<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended September 30, 1999.
Commission file number 1-11834
UNUMPROVIDENT CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 62-1598430
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2211 CONGRESS STREET
PORTLAND, MAINE 04122
(Address of principal executive offices)
(Zip Code)
207.770.2211
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
-----
Indicate the number of shares outstanding for each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at September 30, 1999
----- ---------------------------------
Common Stock, $0.10 Par Value 240,027,742
1
<PAGE>
UNUMPROVIDENT CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial
Condition at September 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 1999 and 1998 5
Condensed Consolidated Statements of Stockholders' Equity
for the Nine Months Ended September 30, 1999 and 1998 6
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 7
Notes to Condensed Consolidated Financial Statements 8
Independent Auditors' Review Report 27
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 44
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 46
</TABLE>
2
<PAGE>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
September 30 December 31
1999 1998
(in millions of dollars)
-----------------------------------------
(Unaudited)
<S> <C> <C>
Assets
Investments
Fixed Maturity Securities
Available-for-Sale $21,447.5 $22,732.2
Held-to-Maturity 325.4 307.0
Mortgage Loans 1,288.0 1,321.2
Real Estate 288.4 309.8
Policy Loans 2,279.5 2,227.2
Short-term Investments 534.4 245.1
Other Investments 57.0 43.5
--------- ---------
Total Investments 26,220.2 27,186.0
Cash and Bank Deposits 139.1 111.2
Premiums Receivable 792.8 570.1
Reinsurance Receivable 4,982.5 4,871.0
Accrued Investment Income 557.2 502.5
Deferred Policy Acquisition Costs 2,347.0 2,060.5
Value of Business Acquired 544.7 570.5
Goodwill 739.2 814.7
Other Assets 1,335.2 1,502.7
Separate Account Assets 413.2 413.0
--------- ---------
Total Assets $38,071.1 $38,602.2
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
September 30 December 31
1999 1998
(in millions of dollars)
-----------------------------------------
(Unaudited)
<S> <C> <C>
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,601.0 $ 1,384.9
Reserves for Future Policy and Contract Benefits and
Unearned Premiums 23,642.6 22,490.7
Other Policyholders' Funds 3,490.9 4,102.7
Federal Income Tax 297.4 969.8
Short-term Debt 531.0 323.7
Long-term Debt 1,216.3 1,225.2
Other Liabilities 1,640.3 1,246.0
Separate Account Liabilities 413.2 413.0
--------- ---------
Total Liabilities 32,832.7 32,156.0
--------- ---------
Commitments and Contingent Liabilities - Note 10
Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debt Securities of the Company 300.0 300.0
--------- ---------
Stockholders' Equity
Common Stock, $0.10 par
Authorized: 725,000,000 shares
Issued: 240,204,037 and 237,802,647 shares 24.0 23.8
Additional Paid-in Capital 1,020.9 959.2
Accumulated Other Comprehensive Income 81.0 914.7
Retained Earnings 3,821.7 4,279.2
Treasury Stock at Cost: 176,295 shares (9.2) (9.2)
Deferred Compensation - (21.5)
--------- ---------
Total Stockholders' Equity 4,938.4 6,146.2
--------- ---------
Total Liabilities and Stockholders' Equity $38,071.1 $38,602.2
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(in millions of dollars, except share data)
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue
Premium Income $ 1,736.2 $ 1,560.5 $ 5,105.1 $ 4,559.2
Net Investment Income 513.4 494.4 1,531.0 1,533.0
Net Realized Investment Gains 77.9 16.4 89.3 30.8
Other Income 105.6 73.6 254.4 231.1
--------- --------- --------- ---------
Total Revenue 2,433.1 2,144.9 6,979.8 6,354.1
--------- --------- --------- ---------
Benefits and Expenses
Benefits and Change in Reserves for Future Benefits 2,053.1 1,329.0 5,245.9 3,947.5
Commissions 217.6 196.0 679.7 635.6
Interest and Debt Expense 34.3 32.6 100.8 90.6
Deferral of Policy Acquisition Costs (182.8) (152.7) (603.0) (500.4)
Amortization of Deferred Policy Acquisition Costs 107.4 94.4 332.0 272.6
Amortization of Value of Business Acquired
and Goodwill 43.4 16.1 103.6 49.9
Other Operating Expenses 422.9 353.6 1,495.0 1,069.6
--------- --------- --------- ---------
Total Benefits and Expenses 2,695.9 1,869.0 7,354.0 5,565.4
--------- --------- --------- ---------
Income (Loss) Before Federal Income Taxes (262.8) 275.9 (374.2) 788.7
Federal Income Taxes (Credit) (45.8) 89.6 (55.3) 264.3
--------- --------- --------- ---------
Net Income (Loss) $ (217.0) $ 186.3 $ (318.9) $ 524.4
========= ========= ========= =========
Net Income (Loss) Per Common Share
Basic $ (0.91) $ 0.79 $ (1.34) $ 2.21
Assuming Dilution $ (0.91) $ 0.77 $ (1.34) $ 2.15
Dividends Paid Per Common Share $ 0.15 $ 0.15 $ 0.43 $ 0.43
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
Accumulated
Additional Other
Preferred Common Paid-in Comprehensive Retained Treasury Deferred
Stock Stock Capital Income Earnings Stock Compensation Total
(in millions of dollars)
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997 $ 156.2 $23.7 $ 954.8 $ 799.0 $3,797.7 $(1.5) $(15.8) $ 5,714.1
Comprehensive Income, Net of Tax
Net Income 524.4 524.4
Change in Net Unrealized
Gain on Securities 252.7 252.7
Change in Foreign Currency
Translation Adjustment (9.6) (9.6)
---------
Total Comprehensive Income 767.5
---------
Common Stock Activity 0.1 (21.0) (7.7) 0.7 (27.9)
Preferred Stock Redeemed (156.2) (156.2)
Dividends to Stockholders (101.9) (101.9)
------- ----- -------- -------- -------- ----- ------ ---------
Balance at September 30, 1998 $ - $23.8 $ 933.8 $1,042.1 $4,220.2 $(9.2) $(15.1) $ 6,195.6
======= ===== ======== ======== ======== ===== ====== =========
Balance at December 31, 1998 $ - $23.8 $ 959.2 $ 914.7 $4,279.2 $(9.2) $(21.5) $ 6,146.2
Comprehensive Loss, Net of Tax
Net Loss (318.9) (318.9)
Change in Net Unrealized Gain
on Securities (847.6) (847.6)
Change in Foreign Currency
Translation Adjustment 13.9 13.9
---------
Total Comprehensive Loss (1,152.6)
---------
Common Stock Activity 0.2 61.7 21.5 83.4
Dividends to Stockholders (138.6) (138.6)
------- ----- -------- -------- -------- ----- ------ ---------
Balance at September 30, 1999 $ - $24.0 $1,020.9 $ 81.0 $3,821.7 $(9.2) $ - $ 4,938.4
======= ===== ======== ======== ======== ===== ====== =========
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
Nine Months Ended September 30
1999 1998
(in millions of dollars)
-------------------------------------
<S> <C> <C>
Net Cash Provided by Operating Activities $ 1,153.2 $ 1,212.2
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments 3,106.3 1,480.3
Proceeds from Maturities of Investments 946.5 1,292.9
Purchase of Investments (4,536.9) (2,912.7)
Net Purchases of Short-term Investments (289.7) (160.0)
Disposition of Business - 58.0
Other (54.2) (50.4)
--------- ---------
Net Cash Used by Investing Activities (828.0) (291.9)
--------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts 156.1 142.7
Maturities and Benefit Payments from Policyholder Accounts (598.5) (976.5)
Net Short-term Borrowings 181.7 40.7
Issuance of Long-term Debt 200.0 650.0
Long-term Debt Repayments (183.3) (763.0)
Issuance of Company-Obligated Mandatorily Redeemable
Preferred Securities - 300.0
Redemption of Preferred Stock - (156.2)
Dividends Paid to Stockholders (103.4) (105.1)
Repurchase of Common Stock - (72.7)
Other 48.1 24.8
--------- ---------
Net Cash Used by Financing Activities (299.3) (915.3)
--------- ---------
Effect of Foreign Exchange Rate on Cash 2.0 (0.4)
--------- ---------
Net Increase in Cash and Bank Deposits 27.9 4.6
Cash and Bank Deposits at Beginning of Period 111.2 94.5
--------- ---------
Cash and Bank Deposits at End of Period $ 139.1 $ 99.1
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 1--Basis of Presentation
On June 30, 1999, Unum Corporation (Unum) merged with and into Provident
Companies, Inc. (Provident) under the name UnumProvident Corporation (the
Company). The merger was accounted for as a pooling of interests. The historical
financial results presented herein and the condensed consolidated statement of
financial condition as of December 31, 1998, give effect to the merger as if it
had been completed at the beginning of the earliest period presented.
The Company values its available-for-sale fixed maturity and equity securities
at fair value, with unrealized holding gains and losses reported as a component
of comprehensive income. Companies are required to also adjust deferred
acquisition costs and/or certain policyholder liabilities to reflect the changes
that would have been necessary if the unrealized investment gains and losses
related to the available-for-sale securities had been realized. Prior to the
merger, Unum adjusted policyholder liabilities and Provident adjusted deferred
policy acquisition costs (DPAC) and value of business acquired (VOBA) for those
products where these assets existed. To present financial information in a
common reporting format, management has determined that the combined entity will
adjust policyholder liabilities rather than DPAC and VOBA. Prior period
financial statements have been restated to reflect this reclassification. The
reclassification did not change other comprehensive income, accumulated other
comprehensive income, or fixed maturity and equity securities. The
reclassification reflected in the December 31, 1998, condensed consolidated
statement of financial condition resulted in an increase of $329.7 million in
DPAC, $1.5 million in VOBA, and, $331.2 million in reserves for future policy
and contract benefits. Certain additional reclassification adjustments have been
made to conform the companies' presentations in the condensed consolidated
financial statements.
The condensed consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three month and nine month periods ended September 30,
1999, are not necessarily indicative of the results that may be expected for the
year ended December 31, 1999. These results are also not necessarily indicative
of the results of operations that would have been realized had the merger been
completed prior to June 30, 1999. For further information, refer to the
consolidated financial statements and footnotes thereto included in Unum's and
Provident's reports on Form 10-Q, in each case for the nine months ended
September 30, 1998, the Company's Form 8-K filed September 2, 1999 for the
fiscal year ended December 31, 1998 and the three months ended March 31, 1999,
and the Company's Form 10-Q for the six months ended June 30, 1999.
Note 2--Merger
On June 30, 1999, prior to the completion of the merger, each outstanding share
of Provident common stock was reclassified and converted into 0.73 of a share of
Provident common stock. Immediately after this reclassification, the merger was
completed, and each share of Unum common stock issued and outstanding
immediately prior to the merger was converted into one share of the Company's
common stock, and the par value was reduced from $1.00 to $0.10 per share. In
the merger, the shares of Provident common stock were not further affected, but
thereafter became shares of the Company's common stock. Unum common stock held
in treasury was retired. Stockholders' equity and per share amounts have been
adjusted to reflect these items.
8
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 2--Merger (Continued)
During the second and third quarters of 1999, the Company recognized $310.6
million of before-tax expenses related to the merger and the early retirement
offer to employees. The breakdown of these expenses by quarter is as follows:
<TABLE>
<CAPTION>
1999
------------------------------
2/nd/ 3/rd/
(in millions of dollars)
------------------------------
<S> <C> <C>
Employee related expense $ 45.2 $32.5
Exit activities related to duplicate facilities/asset abandonments 57.4 10.0
Investment banking, legal, and accounting fees 39.6 -
------ -----
Subtotal 142.2 42.5
Expense related to the early retirement offer to employees 125.9 -
------ -----
Subtotal 268.1 42.5
Income tax benefit 74.3 14.9
------ -----
Total $193.8 $27.6
====== =====
</TABLE>
Employee related expense consists of employee severance costs, change in control
costs, restricted stock costs which fully vested upon stockholder adoption of
the merger agreement or upon completion of the merger, and outplacement costs to
assist employees who have been involuntarily terminated. Severance benefits and
change in control costs are $60.2 million, and costs associated with the vesting
of restricted stock are $17.5 million. The Company now estimates that in total
approximately 1,615 positions will be eliminated over a twelve month period
beginning June 30, 1999, 215 positions higher than the original estimate of
1,400. Approximately 1,000 of these positions will be eliminated through the
early retirement offer. At September 30, 1999, approximately 500 and 160
positions have been eliminated as a result of the early retirement offer and
involuntary terminations, respectively, and $13.3 million of the estimated $60.2
million has been paid for severance benefits and change in control costs.
Exit activities related to duplicate facilities/asset abandonments consist of
closing of duplicate offices and write-off of redundant computer hardware and
software. The Company currently expects to close approximately 90 duplicate
field offices over a period of one year after June 30, 1999, the completion date
of the merger. The cost associated with these office closures is approximately
$25.6 million, which represents the cost of future minimum lease payments less
any estimated amounts recovered under subleases. As of September 30, 1999, $2.3
million of this estimated liability has been paid. Also, certain physical
assets, primarily computer equipment, redundant systems, and systems incapable
of supporting the combined entity, have been abandoned as a result of the
merger. This abandonment resulted in a write-down of the assets' book values by
approximately $31.8 million during the second quarter of 1999. During the third
quarter, hardware and software abandonments increased $10.0 million due to the
identification of additional redundancies. Approximately $27.7 million of assets
were abandoned and removed from service on the date the merger was consummated.
Of the remaining $14.1 million of identified abandonments, $10.5 million were
removed from service during the third quarter, and $3.6 million are expected to
be abandoned during the fourth quarter of 1999.
The expenses related to the merger reduced second quarter 1999 earnings $142.2
million before tax and $112.0 million after tax ($0.47 per common share). The
expense related to the early retirement offer reduced earnings $125.9 million
before tax and $81.8 million after tax ($0.34 per common share). The impact of
merger related expenses on third quarter 1999 earnings was $42.5 million before
tax and $27.6 million after tax ($0.12 per common share).
Additionally during the second quarter of 1999, 546,362 shares of outstanding
restricted stock became unrestricted and stock options on 5,301,683 shares
became immediately exercisable effective with the merger, in accordance with
Unum's and Provident's restricted stock and stock option plan provisions
concerning a change in control.
9
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 2--Merger (Continued)
The expense related to restricted stock vesting has been included in merger
related expenses. The Company applies Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations in
accounting for the stock option plans. Accordingly, no compensation cost was
recognized for stock option vesting.
Generally, because of the effort and time involved, reviews and updates of
assumptions related to benefit liabilities are periodically undertaken over time
and are reflected in the calculation of benefit liabilities as completed. Many
factors influence assumptions underlying reserves, and considerable judgment is
required to interpret current and historical experience underlying all of the
assumptions and to assess the future factors that are likely to influence the
ultimate cost of settling existing claims.
Prior to the merger, Unum's process and assumptions used to calculate the
discount rate for claim reserves of certain disability businesses differed from
that used by Provident. While Unum's and Provident's methods were both in
accordance with generally accepted accounting principles, management believed
that the combined entity should have consistent discount rate accounting
policies and methods for applying those policies for similar products. Unum's
former methodology used the same investment strategy for assets backing both
liabilities and surplus. Provident's methodology, which allows for different
investment strategies for assets backing surplus than those backing product
liabilities, was determined by management to be the more appropriate approach
for the Company. Accordingly, at June 30, 1999 the Company adopted Provident's
method of calculating the discount rate for claim reserves.
The discount rates affected by this change in Unum's methodology were as
follows:
<TABLE>
<CAPTION>
June 30, 1999
-----------------------------------------
Current Rates Former Rates
-----------------------------------------
<S> <C> <C>
Group Long-term Disability (North America) 6.75% 7.74%
Group Long-term Disability and Individual Disability (United Kingdom) 7.45% 8.80%
Individual Disability (North America) 6.88% 7.37%
</TABLE>
The unpaid claim reserves for these disability lines as of June 30, 1999 were
$5,318.3 million using the former method for determining reserve discount rates
and $5,559.0 million using the current method. The impact on 1999 second quarter
earnings related to the change in method of calculating the discount rate for
claim reserves was $240.7 million before tax and $156.5 million after tax ($0.66
per common share).
Subsequent to the merger date, the Company began to integrate the valuation
procedures of the two organizations to provide for a more effective linking of
pricing and reserving assumptions and to facilitate a more efficient process for
adjusting liabilities to emerging trends. Included in this integration activity
were a review and an update of assumptions that underlie policy and contract
benefit liabilities. The purpose of the study was to confirm or update the
assumptions which were viewed as likely to affect the ultimate liability for
contract benefits. Accordingly, as a result of the merger, the Company
accelerated the performance of its normal reviews of the assumptions underlying
reserves to determine the assumptions that the newly merged Company will use in
the future for pricing, performance management, and reserving.
10
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 2--Merger (Continued)
The review resulted in an increase in the benefits and reserves for future
benefits for the Company's domestic and Canadian group long-term disability
unpaid claim liabilities. As a result of the review, the Company increased its
policy and contract benefit liabilities $359.2 million, which reduced third
quarter 1999 earnings $359.2 million before tax and $233.5 million after tax
($0.97 per common share).
The increase in policy and contract benefit liabilities primarily resulted from
revisions to assumptions in the following three key components: claim
termination rates, incurred but not reported (IBNR) factors, and discount rates.
These components and their effect on the reserve increase are summarized and
discussed below.
<TABLE>
<CAPTION>
(in millions)
----------------
<S> <C>
Claim termination rates $ 372.6
Incurred but not reported factors 101.4
Discount rates (114.8)
-------
Net change $ 359.2
=======
</TABLE>
The assumptions concerning claim termination rates relate to changes in the
estimated average length of time a claim is open (duration) and the ultimate
cost of settling claims. Recent trends indicate the duration of a disability
claim is increasing. Claim termination rates are based on industry experience
adjusted for Company historical and anticipated experience, which considers
emerging trends and Company actions that would have a material effect on claim
termination rates.
The increase in policy and contract benefit liabilities that results from the
revised claim termination rates is attributable to two elements. The first
element is the claim resolution assumption, which is the portion of claim
terminations related to the disabled returning to work or the expiration of the
benefit period. The second element is the mortality assumption, which is the
portion of claim terminations that result from death of the disabled. The effect
of these two elements on the increase in policy and contract benefit liabilities
is discussed below.
Claim resolution assumptions have been determined considering both external
trends and the Company's current and planned actions which would have a material
effect on claim resolution rates. Due to the high variability in claim
resolution rates, considerable judgment is required in setting claim resolution
assumptions. Revised claim resolution assumptions have been determined after
consideration of the merger integration plans, including the short-term
disruption of the claims management process from integration activities. Other
factors considered included emerging external trends, such as the developing
trend for some claimants to remain on claim longer, current and historical claim
resolution experience, industry claim resolution experience, and changes in
planned actions, as well as the anticipated future effectiveness of the claims
operations in settling existing claims. The revised assumptions for claim
resolution rates resulted in an increase in benefit liabilities of approximately
$194.8 million. These estimates rely on the Company's ability to complete
integration and claims processing changes as planned and those changes having
the anticipated impact on claim recovery rates.
The review also examined assumptions for mortality. Revision of mortality
assumptions resulted in an increase in benefit liabilities of approximately
$177.8 million. Mortality is a critical factor influencing the length of time a
claimant receives monthly disability benefits. Mortality has been improving for
the general population, and this improvement is now considered permanent. Life
expectancy has been extended dramatically for individuals suffering from
acquired immune deficiency syndrome (AIDS). Early observations of this trend and
related medical literature raised questions concerning the long-term
sustainability of the mortality improvements. The Company also assumed that, if
the trend did continue, many of the individuals responding positively to
treatment could be returned to productive employment.
11
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 2--Merger (Continued)
The previous review of mortality performed by the Company did not indicate a
need to change mortality assumptions. However, recent analysis indicates that
the improved mortality trend is sustainable and that rehabilitation of afflicted
individuals to return to work has been minimally successful to date. AIDS
related disabilities are 2.46 percent of the Company's total disability claims.
In addition to the AIDS mortality trend, the recent review demonstrates that
survival from other frequently fatal diseases such as cancer and heart disease
has improved over recent periods and is now judged to be more permanent due to
advances in medical sciences and treatments. While the treatment advances have
lengthened life expectancies, they do not always result in the claimant being
able to return to work; thus, the ultimate level of payments to be made on a
disability claim increases. Of the total increase in benefit liabilities for
revised mortality assumptions, $85.4 million is related to AIDS related
disabilities and $92.4 million to cancer and other disabilities.
The second component of the increase in benefit liabilities is the provision for
claims incurred but not yet reported, which resulted in an increase in benefit
liabilities of $101.4 million. This provision is an estimate of the outstanding
liability related to claims that have been incurred by individual insureds as of
the valuation date, but the claims have not yet been reported to the Company.
This liability is affected by the estimate of the number of outstanding claims.
Because of the long elimination periods, generally 90 to 180 days or longer, the
development of the factors must cover a period of sufficient length to mitigate
the effects of random fluctuations and to establish the presence of trends.
Recent trends indicate an increase in new claim rates which results in an
increase in the estimate of outstanding claims. Another item affecting this
liability is the estimate of the average cost of each outstanding claim. The
lengthening of time a claimant receives monthly benefits resulting from the
factors noted above also results in an increase in the estimate of the average
cost of each claim.
The third component of the change in benefit liabilities is the change in the
rate used to discount claim reserves, including IBNR reserves, which resulted in
a decrease of $114.8 million in benefit liabilities. Subsequent to the merger,
the Company significantly restructured the investment portfolio backing these
liabilities with the objective of improving asset and liability management and
improving yield. As part of this strategy, during the third quarter of 1999, the
Company sold $426.1 million of assets with a book yield of 5.98 percent and
purchased $546.6 million of assets with a yield of 8.87 percent, improving the
overall yield on the assets backing liabilities. As a result of this investment
restructuring and consistent with its policy, the Company increased the rate
used to discount claim reserves to 7.35 percent, resulting in a decrease of
$114.8 million in benefit liabilities.
The updated assumptions will be reflected in new and renewal pricing actions,
and a higher benefit ratio is expected over the next several quarters until the
effect of pricing actions is reflected in premium income. Actual experience
could fluctuate from these assumptions, and such fluctuations may have a
material positive or negative effect on net income.
12
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 2--Merger (Continued)
The results of operations for the separate companies and the combined amounts
for the periods prior to the merger were as follows:
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended Nine Months Ended
June 30, 1999 September 30, 1998 September 30, 1998
(in millions of dollars)
----------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue
Unum $2,557.8 $1,169.6 $3,402.2
Provident 1,988.9 975.3 2,951.9
-------- -------- --------
Combined Revenue $4,546.7 $2,144.9 $6,354.1
======== ======== ========
Net Income (Loss)
Unum $ (189.7) $ 104.4 $ 296.6
Provident 87.8 81.9 227.8
-------- -------- --------
Combined Net Income (Loss) $ (101.9) $ 186.3 $ 524.4
======== ======== ========
</TABLE>
Included in Unum's net loss for the six months ended June 30, 1999, is $131.8
million after tax for expenses related to the merger and the early retirement
offer to employees and $156.5 million after tax for the reserve discount rate
change. Unum's net loss for the six months ended June 30, 1999 also includes an
after-tax first quarter charge of $88.0 million related to its reinsurance
businesses. Included in Provident's net income for the six months ended June 30,
1999, is $62.0 million after tax for expenses related to the merger and the
early retirement offer to employees.
Note 3--Liability for Unpaid Claims and Claim Adjustment Expenses
It is the Company's policy to estimate the ultimate cost of settling claims in
each reporting period based upon the information available to management at the
time. Actual claim resolution results are monitored and compared to those
anticipated in claim reserve assumptions. Claim resolution rate assumptions are
based upon industry standards adjusted as appropriate to reflect actual Company
experience as well as Company actions which would have a material impact on
claim resolutions. Company actions for which plans have been established and
committed to by management are factors which would modify past experience in
establishing claim reserves. Adjustments to the reserve assumptions will be made
if expectations change. Given that insurance products contain inherent risks and
uncertainties, the ultimate liability may be more or less than such estimates
indicate.
During the fourth quarter of 1998, the Company recorded a $153.0 million
increase in the reserve for individual and group disability claims incurred as
of December 31, 1998. Incurred claims include claims known as of that date and
an estimate of those claims that have been incurred but not yet reported. Claims
that have been incurred but not yet reported are considered liabilities of the
Company. These claims are expected to be reported during 1999 and will be
affected by the claims operations integration activities. The $153.0 million
claim reserve increase represents the estimated value of cash payments to be
made to these claimants over the life of the claims as a result of the claims
operations integration activities.
Management believes the reserve adjustment was required based upon the
integration plans it had in place and to which it had committed and based upon
its ability to develop a reasonable estimate of the financial impact of the
expected disruption to the claims management process. Claims management is an
integral part of the disability operations. Disruptions in that process can
create material, short-term increases in claim costs. The merger has had a near-
term adverse impact on the efficiency and effectiveness of the Company's claims
management function
13
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 3--Liability for Unpaid Claims and Claim Adjustment Expenses (Continued)
resulting in some delay in claim resolutions and additional claim payments to
policyholders. Claims personnel have been distracted from normal claims
management activities as a result of planning and implementing the integration
of the two companies' claims organizations. In addition, employee turnover and
additional training have reduced resources and productivity. An important part
of the claims management process is assisting disabled policyholders with
rehabilitation efforts. This complex activity is important to the policyholders
because it can assist them in returning to productive work and lifestyles more
quickly, and it is important to the Company because it shortens the duration of
claim payments and thereby reduces the ultimate cost of settling claims.
Immediately following the announcement of the merger and continuing into
December of 1998, senior management of the Company worked to develop the
strategic direction of the Company's claims organization. As part of the
strategic direction, senior management committed claims management personnel to
be involved in developing the detailed integration plans and implementing the
plans during 1999. Knowing that those involved in the claims operations
integration activities would not be available full time to perform their normal
claims management functions, management deemed it necessary to anticipate this
effect on the claim reserves at December 31, 1998. Prior to the merger, during
the first six months of 1999 approximately 90 claims managers and benefit
specialists spent nearly 40 percent of their time developing the detailed
integration plans. Effective with the merger, virtually all claims personnel
have been involved in the process of implementing the new work processes and
required training. The implementation and training efforts are estimated to
require an average of one month of productive time from each of the claims staff
between June 30, 1999 and December 31, 1999. Management now believes that
implementation and related systems conversions will continue into the second
quarter of 2000. However, due to actions taken by management to mitigate effects
on resolution rates, the effect on new claim resolution rates is not anticipated
to be material after the end of 1999. Actions by management to mitigate the
effect on resolution rates include aggressive hiring of new claims staff,
restrictions on early retirement elections, selective use of personnel for
integration planning, and significant communications with staff members.
The reserving process begins with the assumptions indicated by past experience
and modifies these assumptions for current trends and other known factors. The
Company anticipated the merger-related developments discussed above would
generate a significant change in claims department productivity, reducing claim
resolution rates, a key assumption when establishing reserves. Management
developed actions to mitigate the impact of the merger on claims department
productivity, including the hiring of additional claims staff and the
restriction of early retirement elections by claims personnel. Where feasible,
management also planned to obtain additional claims management resources through
outsourcing. All such costs are expensed in the period incurred and are not
material in relation to results of operations. Management reviewed its
integration plans and the actions intended to mitigate the impact of the
integration with claims managers to determine the extent of disruption in normal
activities. Considering all of the above, the revised claim resolution rates, as
a percentage of original assumptions (i.e., before adjusting for the effect of
the claims operations integration activities), are 90 percent for the first and
second quarters of 1999, 84 percent for the third quarter, and 89 percent for
the fourth quarter of 1999. The revised claim resolution rates for the third
quarter and fourth quarter are lower than the first and second quarters because
all claims personnel are expected to be involved in the implementation and
training efforts. The effect of integration activities on new claim resolution
rates is not expected to be material after December 31, 1999.
In order to validate these assumptions, the Company also examined the historical
level and pattern of claims management effectiveness as reflected in claim
resolution rates for the insurance subsidiaries of The Paul Revere Corporation
(Paul Revere) which was acquired in 1997. Subsequent to the Paul Revere
acquisition and integration, management has been able to develop experience
studies for the Paul Revere business. These studies are prepared for pricing
purposes and to identify trends or changes in the business.
14
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 3--Liability for Unpaid Claims and Claim Adjustment Expenses (Continued)
These studies, which were not available for the Paul Revere business at the time
of the acquisition, allowed management to gain a greater understanding of the
impact of the claims integration activities on the claim resolution rates of the
Paul Revere business. These studies show that the Paul Revere business
experienced a decline in its claim resolution rates from a base in 1995 of 100
percent to 90.4 percent in 1996 and 80.3 percent in 1997. Changes in morbidity
and other factors were considered and reviewed to determine that a primary cause
of the reduced claim resolution rates was the disruption caused by the change in
the claims management process. Although the circumstances of the merger are very
different from the Paul Revere acquisition, the claims integration activities
are similar, and the Paul Revere experience is relevant. The primary
circumstances that created claims disruption for Paul Revere were the initial
lack of clarity of the organization, process, and structure, the need to plan
for a significant transition to new claims processes, and the training and
implementation related to those changes. All of those elements have impacted the
Company as a result of the merger. One primary difference is that the duration
of the potential disruption in the merger is not expected to be as long as was
the case with the Paul Revere acquisition. The Company's revised claim
resolution rates assumed for the first two quarters of 1999 were compared to the
Paul Revere experience in 1996, the period preceding the acquisition. It was
determined that the revised assumptions appeared to be reasonable. During the
third and fourth quarters of 1999, the claims integration plans provide for
increased activity due to training and implementation of new processes. The
Company's revised claim resolution rates for the third and fourth quarters of
1999 were compared to the Paul Revere experience in 1997 during the
implementation and training phase of the Paul Revere claims organization when
claims resolution rates declined to 80.3 percent of prior levels. Management
judged that it was reasonable to assume that the impact to the Company would be
less than it was to Paul Revere since some of the Company's claims management
practices will not change. The historical experience of Paul Revere provides a
statistical reference for the expected experience for the Company when adjusted
for the projected effects of the claims integration plans.
In order to evaluate the financial effect of merger-related integration
activities, the Company projected the ultimate cost of settling all claims
incurred as of December 31, 1998, using the revised claim resolution rates. This
projection was compared to the projection excluding the adjustment to the claim
resolution rates to obtain the amount of the charge. The Company reviewed its
estimates of the financial impact of the claims operations integration
activities with its actuaries and independent auditors.
Claim reserves at December 31, 1998 include $153.0 million as the estimated
value of projected additional claim payments resulting from these claims
operations integration activities. This reserve increase was reflected as a
$142.6 million increase in benefits and reserves for future benefits, and a
$10.4 million reduction in other income. If claim resolutions emerge as
expected, there will be no impact to results of operations during 1999. Any
variance from the assumptions will be reflected in operations in the current
period. The adverse impact of the claims operations integration activities on
new claim resolution rates is not expected to be material after the end of 1999.
As part of the periodic review of claim reserves, management will review the
status and execution of the claims operations integration plans with the claims
management on a quarterly basis. The review will consider claims operations
integration activities planned for future periods and evaluate whether the
future planned activities will result in claim resolution rates consistent with
those considered in the reserve established at December 31, 1998. The claim
reserves may require further increases or decreases as facts concerning the
merger and its effect on benefits to policyholders emerge. Among the factors
that could affect the reserve assumptions are the level of employee turnover,
timing and complexity of computer system conversions, and the timing and level
of training and integration activities of the claims management staff relative
to the original integration plans of the Company.
15
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 3--Liability for Unpaid Claims and Claim Adjustment Expenses (Continued)
Quarterly information concerning the estimated and actual impact of the claims
operations integration activities is as follows:
<TABLE>
<CAPTION>
1999
---------------------------------------------------------------
1st 2nd 3rd 4th
(in millions of dollars)
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Revised Claim Resolution Rates
at December 31, 1998 90% 90% 84% 89%
Actual Claim Resolution Rates for the Period 89% 90% 84%
Estimated Effect of Lower Claim Resolution
Rates at December 31, 1998 $ 36.2 $36.2 $47.6 $33.0
Actual Effect of Lower Claim Resolution
Rates for the Period $ 39.2 $36.2 $43.0
Further Increases (Decreases) to the Estimated
Liability at December 31, 1998 Recorded
During the Period $ - $ - $ -
Liability Remaining for Claims Operation
Integration Activities at End of Period $116.8 $80.6 $33.0
</TABLE>
Management expects the remaining claims operations integration activities to
impact claim reserves as anticipated at December 31, 1998. The expected
disruption to the claims management process and the related increase to the
disability claim reserve was considered in the review and update of assumptions
underlying the group disability policy and contract benefit liabilities
completed in the third quarter of 1999. Management will continue to evaluate the
impact of the merger on disability claims experience and the assumptions related
to expected claim resolutions.
Note 4--Reinsurance Operations
During the first quarter of 1999, the Company began a comprehensive strategic
review of its reinsurance operations to determine the appropriateness of their
fit within the context of the merged entity. These operations include the
reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk
assumption, which includes reinsurance pool participation; direct reinsurance
which includes accident and health (A&H), long-term care (LTC), and long-term
disability coverages; and Lloyd's of London (Lloyd's) syndicate participations.
In April 1999, the strategic review was completed, and the Company concluded
that these operations were not solidly aligned with the Company's strength in
the disability insurance market. The Company decided to exit these operations
through a combination of a sale, reinsurance, and/or placing certain components
in run-off.
16
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 4--Reinsurance Operations (Continued)
During the first three quarters of 1999, the Company recognized $325.1 million
of before-tax charges related to its reinsurance operations. The breakdown of
these charges by quarter is as follows:
<TABLE>
<CAPTION>
1999
-------------------------------------------------------
1st 2nd 3rd Nine Months
(in millions of dollars)
-------------------------------------------------------
<S> <C> <C> <C> <C>
North American Reinsurance Operations:
Loss on Sale of A&H and LTC Reinsurance $ - $ - $ 12.9 $12.9
Management Operations (includes write-off of
$6.0 million of goodwill)
Provision for Loss on Reinsurance of A&H and - - 10.0 10.0
LTC Risk Participations
Provision for Losses on Retained Business 28.6 - 13.5 42.1
International Reinsurance Operations:
Provision for Losses on Lloyd's of London 45.5 - 141.0 186.5
Syndicate Participations
Provision for Losses on Reinsurance Pool - - 21.9 21.9
Participations Other than Lloyd's
Goodwill Impairment Excluding Amount
Recognized on Sale 27.0 2.0 22.7 51.7
------ ---- ------ ------
Total Before-Tax Charge $101.1 $2.0 $222.0 $325.1
====== ==== ====== ======
</TABLE>
The Company's first quarter charge of $101.1 million before tax and $88.0
million after tax consisted of the following:
North American Reinsurance Operations:
Provision for Losses on Retained Business - As a result of the review
performed on the Lloyd's syndicates discussed above and other third
party publicized reinsurance exposures, the Company undertook a
periodic review of certain other reinsurance facilities related to new
information regarding the ultimate cost of settling claims. The
reinsurance pool business consists of more than 20 different pool
facilities, the majority of which are managed by the subsidiary
Duncanson & Holt, Inc. and a few pools which are managed by third
parties. Reserve assumptions are periodically reviewed to support the
determination of the ultimate cost of settling claims for certain
reinsurance pools. During the first quarter of 1999, the Company
reviewed the actuarial assumptions used to set reserves for certain
reinsurance facilities based on the most current information available
from the reinsurance pool managers. The Company also received new
information pertaining to a reinsurance pool managed by a third party
that indicated a reserve increase was required. The Company relied
primarily on the third party pool manager's judgement and recorded its
portion of the reserve as reflected in the reinsurance pool statement
from the third party pool manager. The new information received from
the managed facilities and the third party facility indicated
deterioration in loss experience, primarily related to a longer
duration of claims and increased incidence of new claims in certain
facilities. The result of these reviews was an increase to claim
reserves of $28.6 million, which was recorded in the first quarter of
1999. The Company determined that the increase to reserves was needed
based on revised actuarial assumptions to reflect current and expected
trends in claims experience and expenses.
17
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 4--Reinsurance Operations (Continued)
International Reinsurance Operations:
Provision for Losses on Lloyd's of London Syndicate Participations -
The periodic method of accounting is followed for Lloyd's syndicate
participation, which requires the premiums be recognized as revenue
over the policy term and claims, including the estimate of claims
incurred but not reported, to be recognized as incurred. During the
first quarter of 1999, the Company received more information about the
Lloyd's market from various sources, including managing
agents/underwriters syndicate reports and published information from
Moody's Investors Service. The information received indicated
significant deterioration in the loss experience of open years of
account primarily related to significant losses in certain syndicates
(space and aviation, accident and health, and other non-marine classes
of business) and continued pressure on the pricing of insurance
coverage provided by the Lloyd's market. In addition, the Company
discussed projected results of the Lloyd's market with the
underwriters of the syndicates that are managed through a subsidiary
of the Company. These projected results also indicated future
deterioration of the open years of account. Using this information and
recent experience with prior revisions of estimated losses in this
business, the Company performed a review of its claim reserve
liabilities related to its open years of account.
The review of estimates related to open years of account was performed
based on a periodic review of these estimates as information was
received from the Lloyd's syndicates. The review resulted in revised
best estimates of the expected ultimate profit or loss for each open
year of account, which were significantly below the levels estimated
in 1998. The resulting charge to earnings in the amount of $44.0
million was reflected in the Company's income in the first quarter of
1999 for the open years of account 1996 through 1999. In addition to
the risk participation charge, the Company recorded a charge of $1.5
million, which represented the reduction of previously recognized
profit commissions related to the Lloyd's management company
operations.
Goodwill Impairment:
When an event or change in circumstance occurs that indicates the
recoverability of an asset should be assessed for impairment, a
recoverability test is performed to determine if an impairment has
occurred. Following the poor results of the reinsurance operations in
the first quarter of 1999, the Company updated the goodwill
recoverability test using the most current results and forecasts. The
goodwill recoverability test used the held for use model that compares
the undiscounted cash flows of these operations to determine whether
those cash flows can recover the unamortized goodwill. After factoring
in the first quarter results and current revised forecasts due to
recent poor performance for these operations, future undiscounted cash
flows were insufficient to recover the entire goodwill amount,
indicating that the goodwill was impaired. Goodwill recoverability
testing of these operations performed prior to March 31, 1999 had
indicated that the goodwill was not impaired.
18
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 4--Reinsurance Operations (Continued)
As a result of the impairment, the Company calculated the estimated
fair value of these operations. In estimating the fair value, two
valuation techniques were utilized, a discount free cash flow model
and a multiple of earnings model. The Company believed that these
valuation techniques were appropriate for this type of business as
these techniques were what the Company would use in evaluating a
potential acquisition of this type of business. The results of the two
valuation techniques created a range of fair values from $47.0 million
to $64.0 million. The Company evaluated the range of values produced
by the valuation techniques and using internal management judgement of
the potential liquidation value, the Company determined its best
estimate of fair value of its investment to be the midpoint of the
range, or $55.0 million. The estimated fair value of $55.0 million was
compared to $82.0 million of book value for the investment, resulting
in a write-down of goodwill in the amount of $27.0 million in the
first quarter of 1999.
In the second quarter of 1999, the Company stated its intent to sell its
reinsurance management operations, assuming the transaction would achieve the
Company's financial objectives. The Company estimated the fair value of the
operations using the held-for-sale model, which compares the carrying value of
the asset with the fair value less costs to sell the asset. This resulted in an
additional write-down of goodwill in the amount of $2.0 million before and after
tax.
During the third quarter of 1999, the Company continued its efforts to sell its
reinsurance management operations. No potential buyers expressed interest in
acquiring the entire domestic and international reinsurance management
operations. However, in early October, the Company entered into an agreement to
sell the reinsurance management operations of its A&H and LTC reinsurance
facilities and to reinsure the Company's risk participation in these facilities.
Because of the limited interest expressed by potential buyers in the reinsurance
management operations, the Company reevaluated its strategy to exit the
reinsurance operations. The Company decided to continue to operate its North
America long-term disability reinsurance operation and to refocus it with the
objective of improving profitability. With respect to Lloyd's, the Company
decided to implement a strategy which attempts to limit participation in year
2000 underwriting risks, ceases participation in Lloyd's underwriting risks
after year 2000, and manages the run-off of its risk participation in open years
of account of Lloyd's reinsurance syndicates. The Company has also decided to
discontinue its accident reinsurance business in London beginning in year 2000.
During the third quarter, the Company recognized a charge of $222.0 million
before tax and $204.3 million after tax ($0.85 per common share) related to its
strategy for the reinsurance operations. The charge consisted of the following:
North American Reinsurance Operations:
Loss on Sale of A&H and LTC Reinsurance Management Operations - The
Company has entered into an agreement with American United Life
Insurance Company (AUL) to sell the reinsurance management operations
of its A&H and LTC reinsurance facilities and to reinsure the
Company's risk participation in these facilities. Certain risks
related to prior operations have not been assumed by AUL. The terms of
the sale require the Company to continue to participate in certain of
the reinsurance facilities in year 2000, thereby assuming underwriting
risks. The transaction is expected to close by the end of 1999 and is
subject to regulatory approval. A before-tax loss of $12.9 million was
recognized in the third quarter of 1999 based upon the terms
19
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 4--Reinsurance Operations (Continued)
and conditions of the definitive agreement. The loss includes the
write-off of $6.0 million of goodwill related to this portion of the
operations.
Provision for Loss on Reinsurance of A&H and LTC Risk Participations -
The Company entered into a separate indemnity reinsurance agreement
with AUL whereby AUL will assume the Company's existing risk
participation in the A&H and LTC reinsurance facilities. As a result,
the Company recognized a third quarter before-tax loss of $10.0
million.
Provision for Losses on Retained Business - The Company updated its
review of reserves related to the retained pool participations. Based
upon the most recent information available, the Company increased its
reserves by $10.5 million, principally related to the long-term
disability business. Also included in this provision is $3.0 million
to recognize the estimated cost of potential uncollectible reinsurance
recoveries for two reinsurers who reinsure certain of the Company's
reinsurance facilities and who, as the losses have increased, have
experienced financial difficulties.
International Reinsurance Operations:
Provision for Losses on Lloyd's of London Syndicate Participations -No
potential buyers expressed an interest in purchasing the Lloyd's
management company operation and in assuming the Company's existing
syndicate underwriting risk participation. The Company is pursuing a
strategy to reduce its syndicate underwriting risk assumption for the
year 2000 by selling its non-managed syndicate risk participation in
the auction market and by seeking to have new capital providers to
participate in syndicate underwriting risk for future years.
Market conditions related to open syndicate years of account continue
to deteriorate. During the third quarter of 1999, underwriters of
syndicates provided to Lloyd's updated estimates of their expected
ultimate profit or loss for each open year of account. These estimates
were significantly below earlier estimates. Market conditions are not
expected to improve dramatically in the near term.
Consistent with overall market trends, the loss estimates received
from the underwriters of syndicates managed by a subsidiary of the
Company indicated significant deterioration in the loss experience of
open years of account from their previous estimate. This information
was discussed with underwriters and used by the Company to update its
review of liabilities related to its open syndicate years of account.
The review resulted in revised estimates of the expected ultimate loss
for each open year of account, which were significantly worse than the
levels estimated in the first quarter of 1999. The resulting $141.0
million charge for the open syndicate years of account 1997 through
1999 was reflected in the Company's before-tax earnings in the third
quarter of 1999.
During the third quarter of 1999, the Company entered into a non-
binding agreement to sell one of its managed syndicates, and a
definitive agreement is being negotiated. Unamortized goodwill of $2.4
million was written off in connection with this planned transaction.
Under the terms of the agreement, the new owner will manage the
syndicate for year 2000 and will manage the open syndicate years of
account. The Company retains the underwriting risk on open syndicate
years
20
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 4--Reinsurance Operations (Continued)
and agreed to provide up to $24.7 million ((pound)15 million) of
capacity for year 2000, down from $36.2 million ((pound)22 million) in
1999.
The Company intends to manage the run-off of the open syndicate years
of account for the remaining managed syndicates and to cease
participating in underwriting risk assumption related to these
syndicates after year 2000.
Provision for Losses on Reinsurance Pool Participations Other than
Lloyd's - In connection with the development of the cost of exiting
the reinsurance operations, the Company updated its review of reserves
related to non Lloyd's reinsurance operations as well as future costs
associated with managing the run-off of the retained reinsurance pools
liabilities. Based upon the most recent information available, the
Company increased reserves related to its participation in certain
managed and non-managed reinsurance facilities by $21.9 million.
Goodwill Impairment:
Prior to the third quarter 1999 charge, the Company's unamortized
goodwill related to its reinsurance operations was $53.7 million. Of
the $31.0 million unamortized balance attributable to the A&H and LTC
business being sold, $6.0 million was determined to be unrecoverable
and was written off in the third quarter and is included in the loss
on sale reported above. The balance of $25.0 million will be recovered
through the sales proceeds when the sale closes. The remaining
unamortized balance of $22.7 million (including the balance of $2.4
million related to one of the Lloyd's syndicates for which the Company
has entered into an agreement to sell) was determined to be
unrecoverable based on revised earnings forecasts for the reinsurance
operations and was also written off in the third quarter of 1999.
Retained Risks:
The Company has provided its best estimate of the cost of known
losses. Under this exit strategy, the Company retained certain risks,
including the exposure associated with the recent arbitration decision
disclosed in the second quarter (see Note 10). Presently, it is not
reasonably possible to determine the liability for the retained risks.
Note 5--Debt
On December 4, 1997, the Company borrowed $168.3 million through a private
placement. Under the terms of the agreement, the investor exercised the right to
redeem the private placement at par value during the second quarter of 1999. The
Company refinanced this debt by issuing $200.0 million of variable rate medium-
term notes in June of 1999 due in June of 2000.
21
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 6--Federal Income Taxes
A portion of the losses recognized in the first three quarters of 1999 relating
to the Company's reinsurance operations does not receive a tax benefit, which
unfavorably impacted the effective tax rate. Additionally, a portion of the
second quarter 1999 expenses related to the merger was non-deductible for
federal income tax purposes, resulting in a tax rate that was less than the U.S.
federal statutory tax rate of 35 percent.
In the second quarter of 1999, the Company reached a settlement agreement with
the Internal Revenue Service (IRS) related to an issue in dispute for the 1992
tax year. The Company recorded a tax benefit of $5.1 million and related
interest of $1.4 million.
In the third quarter of 1999, the Company recorded a refund from the IRS
relating to the final settlement of remaining issues for the 1986 through 1992
tax years. The refund of taxes was $25.3 million and interest on the refund was
$31.5 million. The Company increased its tax liability $16.6 million
attributable to tax years subsequent to 1992. Overall, including interest
received and the tax provision thereon, third quarter of 1999 results increased
$29.2 million due to the refund.
As of September 30, 1999, UnumProvident Corporation (formerly Provident
Companies, Inc.), Provident Life and Accident Insurance Company, Provident Life
and Casualty Insurance Company, and Provident National Assurance Company have
tax years through 1992 closed to further assessments by the IRS. The Paul Revere
Corporation and subsidiaries have tax years through 1990 closed to further IRS
assessments. The subsidiaries of Unum Holding Company have tax years closed
through 1991, Colonial Life and Accident Insurance Company has tax years closed
through 1993, and Duncanson & Holt, Inc. and its subsidiaries have tax years
closed through July 30, 1992. No additional federal tax liabilities can be
assessed for these closed years.
Note 7--Stockholders' Equity and Earnings Per Common Share
In accordance with the restated certificate of incorporation, the Company has
25,000,000 shares of preferred stock authorized with a par value of $0.10 per
share. At September 30, 1999, no preferred stock had been issued.
Net income (loss) per common share is determined as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(in millions of dollars, except share data)
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Numerator
Net Income (Loss) $ (217.0) $ 186.3 $ (318.9) $ 524.4
Preferred Stock Dividends - - - 1.9
-------- -------- -------- --------
$ (217.0) $ 186.3 $ (318.9) $ 522.5
======== ======== ======== ========
Denominator (000s)
Weighted Average Common Shares - Basic 239,740 237,033 238,670 236,895
Dilutive Securities - 5,271 - 5,731
-------- -------- -------- --------
Weighted Average Common Shares -
Assuming Dilution 239,740 242,304 238,670 242,626
======== ======== ======== ========
</TABLE>
22
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 7--Stockholders' Equity and Earnings Per Common Share (Continued)
In computing earnings per share assuming dilution, only potential common shares
that are dilutive (those that reduce earnings per share) are included. Potential
common shares are not used when computing earnings per share assuming dilution
if the result would be antidilutive, such as when a net loss is reported or if
options are out-of-the-money. In-the-money options to purchase approximately 2.4
million and 3.7 million common shares for the three and nine month periods ended
September 30, 1999, were not considered dilutive due to net losses being
reported for the periods. Approximately 5.4 million and 2.0 million options for
the three and nine month periods ended September 30, 1999, respectively, were
not considered dilutive due to the options being out-of-the-money. Approximately
2.1 million options for the three month period ended September 30, 1998 were not
considered dilutive due to the options being out-of-the-money. Out-of-the-money
options for the nine months ended September 30, 1998 were immaterial.
Note 8--Comprehensive Income (Loss)
The components of other comprehensive income, net of deferred tax, are as
follows:
<TABLE>
<CAPTION>
September 30 December 31
1999 1998
(in millions of dollars)
---------------------------------------
<S> <C> <C>
Net Unrealized Gain on Securities $121.8 $969.4
Foreign Currency Translation Adjustment (40.8) (54.7)
------ ------
Accumulated Other Comprehensive Income $ 81.0 $914.7
====== ======
</TABLE>
The components of comprehensive income (loss) and the related deferred tax are
as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(in millions of dollars)
----------------------------------------------------
<S> <C> <C> <C> <C>
Net Income (Loss) $(217.0) $186.3 $ (318.9) $524.4
------- ------ --------- ------
Change in Net Unrealized Gain on Securities:
Change Before Reclassification Adjustment (194.2) 182.0 (1,168.7) 408.6
Reclassification Adjustment for Net Realized Investment
Gains Included in Net Income (Loss) (77.9) (16.4) (89.3) (30.8)
Change in Foreign Currency Translation Adjustment 4.6 (5.3) 19.7 (14.6)
------- ------ --------- ------
(267.5) 160.3 (1,238.3) 363.2
Change in Deferred Tax (83.2) 49.7 (404.6) 120.1
------- ------ --------- ------
Other Comprehensive Income (Loss) (184.3) 110.6 (833.7) 243.1
------- ------ --------- ------
Comprehensive Income (Loss) $(401.3) $296.9 $(1,152.6) $767.5
======= ====== ========= ======
</TABLE>
23
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 9--Segment Information
Selected data by segment is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(in millions of dollars)
-------------------------------------------------------------
<S> <C> <C> <C> <C>
Premium Income
Employee Benefits $ 984.8 $ 859.0 $2,898.8 $2,492.6
Individual 439.6 419.8 1,300.0 1,256.7
Voluntary Benefits 172.4 167.4 516.7 498.7
Other 139.4 114.3 389.6 311.2
-------- -------- -------- --------
1,736.2 1,560.5 5,105.1 4,559.2
Net Investment Income and Other Income
Employee Benefits 186.4 164.7 546.7 492.9
Individual 231.4 227.5 692.7 670.2
Voluntary Benefits 28.1 26.9 81.5 76.8
Other 133.5 141.7 409.9 500.2
Corporate 39.6 7.2 54.6 24.0
-------- -------- -------- --------
619.0 568.0 1,785.4 1,764.1
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Employee Benefits 1,171.2 1,023.7 3,445.5 2,985.5
Individual 671.0 647.3 1,992.7 1,926.9
Voluntary Benefits 200.5 194.3 598.2 575.5
Other 272.9 256.0 799.5 811.4
Corporate 39.6 7.2 54.6 24.0
-------- -------- -------- --------
2,355.2 2,128.5 6,890.5 6,323.3
Benefits and Expenses
Employee Benefits 1,384.5 871.1 3,540.6 2,548.2
Individual 579.1 568.0 1,773.1 1,687.8
Voluntary Benefits 168.3 158.9 503.4 481.9
Other 449.1 231.5 1,029.1 730.2
Corporate 114.9 39.5 507.8 117.3
-------- -------- -------- --------
2,695.9 1,869.0 7,354.0 5,565.4
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Employee Benefits (213.3) 152.6 (95.1) 437.3
Individual 91.9 79.3 219.6 239.1
Voluntary Benefits 32.2 35.4 94.8 93.6
Other (176.2) 24.5 (229.6) 81.2
Corporate (75.3) (32.3) (453.2) (93.3)
-------- -------- -------- --------
(340.7) 259.5 (463.5) 757.9
Net Realized Investment Gains 77.9 16.4 89.3 30.8
-------- -------- -------- --------
Income (Loss) Before Federal Income Taxes (262.8) 275.9 (374.2) 788.7
Federal Income Taxes (Credit) (45.8) 89.6 (55.3) 264.3
-------- -------- -------- --------
Net Income (Loss) $ (217.0) $ 186.3 $ (318.9) $ 524.4
======== ======== ======== ========
</TABLE>
24
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 9--Segment Information (Continued)
<TABLE>
<CAPTION>
September 30 December 31
1999 1998
(in millions of dollars)
------------------------------------
<S> <C> <C>
Assets
Employee Benefits $ 9,636.4 $ 9,275.7
Individual 15,459.2 15,887.7
Voluntary Benefits 2,138.8 2,057.3
Other 9,491.5 9,610.2
Corporate 1,345.2 1,771.3
--------- ---------
$38,071.1 $38,602.2
========= =========
</TABLE>
The Employee Benefits segment includes group long-term and short-term disability
insurance, group life insurance, accidental death and dismemberment coverages,
group long-term care, and the results of managed disability. The Individual
segment includes results from the individual disability, individual life, and
individual long-term care lines of business. The Voluntary Benefits segment
includes the results of products sold to employees through payroll deduction at
the work site. These products include life insurance and health products,
primarily disability, accident and sickness, and cancer. The Other operating
segment includes results from products no longer actively marketed, including
corporate-owned life insurance, group pension, health insurance, individual
annuities, and reinsurance pools and management. The Corporate segment includes
investment earnings on corporate assets not specifically allocated to a line of
business, corporate interest expense, amortization of goodwill, and certain
corporate expenses not allocated to a line of business.
Note 10--Commitments and Contingent Liabilities
In 1997 two alleged class action lawsuits were filed in Superior Court in
Worcester, Massachusetts (Superior Court) against the Company--one purporting to
represent all career agents of subsidiaries of Paul Revere whose employment
relationships ended on June 30, 1997 and were offered contracts to sell
insurance policies as independent producers and the other purporting to
represent independent brokers who sold certain Paul Revere individual disability
income policies with benefit riders. Motions filed by the Company to dismiss
most of the counts in the complaints, which allege various breach of contract
and statutory claims, have been denied, but the cases remain at a preliminary
stage. To date no class has been certified in either lawsuit. However, a hearing
to determine class certification has been set for December 20, 1999 in
Massachusetts state court. The Company has filed a conditional counterclaim in
each action which requests a substantial return of commissions should the
Superior Court agree with the plaintiff's interpretation of the contracts. The
Company believes that it has strong defenses to both lawsuits and plans to
vigorously defend its position and resist certification of the classes. In
addition, the same plaintiff's attorney who has filed the purported class action
lawsuits has filed 44 individual lawsuits on behalf of current and former Paul
Revere sales managers alleging various breach of contract claims. The Company
has filed a motion in federal court to compel arbitration for 16 of the
plaintiffs who are licensed by the National Association of Securities Dealers
and have executed the Uniform Application for Registration or Transfer in the
Securities Industry (Form U-4). The federal court has denied those motions,
except for two plaintiffs where the issue is still pending. The Company is
appealing the court's ruling on the remaining 14 plaintiffs. Motions to dismiss
in the state court have been denied, but the Company is seeking interlocutory
appeal on one issue. The Company believes that it has strong defenses and plans
to vigorously defend its position in these cases. Although the alleged class
action lawsuits and individual lawsuits are in the early stages, management does
not currently expect these suits to materially affect the financial position or
results of operations of the Company.
25
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 30, 1999
Note 10--Commitments and Contingent Liabilities (Continued)
During September and October 1999, the Company and several of its officers were
named as defendants in five class action lawsuits filed in the United States
District Court for the District of Maine. The complaints assert a variety of
virtually identical claims under the Securities Exchange Act of 1934, as
amended, and the Securities Act of 1933, as amended, on behalf of a putative
class of shareholders who purchased or otherwise acquired stock in the Company
or Unum between February 4, 1998 and August 2, 1999. The complaints allege that
the defendants made false and misleading public statements concerning, among
other things, Unum's and the Company's reserves for disability insurance,
Provident's and the Company's disability insurance claims and pending lawsuits
concerning certain of those claims, and the Company's merger costs and the
adequacy of the due diligence reviews performed in connection with the merger.
The complaints seek money damages on behalf of all persons who purchased or
otherwise acquired Company or Unum securities in the class period or who were
issued Company securities pursuant to the merger. To date, no class has been
certified, and no defendant has answered the complaints. The Company disputes
the claims alleged in the complaints and plans to vigorously contest them.
Recent information indicates that in certain reinsurance pools associated with
the Company's reinsurance businesses there are disputes among the pool members
and reinsurance participants concerning the scope of their obligations and
liabilities within the complex pool arrangements, including a pool for which a
subsidiary of the Company acted as pool underwriting agent and another
subsidiary is a pool member. It is likely that the Company's agent subsidiary
will be brought into a dispute, arbitration, or litigation with other pool
members or reinsurers of the pool for which it acted as agent and which have
been subject to a recent arbitration proceeding, but it is unclear what exposure
the Company's subsidiary may ultimately have to share in losses of pool members
or reinsurers because of the subsidiary's activities as agent in placing
reinsurance.
Various other lawsuits against the Company have arisen in the normal course of
its business. Contingent liabilities that might arise from such other litigation
are not deemed likely to materially affect the financial position or results of
operations of the Company.
Note 11--Changes in Accounting Principles and Accounting Pronouncement
Outstanding
Effective January 1, 1999, the Company adopted the provisions of Statement of
Position 97-3 (SOP 97-3), Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments. SOP 97-3 provides guidance for determining when
an entity should recognize a liability or an asset for insurance-related
assessments and how to measure these items. The Company fully adopted the
provisions of Statement of Position 98-1 (SOP 98-1), Accounting for the Costs of
Computer Software Developed for or Obtained for Internal Use, effective January
1, 1999. SOP 98-1 requires the capitalization of certain costs incurred in
connection with developing or obtaining software for internal use. The effect of
the adoptions of SOP 97-3 and SOP 98-1 on the Company's financial position and
results of operations was immaterial.
In June 1999, Statement of Financial Accounting Standards No. 137 (SFAS 137),
Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 was issued. SFAS 137 defers for one
year the effective date of Statement of Financial Accounting Standards No. 133
(SFAS 133), Accounting for Derivative Instruments and Hedging Activities. The
Company plans to adopt the provisions of SFAS 133 effective January 1, 2001. At
this time the Company has not determined the effects that adoption of SFAS 133
will have on its financial statements.
26
<PAGE>
Independent Auditors' Review Report
Board of Directors and Shareholders
UnumProvident Corporation
We have reviewed the accompanying condensed consolidated statement of financial
condition of UnumProvident Corporation and Subsidiaries as of September 30,
1999, the related condensed consolidated statements of operations for the three
and nine month periods ended September 30, 1999 and 1998, and the condensed
consolidated statements of stockholders' equity and cash flows for the nine
month periods ended September 30, 1999 and 1998. These financial statements are
the responsibility of the Company's management.
We were furnished with the report of other accountants on their review of the
interim information of the former Unum Corporation and Subsidiaries whose total
assets as of September 30, 1999, and whose revenues for the three month and nine
month periods then ended constituted 42 percent, 56 percent, and 56 percent,
respectively, of the related consolidated totals.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, which will be performed
for the full year with the objective of expressing an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews and the report of other accountants, we are not aware of
any material modifications that should be made to the accompanying financial
statements for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial condition of UnumProvident
Corporation as of December 31, 1998, and the related consolidated statements of
income, stockholders' equity, and cash flows for the year then ended not
presented herein, and in our report dated August 2, 1999, we expressed an
unqualified opinion on those consolidated financial statements. We did not audit
the financial statements of the former Unum Corporation which statements reflect
total assets and total revenues constituting 39 percent and 54 percent,
respectively, in 1998 of the related consolidated totals. Those statements were
audited by other auditors whose report has been furnished to us, and our
opinion, in so far as it relates to data included for the former Unum
Corporation, is based solely on the report of other auditors. In our opinion,
the information set forth in the accompanying condensed consolidated statement
of financial condition as of December 31, 1998, is fairly stated, in all
material respects, in relation to the consolidated statement of financial
condition from which it has been derived.
/s/ ERNST & YOUNG LLP
Chattanooga, Tennessee
November 12, 1999
27
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cautionary Statement Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the Act) provides a "safe-
harbor" for forward-looking statements which are identified as such and are
accompanied by the identification of important factors which could cause actual
results to differ materially from the forward-looking statements. UnumProvident
Corporation (the Company) claims the protection afforded by the safe harbor in
the Act. Certain information contained in this discussion, or in any other
written or oral statements made by the Company, is or may be considered as
forward-looking. Examples of disclosures that contain such information include,
among others, sales estimates, income projections, reserves and related
assumptions, and the year 2000 date conversion. Forward-looking statements are
those not based on historical information, but rather relate to future
operations, strategies, financial results, or other developments. These
statements may be made directly in this document or may be made part of this
document by reference to other documents filed with the Securities and Exchange
Commission by the Company, which is known as "incorporation by reference." You
can find many of these statements by looking for words such as "may," "should,"
"believes," "expects," "anticipates," "estimates," "intends," "projects,"
"goals," "objectives," or similar expressions in this document or in documents
incorporated herein.
These forward-looking statements are subject to numerous assumptions, risks, and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by the forward-looking statements include, among others, the
following possibilities:
. Competitive pressures in the insurance industry may increase
significantly through industry consolidation, competitor
demutualization, or otherwise.
. General economic or business conditions, both domestic and foreign,
whether relating to the economy as a whole or to particular sectors,
may be less favorable than expected, resulting in, among other things,
lower than expected revenues, and the Company could experience higher
than expected claims or claims with longer duration than expected.
. Insurance reserve liabilities can fluctuate as a result of changes in
numerous factors, and such fluctuations can have material positive or
negative effects on net income.
. Costs or difficulties related to the integration of the business of
the Company following the merger may be greater than expected,
including costs or difficulties related to the management of claims.
. Legislative or regulatory changes may adversely affect the businesses
in which the Company is engaged.
. Necessary technological changes, including changes to address year
2000 data systems issues, may be more difficult or expensive to make
than anticipated, and year 2000 issues at other companies may
adversely affect operations.
. Adverse changes may occur in the securities market.
. Changes in the interest rate environment may adversely affect profit
margins and the Company's investment portfolio.
. The rate of customer bankruptcies may increase.
. Incidence and recovery rates may be influenced by, among other
factors, the emergence of new diseases, new trends and developments in
medical treatments, and the effectiveness of risk management programs.
. Retained risks in the Company's reinsurance operations are influenced
by many factors and can fluctuate as a result of changes in these
factors, and such fluctuations can have material positive or negative
effects on net income.
For further discussion of risks and uncertainties which could cause actual
results to differ from those contained in the forward-looking statements, see
"Forward-Looking Information" in Unum Corporation's Form 10-K/A and "Cautionary
Statement Regarding Forward-Looking Statements" and "Risk Factors" in Provident
Companies Inc.'s Form 10-K/A, in each case for the fiscal year ended December
31, 1998.
All subsequent written and oral forward-looking statements attributable to the
Company or any person acting on its behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to in this section.
The Company does not undertake any obligation to release publicly any revisions
to such forward-looking statements to reflect events or circumstances after the
date of this document or to reflect the occurrence of unanticipated events.
28
<PAGE>
Introduction
On June 30, 1999, Unum Corporation (Unum) merged with and into Provident
Companies, Inc. (Provident) under the name UnumProvident Corporation. The merger
was accounted for as a pooling of interests. The historical financial results
discussed herein give effect to the merger as if it had been completed at the
beginning of the earliest period presented. See Notes 1 and 2 of the "Notes to
Condensed Consolidated Financial Statements" for further discussion.
The following should be read in conjunction with the condensed consolidated
financial statements and notes thereto contained herein and with the discussion,
analysis, and consolidated financial statements and notes thereto in Exhibits
99.1, 99.2, and 99.3 of the Company's Form 8-K for the fiscal year ended
December 31, 1998.
This discussion of consolidated operating results and operating results by
segment excludes net realized investment gains and losses from revenue and
income before taxes. The Company's investment focus has been on investment
income to support its insurance liabilities as opposed to the generation of
realized investment gains. Due to the nature of the Company's business, a long-
term focus is necessary to maintain profitability over the life of the business.
The realization of investment gains and losses will impact future earnings
levels as the underlying business is long-term in nature and requires that the
Company be able to sustain the assumed interest rates in its liabilities.
However, income excluding realized investment gains and losses does not replace
net income as a measure of the Company's profitability.
Management believes that the trends in new annualized sales in the Employee
Benefits, Individual, and Voluntary Benefits segments are important for
investors to assess in their analysis of the Company's results of operations.
The trends in new sales are indicators of the Company's potential for growth in
its respective markets and the level of market acceptance of price changes and
new products. The Company has closely linked its various incentive compensation
plans for management and employees to the achievement of its goals for new
sales. The Company's long-term financial objectives, which balance growth and
profitability, are to achieve sales growth of 10 to 12 percent per year and to
maintain premium growth of approximately 10 percent.
Accounting Policy Changes, Financial Statement Reclassifications, and Merger
Expenses
As a result of the merger, certain accounting policy changes and
reclassification adjustments have been made. The following summarizes these
changes and reclassifications as well as the expenses related to the merger and
the early retirement offer to employees.
The Company values its available-for-sale fixed maturity and equity securities
at fair value, with unrealized holding gains and losses reported as a component
of comprehensive income. Companies are required to also adjust deferred
acquisition costs and/or certain policyholder liabilities to reflect the changes
that would have been necessary if the unrealized investment gains and losses
related to the available-for-sale securities had been realized. Prior to the
merger, Unum adjusted policyholder liabilities and Provident adjusted deferred
policy acquisition costs (DPAC) and value of business acquired (VOBA) for those
products where these assets existed. To present financial information in a
common reporting format, management has determined that the combined entity will
adjust policyholder liabilities rather than DPAC and VOBA. Prior period
financial statements have been restated to reflect this reclassification. The
reclassification did not change other comprehensive income, accumulated other
comprehensive income, or fixed maturity and equity securities. The
reclassification reflected in the December 31, 1998, condensed consolidated
statement of financial condition resulted in an increase of $329.7 million in
DPAC, $1.5 million in VOBA, and $331.2 million in reserves for future policy and
contract benefits.
Generally, because of the effort and time involved, reviews and updates of
assumptions related to benefit liabilities are periodically undertaken over time
and are reflected in the calculation of benefit liabilities as completed. Many
factors influence assumptions underlying reserves, and considerable judgment is
required to interpret current and historical experience underlying all of the
assumptions and to assess the future factors that are likely to influence the
ultimate cost of settling existing claims.
29
<PAGE>
Prior to the merger, Unum's process and assumptions used to calculate the
discount rate for claim reserves of certain disability businesses differed from
that used by Provident. While Unum's and Provident's methods for calculating the
discount rate for disability claim reserves were both in accordance with
generally accepted accounting principles, management believed that the combined
entity should have consistent discount rate accounting policies and methods for
applying these policies for similar products. The previous Unum methodology used
the same investment strategy for assets backing both liabilities and surplus.
Provident's methodology, which allows for different investment strategies for
assets backing surplus than those backing product liabilities, was determined by
management to be the more appropriate approach for the combined entity.
Accordingly, Unum adopted Provident's method of calculating the discount rate
for claim reserves. The impact on 1999 second quarter earnings related to the
change in method of calculating the discount rate for claim reserves was $240.7
million before tax and $156.5 million after tax. The charge was reflected in the
Employee Benefits, Individual, and Other segments as an increase in benefits to
policyholders of $191.7 million, $38.9 million, and $10.1 million, respectively.
Subsequent to the merger date, the Company began to integrate the valuation
procedures of the two organizations to provide for a more effective linking of
pricing and reserving assumptions and to facilitate a more efficient process for
adjusting liabilities to emerging trends. Included in this integration activity
were a review and an update of assumptions that underlie policy and contract
benefit liabilities. The purpose of the study was to confirm or update the
assumptions which were viewed as likely to affect the ultimate liability for
contract benefits. Accordingly, as a result of the merger, the Company
accelerated the performance of its normal reviews of the assumptions underlying
reserves to determine the assumptions that the newly merged Company will use in
the future for pricing, performance management, and reserving.
The review resulted in an increase in the benefits and reserves for future
benefits for the Company's domestic group long-term disability unpaid claim
liabilities. As a result of the review, the Company increased its policy and
contract benefit liabilities $359.2 million, which reduced third quarter 1999
results $359.2 million before tax and $233.5 million after tax. See Note 2 of
the "Notes to Condensed Consolidated Financial Statements" for further
discussion of the second and third quarter charges and "Liquidity and Capital
Resources" for a discussion of capital and financing needs.
The Company also completed its review of the methodology and assumptions used
for the capitalization and amortization of the costs of acquiring new business.
The result of the review was immaterial and was reflected in current period
operating earnings. The Company's before-tax results were increased $5.9 million
during the third quarter to reflect the application of the revised estimate. The
change in estimate will be applied to amounts capitalized in 1999 and future
years and will reflect the combined entity's practices and pricing assumptions.
There was not a need to adjust amounts capitalized in years prior to 1999, as
those amounts are believed to be recoverable from the related policies. A key
element in the ability to recover amounts capitalized in prior periods is the
persistency of the business. The Company monitors persistency and reflects
adverse changes in persistency in the current year's amortization of deferred
acquisition costs. Actual persistency experience for both Unum and Provident
compares favorably with expected experience to date.
On the date the merger was completed, the Company recorded before-tax expenses
related to the merger of approximately $142.2 million ($112.0 million after tax)
for severance and related costs, exit costs for duplicate facilities and asset
abandonments, and investment banking, legal, and accounting fees. The Company
also recorded in the second quarter a before-tax expense of approximately $125.9
million ($81.8 million after tax) related to the early retirement offer to the
Company's employees. During the third quarter, the Company recorded additional
before-tax expenses of $42.5 million ($27.6 after tax) related to the merger.
These expenses are reported in the Corporate segment as other operating expenses
and are further discussed in the section "Corporate Segment Operating Results."
Additionally, in the three and nine months ended September 30, 1999 the Company
expensed $4.7 million and $24.7 million, respectively, ($3.1 million and $16.1
million after tax) of incremental costs associated with the merger. These
incremental costs consist primarily of compensation, training, integration, and
licensing costs.
30
<PAGE>
Consolidated Operating Results
<TABLE>
<CAPTION>
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
1999 1998 % Change 1999 1998 % Change
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $1,736.2 $1,560.5 11.3% $5,105.1 $4,559.2 12.0%
Net Investment Income 513.4 494.4 3.8 1,531.0 1,533.0 (0.1)
Other Income 105.6 73.6 43.5 254.4 231.1 10.1
-------- -------- -------- --------
Total Revenue 2,355.2 2,128.5 10.7 6,890.5 6,323.3 9.0
Benefits and Expenses 2,695.9 1,869.0 44.2 7,354.0 5,565.4 32.1
-------- -------- ------- --------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains (340.7) 259.5 N.M. (463.5) 757.9 N.M.
Federal Income Taxes (Credit) (73.1) 83.9 N.M. (86.6) 253.8 N.M.
-------- -------- -------- --------
Income (Loss) Before Net
Realized Investment Gains (267.6) 175.6 N.M. (376.9) 504.1 N.M.
Net Realized Investment Gains 50.6 10.7 N.M. 58.0 20.3 N.M.
-------- -------- -------- --------
Net Income (Loss) $ (217.0) $ 186.3 N.M. $ (318.9) $ 524.4 N.M.
======== ======== ======== ========
</TABLE>
N.M. = not a meaningful percentage
In addition to the third quarter increase in benefit liabilities of $359.2
million and the third quarter merger-related expenses of $42.5 million discussed
in the previous section, the Company recognized $222.0 million of before-tax
charges related to its reinsurance operations. During the first three quarters
of 1999, the Company has recognized $325.1 million of before-tax charges for its
reinsurance operations. The breakdown of these charges by quarter is as follows:
<TABLE>
<CAPTION>
1999
-------------------------------------------------------
1st 2nd 3rd Nine Months
(in millions of dollars)
-------------------------------------------------------
<S> <C> <C> <C> <C>
North American Reinsurance Operations:
Loss on Sale of A&H and LTC Reinsurance $ - $ - $ 12.9 $ 12.9
Management Operations (includes write-off of
$6.0 million of goodwill)
Provision for Loss on Reinsurance of A&H and - - 10.0 10.0
LTC Risk Participations
Provision for Losses on Retained Business 28.6 - 13.5 42.1
International Reinsurance Operations:
Provision for Losses on Lloyd's of London 45.5 - 141.0 186.5
Syndicate Participations
Provision for Losses on Reinsurance Pool - - 21.9 21.9
Participations Other than Lloyd's
Goodwill Impairment Excluding Amount
Recognized on Sale 27.0 2.0 22.7 51.7
------ ----- ------ ------
Total Before-Tax Charge $101.1 $ 2.0 $222.0 $325.1
====== ===== ====== ======
</TABLE>
See "Other Segment Operating Results" and Note 4 of the "Notes to Condensed
Consolidated Financial Statements" for further discussion of the Company's
reinsurance operations.
A portion of the losses recognized in the first three quarters of 1999 relating
to the Company's reinsurance operations does not receive a tax benefit, which
unfavorably impacted the effective tax rate. Additionally, a portion of the
second quarter 1999 expenses related to the merger was non-deductible for
federal income tax purposes, resulting in a tax rate that was less than the U.S.
federal statutory tax rate of 35 percent.
In the third quarter of 1999, the Company recorded a refund from the Internal
Revenue Service relating to the final settlement of remaining issues for the
1986 through 1992 tax years. The refund of taxes was $25.3 million and interest
on the refund was $31.5 million. The Company increased its tax liability $16.6
million attributable to tax
31
<PAGE>
years subsequent to 1992. Overall, including interest received and the tax
provision thereon, third quarter of 1999 results increased $29.2 million as a
result of the refund.
In the following discussion of operating results by segment, "revenue" includes
premium income, net investment income, and other income. "Income" or "loss"
excludes net realized investment gains and losses and federal income taxes.
Employee Benefits Segment Operating Results
<TABLE>
<CAPTION>
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
1999 1998 % Change 1999 1998 % Change
----- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
Premium Income
Group Long-term Disability $ 514.7 $ 457.1 12.6% $ 1,511.8 $1,331.3 13.6%
Group Short-term Disability 120.6 93.3 29.3 347.7 269.4 29.1
Group Life 290.6 253.7 14.5 866.4 733.1 18.2
Accidental Death & Dismemberment 48.0 47.7 0.6 141.9 138.1 2.8
Group Long-term Care 10.9 7.2 51.4 31.0 20.7 49.8
-------- -------- --------- --------
Total Premium Income 984.8 859.0 14.6 2,898.8 2,492.6 16.3
Net Investment Income 152.3 134.8 13.0 445.0 403.9 10.2
Other Income 34.1 29.9 14.0 101.7 89.0 14.3
-------- -------- --------- --------
Total Revenue 1,171.2 1,023.7 14.4 3,445.5 2,985.5 15.4
Benefits and Expenses 1,384.5 871.1 58.9 3,540.6 2,548.2 38.9
-------- -------- --------- --------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains $ (213.3) $ 152.6 N.M. $ (95.1) $ 437.3 N.M.
======== ======== ========= ========
</TABLE>
The Employee Benefits segment includes group long-term and short-term disability
insurance, group life insurance, accidental death and dismemberment coverages,
group long-term care, and the results of managed disability.
The increases in premium income result from strong sales trends over the past
several quarters as well as an emphasis on renewal of existing business.
However, the rate of growth in new annualized group disability and group life
sales decreased in the third quarter, and management expects that the growth
rate will be lower in the fourth quarter of 1999 as compared to the fourth
quarter of 1998. Several factors have contributed to the decrease in sales,
including rate increases, turnover in the sales force, and merger-related
activities (training, office relocation, and new processes and systems). The
Company has a number of initiatives underway to help restore sales momentum,
including targeted incentive plans, organizational changes to create a greater
focus on the customer, and enhanced communication with producers. The Company
expects that these actions will favorably impact future sales growth, but
management intends to maintain pricing discipline to balance sales growth and
profitability which will likely lead to lower long-term sales growth than
historically experienced by the Company. Employee Benefits new annualized sales
decreased 11.1 percent to $212.4 million in the third quarter of 1999 from
$238.9 million in the third quarter of 1998. New annualized sales for this
segment increased 15.5 percent to $723.3 million for the first nine months of
1999 from $626.2 million in the same period of 1998.
Revenue from the managed disability line of business, which includes GENEX
Services, Inc. and Options and Choices, Inc., totaled $27.2 million in the third
quarter of 1999 compared to $24.2 million in the third quarter of 1998. On a
year-to-date basis, this revenue was $80.4 million in 1999 compared to $71.9
million in 1998.
Group Disability
Group disability revenue increased to $764.0 million in the third quarter of
1999 compared to $666.2 million in 1998. Premium income growth was driven by
prior period sales and persistency, which was favorable and remains well within
expectations. However, as discussed above, new sales for the quarter decreased.
New annualized sales for group long-term disability were $91.9 million in the
third quarter of 1999 compared to $112.6 million in the same period of 1998. New
annualized sales for group short-term disability were $32.9 million in the third
quarter of 1999 as compared to $37.1 million in the third quarter of 1998. A
critical part of the Company's strategy for group disability during the
remainder of 1999 and 2000 involves executing an aggressive renewal program and
managing persistency, both of which management expects will have a positive
impact on future premium growth and
32
<PAGE>
profitability. The Company is implementing pricing changes in the group
disability line. Prices will increase or decrease by market segment, as
appropriate, to respond to current claim experience and various other factors
and assumptions.
Group disability reported a loss of $277.8 million for the third quarter of
1999, as compared with $95.3 million of income for the same period in 1998. As
discussed in the preceding "Accounting Policy Changes, Financial Statement
Reclassifications, and Merger Expenses," in the third quarter of 1999 the
Company revised the underlying assumptions and changed the estimate of the
ultimate cost of unpaid group long-term disability claims, resulting in a $359.2
million decrease in income. Excluding the effect of the third quarter charge,
this line reported a higher benefit ratio for its domestic business in the third
quarter of 1999 as compared with the second quarter of 1999 and the third
quarter of 1998, primarily due to lower claim resolutions. The new claim
incidence rates in the third quarter of 1999 improved relative to levels
experienced in the second quarter of 1999 and the third quarter of 1998. Small
case business continues to perform well, and large case and mid-size business
showed improvement in the third quarter of 1999. The health services sector
continues to experience higher incidence levels than average, but improved in
the third quarter of 1999. Incidence levels for the manufacturing sector also
improved, declining to the levels experienced prior to the third quarter of
1998. The level of claim incidence is being taken into account in the pricing of
new business and the renewal of existing cases. Also, as explained in more
detail below, the actual increase in claims durations was greater than assumed
in the fourth quarter of 1998 claims disruption charge, resulting in a negative
impact on the third quarter 1999 benefit ratio. Additionally, the 1998 benefit
ratio was positively impacted by the updated factors used in calculating social
security offset amounts.
Group disability reported a loss of $281.9 million for the first nine months of
1999, as compared with $291.4 million of income for the same period in 1998. The
loss was the result of the $191.7 million second quarter 1999 charge resulting
from lowering the discount rate used to calculate certain of Unum's disability
claim reserves to conform with Provident's process and assumptions and the
$359.2 million third quarter 1999 charge resulting from the revision in the
underlying assumptions used to estimate the ultimate cost of unpaid group long-
term disability claims. New annualized sales for the first nine months of 1999
were $298.9 million and $127.8 million for group long-term and short-term
disability, respectively, compared to $288.1 million and $115.1 million for the
comparable period in 1998.
Results for group disability increased $0.6 million in the third quarter and
nine months of 1999 due to the change in estimates used for the capitalization
and amortization of the costs of acquiring new business. Increased investment
income and a slight improvement in the operating expense ratio also positively
impacted third quarter and nine months 1999 group disability results.
In the fourth quarter of 1998, the Company recorded a $50.3 million charge for
the group long-term disability line of business in the Employee Benefits segment
for the expected increase in claims durations due to management's expectation
that productivity in the claims organization will be impacted as a result of
planning, consolidation, and integration efforts related to the merger.
Management expects the claims integration efforts to have some benefits,
primarily related to claims incurred in future periods, as well as the potential
for improved customer satisfaction and lower ultimate claim costs as best
practices in return-to-work and claims management are implemented. As benefits
related to the integration become known, reserve assumptions will be revised, if
appropriate. Insurance policies that are impacted by the temporary change in
claim resolution rates will not perform as anticipated when priced. However,
since the cause of the additional claim cost is of a temporary nature, it is not
anticipated to have an effect on future policy pricing. The $50.3 million
reserve increase is not considered material from a capital adequacy position.
During the first nine months of 1999, those claim operations integration
activities progressed as assumed. At December 31, 1998, management assumed the
revised group disability claim resolution rates for the first, second, and third
quarters of 1999 to be 90, 90, and 81 percent of assumptions, before adjusting
for the impact of the claim operations integration activities. The actual
experience was 89 percent for the first quarter of 1999, 90 percent for the
second quarter, and 67 percent for the third quarter. If the impact of merger-
related claim operations integration activities on claim durations had not been
anticipated at December 31, 1998, the third quarter and nine months 1999 loss
for the group long-term disability line of business would have been negatively
impacted by $15.5 million and $39.1 million, respectively. However, the
shortfall of the actual third quarter experience below that assumed resulted in
a negative effect on results in the current quarter of $11.8 million. As
discussed in Note 2 of the "Notes to Condensed Consolidated Financial
Statements," claim resolution assumptions underlying existing claim reserves
were revised in the third quarter of 1999, resulting in an increase in benefit
liabilities of $194.8 million. In selecting
33
<PAGE>
the revised claim resolution assumptions, consideration was given to claims
operations integration activities referenced here as well as other factors
expected to impact the future effectiveness of the claims operations. See Notes
2 and 3 of the "Notes to Condensed Consolidated Financial Statements" for
further discussion.
As discussed under "Cautionary Statement Regarding Forward-Looking Statements,"
certain risks and uncertainties are inherent in the Company's business.
Components of claims experience, including but not limited to, incidence levels
and claims duration, may continue for some period of time at or above the higher
levels experienced in 1998. Therefore, management continues to monitor claims
experience in group disability and responds to changes by periodically adjusting
prices, refining underwriting guidelines, changing product features, and
strengthening risk management policies and procedures. The Company expects to
price new business and re-price existing business, at contract renewal dates, in
an attempt to mitigate the effect of these and other factors, including interest
rates, on new claim liabilities. However, given the competitive market
conditions for the Company's disability products, it is uncertain whether
pricing actions can mitigate the entire effect.
Group Life, Accidental Death and Dismemberment, and Long-term Care
Group life, accidental death and dismemberment, and long-term care reported
income of $63.3 million in the third quarter of 1999 compared to $55.8 million
in the third quarter of 1998. The increase resulted from the growth in premium
income, which was driven by strong prior period sales, and a lower third quarter
1999 operating expense ratio. The results also benefited from higher net
investment income and a higher volume of business. New annualized sales
decreased slightly to $87.6 million in the third quarter of 1999 compared to
$89.2 million in the year ago quarter. Year-to-date 1999 income was $182.8
million compared to $142.1 million in 1998. The increase resulted from increased
premium income as well as a 72.7 percent benefit ratio in 1999 compared to 73.2
percent in 1998. Year-to-date new annualized sales were $296.6 million in 1999
compared to $223.0 million in 1998. Income for this line increased $0.5 million
in the third quarter of 1999 due to the change in estimates used for the
capitalization and amortization of the costs of acquiring new business.
Individual Segment Operating Results
<TABLE>
<CAPTION>
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
1999 1998 % Change 1999 1998 % Change
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
Premium Income
Individual Disability $393.7 $ 382.7 2.9% $1,168.9 $1,147.9 1.8%
Individual Life 21.5 21.4 0.5 65.9 65.4 0.8
Individual Long-term Care 24.4 15.7 55.4 65.2 43.4 50.2
------ ------- -------- --------
Total Premium Income 439.6 419.8 4.7 1,300.0 1,256.7 3.4
Net Investment Income 218.6 208.3 4.9 650.6 613.3 6.1
Other Income 12.8 19.2 (33.3) 42.1 56.9 (26.0)
------ ------- -------- --------
Total Revenue 671.0 647.3 3.7 1,992.7 1,926.9 3.4
Benefits and Expenses 579.1 568.0 2.0 1,773.1 1,687.8 5.1
------ ------- -------- --------
Income Before Federal Income Taxes
and Net Realized Investment Gains $ 91.9 $ 79.3 15.9% $ 219.6 $ 239.1 (8.2)%
====== ======= ======== ========
</TABLE>
The Individual segment includes results from the individual disability,
individual life, and individual long-term care lines of business.
Individual Disability
New annualized sales in the individual disability income line of business were
$27.9 million in the third quarter of 1999 and $31.3 million in the third
quarter of 1998. Year-to-date new annualized sales were $93.2 million, a 3.9
percent increase over the comparable period of 1998. The persistency of existing
individual disability income business continued to be favorable. Management
expects that premium income in the individual disability income line will grow
on a year-over-year basis as the product transition produces increasing levels
of new sales of individual disability products and as a result of the sales
initiatives discussed under "Employee Benefits Segment Operating Results."
34
<PAGE>
Income in the individual disability income line of business increased to $81.7
million in the third quarter of 1999 from $74.6 million in the third quarter of
1998. On a year-to-date basis, income was $188.5 million in 1999 and $215.7
million in 1998. As discussed in the preceding "Accounting Policy Changes,
Financial Statement Reclassifications, and Merger Expenses," in the second
quarter of 1999 the Company lowered the discount rate used to calculate certain
of Unum's disability claim reserves to conform with Provident's process and
assumptions, which decreased individual disability income by $38.9 million for
the second quarter and nine months of 1999.
This line reported an increase in the benefit ratio in the third quarter of 1999
compared to the third quarter of 1998, but the benefit ratio has improved from
the previous two quarters. The claim resolution rate compares unfavorably with
the third quarter 1998, but when compared to the prior three quarters, the claim
resolution rate has remained at a consistent level. Individual disability
experienced a decline in new claim levels for the second consecutive quarter,
but the level of new claims remained above that experienced in the third quarter
of 1998. This line benefited from higher net investment income and a favorable
operating expense ratio for the third quarter of 1999 as compared to the third
quarter of 1998. Income for individual disability increased $4.0 million in the
third quarter of 1999 due to the change in estimates used for the capitalization
and amortization of the costs of acquiring new business.
As noted in the "Employee Benefits Segment Operating Results," claim resolution
rates were revised downward in the fourth quarter of 1998 for claim operations
integration activities related to the merger. The Company recorded a $100.3
million charge in the fourth quarter of 1998 in the Individual segment related
to the revised claim resolution rates for individual disability. At December 31,
1998, management assumed the revised individual disability claim resolution
rates for the first, second, and third quarters of 1999 to be 90, 90, and 85
percent of assumptions, before adjusting for the impact of the claim operations
integration activities. The actual experience for the Company was 89 percent in
the first quarter, 90 percent in the second quarter, and 93 percent in the third
quarter of 1999. If the impact of merger-related claim operations integration
activities on claim durations had not been anticipated at December 31, 1998,
third quarter and year-to-date 1999 income for the individual disability line of
business would have been negatively impacted by $31.5 million and $79.1 million,
respectively. In addition, the excess of the actual third quarter experience
over that assumed resulted in a positive effect on income of $16.4 million. The
$100.3 million reserve increase in the Individual segment is not considered
material from a capital adequacy position. See Note 3 of the "Notes to Condensed
Consolidated Financial Statements" for further discussion.
Individual Life and Long-term Care
The individual long-term care line of business reported increased premium income
for the quarter and year-to-date, primarily due to new sales growth. New
annualized sales were $10.0 million and $28.1 million for the quarter and year-
to-date, an increase of 66.7 percent and 109.7 percent, respectively. The
Company expects the strong sales momentum in individual long-term care to
continue.
Income in the individual life and long-term care lines of business increased to
$10.2 million in the third quarter of 1999 from $4.7 million in the third
quarter of 1998. The primary reason was an unfavorable benefit ratio for both
individual life and long-term care in the third quarter of 1998. Year-to-date
income was $31.1 million or 32.9 percent higher than the first nine months of
1998, due primarily to the increase in premium income and an improvement in the
individual life benefit ratio. The change in estimates used for the
capitalization and amortization of the costs of acquiring new business decreased
income in this line by $1.2 million in the third quarter of 1999.
Voluntary Benefits Segment Operating Results
<TABLE>
<CAPTION>
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
1999 1998 % Change 1999 1998 % Change
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $172.4 $167.4 3.0% $516.7 $498.7 3.6%
Net Investment Income 26.7 25.0 6.8 76.8 70.4 9.1
Other Income 1.4 1.9 (26.3) 4.7 6.4 (26.6)
------ ------ ------ ------
Total Revenue 200.5 194.3 3.2 598.2 575.5 3.9
Benefits and Expenses 168.3 158.9 5.9 503.4 481.9 4.5
------ ------ ------ ------
Income Before Federal Income Taxes
and Net Realized Investment Gains $ 32.2 $ 35.4 (9.0)% $ 94.8 $ 93.6 1.3%
====== ====== ====== ======
</TABLE>
35
<PAGE>
The Voluntary Benefits segment includes the results of products sold to
employees through payroll deduction at the work site. These products include
life insurance and health products, primarily disability, accident and sickness,
and cancer.
Revenue in the Voluntary Benefits segment increased to $200.5 million in the
third quarter of 1999 from $194.3 million in the third quarter of 1998. On a
year-to-date basis, revenue for 1999 was $598.2 million compared to $575.5
million in 1998. Sales growth and favorable persistency were the primary factors
contributing to the increase in premium income. New annualized sales in this
segment were $52.0 million in the third quarter of 1999 and $53.8 million in the
comparable period of 1998. For the nine months, new annualized sales were $169.1
million in 1999 and $158.0 million in 1998. However, these sales are not
necessarily indicative of the levels that may be attained in the future. Income
in the Voluntary Benefits segment in the third quarter of 1999 was $32.2 million
versus $35.4 million in 1998. For the first nine months, income was $94.8
million in 1999 and $93.6 million in 1998. The increase in income for the nine
months is primarily due to the increase in premium income in all of the product
lines, partially offset by a slightly higher benefit ratio in the life and the
accident, sickness, and disability product lines. Income for this segment
increased $2.0 million in the third quarter of 1999 due to the change in
estimates used for the capitalization and amortization of the costs of acquiring
new business.
Other Segment Operating Results
<TABLE>
<CAPTION>
(in millions of dollars)
Three Months Ended September 30 Nine Months Ended September 30
1999 1998 % Change 1999 1998 % Change
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $ 139.4 $114.3 22.0% $ 389.6 $311.2 25.2%
Net Investment Income 110.6 119.3 (7.3) 338.6 422.1 (19.8)
Other Income 22.9 22.4 2.2 71.3 78.1 (8.7)
------- ------ -------- ------
Total Revenue 272.9 256.0 6.6 799.5 811.4 (1.5)
Benefits and Expenses 449.1 231.5 94.0 1,029.1 730.2 40.9
------- ------ -------- ------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains $(176.2) $ 24.5 N.M. $ (229.6) $ 81.2 N.M.
======= ====== ======== ======
</TABLE>
The Other operating segment includes results from reinsurance pools and
management and other products no longer actively marketed, including corporate-
owned life insurance, group pension, and individual annuities. It is expected
that revenue and income in this segment will decline over time as these business
lines wind down. Management expects to reinvest the capital supporting these
lines of business in the future growth of the Employee Benefits, Individual, and
Voluntary Benefits segments. The closed blocks of business have been segregated
for reporting and monitoring purposes. During the third quarter of 1999, the
Company recognized a charge of $193.3 million in the Other segment related to
its decision to exit the reinsurance operations.
Reinsurance Pools and Management
Premium income increased $28.2 million and $87.2 million for the three and nine
months, respectively, to $114.1 million and $317.6 million due primarily to
increased participation in the Lloyd's of London syndicates. The reinsurance
pools and management reported a loss of $191.6 million in the third quarter of
1999 compared to income of $0.8 million in the third quarter of 1998. The
reinsurance pools and management reported a loss of $278.3 million in the first
nine months of 1999 compared to income of $10.6 million in 1998. Year-to-date
income in the reinsurance pools and management line decreased $267.4 million due
to the first quarter charge of $74.1 million and the third quarter charge of
$193.3 million.
During the first quarter of 1999, the Company began a comprehensive strategic
review of its reinsurance operations to determine the appropriateness of their
fit within the context of the merged entity. These operations include the
reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk
assumption, which includes reinsurance pool participation; direct reinsurance
which includes accident and health (A&H), long-term care (LTC), and long-term
disability coverages; and Lloyd's of London (Lloyd's) syndicate participations.
In April 1999, the strategic review was completed, and the Company concluded
that these operations were not solidly aligned with the Company's strength in
the disability insurance market. The Company decided to exit these operations
through a combination of a sale, reinsurance, and/or placing certain components
in run-off. The Company recorded a first quarter charge of $74.1 million in the
Other segment.
36
<PAGE>
During the third quarter of 1999, the Company continued its efforts to sell its
reinsurance management operations. No potential buyers expressed interest in
acquiring the entire domestic and international reinsurance management
operations. However, in early October, the Company entered into an agreement to
sell the reinsurance management operations of its A&H and LTC reinsurance
facilities and to reinsure the Company's risk participation in these facilities.
Because of the limited interest expressed by potential buyers in the reinsurance
management operations, the Company reevaluated its strategy to exit the
reinsurance operations. The Company decided to continue to operate its North
America long-term disability reinsurance operation and to refocus it with the
objective of improving profitability. With respect to Lloyd's, the Company
decided to implement a strategy which limits participation in year 2000
underwriting risks, ceases participation in Lloyd's underwriting risks after
year 2000, and manages the run-off of its risk participation in open years of
account of Lloyd's reinsurance syndicates. The Company has also decided to
discontinue its accident reinsurance business in London beginning in year 2000.
During the third quarter, the Company recognized a charge of $193.3 million in
the Other segment and $28.7 million in the Corporate segment related to the
write-off of goodwill. See Note 4 of the "Notes to Condensed Consolidated
Financial Statements" for further discussion of the 1999 charges related to the
reinsurance businesses.
As discussed in the preceding "Accounting Policy Changes, Financial Statement
Reclassifications, and Merger Expenses," the Company lowered the discount rate
used to calculate certain of Unum's disability claim reserves to conform with
Provident's process and assumptions, which decreased group long-term disability
reinsurance second quarter and nine months 1999 income by $10.1 million.
In the fourth quarter of 1998, the Company recorded a $2.4 million charge
related to the revised claim resolution rates for group long-term disability
reinsurance. If the impact of merger-related claim operations integration
activities on claim duration had not been anticipated at December 31, 1998,
third quarter and nine months 1999 income for the reinsurance pools and
management line of business would have been negatively impacted by $0.6 million
and $1.8 million, respectively. See Note 3 of the "Notes to Condensed
Consolidated Financial Statements" for further discussion.
Corporate-Owned Life
Income from this line of business decreased to $7.5 million in the third quarter
of 1999 compared to $9.6 million in the same period of 1998. Income was $21.7
million in the first nine months of 1999 versus $20.6 million in 1998. The nine
month results reflect slightly higher premium income and wider spreads between
interest earned and credited rates.
Group Pension
Income in the group pension line of business was $7.3 million in the third
quarter of 1999 and $7.7 million in the third quarter of 1998. For the first
nine months, income was $21.9 million in 1999 compared to $22.0 million in 1998.
On a year-to-date basis, the 1998 results were lower due to a $1.9 million
charge for guaranty fund assessments. The run-off of the group pension line
results in a decline in assets under management and, in turn, a continued
decline in the net investment income produced by the assets.
Individual Annuities
In the second quarter of 1998, the Company closed the sale of Provident's in-
force individual and tax-sheltered annuity business to affiliates of American
General Corporation (American General). The sale was effected by reinsurance in
the form of 100 percent coinsurance agreements. The in-force business sold
consisted primarily of individual fixed annuities and tax-sheltered annuities.
In addition, American General acquired a number of miscellaneous group pension
lines of business sold in the 1970s and 1980s which were no longer actively
marketed. The sale did not include Provident's block of guaranteed investment
contracts or group single premium annuities, which will continue in a run-off
mode. In consideration for the transfer of the approximately $2.4 billion of
statutory reserves, American General paid the Company a ceding commission of
approximately $58.0 million. The before-tax gain included in other income for
the second quarter and nine months of 1998 was $12.2 million.
37
<PAGE>
Other
Effective January 1, 1998, the Company entered into an agreement with
Connecticut General Life Insurance Company (Connecticut General) for Connecticut
General to reinsure, on a 100 percent coinsurance basis, its in-force medical
stop-loss insurance coverages sold to clients of CIGNA Healthcare and its
affiliates (CIGNA). This reinsured block constitutes substantially all of the
Company's medical stop-loss insurance business. The small portion remaining
consists of medical stop-loss coverages sold to clients other than those of
CIGNA. The medical stop-loss business produced revenue of $14.1 million in 1998.
Corporate Segment Operating Results
The Corporate segment includes investment income on corporate assets not
specifically allocated to a line of business, corporate interest expense,
amortization of goodwill, and certain corporate expenses not allocated to a line
of business.
Revenue in the Corporate segment was $39.6 million in the third quarter of 1999
and $7.2 million in the third quarter of 1998. For the first nine months,
revenue was $54.6 million in 1999 and $24.0 million in 1998. Included in the
third quarter and nine months 1999 revenue is $31.5 million of interest income
on an accrued refund of taxes from the Internal Revenue Service relating to the
final settlement of remaining issues for the 1986 through 1992 tax years, as
previously discussed under "Consolidated Operating Results."
The Corporate segment reported a loss of $75.3 million in the third quarter of
1999 compared to a loss of $32.3 million in the third quarter of 1998. On a
year-to-date basis, the losses were $453.2 million for 1999 and $93.3 million
for 1998. Interest and debt expense increased to $34.3 million and $100.8
million for the third quarter and nine months of 1999 compared to $27.7 million
and $82.7 million for the comparable periods of 1998 due to a higher average
debt balance. In addition, the Company recorded write-downs of goodwill of $27.0
million, $2.0 million, and $28.7 million in the 1999 first, second, and third
quarters, respectively, related to its reinsurance operations. See previous
discussions under "Consolidated Operating Results," "Other Segment Operating
Results," and Note 4 of the "Notes to Condensed Consolidated Financial
Statements."
As discussed in the preceding "Accounting Policy Changes, Financial Statement
Reclassifications, and Merger Expenses," during the second and third quarters of
1999, the Company recognized $310.6 million of before-tax expenses related to
the merger and the early retirement offer to employees. The breakdown of these
expenses by quarter is as follows:
<TABLE>
<CAPTION>
1999
-------------------------
2nd 3rd
(in millions of dollars)
-------------------------
<S> <C> <C>
Employee related expense $ 45.2 $ 32.5
Exit activities related to duplicate facilities/asset abandonments 57.4 10.0
Investment banking, legal, and accounting fees 39.6 -
------- ------
Subtotal 142.2 42.5
Expense related to the early retirement offer to employees 125.9 -
------- ------
Subtotal 268.1 42.5
Income tax benefit 74.3 14.9
------- ------
Total $ 193.8 $ 27.6
======= ======
</TABLE>
Employee related expense consists of employee severance costs, change in control
costs, restricted stock costs which fully vested upon stockholder adoption of
the merger agreement or upon completion of the merger, and outplacement costs to
assist employees who have been involuntarily terminated. Severance benefits and
change in control costs are $60.2 million, and costs associated with the vesting
of restricted stock are $17.5 million. The Company now estimates that in total
approximately 1,615 positions will be eliminated over a twelve month period
beginning June 30, 1999, 215 positions higher than the original estimate of
1,400. Approximately 1,000 of these positions will be eliminated through the
early retirement offer. At September 30, 1999, approximately 500 and 160
positions have been eliminated as a result of the early retirement offer and
involuntary terminations, respectively, and $13.3 million of the estimated $60.2
million has been paid for severance benefits and change in control costs.
38
<PAGE>
Exit activities related to duplicate facilities/asset abandonments consist of
closing of duplicate offices and write-off of redundant computer hardware and
software. The Company currently expects to close approximately 90 duplicate
field offices over a period of one year after June 30, 1999, the completion date
of the merger. The cost associated with these office closures is approximately
$25.6 million, which represents the cost of future minimum lease payments less
any estimated amounts recovered under subleases. As of September 30, 1999, $2.3
million of this estimated liability has been paid. Also, certain physical
assets, primarily computer equipment, redundant systems, and systems incapable
of supporting the combined entity, have been abandoned as a result of the
merger. This abandonment resulted in a write-down of the assets' book values by
approximately $31.8 million during the second quarter of 1999. During the third
quarter, hardware and software abandonments increased $10.0 million due to the
identification of additional software redundancies. Approximately $27.7 million
of assets were abandoned and removed from service on the date the merger was
consummated. Of the remaining $14.1 million of identified abandonments, $10.5
million were removed from service during the third quarter and $3.6 million are
expected to be abandoned during the fourth quarter of 1999.
These expenses are $77.6 million higher on a before-tax basis than the estimated
expenses disclosed in the Joint Proxy Statement/Prospectus of Unum and Provident
dated June 2, 1999. This increase results from approximately 350 more employees
than estimated accepting the early retirement offer, approximately 215
additional positions which will be eliminated during the twelve month post-
merger period, additional change in control costs of $27.4 million recognized in
the third quarter, and the identification of additional software redundancies.
In addition to the expenses described above, in the three and nine months ended
September 30, 1999, the Company expensed $4.7 million and $24.7 million,
respectively, of other incremental costs associated with the merger, $4.7
million and $21.8 million of which are included in the Corporate segment. These
expenses consist primarily of compensation, training, integration, and licensing
costs.
The financial statements do not reflect any benefit expected from revenue
enhancements or derived from potential cost savings related to the merger.
Although management anticipates revenue enhancements and costs savings will
result from the merger, there can be no assurance that these items will be
achieved. Economies of scale, the elimination of duplicative expenditures, and
the consistent use of the best practices of Provident and Unum are expected to
enable the Company to achieve annual cost savings of approximately $130 million
in 2000. In the third quarter of 1999 the Company realized expense savings of
approximately $20.0 million compared to the second quarter of 1999.
Investments
Investment activities are an integral part of the Company's business, and
profitability is significantly affected by investment results. Invested assets
are segmented into portfolios, which support the various product lines.
Generally, the investment strategy for the portfolios is to match the effective
asset durations with related expected liability durations and to maximize
investment returns, subject to constraints of quality, liquidity,
diversification, and regulatory considerations. During the quarter ending
September 30, 1999, the Company actively pursued its strategy of extending the
duration of its investments and shifting the mix of assets for approximately
$2.1 billion of its investments. This program was approximately two-thirds
complete as of September 30, 1999. Management believes this strategy will reduce
its vulnerability to interest rate risk in the future and anticipates that, as a
result, investment income may increase on an annualized basis approximately $30
million.
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately $2.3
billion on an amortized cost basis at September 30, 1999, and $2.1 billion at
December 31, 1998. At September 30, 1999, the mortgage-backed securities had an
average life of 12.2 years and effective duration of 10.4 years. The mortgage-
backed securities are valued on a monthly basis using valuations supplied by the
brokerage firms that are dealers in these securities. The primary risk involved
in investing in mortgage-backed securities is the uncertainty of the timing of
cash flows from the underlying loans due to prepayment of principal. The Company
uses models which incorporate economic variables and possible future interest
rate scenarios to predict future prepayment rates. The Company has not
39
<PAGE>
invested in mortgage-backed derivatives, such as interest-only, principal-only
or residuals, where market values can be highly volatile relative to changes in
interest rates.
Below-investment-grade bonds are inherently more risky than investment-grade
bonds since the risk of default by the issuer, by definition and as exhibited by
bond rating, is higher. Also, the secondary market for certain below-investment-
grade issues can be highly illiquid. Management does not anticipate any
liquidity problem caused by the investments in below-investment-grade
securities, nor does it expect these investments to adversely affect its ability
to hold its other investments to maturity.
The Company's exposure to below-investment-grade fixed maturity securities at
September 30, 1999, was $1,896.3 million, representing 7.2 percent of invested
assets, below the Company's internal limit of 10.0 percent of invested assets
for this type of investment. The Company's exposure to below-investment-grade
fixed maturities totaled $1,452.6 million at December 31, 1998, representing 5.3
percent of invested assets.
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $1,288.0 million and $1,321.2 million
at September 30, 1999, and December 31, 1998, respectively. The Company uses a
comprehensive rating system to evaluate the investment and credit risk of each
mortgage loan and to identify specific properties for inspection and
reevaluation. The Company establishes allowances for probable mortgage loan
losses based on a review of individual loans and the overall loan portfolio,
considering the value of the underlying collateral.
The mortgage loan portfolio is well diversified geographically and among
property types. The incidence of new problem mortgage loans and foreclosure
activity has remained low in 1999 and 1998, reflecting improvements in overall
economic activity and improving real estate markets in the geographic areas
where the Company has mortgage loans. Management expects the level of
delinquencies and problem loans to remain low in the future.
At September 30, 1999, and December 31, 1998, impaired loans totaled $18.2
million and $20.7 million, respectively. Included in the impaired loans at
September 30 were $6.7 million of loans which had a related, specific allowance
for probable losses of $2.4 million and $11.5 million of loans which had no
related, specific allowance for probable losses. Impaired mortgage loans are not
expected to have a material impact on the Company's liquidity, financial
position, or results of operations.
Restructured mortgage loans totaled $9.2 million at September 30, 1999, compared
to $14.5 million at December 31, 1998, and represent loans that have been
refinanced with terms more favorable to the borrower. Interest lost on
restructured loans was immaterial for the nine and twelve month periods ended
September 30, 1999, and December 31, 1998.
Real estate was $288.4 million and $309.8 million at September 30, 1999, and
December 31, 1998. Investment real estate is carried at cost less accumulated
depreciation. Real estate acquired through foreclosure is valued at fair value
at the date of foreclosure and may be classified as investment real estate if it
meets the Company's investment criteria. If investment real estate is determined
to be permanently impaired, the carrying amount of the asset is reduced to fair
value. Occasionally, investment real estate is reclassified to real estate held
for sale when it no longer meets the Company's investment criteria. Real estate
held for sale, which is valued net of a valuation allowance that reduces the
carrying value to the lower of cost or fair value less estimated cost to sell,
amounted to $145.9 million at September 30, 1999, and $15.6 million at December
31, 1998. The Company sold four properties held for sale during the quarter
ending September 30, 1999 and reasonably expects to sell the remaining held for
sale properties during the fourth quarter of 1999 or in 2000. These sales are
not expected to have a material impact on the Company's liquidity, financial
position, or results of operations.
Allowances for probable losses on mortgage loans and real estate held for sale
are established based on a review of specific assets as well as on an overall
portfolio basis, considering the value of the underlying assets and collateral.
If a decline in value is considered to be other than temporary or if the asset
is deemed permanently impaired, the investment is reduced to estimated net
realizable value, and the reduction is recorded as a realized investment loss.
The allowance for probable losses on mortgage loans and real estate was $32.9
million and $39.9 million, respectively, at September 30, 1999. Management
monitors the risk associated with the invested asset portfolio and regularly
reviews and adjusts the allowance for probable losses.
40
<PAGE>
Other
The Company's exposure to non-current investments totaled $21.6 million at
September 30, 1999, or 0.1 percent of invested assets. These non-current
investments are foreclosed real estate held for sale and fixed income securities
and mortgage loans that became more than thirty days past due in principal and
interest payments.
The Company utilizes forward interest rate swaps, forward treasury purchases,
and options on forward interest rate swaps or forward treasuries to manage
duration and increase yield on cash flows expected from current holdings. All
transactions are hedging in nature and not speculative. Almost all transactions
are associated with the individual and group disability product portfolio. All
other product portfolios are periodically reviewed to determine if hedging
strategies would be appropriate for risk management purposes.
Liquidity and Capital Resources
The Company's liquidity requirements are met primarily by cash flows provided
from operations, principally in its insurance subsidiaries. Premium and
investment income, as well as maturities and sales of invested assets, provide
the primary sources of cash. Cash is applied to the payment of policy benefits,
costs of acquiring new business (principally commissions) and operating expenses
as well as purchases of new investments. The Company has established an
investment strategy that management believes will provide for adequate cash
flows from operations. Cash flows from operations were $1,153.2 million for the
nine months ended September 30, 1999, as compared to $1,212.2 million in the
comparable period in 1998.
The Company believes the cash flows from its operations will be sufficient to
meet its operating and financial cash flow requirements excluding the strain
placed on capital as a result of the charges recorded in connection with the
merger and the early retirement program. As a result of the effect of the second
and third quarter reserve increases, the merger related expenses, and the cost
of the early retirement program on capital, the Company will need to raise
approximately $500 million during the fourth quarter of 1999. The Company
expects to raise the capital for its insurance subsidiaries through the debt
markets. In early November, the Company increased its bank facility and
commercial paper program by $500 million and is currently exploring alternative
financing sources to further increase its financial flexibility. The Company
intends to file a shelf registration during the first quarter of 2000 in order
to provide funding flexibility through the issuance of debt or equity
securities. The funding will be used to refinance, on a long-term basis, the
capital need referenced above and to fund internal expansion, acquisitions,
investment opportunities, and the retirement of the Company's debt and equity.
At September 30, 1999, the Company had short-term and long-term debt totaling
$531.0 million and $1,216.3 million, respectively. At September 30, 1999,
approximately $193.8 million was available for additional financing under the
existing revolving credit facility.
In the fourth quarter of 1997, the Company borrowed $168.3 million through a
private placement. Under the terms of the agreement, the investor exercised the
right to redeem the private placement at par value during the second quarter of
1999. The Company refinanced this debt by issuing $200.0 million of variable
rate medium-term notes in June of 1999, due in June of 2000. The notes had an
interest rate of 5.135% at September 30, 1999.
In 1998, the Company rescinded its stock repurchase program as a result of the
pending merger. As a result, no shares of common stock were repurchased during
the first nine months of 1999. During the first nine months of 1998, the Company
acquired approximately 1.4 million shares of its common stock in the open market
at an aggregate cost of $72.7 million. At the completion of the merger, Unum
common stock held in treasury was retired.
Ratings
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's), and
A.M. Best Company (AM Best) are among the third parties that provide the Company
assessments of its overall financial position. Ratings from these agencies for
financial strength are available for the individual U.S. domiciled insurance
company subsidiaries. Financial strength ratings are based primarily on U.S.
statutory financial information for the individual U.S. domiciled insurance
companies. Debt ratings for the Company are based primarily on consolidated
financial information prepared using generally accepted accounting principles.
Both financial strength ratings and debt ratings incorporate qualitative
analyses by rating agencies on an ongoing basis.
41
<PAGE>
The rating agencies reviewed and, in some instances, revised their ratings to
reflect the completion of the merger. The table below reflects the most recent
debt ratings for the Company and the financial strength ratings for the U.S.
domiciled insurance company subsidiaries. On October 12, 1999, Moody's placed
the ratings on review for possible downgrade. On November 3, S&P placed its
ratings on CreditWatch with negative implications. On November 4, AM Best placed
a negative rating outlook on its current ratings. Duff & Phelps has removed all
ratings of the Company from its previous Rating Watch-Up status and reaffirmed
the ratings at their current levels. Should downgrades occur, the Company does
not expect that sales will be materially impacted.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
S&P Moody's Duff & Phelps AM Best
--- ------- ------------- -------
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
UnumProvident Corporation
- ------------------------------------------------------------------------------------------------------------------------
Senior Debt A (Strong) A2 (Upper Medium A- Not Rated
Grade) (Investment Grade)
- ------------------------------------------------------------------------------------------------------------------------
Junior Subordinated Debt BBB+ (Good) A3 (Upper Medium BBB+ Not Rated
Grade) (Investment Grade)
- ------------------------------------------------------------------------------------------------------------------------
Commercial Paper A-1 (Strong) Prime-1 (Superior Not Rated Not Rated
Ability)
- ------------------------------------------------------------------------------------------------------------------------
U.S. Insurance Subsidiaries
- ------------------------------------------------------------------------------------------------------------------------
Provident Life & Accident AA- (Very Strong) Aa3 (Excellent) AA-(Secure/ A+ (Superior)
Investment Grade)
- ------------------------------------------------------------------------------------------------------------------------
Provident Life & Casualty Not Rated Not Rated Not Rated A+ (Superior)
- ------------------------------------------------------------------------------------------------------------------------
Provident National Assurance Not Rated Aa3 (Excellent) AA-(Secure/ A+ (Superior)
Investment Grade)
- ------------------------------------------------------------------------------------------------------------------------
Unum Life of America AA- (Very Strong) Aa3 (Excellent) Not Rated A+ (Superior)
- ------------------------------------------------------------------------------------------------------------------------
First Unum Life AA- (Very Strong) Aa3 (Excellent) Not Rated A+ (Superior)
- ------------------------------------------------------------------------------------------------------------------------
Colonial Life & Accident AA- (Very Strong) Aa3 (Excellent) Not Rated A+ (Superior)
- ------------------------------------------------------------------------------------------------------------------------
Paul Revere Life AA- (Very Strong) Aa3 (Excellent) AA-(Secure/ A+ (Superior)
Investment Grade)
- ------------------------------------------------------------------------------------------------------------------------
Paul Revere Variable AA- (Very Strong) Aa3 (Excellent) Not Rated A+ (Superior)
- ------------------------------------------------------------------------------------------------------------------------
Paul Revere Protective AA- (Very Strong) Aa3 (Excellent) Not Rated A+ (Superior)
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Year 2000 Date Conversion
As are many other businesses in this country and abroad, the Company is affected
in numerous ways, both by its own computer information systems and by third
parties with which it has business relationships, in the processing of date data
relating to the year 2000 and beyond. Failure to adequately address and
substantially resolve year 2000 issues could, and as to mission critical systems
in certain circumstances would, have a material adverse effect on the Company's
business, results of operations, or financial condition. While there can be no
assurance as to its success, the Company has a project underway which is
intended and designed to avoid and/or mitigate any such material adverse effect
from year 2000 issues.
The Company's program for the year 2000 is organized into a number of phases for
rectifying its internal computer systems, including assessment, code
remediation, testing and deployment. As of September 30, 1999, the Company had
completed the assessment and code remediation phases for all of its critical and
non-critical business systems with over 95 percent completing the compliance
testing phase. Deployment is substantially completed for most critical and non-
critical systems. As previously discussed in Provident's and Unum's Annual
Reports on Form 10-K/A, management continues to expect completion of all phases
by the end of 1999.
There are numerous instances in which third parties having a relationship with
the Company have year 2000 issues to address and resolve. These include, among
others, vendors of hardware and software, holders of group insurance policies,
issuers of investment securities, financial institutions, governmental agencies,
and suppliers. An aspect of the Company's year 2000 program has been to assess
its critical external dependencies and, as part of its due diligence efforts, to
contact certain third parties seeking written assurance as to their expectancy
to be year 2000 compliant. The nature of the Company's follow up to its written
requests to third parties depends upon its assessment of the response and of the
materiality of the effect of non-compliance by the third party on the Company.
In some instances the Company is performing site visits to certain third party
businesses and testing their systems for compliance. In addition, the Company is
testing external electronic interfaces with certain critical business partners.
42
<PAGE>
To date, no significant issues from critical external dependencies have been
identified; however, there can be no guarantee that the computer systems of
these third parties will be year 2000 compliant. The Company has finalized and
implemented contingency plans to alleviate the potential business impact of
third parties not being year 2000 compliant.
The effort of internal business and systems personnel devoted to the project has
been considerable. Temporary personnel and subject matter consultants have been
utilized, when appropriate, to assist full time personnel in some phases or
aspects of the project. The Company has utilized compensation programs to retain
project personnel in order to keep the project on schedule. While the project
has required systems management to more closely scrutinize the prioritization of
information technology projects, it is not believed that any deferral of
information technology projects has had a material impact on the Company. The
Company has also had occasional contact with certain peer companies comparing
approaches to year 2000 issues.
Given the range of possibilities that may occur in connection with non-
compliance with year 2000 that could affect the Company, particularly as a
consequence of third parties, the Company is unable to provide an estimate of
the impact of such non-compliance on its business, results of operations, or
financial condition. With regard to non-compliance resulting from the Company's
systems, which the Company believes to be less likely than that resulting from
third parties, the Company would devote its financial and personnel resources to
remediate the problem as soon as possible. With regard to non-compliance
resulting from third party failure, the Company is finalizing appropriate
contingency arrangements that will minimize such impact; however, given the
range of possibilities, no assurance can be given that the Company's efforts
will be successful. In addition, the Company is developing detailed plans for
activities for managing the year-end rollover period. This includes plans for
appropriate backup of data, year-end processing schedules, limiting
installations of new code, and the availability of special response teams tasked
with identifying and resolving any issues which might occur during the rollover
period. These teams include both information technology and business
professionals.
The foregoing discussion of the year 2000 issue contains forward-looking
statements relating to such matters as financial performance and the business of
the Company. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor for forward-looking statements. In order for the Company to comply
with the terms of the safe harbor, the Company notes that a variety of factors
could cause the Company's actual results and experience relating to compliance
with year 2000 to differ materially from the anticipated results or other
expectations expressed in the Company's forward-looking statements concerning
year 2000 issues, which involve certain risks and uncertainties. These factors
include (i) the unanticipated material impact of a system fault of the Company
relating to year 2000, (ii) the failure to successfully remediate, in spite of
testing, material systems of the Company, (iii) the time it may take to
successfully remediate a failure once it occurs, as well as the resulting costs
and loss of revenues, and (iv) the failure of third parties to properly
remediate material year 2000 problems.
Since inception of the project, the Company has expensed approximately $30.3
million through September 30, 1999, in connection with incremental cost of the
year 2000 project and estimates an additional $2.1 million to complete the
project. The costs of the project and the date on which the Company plans to
complete year 2000 modifications are based on management's best estimates,
derived using numerous assumptions about future events. However, there can be no
guarantee that these estimates will be achieved, and actual results could differ
materially from those plans. See Part II, Item 7 of Provident's and Unum's
Annual Reports on Form 10-K/A for further discussion of the year 2000 issues.
43
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is subject to various market risk exposures including interest rate
risk and foreign exchange rate risk. The Company employs various derivative
programs to manage these material market risks. The operations of the Company
are subject to risk resulting from interest rate fluctuations, primarily long-
term U.S. interest rates. Changes in interest rates and individuals' behavior
affect the amount and timing of asset and liability cash flows. Management
continually models and tests asset and liability portfolios to improve interest
rate risk management and net yields. Testing the asset and liability portfolios
under various interest rate and economic scenarios allows management to choose
the most appropriate investment strategy within acceptable risk tolerances. This
analysis is the precursor to the Company's activities in derivative financial
instruments. The Company uses interest rate swaps, interest rate forward
contracts, exchange-traded interest rate futures contracts, and options to hedge
interest rate risks and to match asset durations and cash flows with
corresponding liabilities.
The Company is also subject to foreign exchange risk arising from its foreign
operations and certain foreign dollar denominated investment securities. Foreign
operations represent 6.7 percent and 6.5 percent of total assets at September
30, 1999 and December 31, 1998, respectively, and 9.2 percent and 8.6 percent of
total revenue for the nine month periods ended September 30, 1999 and 1998,
respectively. At September 30, 1999, there were no outstanding derivatives
hedging this foreign currency risk.
For further discussion of the qualitative and quantitative aspects of market
risk, including derivative financial instrument activity, see Part II, Items 7,
7A, and 8 of Provident's and Unum's Annual Reports on Form 10-K/A, in each case
for the fiscal year ended December 31, 1998, and Item 7 of the Company's Form 8-
K filed September 2, 1999 for the fiscal year ended December 31, 1998. During
the first nine months of 1999, there was no substantive change to the Company's
market risk.
44
<PAGE>
REVIEW BY INDEPENDENT AUDITORS
The condensed consolidated financial statements at September 30, 1999, and for
the three month and nine month periods then ended, have been reviewed, prior to
filing, by Ernst & Young LLP, the Company's independent auditors, and their
report is included herein.
45
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 10.1 Form of Change in Control Severance Agreement
Exhibit 15 Letter re unaudited interim financial
information
Exhibit 27 Financial data schedules (for SEC use only)
(b) Reports on Form 8-K
Form 8-K filed on August 5, 1999, reporting second quarter 1999
financial results.
Form 8-K filed September 2, 1999, in which the historical
financial results presented therein gave effect to the merger of
Unum Corporation and Provident Companies, Inc., which was
completed June 30, 1999, as if it had been completed at the
beginning of the earliest period presented.
46
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UnumProvident Corporation
(Registrant)
Date: November 12, 1999
/s/J. Harold Chandler
----------------------------------------
J. Harold Chandler
Chairman, President, and Chief Executive
Officer
Date: November 12, 1999
/s/Thomas R. Watjen
----------------------------------------
Thomas R. Watjen
Executive Vice President, Finance and
Risk Management
Date: November 12, 1999
/s/Robert E. Broatch
----------------------------------------
Robert E. Broatch
Senior Vice President and Chief
Financial Officer
47
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
to
FORM 10-Q
UNUMPROVIDENT CORPORATION
48
<PAGE>
INDEX OF EXHIBITS
EXHIBIT
Exhibit 10.1 Form of Change in Control Severance Agreement
Exhibit 15 Letter re unaudited interim financial information
Exhibit 27 Financial data schedules (for SEC use only)
49
<PAGE>
CHANGE IN CONTROL SEVERANCE AGREEMENT
AGREEMENT by and between UNUMProvident Corporation, a Delaware
corporation having its principal executive offices in Portland, Maine and
Chattanooga, Tennessee (the "Company"), and (the "Executive")
dated as of the day of.
The Company has determined that it is in the best interests of its
shareholders to provide the Company with continuity of management, including the
continued dedication of Executive. Therefore, in order to accomplish these
objectives, the Executive and the Company desire to enter into this Agreement.
NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:
1. Effective Date. The "Effective Date" shall mean September 30,
1999, provided the Executive is employed by the Company on such date. As of the
date hereof, the prior Severance Agreement effective October 30, 1997 ("Former
Severance Agreement") between the Executive and the Company (or Provident
Companies, Inc. or UNUM Corporation) shall terminate and become null and void.
2. Term of Agreement. The Company hereby agrees that the term of
this Agreement shall be for the period commencing on the Effective Date and
ending on the second anniversary of the Effective Date (the "Initial Term").
Beginning on the second anniversary of the Effective Date, the Initial Term
shall be automatically extended for one year terms unless either the Company or
the Executive shall give the other party not less than ninety (90) days prior
written notice of the intention to terminate this Agreement.
3. Termination of Employment.
(a) Death or Disability. The Executive's employment shall
terminate automatically upon the Executive's death. If the Company determines in
good faith that the Disability of the Executive has occurred (pursuant to the
definition of Disability set forth below), it may give to the Executive written
notice in accordance with Section 10(b) of this Agreement of its intention to
terminate the Executive's employment. In such event, the Executive's employment
with the Company shall terminate effective on the 30th day after receipt of such
notice by the Executive (the "Disability Effective Date"), provided that, within
the 30 days after such receipt, the Executive shall not have returned to full-
time performance of the Executive's duties. For purposes of this Agreement,
"Disability" shall mean the absence of the Executive from the Executive's duties
with the Company on a full-time basis for 180 business days during any
consecutive twelve month period as a result of incapacity due to mental or
physical illness which is determined to be total and permanent by a physician
selected by the Company or its insurers and acceptable to the Executive or the
Executive's legal representative.
<PAGE>
(b) Cause. The Company may terminate the Executive's
employment for Cause. For purposes of this Agreement, "Cause" shall mean:
(i) the continued failure of the Executive to perform
substantially the Executive's duties with the Company or one of its
affiliates (other than any such failure resulting from incapacity due to
physical or mental illness), after a written demand for substantial
performance is delivered to the Executive by the Chief Executive Officer of
the Company ("CEO") or the Chief Operating Officer of the Company ("COO")
which specifically identifies the manner in which the CEO or COO believes
that the Executive has not substantially performed the Executive's duties,
or
(ii) the willful engaging by the Executive in illegal
conduct (as determined by the Company after due inquiry) or gross
misconduct which is materially and demonstrably injurious to the Company,
or
(iii) conviction of a felony or guilty or nolo
contendere plea by the Executive with respect thereto.
For purposes of this provision, no act or failure to act, on the part of the
Executive, shall be considered "willful" unless it is done, or omitted to be
done, by the Executive in bad faith or without reasonable belief that the
Executive's action or omission was in the best interests of the Company. Any
act, or failure to act, based upon authority given pursuant to a resolution duly
adopted by the Board or upon the instructions of the CEO or COO or based upon
the advice of counsel for the Company shall be conclusively presumed to be done,
or omitted to be done, by the Executive in good faith and in the best interests
of the Company. The cessation of employment of the Executive shall not be deemed
to be for Cause unless and until there shall have been delivered to the
Executive written notice signed by the CEO or COO of the Company of an event
constituting cause within ninety days of the Company's knowledge of its
existence.
(c) Good Reason. The Executive's employment may be terminated
by the Executive for Good Reason. For purposes of this Agreement, "Good Reason"
shall mean in the absence of a written consent of the Executive:
(i) the assignment to the Executive of any duties
inconsistent with the Executive's position (including status, offices,
titles and reporting requirements), authority, duties or responsibilities,
or any other action by the Company which results in a diminution in such
position, authority, duties or responsibilities, excluding for this purpose
an isolated, insubstantial and
-2-
<PAGE>
inadvertent action not taken in bad faith and which is remedied by the
Company promptly after receipt of written notice thereof given by the
Executive within 30 days of knowledge of such action;
(ii) reduction in annual base salary or annual target
bonus as in effect prior to a Change in Control other than an isolated,
insubstantial and inadvertent failure not occurring in bad faith and which
is remedied by the Company promptly after receipt of written notice thereof
given by the Executive within 30 days of knowledge of such action;
(iii) the failure of the Company to (A) continue in
effect any employee benefit plan, compensation plan, welfare benefit plan
or material fringe benefit plan in which Executive is participating
immediately prior to such Change in Control or the taking of any action by
the Company which would adversely affect Executive's participation in or
reduce Executive's benefits under any such plan, unless Executive is
permitted to participate in other plans providing Executive with
substantially equivalent benefits in the aggregate (at substantially
equivalent cost with respect to welfare benefit plans), or (B) provide
Executive with paid vacation in accordance with the most favorable
vacation, policies of the Company as in effect for Executive immediately
prior to such Change in Control, including the crediting of all service for
which Executive had been credited under such vacation policies prior to the
Change in Control;
(iv) any failure by the Company to comply with and
satisfy Section 9(c) of this Agreement; or
(v) any required relocation of the Executive
following a Change in Control (as defined herein) of more than 50 miles
from Executive's principal business office shall be considered to
constitute Good Reason.
(d) Change in Control. For purposes of this Agreement,
"Change of Control" shall mean the occurrence of any one of the following
events, with the exception of the merger of Unum Corporation and Provident
Companies pursuant to the Agreement and Plan of Merger dated as of November 22,
1998 as amended as of May 25, 1999 and consummated on June 30, 1999:
(i) during any period of two consecutive years,
individuals who, at the beginning or such period, constitute the Board (the
"Incumbent Directors") cease for any reason to constitute at least a
majority of the Board, provided that any person becoming a director and
whose election or
-3-
<PAGE>
nomination for election was approved by a vote of at least two-thirds of
the Incumbent Directors then on the Board (either by a specific vote or by
approval of the proxy statement of the Company in which such person is
named as a nominee for director, without written objection to such
nomination) shall be an Incumbent Director; provided, however, that no
-------- -------
individual initially elected or nominated as a director of the Company as a
result of an actual or threatened election contest (as described in Rule
14a-11 under the Act) ("Election Contest") or other actual or threatened
solicitation of proxies or consents by or on behalf of any "person" (as
such term is defined in Section 3(a)(9) of the Act and as used in Sections
13(d)(3) and 14(d)(2) of the Act) other than the Board ("Proxy Contest"),
including by reason of any agreement intended to avoid or settle any
Election or Contest or Proxy Contest, shall be deemed an Incumbent
Director;
(ii) any person is or becomes a "beneficial owner" (as
defined in Rule 13d-3 under the Act), directly or indirectly, of securities
of the Company representing 20% or more of the combined voting power of the
Company's then outstanding securities eligible to vote for the election of
the Board (the "Company Voting Securities"); provided, however, that the
-------- -------
event described in this paragraph (ii) shall not be deemed to be a Change
in Control of the Company by virtue of any of the following acquisitions:
(A) by the Company of any subsidiary, (B) by any employee benefit plan (or
related trust) sponsored or maintained by the Company or any subsidiary,
(C) by an underwriter temporarily holding securities pursuant to an
offering of such securities, (D) pursuant to a Non-Qualifying Transaction
(as defined in paragraph (iii), or (E) a transaction (other than one
described in (iii) below) in which Company Voting Securities are acquired
from the Company, if a majority of the Incumbent Directors approve a
resolution providing expressly that the acquisition pursuant to this clause
(E) does not constitute a Change in Control of the Company under this
paragraph (ii);
(iii) the consummation of a merger, consolidation,
statutory share exchange or similar form of corporate transaction involving
the Company or any of its subsidiaries that requires the approval of the
Company's stockholders, whether for such transaction or the issuance of
securities in the transaction (a "Reorganization"), or sale or other
disposition of all or substantially all of the Company's assets to an
entity that is not an affiliate of the Company (a "Sale"), unless
immediately following such Reorganization or Sale: (A) more than 50% of the
total voting power of (x) the corporation resulting from such
Reorganization or the corporation which has acquired all or substantially
all of the assets of the Company (in either case, the "Surviving
Corporation"), or (y) if applicable, the ultimate parent corporation that
directly or indirectly has beneficial
-4-
<PAGE>
ownership of 100% of the voting securities eligible to elect directors of
the Surviving Corporation (the "Parent Corporation"), is represented by the
Company Voting Securities that were outstanding immediately prior to such
Reorganization or Sale (or, if applicable, is represented by shares into
which such Company Voting Securities were converted pursuant to such
Reorganization or Sale), and such voting power among the holders thereof is
in substantially the same proportion as the voting power of such Company
Voting Securities among the holders thereof immediately prior to the
Reorganization or Sale, (B) no person (other than any employee benefit plan
(or related trust) sponsored or maintained by the Surviving Corporation or
the Parent Corporation) is or becomes the beneficial owner, directly or
indirectly, of 20% or more of the total voting power of the outstanding
voting securities eligible to elect directors of the Parent Corporation
(or, if there is no Parent Corporation, the Surviving Corporation) and (C)
at least a majority of the members of the board of directors of the Parent
Corporation (or, if there is no Parent Corporation, the Surviving
Corporation) following the consummation of the Reorganization or Sale were
Incumbent Directors at the time of the Board's approval of the execution of
the initial agreement providing for such Reorganization or Sale (any
Reorganization or Sale which satisfies all of the criteria specified in
(A), (B) and (C) above shall be deemed to be a "Non-Qualifying
Transaction"); or
(iv) the stockholders of the Company approve a plan of
complete liquidation or dissolution of the Company.
Notwithstanding the foregoing, a Change in Control of the Company shall not be
deemed to occur solely because any person acquires beneficial ownership of more
than 20% of the Company Voting Securities as a result of the acquisition of
Company Voting Securities by the Company which reduces the number of Company
Voting Securities outstanding; provided, that if after such acquisition by the
-------- ----
Company such person becomes the beneficial owner of additional Company Voting
Securities that increases the percentage of outstanding Company Voting
Securities beneficially owned by such person, a Change in Control of the Company
shall then occur.
(e) Notice of Termination. Any termination by the Company or
by the Executive shall be communicated by Notice of Termination to the other
party hereto given in accordance with Section 11(b) of this Agreement. For
purposes of this Agreement, a "Notice of Termination" means a written notice
which (i) indicates the specific termination provision in this Agreement relied
upon, (ii) to the extent applicable, sets forth in reasonable detail the facts
and circumstances claimed to provide a basis for termination of the Executive's
employment under the provision so indicated and (iii) if
-5-
<PAGE>
the Date of Termination (as defined below) is other than the date of receipt of
such notice, specifies the termination date (which date shall be not more than
thirty days after the giving of such notice). The failure by the Executive or
the Company to set forth in the Notice of Termination any fact or circumstance
which contributes to a showing of Good Reason or Cause shall not waive any right
of the Executive or the Company, respectively, hereunder or preclude the
Executive or the Company, respectively, from asserting such fact or circumstance
in enforcing the Executive's or the Company's rights hereunder.
(f) Date of Termination. "Date of Termination" means if the
Executive's employment is terminated by the Company other than for Disability,
or by the Executive, the date of receipt of the Notice of Termination or any
later date specified therein within 30 days of such notice, and if the
Executive's employment is terminated by reason of death or Disability, the Date
of Termination shall be the date of death of the Executive or the Disability
Effective Date, as the case may be.
4. Obligations of the Company upon Termination.
(a) Good Reason; Other Than for Cause, Death or Disability. If,
within two years of a Change in Control, the Company shall terminate the
Executive's employment other than for Cause, Disability or death, or the
Executive shall terminate employment for Good Reason:
(i) the Company shall pay to the Executive in a lump
sum in cash within 30 days after the Date of Termination:
A. the product of two (2) times the sum of (1)
the Executive's annual bonus (based upon the higher of the Executive's
current bonus or the bonus he received prior to the Change in Control)
and (2) the Executive's annual base salary (based upon the higher of
the Executive's current annual base salary or the annual base salary
he received prior to the Change in Control);
B. the sum of (x) the Executive's annual base
salary through the Date of Termination to the extent not theretofore
paid, and (y) the product of (1) the Executive's current annual bonus
assuming that Executive achieved his target and (2) a fraction, the
numerator of which is the number of days in the fiscal year in which
the Date of Termination occurs through the Date of Termination and the
denominator of which is 365, to the extent not theretofore paid (the
sum of the amounts
-6-
<PAGE>
described in clauses (x) and (y) shall be hereinafter referred to as
the "Accrued Obligations"); and
C. any compensation previously deferred by
Executive other than pursuant to a tax-qualified plan (together with
any earnings and interest thereon).
(ii) the Company shall continue to provide, for a
period of two (2) years following the Executive's Date of Termination, the
Executive (and the Executive's dependents, if applicable) with the same
level of medical, dental, accident, disability and life insurance benefits
upon substantially the same terms and conditions (including contributions
required by the Executive for such benefits) as existed immediately prior
to the Executive's Date of Termination (or, if more favorable to the
Executive, as such benefits and terms and conditions existed immediately
prior to the Change in Control); provided that, if the Executive cannot
continue to participate in the Company plans providing such benefits, the
Company shall otherwise provide such benefits on the same after-tax basis
as if continued participation had been permitted. Notwithstanding the
foregoing, in the event the Executive becomes reemployed with another
employer and becomes eligible to receive welfare benefits from such
employer, the welfare benefits described herein shall be secondary to such
benefits during the period of the Executive's eligibility, but only to the
extent that the Company reimburses the Executive for any increased cost and
provides any additional benefits necessary to give the Executive the
benefits provided hereunder.
(iii) all stock options, restricted stock awards and
other equity based awards granted on or after the date hereof (the "Equity
Awards") shall vest and shall remain exercisable for a period of ninety
days from the Date of Termination or the earlier expiration of their
initial term; provided, that, if the Executive would be prohibited from
-------- ----
exercising any stock option due to pooling of interests or other restraints
imposed under applicable accounting rules or securities laws, such option
shall remain exercisable for thirty days after such restriction ceases to
apply.
(iv) the Executive's benefit under the Company's tax-
qualified defined benefit pension plan and the supplemental defined benefit
pension plan shall be determined assuming the Executive had two (2)
additional years of service credit and the resulting amount shall be paid
outside such plan.
-7-
<PAGE>
(v) to the extent not theretofore paid or provided,
the Company shall timely pay or provide to the Executive any other amounts
or benefits required to be paid or provided or which the Executive is
eligible to receive under any plan, program, policy or practice or contract
or agreement of the Company and its affiliated companies through the Date
of Termination (such other amounts and benefits shall be hereinafter
referred to as the "Other Benefits").
(vi) the Company shall provide individual outplacement
services to the Executive in accordance with the practices and policies of
the Company in effect immediately prior to the Change in Control of the
Company.
Notwithstanding anything in this Agreement to the contrary, if (i) Executive's
employment is terminated prior to a Change in Control for reasons that would
have constituted a Good Reason or without Cause termination if they had occurred
following a Change in Control; (ii) Executive reasonably demonstrates that such
termination (or Good Reason event) was at the request of a third party who had
indicated an intention or taken steps reasonably calculated to effect a Change
in Control; and (iii) a Change in Control involving such third party (or a party
competing with such third party to effectuate a Change in Control) does occur,
then for purposes of this Agreement, the date immediately prior to the date of
such termination of employment or event constituting Good Reason shall be
treated as a Change in Control. For purposes of determining the timing of
payments and benefits to Executive under this Section 4(a), the date of the
actual Change in Control shall be treated as Executive's Date of Termination
under Section 3(f).
(b) Death or Disability. If the Executive's employment is
terminated by reason of the Executive's death or disability, this Agreement
shall terminate without further obligations to the Executive's legal
representatives or to the Executive, as the case may be, under this Agreement,
other than for payment of Accrued Obligations and the timely payment or
provision of Other Benefits. Accrued Obligations shall be paid to the Executive,
the Executive's estate or beneficiary, as applicable, in a lump sum in cash
within 30 days of the Date of Termination.
(c) Cause; Other than for Good Reason. If the Executive's
employment shall be terminated for Cause or the Executive terminates his
employment without Good Reason, this Agreement shall terminate without further
obligations to the Executive other than the obligation to pay to the Executive
(i) his Annual Base Salary through the Date of Termination to the extent
theretofore unpaid and, (ii) the Other Benefits.
-8-
<PAGE>
5. Non-exclusivity of Rights. Except as specifically provided,
nothing in this Agreement shall prevent or limit the Executive's continuing or
future participation in any plan, program, policy or practice provided by the
Company or any of its affiliated companies and for which the Executive may
qualify, nor, subject to Sections 1 and 11(f), shall anything herein limit or
otherwise affect such rights as the Executive may have under any contract or
agreement with the Company or any of its affiliated companies. Amounts which are
vested benefits or which the Executive is otherwise entitled to receive under
any plan, policy, practice or program of or any contract or agreement with the
Company or any of its affiliated companies at or subsequent to the Date of
Termination shall be payable in accordance with such plan, policy, practice or
program or contract or agreement except as explicitly modified by this
Agreement; provided that the Executive shall not be eligible for severance
benefits under any other program or policy of the Company.
6. Full Settlement. The Company's obligation to make the payments
provided for in this Agreement and otherwise to perform its obligations
hereunder shall not be affected by any set-off, counterclaim, recoupment,
defense or other claim, right or action which the Company may have against the
Executive or others. In no event shall the Executive be obligated to seek other
employment or take any other action by way of mitigation of the amounts payable
to the Executive under any of the provisions of this Agreement, and such amounts
shall not be reduced whether or not the Executive obtains other employment. The
Company agrees to pay as incurred, to the full extent permitted by law, all
legal fees and expenses which the Executive may reasonably incur as a result of
any contest (regardless of the outcome thereof) pursued or defended against in
good faith by the Executive regarding the validity or enforceability of, or
liability under, any provision of this Agreement or any guarantee of performance
thereof (including as a result of any contest by the Executive about the amount
of any payment pursuant to this Agreement), plus in each case interest on any
delayed payment at the applicable Federal rate provided for in Section
7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the "Code").
7. Certain Additional Payments by the Company.
(a) Anything in this Agreement to the contrary
notwithstanding and except as set forth below, in the event it shall be
determined that any payment or distribution by the Company to or for the benefit
of the Executive (whether paid or payable or distributed or distributable
pursuant to the terms of this Agreement or otherwise, but determined without
regard to any additional payments required under this Section 7) (a "Payment"),
would be subject to the excise tax imposed by Section 4999 of
-9-
<PAGE>
the Code or any interest or penalties are incurred by the Executive with respect
to such excise tax (such excise tax, together with any such interest and
penalties, are hereinafter collectively referred to as the "Excise Tax"), then
the Executive shall be entitled to receive an additional payment (a "Gross-Up
Payment") in an amount such that after payment by the Executive of all taxes
(including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and penalties
imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment,
the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax
imposed upon the Payments. Notwithstanding the foregoing provisions of this
Section 7(a), if it shall be determined that the Executive is entitled to a
Gross-Up Payment, but that the Payments do not exceed 110% of the greatest
amount (the "Reduced Amount") that could be paid to the Executive such that the
receipt of Payments would not give rise to any Excise Tax, then no Gross-Up
Payment shall be made to the Executive and the Payments, in the aggregate, shall
be reduced to the Reduced Amount.
(b) Subject to the provisions of Section 7(c), all
determinations required to be made under this Section 7, including whether and
when a Gross-Up Payment is required and the amount of such Gross-Up Payment and
the assumptions to be utilized in arriving at such determination, shall be made
by the Company's independent auditors or such other certified public accounting
firm reasonably acceptable to the Executive as may be designated by the Company
(the "Accounting Firm") which shall provide detailed supporting calculations
both to the Company and the Executive within 15 business days of the receipt of
notice from the Executive that there has been a Payment, or such earlier time as
is requested by the Company. All fees and expenses of the Accounting Firm shall
be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to
this Section 7, shall be paid by the Company to the Executive within five days
of the later of (i) the due date for the payment of any Excise Tax, and (ii) the
receipt of the Accounting Firm's determination. Any determination by the
Accounting Firm shall be binding upon the Company and the Executive. As a result
of the uncertainty in the application of Section 4999 of the Code at the time of
the initial determination by the Accounting Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that the Company exhausts its remedies pursuant to
Section 7(c) and the Executive thereafter is required to make a payment of any
Excise Tax, the Accounting Firm shall determine the amount of the Underpayment
that has occurred and any such Underpayment shall be promptly paid by the
Company to or for the benefit of the Executive.
-10-
<PAGE>
(c) The Executive shall notify the Company in writing of any
claim by the Internal Revenue Service that, if successful, would require the
payment by the Company of the Gross-Up Payment. Such notification shall be given
as soon as practicable but no later than ten business days after the Executive
is informed in writing of such claim and shall apprise the Company of the nature
of such claim and the date on which such claim is requested to be paid. The
Executive shall not pay such claim prior to the expiration of the 30-day period
following the date on which it gives such notice to the Company (or such shorter
period ending on the date that any payment of taxes with respect to such claim
is due). If the Company notifies the Executive in writing prior to the
expiration of such period that it desires to contest such claim, the Executive
shall:
(i) give the Company any information reasonably
requested by the Company relating to such claim,
(ii) take such action in connection with contesting
such claim as the Company shall reasonably request in writing from time to
time, including, without limitation, accepting legal representation with
respect to such claim by an attorney reasonably selected by the Company,
(iii) cooperate with the Company in good faith in order
effectively to contest such claim, and
(iv) permit the Company to participate in any
proceedings relating to such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and hold the Executive harmless, on an
after-tax basis, for any Excise Tax or income tax (including interest and
penalties with respect thereto) imposed as a result of such representation and
payment of costs and expenses. Without limitation on the foregoing provisions of
this Section 7(c), the Company shall control all proceedings taken in connection
with such contest and, at its sole option, may pursue or forgo any and all
administrative appeals, proceedings, hearings and conferences with the taxing
authority in respect of such claim and may, at its sole option, either direct
the Executive to pay the tax claimed and sue for a refund or contest the claim
in any permissible manner, and the Executive agrees to prosecute such contest to
a determination before any administrative tribunal, in a court of initial
jurisdiction and in one or more appellate courts, as the Company shall
determine; provided, however, that, if the Company directs the Executive to pay
such claim and sue for a refund, the Company shall advance the amount of such
payment to the Executive, on an interest-free basis and shall indemnify and hold
the Executive harmless, on an after-tax basis, from any Excise Tax or income
-11-
<PAGE>
tax (including interest or penalties with respect thereto) imposed with respect
to such advance or with respect to any imputed income with respect to such
advance; and further provided that any extension of the statute of limitations
relating to payment of taxes for the taxable year of the Executive with respect
to which such contested amount is claimed to be due is limited solely to such
contested amount. Furthermore, the Company's control of the contest shall be
limited to issues with respect to which a Gross-Up Payment would be payable
hereunder and the Executive shall be entitled to settle or contest, as the case
may be, any other issue raised by the Internal Revenue Service or any other
taxing authority.
(d) If, after the receipt by the Executive of an amount
advanced by the Company pursuant to Section 7(c), the Executive becomes entitled
to receive any refund with respect to such claim, the Executive shall promptly
pay to the Company the amount of such refund (together with any interest paid or
credited thereon after taxes applicable thereto). If, after the receipt by the
Executive of an amount advanced by the Company pursuant to Section 7(c), a
determination is made that the Executive shall not be entitled to any refund
with respect to such claim and the Company does not notify the Executive in
writing of its intent to contest such denial of refund prior to the expiration
of 30 days after such determination, then such advance shall be forgiven and
shall not be required to be repaid and the amount of such advance shall offset,
to the extent thereof, the amount of Gross-Up Payment required to be paid.
8. Confidential Information and Non-Solicitation.
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<PAGE>
(a) The Executive hereby acknowledges that, as an employee of
the Company, he will be making use of, acquiring and adding to confidential
information of a special and unique nature and value relating to the Company and
its strategic plan and financial operations. The Executive further recognizes
and acknowledges that all confidential information is the exclusive property of
the Company, is material and confidential, and is critical to the successful
conduct of the business of the Company. Accordingly, the Executive hereby
covenants and agrees that he will use confidential information for the benefit
of the Company only and shall not at any time, directly or indirectly, during
the term of this Agreement, and thereafter for all periods during which
severance or other amount is paid, divulge, reveal or communicate any
confidential information to any person, firm, corporation or entity whatsoever,
or use any confidential information for his own benefit or for the benefit of
others. The Executive also agrees not to hire or solicit for hire, directly or
indirectly, any employee on the payroll of the Company for any third party
during the term of this Agreement and for one year after the Date of Termination
without the prior written consent of the Company. In no event shall an asserted
violation of the provisions of this Section 8 constitute a basis for deferring
or withholding any amounts otherwise payable to the Executive under this
Agreement.
(b) Any termination of the Executive's employment or of this
Agreement shall have no effect on the continuing operation of this Section 8.
(c) The Executive acknowledges and agrees that the Company
will have no adequate remedy at law, and could be irreparably harmed, if the
Executive breaches or threatens to breach any of the provisions of this Section
8. The Executive agrees that the Company shall be entitled to equitable and/or
injunctive relief to prevent any breach or threatened breach of this Section 8,
and to specific performance of each of the terms hereof in addition to any other
legal or equitable remedies that the Company may have. The Executive further
agrees that he shall not, in any equity proceeding relating to the enforcement
of the terms of this Section 8, raise the defense that the Company has an
adequate remedy at law.
9. Successors.
(a) This Agreement is personal to the Executive and without
the prior written consent of the Company shall not be assignable by the
Executive otherwise than by will or the laws of descent and distribution. This
Agreement shall inure to the benefit of and be enforceable by the Executive's
legal representatives.
-13-
<PAGE>
(b) This Agreement shall inure to the benefit of and be
binding upon the Company and its successors and assigns.
(c) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Company to assume
expressly and agree to perform this Agreement in the same manner and to the same
extent that the Company would be required to perform it if no such succession
had taken place. As used in this Agreement, "Company" shall mean the Company as
hereinbefore defined and any successor to its business and/or assets as
aforesaid which assumes and agrees to perform this Agreement by operation of
law, or otherwise.
10. Miscellaneous.
(a) This Agreement shall be governed by and construed in
accordance with the laws of the State of Delaware, without reference to
principles of conflict of laws. The captions of this Agreement are not part of
the provisions hereof and shall have no force or effect. This Agreement may not
be amended or modified otherwise than by a written agreement executed by the
parties hereto or their respective successors and legal representatives.
(b) All notices and other communications hereunder shall be
in writing and shall be given by hand delivery to the other party or by
registered or certified mail, return receipt requested, postage prepaid,
addressed as follows:
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<PAGE>
If to the Executive:
If to the Company:
UNUMProvident Corporation
211 Congress Street
Portland, Maine 04122
or
1 Fountain Square
Chattanooga, Tennessee 37402
Attention: Chief Executive Officer
or to such other address as either party shall have furnished to the other in
writing in accordance herewith. Notice and communications shall be effective
when actually received by the addressee.
(c) The invalidity or unenforceability of any provision of
this Agreement shall not affect the validity or enforceability of any other
provision of this Agreement.
(d) The Company may withhold from any amounts payable under
this Agreement such Federal, state, local or foreign taxes as shall be required
to be withheld pursuant to any applicable law or regulation.
(e) The Executive's or the Company's failure to insist upon
strict compliance with any provision of this Agreement or the failure to assert
any right the Executive or the Company may have hereunder, including, without
limitation, the right of the Executive to terminate employment for Good Reason
pursuant to Section 4(c)(i)-(iv) of this Agreement, shall not be deemed to be a
waiver of such provision or right or any other provision or right of this
Agreement.
(f) From and after the Effective Date this Agreement shall
supersede any other employment, severance or change of control agreement between
the parties with respect to the subject matter hereof.
-15-
<PAGE>
11. General Release. All payments under this Agreement to be made
in connection with the Executive's termination of employment will be conditioned
on the Executive signing a general form of release.
IN WITNESS WHEREOF, the Executive has hereunto set the Executive's
hand and, pursuant to the authorization from its Board of Directors, the Company
has caused these presents to be executed in its name on its behalf, all as of
the day and year first above written.
Executive
-------------------------------
Name:
UNUMProvident Corporation
By
-------------------------------
Name:
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<PAGE>
EXHIBIT 15
Board of Directors and Stockholders
UnumProvident Corporation
We are aware of the incorporation by reference in the Registration Statements
(Form S-8 No. 33-47551, Form S-8 No. 33-88108, Form S-8 No. 33-62231, Form S-8
No. 333-81669 and Form S-8 No. 333-81969) of Provident Companies, Inc.
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 Plan of 1994, the Provident Life and Accident Insurance
Company Employee Stock Purchase Plan of 1995, the Provident Life and Accident
Insurance Company Management Incentive Compensation Plan of 1994, The Paul
Revere Savings Plan, Provident Companies, Inc. Stock Plan of 1999, Provident
Companies, Inc., Non-Employee Director Compensation Plan of 1998, Employee Stock
Option Plan of 1998, and Amended and Restated Annual Management Incentive
Compensation Plan of 1994, the UnumProvident Corporation 1987 Executive Stock
Option Plan, UnumProvident Corporation 1990 Long-Term Stock Incentive Plan,
UnumProvident Corporation Plan 1996 Long-Term Stock Incentive Plan and
UnumProvident Corporation 1998 Goals Stock Option Plan, and in the Registration
Statement (Form S-3 No. 333-17849) of Provident Companies, Inc. for the
registration of 9,523,810 shares of its common stock of our report dated
November 12, 1999 relating to the unaudited condensed consolidated interim
financial statements of UnumProvident Corporation and subsidiaries which are
included in its Form 10-Q for the quarter ended September 30, 1999.
Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part
of the registration statements prepared or certified by accountants within the
meaning of Section 7 or 11 of the Securities Act of 1933.
/s/ERNST & YOUNG
Chattanooga, Tennessee
November 12, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
EXHIBIT 27.1 - THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE FINANCIAL STATEMENTS OF UNUMPROVIDENT CORPORATION FOR THE NINE MONTHS
ENDED SEPTEMBER 30,1999.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 21,447,500
<DEBT-CARRYING-VALUE> 325,400
<DEBT-MARKET-VALUE> 331,300
<EQUITIES> 0
<MORTGAGE> 1,288,000
<REAL-ESTATE> 288,400
<TOTAL-INVEST> 26,220,200<F1>
<CASH> 139,100
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 2,347,000
<TOTAL-ASSETS> 38,071,100
<POLICY-LOSSES> 23,642,600<F2>
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 1,601,000
<POLICY-HOLDER-FUNDS> 3,490,900
<NOTES-PAYABLE> 1,747,300
0
0
<COMMON> 24,000
<OTHER-SE> 4,914,400
<TOTAL-LIABILITY-AND-EQUITY> 38,071,100
5,105,100
<INVESTMENT-INCOME> 1,531,000
<INVESTMENT-GAINS> 89,300
<OTHER-INCOME> 254,400
<BENEFITS> 5,245,900
<UNDERWRITING-AMORTIZATION> 332,000
<UNDERWRITING-OTHER> 1,776,100
<INCOME-PRETAX> (374,200)
<INCOME-TAX> (55,300)
<INCOME-CONTINUING> (318,900)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (318,900)
<EPS-BASIC> (1.34)
<EPS-DILUTED> (1.34)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>"Total-Invest" includes equity securities of $47,300.
<F2>"Policy-Losses include reserves for future policy and contract benifits of
$23,415,400 and unearned premiums of $227,200.
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
EXHIBIT 27.2 - THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE FINANCIAL STATEMENTS OF UNUMPROVIDENT CORPORATION FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1998
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 22,643,600<F1>
<DEBT-CARRYING-VALUE> 298,900
<DEBT-MARKET-VALUE> 355,200
<EQUITIES> 0
<MORTGAGE> 1,233,300
<REAL-ESTATE> 314,600
<TOTAL-INVEST> 27,146,000<F2>
<CASH> 99,100
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 1,962,100
<TOTAL-ASSETS> 38,542,100
<POLICY-LOSSES> 22,285,800<F3>
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 1,324,500
<POLICY-HOLDER-FUNDS> 4,377,700
<NOTES-PAYABLE> 1,446,500
0
0
<COMMON> 23,800
<OTHER-SE> 6,171,800
<TOTAL-LIABILITY-AND-EQUITY> 38,542,100
4,559,200
<INVESTMENT-INCOME> 1,533,000
<INVESTMENT-GAINS> 30,800
<OTHER-INCOME> 231,100
<BENEFITS> 3,947,500
<UNDERWRITING-AMORTIZATION> 272,600
<UNDERWRITING-OTHER> 1,345,300
<INCOME-PRETAX> 788,700
<INCOME-TAX> 264,300
<INCOME-CONTINUING> 524,400
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 524,400
<EPS-BASIC> 2.21
<EPS-DILUTED> 2.15
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>On June 30, 1999, UNUM Corporation merged with and into Provident Companies,
Inc. under the name UNUMProvident Corporation. The merger was accounted for as
a pooling of interests. The financial results presented herein give effect to
the merger as if it had been completed at the beginning of the period.
<F2>"Total-Invest" includes equity securities of $41,200.
<F3>"Policy-Losses" include reserves for future policy and contract benefits of
$22,070,300 and unearned premiums of $215,500.
</FN>
</TABLE>
