ========
Discount rate assumed in the accounting for postretirement
benefits other than pensions 7.50% 7.25%
======== ========
</TABLE>
The weighted average annual assumed rate of increase in the per capita
cost of covered benefits (that is, health care cost trend rate) is 6.5% for
retirees age 65 and older and 9% for retirees under age 65 in 1997. Both
rates are assumed to decrease gradually to 5.5% until 2001 and 2003,
respectively, and remain at that rate thereafter. Increasing these rates by
one percentage point in each year would have increased the accumulated
postretirement benefit obligation as of December 31, 1996 and 1995 by
$1,000,000 and $1,100,000, respectively, and increased the aggregate of the
service and interest components of postretirement benefits costs by $100,000
during each of the two years in the period ended December 31, 1996.
Savings Plan
The Company offers the Paul Revere Savings Plan (the "Savings Plan") to
its home office and field employees which complies with requirements
established by ERISA and is qualified under Section 401(K) of the Internal
Revenue Code. Participation in the Savings Plan is voluntary; however, 50% of
employee contributions are required to be invested in the Company's common
stock fund. The Company contributes fifty cents for every dollar contributed
by Savings Plan participants, up to a maximum 5% of the participant's annual
compensation. All Company contributions are required to be invested in the
Company's common stock. Employer contributions to the Savings Plan are charged
to current operations.
<PAGE> 30
Long-Term Incentive Plan
The 1993 Long-Term Incentive Plan (the "Plan") authorizes the grant of
stock appreciation rights ("SARs"), performance share units ("PSUs"), or a
combination of both, to certain officers and other selected employees of the
Company and its subsidiaries to induce them to continue as employees and to
reward them for improvement in the Company's long-term performance. The Plan
became effective October 1, 1993, and no award may be granted under the Plan
after December 31, 1997.
The maximum number of SARs which may be granted under the Plan is
750,000. Upon exercise of a SAR, the participant receives cash equal to the
excess of the value of a share of common stock on the date of exercise over the
value of the SAR on the date granted. In accordance with the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees", compensation expense is accrued in the Company's consolidated
statements of operations over the period the participant achieves the required
objective. This accrual is subsequently adjusted for fluctuations in the quoted
market value of the Company's common stock.
The following table summarizes activity related to SARs under the Plan:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Rights outstanding at beginning of year 173,700 196,900 97,600
Rights granted during the year:
Price granted at $21.875 102,600 -- --
Price granted at $14.625 -- -- 99,300
Rights exercised during the year
Price granted at $14.625 (55,250) -- --
Price granted at $25.00 (80,500) -- --
Rights cancelled during the year:
Price granted at $14.625 -- (10,200) --
Price granted at $25.00 (2,500) (13,000) --
------- ------- -------
Rights outstanding at end of year 138,050 173,700 196,900
======= ======= =======
</TABLE>
The maximum number of performance share units which may be granted under the
Plan is 150,000. Performance share units are fictional shares of the Company's
common stock. Any payment of earned performance share units is made in cash
equal to the per share value of the Company's common stock on the date earned
times the number of performance share units earned. At the time of grant,
primary and minimum performance targets or measures are established for each
participant, in addition to the award period during which the targets or
measures are to be accomplished. In accordance with the provisions of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", performance share
units are recorded when earned, as compensation expense in the Company's
consolidated statements of operations.
<PAGE> 31
The following table summarizes activity related to PSUs under the Plan:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Units outstanding at beginning of year 39,400 16,500 7,500
Units granted during the year 32,500 31,400 9,000
Units exercised during the year -- -- --
Units cancelled during the year (30,675) (8,500) --
------- ------ ------
Units outstanding at end of year 41,225 39,400 16,500
======= ====== ======
</TABLE>
In accordance with the provisions of the Plan, the approval of the Merger
Agreement by the stockholders of the Company on December 31, 1996 constituted a
change in control of the Company causing all outstanding SARs to become
immediately exercisable in full and the award period for each outstanding PSU
to end, with the PSU becoming earned and immediately payable. The market price
of the Company's common stock was $37.25 per share on December 31, 1996.
Compensation expense related to SARs, recorded in the accompanying financial
statements, was $2,363,000, $521,000 and $25,000 for the years ended December
31, 1996, 1995 and 1994, respectively. Compensation expense related to PSUs,
recorded in the accompanying financial statements was $1,816,000 for the year
ended December 31, 1996. No compensation expense related to PSUs was recorded
in the years ended December 31, 1995 and 1994.
In October 1995, the FASB issued Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("FAS 123"), which was effective
for fiscal years beginning after December 15, 1995. FAS 123 encouraged, but did
not require, accounting for stock-based compensation based on the fair value of
an option or right as of the date of grant. The Company elected to continue
using APB Opinion No. 25 under the guidance set forth in FAS 123, however, due
to the change in control provision being activated, it was necessary for the
Company to record related expenses in 1996.
NOTE 11. PREFERRED STOCK PURCHASE RIGHTS
The Company has adopted a Stockholder Rights Plan, under which a
dividend distribution of one right (a "Right") for each outstanding share of
common stock was declared to shareholders of record on October 26, 1993. Each
Right, under certain specific circumstances, entitles the owner to purchase one
one-hundredth of a share of Junior Participating Preferred Stock at a purchase
price of $125.
The Rights become exercisable at a specified time after (1) a person or
group acquires 10% or more of the Company's common stock or (2) a tender or
exchange offer for 10% or more of the Company's common stock. The Rights
expire on September 23, 2003, unless earlier redeemed by the Company under
certain circumstances at a price of $0.01 per Right.
In connection with the execution of the Merger Agreement between the
Company and Provident (see Note 1), the Company amended the Stockholder Rights
Plan to provide that neither the approval, execution, or delivery of the merger
agreement, nor consummation of the transactions contemplated thereby, will
trigger any rights with respect to the Rights. In addition, the merger
agreement provides that if the Company redeems the Rights in response to any
actions taken by any person other than Provident, Provident will deliver to the
Company an amount equal to the aggregate redemption price to be paid to the
Company's stockholders, other than Textron, under the Stockholder Rights Plan.
<PAGE> 32
NOTE 12. INCOME TAXES (BENEFITS)
Details of income (loss) before income taxes and income taxes (benefits) are
summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Income (loss) before income taxes:
United States $ (280,035) $ 105,869 $ 113,766
Canada 32,144 31,392 33,523
---------- --------- ---------
Total $ (247,891) $ 137,261 $ 147,289
========== ========= =========
Income taxes (benefits):
Current:
U.S. Federal $ 29,990 $ (25,567) $ 15,766
Canadian Federal 3,350 13,112 --
State 2,870 543 1,364
---------- --------- ---------
36,210 (11,912) 17,130
---------- --------- ---------
Deferred:
U.S. Federal (125,496) 65,464 22,303
Canadian Federal 7,548 (4,322) 13,766
State (3,300) 2,725 2,336
---------- --------- ---------
(121,248) 63,867 38,405
---------- --------- ---------
Total $ (85,038) $ 51,955 $ 55,535
========== ========= =========
</TABLE>
Following is a reconciliation of the federal statutory income tax rate
to the effective income tax rate applicable to income (loss) before income
taxes, as reflected in the consolidated statements of operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Federal statutory income tax rate (35.0)% 35.0% 35.0%
Increase (decrease) in taxes resulting from:
Nontaxable investment income (0.4) (0.8) (0.7)
Amortization of goodwill 1.2 2.0 2.0
State income taxes and other (0.1) 1.7 1.4
----- ---- ----
Effective income tax rate (34.3)% 37.9% 37.7%
===== ==== ====
</TABLE>
<PAGE> 33
The components of the Company's net deferred tax (asset) liability are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Liability for postretirement benefits other than pensions $ (7,048) $ (6,967) $ (6,961)
Liabilities for future policy benefits (165,133) (52,844) (42,204)
Differences in investment valuation -- -- (20,645)
Other -- -- (4,725)
--------- -------- --------
Total deferred tax assets (172,181) (59,811) (74,535)
Deferred policy acquisition costs and value assigned
purchased insurance in-force 262,676 246,243 245,757
Fixed assets, principally depreciation 1,808 3,504 3,605
Differences in investment valuation 78,986 164,457 --
Other 1,828 5,615 --
--------- -------- --------
Total deferred tax liabilities 345,298 419,819 249,362
--------- -------- --------
Total net deferred tax liability $ 173,117 $360,008 $174,827
========= ======== ========
</TABLE>
Prior to 1984, life insurance companies were allowed certain special
deductions for federal income tax purposes which could become subject to tax at
normal rates under certain circumstances. These special deductions were set
aside in a Policyholders' Surplus Account. Under a law adopted in 1984, no
further additions to this account are permitted. At December 31, 1996,
consolidated shareholders' equity included approximately $80,503,000 of the
life insurance subsidiaries' Policyholders' Surplus Account on which no income
taxes have been provided. The amount of taxes, at current rates, which would
become due if the surplus were distributed to the life insurance subsidiaries'
shareholders is approximately $28,176,000. Under present circumstances, it is
not anticipated that any of these earnings will become taxable.
Income taxes paid (received) by the Company amounted to $50,778,761,
($26,384,000) and $30,403,000 in 1996, 1995 and 1994, respectively.
NOTE 13. STATUTORY FINANCIAL INFORMATION
Paul Revere and PRV are domiciled in Massachusetts and prepare their
statutory financial statements in accordance with accounting principles and
practices prescribed or permitted by the Division of Insurance of the
Commonwealth of Massachusetts. PRP is domiciled in Delaware and prepares its
statutory financial statements in accordance with accounting principles and
practices prescribed or permitted by the State of Delaware Insurance
Department. Prescribed statutory accounting practices include state laws,
regulations, and general administrative rules, as well as a variety of
publications of the NAIC. Permitted statutory accounting practices encompass
all accounting practices that are not prescribed; such practices differ from
state to state, may differ from company to company within a state, and may
change in the future. Paul Revere, PRV and PRP are not currently utilizing any
material permitted accounting practices in the preparation of their statutory
financial statements.
Statutory surplus differs from shareholders' equity reported in
accordance with generally accepted accounting principles primarily because
policy acquisition costs are expensed when incurred, investment reserves are
based on different assumptions, postretirement benefit costs are based on
different assumptions and reflect a different method of adoption, life
insurance reserves are based on different assumptions and income tax expense
reflects only taxes paid or currently payable. Combined statutory net income
(loss) and surplus are as follows:
<PAGE> 34
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Statutory net income (loss) $(114,666) $ 30,405 $(36,381)
========= ======== ========
Statutory surplus $ 345,927 $375,642 $348,103
========= ======== ========
</TABLE>
In 1996, in connection with a statutory reserve study, the Company
increased its aggregate statutory individual disability insurance reserves by
$144,000,000, which decreased net income (loss) (after taxes) by $121,000,000.
The Company's insurance subsidiaries are subject to various state
insurance regulatory restrictions that limit the maximum amounts of dividends
available from its insurance subsidiaries without prior approval. Under
current law, during 1997, approximately $34,592,000 will be available for
payment of dividends by Paul Revere without state insurance regulatory
approval. Dividends in excess of this amount may only be paid with regulatory
approval.
NOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," as amended by Statement of Financial
Accounting Standards No. 119, "Disclosure About Derivative Financial
Instruments and Fair Value of Financial Instruments," requires disclosure of
fair value information about all financial instruments held or owed by a
company except for certain excluded instruments and instruments for which it is
not practicable to estimate fair value. The following methods and assumptions
were used in estimating the fair value of the Company's financial instruments:
Investments
The estimated fair values of investment securities, except for mortgage
and policy loans, are based on quoted market prices, where available, from an
independent pricing service. Fair values for private placement securities and
fixed maturities not provided by an independent pricing service are estimated
by the Company using a current market rate applicable to the yield, credit
quality and maturity of the investments. The fair value of mortgage loans has
been estimated based on discounted cash flow analyses, using interest rates
currently being offered for similar loans to borrowers of similar credit
quality. The fair values of real estate and other invested assets were
determined through Member of Appraisal Institute (MAI) appraisals and in-house
valuations. For policy loans, fair value approximates carrying value.
Insurance reserves and claims
The estimated fair value of other policyholder funds was based on the
cash surrender value of the Company's financial products portfolio. The fair
value of reserves or liabilities relating to the Company's other insurance
products is not required to be disclosed under generally accepted accounting
principles. However, the fair values of liabilities under all insurance
contracts are taken into consideration in the overall management of the
Company's interest rate risk, which minimizes exposure to changing interest
rates through the matching of investment maturities with the timing of amounts
estimated to be payable under insurance contracts.
<PAGE> 35
The carrying values and estimated fair values of the Company's financial
instruments for which it is practicable to calculate a fair value are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- -----------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
----- ---------- ----- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Available for sale:
Fixed maturities $5,003,432 $5,003,432 $4,619,841 $4,619,841
Equity securities 89,024 89,024 90,001 90,001
Short-term investments 239,741 239,741 71,326 71,326
Mortgage loans 329,020 335,622 309,046 342,826
Real estate 2,696 3,690 9,291 12,206
Policy loans 73,816 73,816 73,933 73,933
Other invested assets 32,657 42,701 31,604 39,673
---------- ---------- ---------- ----------
Total investments 5,770,386 5,788,026 5,205,042 5,249,806
---------- ---------- ---------- ----------
Liabilities:
Other policyholder funds 1,973,118 1,946,479 1,876,324 1,849,078
Notes payable 134,707 134,707 38,020 38,020
</TABLE>
NOTE 15. RELATED PARTY TRANSACTIONS
The Company provides group life, accidental death and dismemberment, and
long-term disability insurance to Textron. Premiums of approximately
$18,020,000, $18,001,000 and $18,682,000 for this coverage were earned from
Textron for the years ended December 31, 1996, 1995 and 1994, respectively.
Included in other liabilities are amounts due to Textron of $2,008,000
and $890,000 at December 31, 1996 and 1995, respectively. These amounts
primarily relate to experience credits on group insurance coverage provided to
Textron.
The Company also provides investment management services to certain
employee benefit funds and other insurance subsidiaries of Textron and receives
related fees. Assets managed include publicly traded bonds and private
placement securities. Fees charged are based on cost and approximate $600,000
per year. The agreements are cancellable by either party upon thirty days'
written notice.
Textron provides various administrative services to the Company at no
charge. These services are not extensive, and the Company believes that the
related costs are not material to the Company's operating results.
At December 31, 1996 and 1995, the Company owned 424,125 shares and
848,250 shares, respectively, of Textron common stock, which are not readily
available for public sale and which represent less than 2% of Textron's
outstanding common stock. The Company has an agreement with Textron whereby
these shares are redeemable at any time, at the Company's option, at the quoted
market price of Textron's registered common stock at the redemption date.
Accordingly, the Company records its investment in Textron common stock at
market value. The Company recorded dividend income related to this stock of
$933,000, $1,489,000 and $1,930,000 for the years ended December 31, 1996, 1995
and 1994, respectively.
The Company and Textron entered into a stock purchase agreement pursuant
to which Textron is purchasing all of the Company's shares of Textron stock in
four annual installments of 424,125 shares each, beginning on April 10, 1994.
These shares will be purchased at a share price equal to the average closing
price of Textron's stock over the fiscal quarter preceding each such purchase.
In April 1996, 1995
<PAGE> 36
and 1994, in connection with this commitment, Textron purchased 424,125 shares
of its common stock at $78.623, $52.738 and $58.137 per share, respectively,
resulting in realized investment gains to the Company of $23,330,000,
$12,278,000 and $14,552,000, respectively, before income taxes. In the event
that the merger with Provident is consummated prior to April 10, 1997, Textron
will repurchase the Company's remaining 424,125 shares of Textron common stock
prior to the effective date of the merger at a price equal to the average
closing price for Textron common stock over the 90-day period immediately
preceding the date of such repurchase (net of taxes), or such other period not
less than 30 days.
NOTE 16. LITIGATION AND CONTINGENCIES
In the normal course of its business operations, the Company is involved
in litigation from time to time with claimants, beneficiaries and others, and a
number of lawsuits were pending at December 31, 1996. In the opinion of
management, the ultimate liability, if any, arising from this litigation is not
expected to have a material adverse affect on the consolidated net income (loss)
or financial condition of the Company.
The laws of many states in which the Company's insurance subsidiaries
are admitted to do business require as a condition of admission that all
insurance companies so admitted collectively guarantee to policyholders the
benefits payable under policies issued by other insurance companies admitted in
the particular state up to statutory levels. While the amount of any
assessments which may be made in the future cannot be predicted, the Company
does not believe the total assessments, if any, will be material to its
operating results or financial position.
NOTE 17. PENDING ACCOUNTING PRONOUNCEMENTS
In June 1996, the FASB issued Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" ("FAS 125"), which will be effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. FAS 125 provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. The statement requires that a liability be
derecognized if and only if either (a) the debtor pays the creditor and is
relieved of its obligation for the liability or (b) the debtor is legally
released from being the primary obligor under the liability either judicially
or by the creditor. The statement provides implementation guidance for
assessing isolation of transferred assets, servicing of financial assets,
securitizations, securities lending transactions, repurchase agreements, risk
participations in banker's acceptances, and extingiushments of liabilities.
The adoption of FAS 125 is not expected to have a material effect on the
Company's financial statements.
NOTE 18. SELECTED FINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC AREA
The Company's principal operations in the United States and Canada are
conducted through Paul Revere, a Massachusetts-domiciled life insurance company
licensed in all fifty states and Canada and Paul Revere's two wholly-owned
subsidiaries, PRV, also a Massachusetts-domiciled life insurance company
licensed in forty-eight states and PRP, a Delaware-domiciled life insurance
company licensed in forty states. The Company reports its operations in five
business segments: Individual Disability Insurance, Group Insurance,
Individual Life Insurance, Financial Products and Corporate.
The Individual Disability Insurance segment includes disability
insurance products directly written or reinsured by the Company. The Company
offers a broad portfolio of individual disability insurance products, each with
numerous options and special features. The Company offers two general types of
individual disability insurance products, one designed to address the personal
needs of the insured and the other designed to provide protection to the
insured's business enterprise. These products are marketed through the
Company's brokerage organization, its National Accounts program and its career
sales agency system.
<PAGE> 37
The Group Insurance segment includes group disability, group life,
accidental death and dismemberment, and group medical and dental insurances.
The Company offers a number of short and long-term disability insurance
products which provide income protection for various groups of individuals in a
wide variety of industries. The Company also offers a number of non-disability
group insurance products including dental insurance, term life insurance,
accidental death and dismemberment coverage and in Canada, supplementary
medical coverage as well. These products are marketed through the Company's
brokerage system as well as its National Accounts program and career sales
agency system.
The Individual Life Insurance segment includes all individual life
products. The Company offers six individual life insurance products, including
annual renewable term life insurance, term life insurance, two
interest-sensitive whole life insurance products, interest-sensitive whole life
insurance with guaranteed level premiums, and interest-sensitive survivorship
life insurance. These products are sold primarily through the Company's career
sales agency system.
The Financial Products segment includes a variety of fixed and variable
annuity products. The Company offers several annuity products, including
tax-sheltered retirement vehicles, single and flexible premium deferred
annuities and a single premium immediate annuity product. Banks, savings and
loans and credit union are significant distributors of the Company's annuity
products to their customers. The Company also sells its annuity products
through its career sales agents and independent brokerage organizations
unaffiliated with the Company's individual and group insurance brokerage
organizations.
The Corporate segment is utilized to segregate investment income
generated by the holding company. Net investment income and net realized
investment gains are allocated to the segments based on designation of
ownership of assets identified to the segments. Operating expenses are
allocated to the segments based on direct charges incurred and time and usage
statistics.
Summarized financial information for the five business segments is as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues:
Individual Disability Insurance $ 995,362 $ 984,414 $ 870,709
Group Insurance 343,187 304,362 255,371
Individual Life Insurance 64,951 74,694 68,939
Financial Products 186,156 170,297 149,643
Corporate 221 271 2,717
---------- ---------- ----------
$1,589,877 $1,534,038 $1,347,379
========== ========== ==========
Income (Loss) Before Income Taxes:
Individual Disability Insurance $ (341,503) $ 59,121 $ 83,986
Group Insurance 23,603 22,164 8,606
Individual Life Insurance 16,220 16,667 16,189
Financial Products 53,568 39,038 35,791
Corporate 221 271 2,717
---------- ---------- ----------
$ (247,891) $ 137,261 $ 147,289
========== ========== ==========
Identifiable Assets:
Individual Disability Insurance $4,253,241 $3,696,867 $3,093,938
Group Insurance 539,252 538,790 425,409
Individual Life Insurance 453,069 520,746 422,129
Financial Products 2,280,061 2,257,556 1,945,580
Corporate 3,316 29,726 22,292
---------- ---------- ----------
$7,528,939 $7,043,685 $5,909,348
========== ========== ==========
</TABLE>
<PAGE> 38
The following is a summary of revenues, income (loss) before income
taxes and identifiable assets by geographic area:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues:
United States $1,430,504 $1,380,025 $1,204,262
Canada 159,373 154,013 143,117
---------- ---------- ----------
$1,589,877 $1,534,038 $1,347,379
========== ========== ==========
Income (Loss) Before Income Taxes:
United States $ (280,035) $ 105,869 $ 113,766
Canada 32,144 31,392 33,523
---------- ---------- ----------
$ (247,891) $ 137,261 $ 147,289
========== ========== ==========
Identifiable Assets:
United States $6,841,731 $6,373,030 $5,370,851
Canada 687,208 670,655 538,497
---------- ---------- ----------
$7,528,939 $7,043,685 $5,909,348
========== ========== ==========
</TABLE>
Capital expenditures and depreciation expense for each of the three
years in the period ended December 31, 1996 were not material to the operations
of the industry segments.
NOTE 19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Following is a summary of unaudited quarterly results of operations for
1996 and 1995:
<TABLE>
<CAPTION>
1996 1ST 2ND 3RD 4TH
- ---- --- --- --- ---
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Premiums, policy and contract charges and fees $ 281,278 $ 279,764 $ 285,912 $ 288,630
Net investment income 98,111 100,427 102,820 104,289
Net realized investment gains 4,250 25,899 9,699 8,798
Benefits to policyholders 255,909 274,543 649,049 276,638
Net income (loss) 19,853 22,661 (224,191) 18,824
Income (loss) per common share 0.44 0.50 (4.98) 0.42
Common stock information:
Weighted average number of common shares
outstanding 45,000,000 45,000,000 45,000,000 45,000,000
=========== =========== =========== ===========
Price range: High $ 24.375 $ 28.375 $ 29.00 $ 39.00
Low $ 20.625 $ 23.625 $ 26.00 $ 26.25
Dividends paid per common share $ 0.06 $ 0.06 $ 0.06 $ 0.06
=========== =========== =========== ===========
</TABLE>
<PAGE> 39
<TABLE>
<CAPTION>
1995 1ST 2ND 3RD 4TH
- ---- --- --- --- ---
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Premiums, policy and contract charges and fees $ 253,906 $ 262,278 $ 269,108 $ 270,001
Net investment income 98,317 99,155 91,511 100,727
Net realized investment gains 6,143 15,728 7,150 60,014
Benefits to policyholders 243,025 247,761 244,479 304,028
Net income 17,247 25,394 21,821 20,844
Income per common share 0.38 0.56 0.48 0.46
Common stock information:
Weighted average number of common shares
outstanding 45,000,000 45,000,000 45,000,000 45,000,000
=========== =========== =========== ===========
Price range: High $ 17.125 $ 17.50 $ 19.25 $ 21.375
Low $ 14.375 $ 15.50 $ 16.625 $ 18.50
Dividends paid per common share $ 0.06 $ 0.06 $ 0.06 $ 0.06
=========== =========== =========== ===========
</TABLE>
A separate computation of income (loss) per common share is made for
each quarter presented and for the year. Accordingly, the sum of the quarterly
income (loss) per common share amounts will not necessarily equal the income
(loss) per common share amount for the year.
During the third quarter of 1996, the Company strengthened individual
disability insurance reserves by $380,000,000 which is reflected in benefits to
policyholders. Net income (loss) was negatively impacted by the after tax
impact of the reserve strengthening, $244,300,000, or $5.43 per share.
During the third and fourth quarters of 1995, the Company experienced
adverse claims experience in the excess-risk reinsurance line of business in the
Individual Disability Insurance segment. As a result of a loss recognition
study, the Company strengthened reserves in this line of business. This
adjustment resulted in a decrease to income (loss) before income taxes of
$59,000,000, which was recorded in the fourth quarter of 1995.
<PAGE> 1
Exhibit 99.2
PRO FORMA CONDENSED COMBINED FINANCIAL DATA
The unaudited pro forma condensed combined financial statements are based
on the historical presentation of the consolidated financial statements of
Provident and Paul Revere. The Unaudited Pro Forma Condensed Combined
Statements of Operations for the years ended December 31, 1996 and 1995, give
effect to the Merger as if it had occurred at the beginning of each of the
periods presented. The Unaudited Pro Forma Condensed Combined Statement of
Financial Condition as of December 31, 1996 gives effect to the Merger as if it
had occurred on December 31, 1996.
The Merger is expected to be accounted for under the purchase method of
accounting. The estimated total purchase price for Paul Revere has been
allocated to tangible and identifiable intangible assets and liabilities based
upon management's estimate of their respective fair market values with the
excess of cost over net assets acquired allocated to goodwill. The allocation of
the purchase price for the Merger is subject to revision when additional
information concerning asset and liability valuation is obtained.
Each of the Unaudited Pro Forma Condensed Combined Statements of Operations
include the historical operating results of Paul Revere from the beginning of
the period covered by such statement until the end of such period. These pro
forma statements may not necessarily be indicative of the results that actually
would have occurred if the Merger had been in effect on the dates indicated or
which may be obtained in the future. These condensed combined pro forma
statements do not reflect any potential savings which may result from the
combined operations of Provident and Paul Revere.
The unaudited pro forma condensed combined financial statements should be
read in conjunction with the historical consolidated financial statements,
including the notes thereto, of Provident, which have been previously filed,
and Paul Revere, which are filed herewith.
2
<PAGE> 2
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL CONDITION
DECEMBER 31, 1996
<TABLE>
<CAPTION>
PRO FORMA
PROVIDENT PAUL REVERE ADJUSTMENTS COMBINED(15)
--------- ----------- ----------- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
ASSETS
Investments:
Fixed maturity securities
Available-for-sale -- at fair value...... $10,880.1 $5,003.4 $113.7 (1) $15,997.2
Held-to-maturity -- at amortized cost.... 264.5 -- -- 264.5
Equity securities -- at fair value.......... 4.9 89.1 -- 94.0
Mortgage loans.............................. -- 329.0 (46.9) (2) 282.1
Real estate................................. 151.1 2.7 (1.9) (2) 151.9
Policy loans................................ 1,749.0 73.8 -- 1,822.8
Other long-term investments................. 15.5 32.7 (12.0) (2) 36.2
Short-term investments...................... 252.3 239.7 (145.0) (3) 347.0
--------- -------- ------- --------
Total investments................... 13,317.4 5,770.4 (92.1) 18,995.7
Other assets:
Cash and bank deposits...................... 19.3 -- -- 19.3
Accounts receivable......................... 40.1 -- -- 40.1
Premiums receivable......................... 72.3 22.4 -- 94.7
Reinsurance receivable...................... 468.3 466.6 -- 934.9
Accrued investment income................... 268.3 85.1 -- 353.4
Deferred policy acquisition costs........... 421.8 878.9 (878.9) (4) 421.8
Value of business acquired.................. -- 60.2 744.6 (5) 804.8
Goodwill.................................... -- 107.5 341.2 (6) 448.7
Property and equipment -- at cost less
accumulated depreciation................. 59.0 32.0 6.0 (7) 97.0
Miscellaneous............................... 25.5 82.6 -- 108.1
Separate account assets..................... 300.5 23.2 -- 323.7
--------- -------- ------- ---------
Total assets........................ $14,992.5 $7,528.9 $ 120.8 $22,642.2
========= ======== ======= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities for benefits to policyholders..... $ 8,521.8 $4,020.6 $ 333.0 (8) $12,875.4
Other policyholders' funds.................... 3,881.1 1,973.1 -- 5,854.2
Federal income tax liability.................. 49.1 164.2 (178.6) (9) 34.7
Long-term debt................................ 200.0 -- 531.2 (10) 731.2
Short-term debt............................... -- 134.7 (108.5) (10) 26.2
Other liabilities............................. 301.4 115.3 51.5 (11) 468.2
Separate account liabilities.................. 300.5 23.2 -- 323.7
--------- -------- ------- ---------
Total liabilities................... 13,253.9 6,431.1 628.6 20,313.6
--------- -------- ------- ---------
Stockholders' equity:
Preferred stock............................. 156.2 -- -- 156.2
Common stock................................ 45.6 45.0 (28.1) (12) 62.5
Additional paid-in capital.................. 11.4 560.1 13.0 (13) 584.5
Net unrealized gain on securities........... 90.9 78.3 (78.3) (14) 90.9
Foreign currency translation adjustment..... (5.2) (14.8) 14.8 (14) (5.2)
Retained earnings........................... 1,439.7 429.2 (429.2) (14) 1,439.7
--------- -------- ------- ---------
Total stockholders' equity.......... 1,738.6 1,097.8 (507.8) 2,328.6
--------- -------- ------- ---------
Total liabilities and stockholders'
equity............................ $14,992.5 $7,528.9 $ 120.8 $22,642.2
========= ======== ======= =========
</TABLE>
See Notes to Unaudited Pro Forma Condensed Combined Statement of Financial
Condition.
3
<PAGE> 3
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL CONDITION
The pro forma condensed combined statement of financial condition assumes a
transaction effective date of December 31, 1996 for presentation purposes only.
The amounts included for Provident were taken from its Annual Report on Form
10-K for the year ended December 31, 1996. The amounts included for Paul Revere
were taken from Exhibit 99-1 to the Current Report. The pro forma adjustments
reflect the proposed financing arrangements, including the acquisition of debt
of $531.2 million and the issuance of $590.0 million of common stock equity.
The composition of the common stock equity will be as follows, giving effect to
each of the three forms of Merger Consideration available for election by the
Paul Revere public stockholders:
ASSUMING THE DESIGNATED FORM OF MERGER CONSIDERATION
IS ELECTED BY ALL PAUL REVERE PUBLIC STOCKHOLDERS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
MIXED CONSIDERATION STOCK CONSIDERATION CASH CONSIDERATION
------------------- ------------------- -------------------
NO. SHARES NO. SHARES NO. SHARES
EQUITY ISSUED EQUITY ISSUED EQUITY ISSUED
------ ---------- ------ ---------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
Zurich.......................... $300.0 9.5 $300.0 9.5 $300.0 9.5
Textron......................... 245.0 6.0 245.0 5.9 245.0 7.7
Paul Revere public
stockholders.................. 45.0 1.4 195.0 5.8 0 0
</TABLE>
The Exchange Ratio and related Average Closing Price per share assumed in
the above examples are as follows:
<TABLE>
<CAPTION>
MIXED STOCK CASH
CONSIDERATION CONSIDERATION CONSIDERATION
------------- ------------- -------------
<S> <C> <C> <C>
Paul Revere Public Stockholders
Exchange Ratio.............................. .0317 .0295 .0343
Average Closing Price Per Share............. $31.500 $33.875 $29.125
Textron
Exchange Ratio.............................. .0265 .0263 .0343
Average Closing Price Per Share............. $41.400 $41.400 $31.714
</TABLE>
The common stock equity portion assumes a $41.40 per share price for
Textron, which, under the Textron Agreement, is the maximum value Textron can
realize for the shares received with any additional value realized becoming
additional capital for Provident. The pro forma condensed combined statement
of financial condition has not anticipated any additional capital that might be
realized. For all other Paul Revere stockholders, the common stock equity
portion assumes a $31.50 per share price, which was the closing price for
Provident Common Stock on April 26, 1996, the last trading day prior to public
announcement of the execution of the Merger
4
<PAGE> 4
Agreement in its original form. For purposes of presentation, all holders of
Paul Revere Common Stock are assumed to elect to receive the Mixed
Consideration.
The fair value adjustments to assets and liabilities as of December 31,
1996 are as follows (dollars in millions):
<TABLE>
<S> <C>
Stockholders' equity as reported by Paul Revere............................ $1,097.8
Fair value adjustments:
Mortgage loans........................................................... (46.9)
Real estate.............................................................. (1.9)
Other long-term investments.............................................. (12.0)
Deferred policy acquisition costs........................................ (878.9)
Value of business acquired............................................... 744.6
Goodwill................................................................. 341.2
Property and equipment................................................... (9.0)
Liability for benefits to policyholders.................................. (333.0)
Other liabilities........................................................ (51.5)
Deferred federal income taxes............................................ 178.6
--------
Total fair value adjustments..................................... (68.8)
Additional assets to be transferred from principal stockholder........... 161.0
--------
Purchase price............................................................. $1,190.0
========
</TABLE>
The individual adjustments shown above are commented on more fully in the
notes that follow.
The adjustments presented are estimates that are believed to be reasonable
approximations of the ultimate adjustments; however, the amounts of the
adjustments will change based upon, among other things, circumstances and
economic conditions existing as of the date of closing and Paul Revere's
statement of financial condition as of the date of closing.
(1) The adjustment reflects the replacement of the bankers acceptances
owned by Paul Revere's insurance company subsidiaries and the replacement of the
debt owed by Paul Revere with fixed maturity securities. The bankers
acceptances contain rights of offset which allow Paul Revere to offset any
obligations with respect to the bankers acceptances against the acceptance
obligation of the bank to the insurance company subsidiaries. As a result, the
total obligation of Paul Revere was offset against the total asset carrying
value of the bankers acceptances. The bankers acceptance program, which was used
to generate statutory capital for the insurance company subsidiaries, must be
replaced upon the change in control resulting from the Merger. The program will
be replaced with a debt arrangement which will result in an increase in total
assets and total liabilities, rather than the netting of the related asset and
liability amounts.
The adjustment also reflects a $121.0 million capital contribution to be
provided to Paul Revere Life (based on the after tax statutory reserve
strengthening required by the Commonwealth of Massachusetts Division of
Insurance, and by the Textron Voting Agreement) as a part of the $161.0 million
of additional assets (which includes the foregoing $121.0 million, $25.0 million
in cash, and other assets valued at 15.0 million, all as contemplated by the
Textron Voting Agreement) to be transferred from Textron. The capital
contribution is in the form of cash, which would be invested in long-term,
investment-grade securities.
(2) Adjustment to market value. The market value is based upon Provident's
estimate of the exchange price that would result between a willing buyer and a
willing seller and reflects Provident's plan to dispose of the portfolios
through a securitization transaction or sale.
(3) These adjustments reflect the use of $145.0 million of short-term
investments to fund a portion of the purchase price.
(4) The adjustment reflects the elimination of the balance reported by Paul
Revere. This amount will be replaced with the value of business acquired.
(5) The adjustment includes the elimination of the 60.2 million
carried by
Paul Revere and the establishment of the $804.8 million balance determined
by Provident based upon its preliminary assessment of
5
<PAGE> 5
the acquired business. The value of business acquired is amortized with interest
based on premium income for products accounted for under Statement of Financial
Accounting Standards (SFAS) No. 60 and on the estimates of future gross profits
for SFAS 97 products. The interest rates used to amortize the value of business
acquired are 7.0% and 5.8% for SFAS 60 and SFAS 97 products, respectively.
Provident will periodically review the carrying amount of the value of business
acquired using the same methods used to evaluate deferred policy acquisition
costs.
The amortization of the value of business acquired before interest
accretion for the first five years following the acquisition is $105.4 million,
$97.2 million, $89.8 million, $84.0 million, and $78.7 million, respectively.
The amount of interest accretion for each of those five years is $47.0 million,
$43.0 million, $39.3 million, $35.9 million, and $32.7 million, respectively,
which results in net amortization for the first five years following the
acquisition of $58.4 million, $54.2 million, $50.5 million, $48.1 million, and
$46.0 million, respectively.
(6) The adjustment includes the elimination of the $107.5 million
reported by Paul Revere and the $448.7 million established by Provident as
the difference between the price paid less the current value of the assets and
liabilities assumed.
(7) Adjustment for $15.0 million of equipment to be transferred to
Paul Revere at the date of sale by Textron and the adjustment of the value of
company-occupied real estate by $9.0 million based upon appraisals recently
completed.
(8) Paul Revere performed a reserve study which resulted in a required
addition to reserves of $380.0 million in the third quarter of 1996. The reserve
addition, as required by GAAP, did not include any margins for adverse
deviation. Provident, as a result of the acquisition and the related valuation
process that occurs under GAAP with respect to the liabilities is allowed to
include margins for adverse deviation in the establishment of reserve
liabilities for products accounted for under SFAS 60. Of the $333.0 million
adjustment, $176.5 million relates to the individual disability income business,
which is accounted for under SFAS 60, and is principally the addition of a
margin for adverse deviation related to morbidity. The two primary assumptions
in the establishment of reserves for individual disability income products are
morbidity and investment rates. With respect to morbidity, Paul Revere assumed a
benefit ratio of 84.9% for 1997 while Provident assumed a benefit ratio of 88.3%
for 1997 with no improvement in morbidity levels in future years. Paul Revere
assumed a beginning portfolio yield of 7.8% and a new investment rate of a level
7.8% and Provident assumed a 7.6% investment rate for the beginning portfolio
yield and the new investment rate. The remaining portion of the adjustment,
$156.5 million, results from the change in market value of the fixed maturity
securities portfolio from September 30, 1996, the date of the reserve study,
through December 31, 1996. Because assumptions in the reserves were reset at
September 30, 1996, subsequent changes in unrealized investment gains on the
related investments would result in a comparable change in the reserves.
For products accounted for under both SFAS 60 and SFAS 97, Provident must
set assumptions consistent with its current expectations as reflected in its
accounting and pricing practices currently in use. As part of the acquisition
process, these assumptions will undergo a validation process to ensure that they
are appropriate for and properly applied to the acquired business. Once this
process is completed, the reserve assumptions for SFAS 60 products will be
"locked-in," i.e., there would be no change in the assumptions unless a loss
recognition test indicated a deficiency. Under SFAS 60, any differences in
assumptions and actual experience are reflected in net income over the life of
the policies as experience is realized.
For SFAS 97 products, the present value of estimated gross profits must be
updated periodically to reflect differences in actual experience and assumptions
as well as any adjustment or change in expectations for the assumptions going
forward. Under SFAS 97, any adjustment is recorded in the current period and is
determined as if the current expectations were known at the inception of the
policy and applied retroactively.
For Paul Revere's business, the products accounted for under the SFAS 60
requirements are individual disability insurance, all group products, and a
portion of the individual life business. The remaining portion of the individual
life business and the annuity products are subject to the SFAS 97 requirements.
Provident views the individual disability income business of Paul Revere as
consisting of two distinct blocks of business for loss recognition testing
purposes: excess-risk reinsurance and all other individual disability income
policies. The excess-risk reinsurance contracts represent approximately $25
million of
6
<PAGE> 6
annualized premium income which is less than 5% of the total premium income from
the individual disability income segment.
The excess-risk reinsurance policies are significantly different from the
primary policies issued in this segment in that the policies were marketed and
issued and are administered by unrelated third party insurance companies who
have ceded to Paul Revere the amounts of insurance coverage provided under the
policies over a specified monthly or indemnity level. Paul Revere ceased writing
any new business of this type in March 1995. In 1995, Paul Revere increased
reserves $59 million as a result of a loss recognition study performed on this
block of business.
Provident's view of future morbidity experience is consistent with Paul
Revere's view as reflected in its recently completed comprehensive reserve
study.
(9) The total adjustment shown reflects the following temporary
differences, at a tax rate of 35%:
<TABLE>
<CAPTION>
BALANCE
IMMEDIATELY BALANCE
PRIOR TO AFTER
MERGER MERGER ADJUSTMENT
----------- ----------- ----------
<S> <C> <C> <C>
Mortgage loans....................................... $ 329.0 $ 282.1 $ (46.9)
Real estate.......................................... 2.7 0.8 (1.9)
Other long-term investments.......................... 32.7 20.7 (12.0)
Deferred policy acquisition costs.................... 878.9 0 (878.9)
Value of business acquired........................... 60.2 804.8 744.6
Property and equipment............................... 32.0 23.0 (9.0)
Liabilities for benefits to policyholders............ (4,020.6) (4,353.6) (333.0)
Other liabilities.................................... (115.3) (166.8) (51.5)
Statutory reserve adjustment not yet deductible...... 0 78.3 78.3
----------
Total adjustments.................................... 510.3
Tax rate............................................. 35%
Adjustment to federal income tax liability........... 178.6
==========
</TABLE>
(10) The adjustment includes additional debt required to fund the
acquisition and replace the debt netted against the bankers acceptances on Paul
Revere's statement of financial condition. The amounts shown for short-term debt
are for the repayment of short-term debt by Textron at closing. The short-term
debt was the instrument used to provide funds to Paul Revere in order to
contribute equity, in advance of closing, to Paul Revere Life prior to
December 31, 1996.
(11) The adjustment includes preliminary estimates of the costs associated
with the acquisition related to change in control provisions in employment and
benefit plan contracts of $28.0 million, the cost of adjustment and combination
of the business operations and facilities of Provident and Paul Revere of $10.9
million, and the other direct, incremental costs incurred to effect the
acquisition of $12.6 million.
(12) The adjustment reflects the elimination of the Paul Revere balance of
$45.0 million and the issuance of 16.9 million shares of Provident Common Stock.
(13) The adjustment reflects the elimination of the Paul Revere balance of
$560.1 million and the issuance of 6.0 million shares of Provident Common
Stock to Textron at $41.40 per share ($40.40 per share of additional paid-in
capital) and the issuance of 1.4 million and 9.5 million shares of Provident
Common Stock to the public stockholders of Paul Revere and to Zurich,
respectively, at $31.50 per share ($30.50 per share of additional paid-in
capital).
(14) The adjustment reflects the elimination of Paul Revere balances.
7
<PAGE> 7
(15) If all public stockholders of Paul Revere Common Stock were to elect
to receive the Stock Consideration or the Cash Consideration, the line items
shown on the Pro Forma Condensed Combined Statement of Financial Condition that
would change are shown below compared to a situation where all such stockholders
elected the Mixed Consideration:
<TABLE>
<CAPTION>
PRO FORMA BALANCES
AS OF DECEMBER 31, 1996
BASED ON
CONSIDERATION ELECTED
------------------------
MIXED STOCK CASH
------ ------ ------
<S> <C> <C> <C>
Long-term debt............................................... 731.2 581.2 776.2
Stockholders' equity:
Common stock............................................... 62.5 66.8 62.8
Additional paid-in capital................................. 584.5 730.2 539.2
</TABLE>
The acquisition of Paul Revere is expected to be accretive to Provident's
net income per share as reflected in the pro forma condensed combined statement
of operations for the year ended December 31, 1995. For the year ended
December 31, 1996, the acquisition would be accretive to Provident's net income
per share, excluding the pre-tax loss recognition adjustment of $380.0 million
recorded in the third quarter of 1996 by Paul Revere shown in the pro forma
condensed combined statements of operations presented on page 9. Provident
expects certain benefits from the acquisition as the operations of the two
companies are combined. These benefits include the effect on expense levels
that result from a larger business base and the effect of shared expertise in
product development, underwriting, and claims management. While neither of
these factors can be reflected in the pro forma financial statements, they are
expected to have a positive effect on future results from operations.
Provident expects to continue its current investment strategy for the
combined companies. That strategy emphasizes the matching of the effective asset
durations with related expected liability durations subject to constraints with
respect to quality, marketability, and diversification. The investment income
and principal repayments combined with the substantial cash flows from renewal
premiums is expected to provide substantial liquidity for expense and benefit
payments for the combined companies.
As of December 31, 1996, each of the Provident and Paul Revere companies
exceeded the statutory capital requirement imposed by their states of domicile,
which is generally the National Association of Insurance Commissioners' risk
based capital model. The companies have historically generated sufficient
capital to fund the growth of their business lines. Capital raised externally
has been used in part to fund growth through acquisitions. Provident believes
that the combined companies will continue to generate sufficient capital to fund
the growth of its targeted business segments.
8
<PAGE> 8
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA
PROVIDENT PAUL REVERE ADJUSTMENTS COMBINED(8)
----------- ----------- ------------ -----------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue:
Premium income....................... $ 1,175.7 $ 1,130.3 $ -- $ 2,306.0
Net investment income................ 1,090.1 405.7 2.6 (1) 1,498.4
Net realized investment gains
(losses).......................... (8.6) 48.6 -- 40.0
Other income......................... 34.7 5.3 -- 40.0
----------- ----------- ------------ -----------
Total revenue................ 2,291.9 1,589.9 2.6 3,884.4
----------- ----------- ------------ -----------
Benefits and expenses:
Benefits to policyholders............ 1,661.2 1,456.1 (6.6)(2) 3,110.7
Amortization of policy acquisition
costs............................. 64.0 56.5 (46.5)(3) 74.0
Amortization of value of business
acquired.......................... -- 5.5 52.8 (4) 58.3
Amortization of goodwill............. -- 8.3 9.6 (5) 17.9
Commissions and other expenses....... 340.5 311.4 23.1 (6) 675.0
----------- ----------- ------------ -----------
Total benefits and
expenses................... 2,065.7 1,837.8 32.4 3,935.9
----------- ----------- ------------ -----------
Income (loss) before federal income
taxes................................ 226.2 (247.9) (29.8) (51.5)
Federal income taxes (credit).......... 80.6 (85.0) (7.1)(7) (11.5)
----------- ----------- ------------ -----------
Net income (loss)...................... $ 145.6 $ (162.9) (22.7) $ (40.0)
=========== =========== ============ ===========
Net income (loss) per common share..... $ 2.92 $ (3.62) $ (0.84)
=========== =========== ===========
Weighted average common shares
outstanding.......................... 45,522,417 45,000,000 62,392,477
=========== =========== ===========
</TABLE>
See Notes to Pro Forma Condensed Combined Statements of Operations.
9
<PAGE> 9
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA
PROVIDENT PAUL REVERE ADJUSTMENTS COMBINED(8)
---------- ----------- ----------- -----------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue:
Premium income............................ $ 1,251.9 $ 1,051.3 $ -- $ 2,303.2
Net investment income..................... 1,221.3 389.7 1.9(1) 1,612.9
Net realized investment gains (losses).... (31.7) 89.0 -- 57.3
Other income.............................. 113.8 4.0 -- 117.8
---------- ----------- ----------- -----------
Total revenue..................... 2,555.3 1,534.0 1.9 4,091.2
---------- ----------- ----------- -----------
Benefits and expenses:
Benefits to policyholders................. 1,904.6 1,039.2 (6.6)(2) 2,937.2
Amortization of policy acquisition
costs.................................. 71.0 51.9 (40.0)(3) 82.9
Amortization of value of business
acquired............................... -- 5.9 45.4(4) 51.3
Amortization of goodwill.................. -- 8.3 9.6(5) 17.9
Commissions and other expenses............ 403.7 291.4 26.7(6) 721.8
---------- ----------- ----------- -----------
Total benefits and expenses....... 2,379.3 1,396.7 35.1 3,811.1
---------- ----------- ----------- -----------
Income before federal income taxes.......... 176.0 137.3 (33.2) 280.1
Federal income taxes........................ 60.4 52.0 (8.3)(7) 104.1
---------- ----------- ----------- -----------
Net income.................................. $ 115.6 $ 85.3 $ (24.9) $ 176.0
========= ========= ========== ==========
Net income per common share................. $ 2.27 $ 1.90 $ 2.62
========= ========= ==========
Weighted average common shares
outstanding............................... 45,381,373 45,000,000 62,251,433
========= ========= ==========
</TABLE>
See Notes to Pro Forma Condensed Combined Statements of Operations.
10
<PAGE> 10
NOTES TO PRO FORMA CONDENSED COMBINED STATEMENTS OF OPERATIONS
The Pro Forma Condensed Combined Statements of Operations for the years
ended December 31, 1996 and 1995 assume a Merger effective date of January 1,
1996 and 1995, respectively, and are for presentation purposes only. The
amounts included for Provident were taken from its Annual Report on Form 10-K
for the year ended December 31, 1996. The amounts included for Paul Revere were
taken from Exhibit 99.1 to this Current Report. The pro forma adjustments
reflect the proposed financing arrangements, including the acquisition of debt
of $531.2 million and the issuance of $590.0 million of common stock equity.
The common stock equity portion assumes a $41.40 per share price for Textron,
which, under the Textron Agreement, is the maximum value Textron can realize
for the shares received with any additional value realized becoming additional
capital for Provident. The pro forma condensed combined statements of
operations have not anticipated any additional capital or investment that might
be realized. For all other stockholders of Paul Revere, the common stock equity
portion assumes a $31.50 per share price, which was the closing price for
Provident Common Stock on April 26, 1996, the last trading day prior to public
announcement of the execution of the Merger Agreement in its original form. For
purposes of presentation, all holders of Paul Revere Common Stock (other than
Textron) are assumed to elect to receive the Mixed Consideration and that
Textron receives the Textron Consideration. The adjustments presented are
preliminary estimates that are believed to be reasonable approximations of the
ultimate adjustments; however, the amounts of the adjustments will change based
upon, among other things, circumstances and economic conditions existing as of
the date of closing.
(1) The adjustment reflects the reduction in net investment income that
results from using $145.0 million of short-term investments held by Provident
to fund a portion of the acquisition price. The adjustment also reflects
a $121.0 million capital contribution provided to Paul Revere as a part
of the $161.0 million of additional assets (which includes the foregoing
$121.0 million, $25.0 million in cash, and other assets valued at $15.0
million, all as contemplated by the Textron Voting Agreement) to be transferred
from Textron. The capital contribution is in the form of cash, which
would be invested in long-term, investment-grade securities.
(2) The adjustment reflects the change in liabilities that results from
establishing higher beginning reserve liabilities and results in lower
accretions to policyholder benefits in the future. The adjustments are discussed
in Note 8 to the Unaudited Pro Forma Condensed Combined Statement of Financial
Condition.
(3) The adjustment to amortization of policy acquisition costs
reflects the elimination of the Paul Revere amounts as shown on its
historical financial statements and the inclusion of amortization on first year
amounts only of $10.0 million and $11.9 million for the years ended
December 31, 1996 and 1995, respectively. The first year amounts are based on
Paul Revere's reported amounts.
(4) The amortization of value of business acquired has been adjusted to
eliminate the amounts reported by Paul Revere and to include the amounts
determined by Provident as a part of its valuation of the business acquired as
discussed in Note 5 to the Unaudited Pro Forma Condensed Combined Statement of
Financial Condition. The assumptions and methods used to amortize the value of
the business acquired were determined and applied in a materially consistent
manner with Provident's current practices applied to its deferred policy
acquisition costs.
(5) The adjustment reflects the elimination of the amortization of
goodwill reported by Paul Revere and the inclusion of the amortization of
goodwill Provident estimates will result from the Merger. Provident is
amortizing the goodwill over 25 years in equal installments.
(6) This adjustment includes two items: interest expense on the new
debt facility and the elimination of the existing debt. The interest expense on
the new debt facility includes the $531.2 million of debt to finance the
acquisition plus the refinancing of the existing $200.0 million of Provident
debt outstanding. This expense would have been $47.1 million for 1995 and
$42.2 million for 1996. The elimination of the interest expense on the
existing debt is $20.4 million for 1995 and $19.1 million for 1996. The
interest rate on the long-term debt is reset quarterly based on LIBOR plus
0.40%. A change of 0.125% in the interest rate would create a change in net
income of $0.01 per share or $0.60 million, $0.48
11
<PAGE> 11
million, and $0.63 million if all Paul Revere public stockholders elected the
Mixed Consideration, the Stock Consideration and the Cash Consideration,
respectively.
(7) Federal income taxes were provided on the income statement
adjustments, except the amortization of goodwill, at a rate of 35%.
(8) If all public stockholders of Paul Revere Common Stock were to elect to
receive the Stock Consideration or the Cash Consideration, the line items, other
than totals, shown on the Pro Forma Condensed Combined Statements of Operations
that would change are shown below compared to a situation where all such
stockholders elected the Mixed Consideration:
<TABLE>
<CAPTION>
PRO FORMA AMOUNTS FOR THE
YEAR ENDED DECEMBER 31, 1996
BASED ON CONSIDERATION ELECTED
------------------------------------
MIXED STOCK CASH
---------- ---------- ----------
<S> <C> <C> <C>
Benefits and expenses:
Commissions and other expenses................... $ 675.0 $ 666.4 $ 671.6
Federal income taxes (credit)...................... (11.5) (8.5) (10.3)
Net income (loss).................................. (40.0) (34.4) (37.8)
Net income (loss) per common share................. $ (0.84) $ (0.71) $ (0.80)
Weighted average common shares outstanding......... 62,392,477 67,719,977 62,771,549
</TABLE>
<TABLE>
<CAPTION>
PRO FORMA AMOUNTS FOR THE
YEAR ENDED DECEMBER 31, 1995
BASED ON CONSIDERATION ELECTED
------------------------------------
MIXED STOCK CASH
---------- ---------- ----------
<S> <C> <C> <C>
Benefits and expenses:
Commissions and other expenses................... $ 721.8 $ 712.2 $ 724.8
Federal income taxes............................... 104.1 107.5 103.1
Net income......................................... 176.0 182.2 174.0
Net income per common share........................ $ 2.62 $ 2.55 $ 2.58
Weighted average common shares outstanding......... 62,251,433 66,578,933 62,630,505
</TABLE>
12
