<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 June 30, 2000.
Commission file number 1-11834
UnumProvident Corporation
(Exact name of registrant as specified in its charter)
Delaware 62-1598430
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 FOUNTAIN SQUARE 2211 CONGRESS STREET
CHATTANOOGA, TENNESSEE 37402 PORTLAND, MAINE 04122
(Address of principal executive offices)
423.755.1011
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
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.
<TABLE>
<CAPTION>
Class Outstanding at June 30, 2000
------------------------------------- -----------------------------------
<S> <C>
Common stock, $0.10 par value 240,657,154
</TABLE>
<PAGE>
TABLE OF CONTENTS
PART I
Cautionary Statement Regarding Forward-Looking Statements............. 1
1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial Condition at June 30,
2000 and December 31, 1999........................................... 2
Condensed Consolidated Statements of Operations for the three and six
months ended June 30, 2000 and 1999.................................. 4
Condensed Consolidated Statements of Stockholders' Equity for the six
months ended June 30, 2000 and 1999.................................. 5
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2000 and 1999......................................... 6
Notes to Condensed Consolidated Financial Statements.................. 7
Independent Auditors' Review Report................................... 14
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 15
3. Quantitative and Qualitative Disclosure about Market Risk............. 29
PART II
4. Submission of Matters to a Vote of Security Holders................... 30
6. Exhibits and Reports on Form 8-K...................................... 31
Signatures............................................................ 32
<PAGE>
PART I
Cautionary Statement Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the Act) provides a "safe-
harbor" for forward-looking statements which are identified as such and are
accompanied by the identification of important factors which could cause actual
results to differ materially from the forward-looking statements. UnumProvident
Corporation (the Company) claims the protection afforded by the safe harbor in
the Act. Certain information contained in this discussion, or in any other
written or oral statements made by the Company, is or may be considered as
forward-looking. Examples of disclosures that contain such information include,
among others, sales estimates, income projections, 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.
. Actual persistency may be lower than projected persistency, resulting in
lower than expected revenue and higher than expected amortization of
deferred policy acquisition costs.
. Reorganization of the Company's field sales force and integrated product
offerings may take longer than originally expected and may adversely
impact new sales and renewals longer than originally expected.
. 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, and some aspects
related to the integration of the business may take longer than expected.
. Legislative or regulatory changes may adversely affect the businesses in
which the Company is engaged.
. Necessary technological changes may be more difficult or expensive to make
than anticipated, and subsequent non-compliance resulting from year 2000
data systems issues may occur.
. 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
"Risk Factors" in Part I of the Company's Form 10-K for the fiscal year ended
December 31, 1999.
All subsequent written and oral forward-looking statements attributable to the
Company or any person acting on its behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to in this section.
The Company does not undertake any obligation to release publicly any revisions
to such forward-looking statements to reflect events or circumstances after the
date of this document or to reflect the occurrence of unanticipated events.
1
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
June 30 December 31
2000 1999
(in millions of dollars)
--------------------------------------------
(Unaudited)
<S> <C> <C>
Assets
Investments
Fixed Maturity Securities
Available-for-Sale $22,205.5 $22,033.2
Held-to-Maturity 335.6 323.5
Mortgage Loans 1,231.3 1,278.1
Real Estate 165.7 211.2
Policy Loans 2,264.5 2,316.9
Short-term Investments 161.0 321.5
Other Investments 60.0 64.9
--------- ---------
Total Investments 26,423.6 26,549.3
Cash and Bank Deposits 110.3 292.4
Accounts and Premiums Receivable 1,933.6 1,144.3
Reinsurance Receivable 5,243.8 4,741.2
Accrued Investment Income 610.2 543.6
Deferred Policy Acquisition Costs 2,413.0 2,391.2
Value of Business Acquired 600.9 534.1
Goodwill 695.1 706.4
Other Assets 1,307.8 1,085.9
Separate Account Assets 447.9 459.1
--------- ---------
Total Assets $39,786.2 $38,447.5
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
June 30 December 31
2000 1999
(in millions of dollars)
-------------------------------------------
(Unaudited)
<S> <C> <C>
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,831.9 $ 1,722.1
Reserves for Future Policy and Contract Benefits and
Unearned Premiums 25,395.1 23,719.7
Other Policyholders' Funds 2,955.2 3,521.8
Federal Income Tax 325.7 271.6
Short-term Debt 1,039.2 1,075.0
Long-term Debt 1,166.5 1,166.5
Other Liabilities 1,240.9 1,229.5
Separate Account Liabilities 447.9 459.1
--------- ---------
Total Liabilities 34,402.4 33,165.3
--------- ---------
Commitments and Contingent Liabilities - Note 7
Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debt Securities of the Company 300.0 300.0
--------- ---------
Stockholders' Equity
Common Stock, $0.10 par
Authorized: 725,000,000 shares
Issued: 240,833,449 and 240,515,180 shares 24.1 24.1
Additional Paid-in Capital 1,033.6 1,028.6
Accumulated Other Comprehensive Loss (93.5) (18.9)
Retained Earnings 4,128.8 3,957.6
Treasury Stock at Cost: 176,295 shares (9.2) (9.2)
--------- ---------
Total Stockholders' Equity 5,083.8 4,982.2
--------- ---------
Total Liabilities and Stockholders' Equity $39,786.2 $38,447.5
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
2000 1999 2000 1999
(in millions of dollars, except share data)
------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue
Premium Income $1,789.9 $1,687.4 $3,570.7 $3,368.9
Net Investment Income 543.0 518.0 1,095.1 1,017.6
Net Realized Investment Gains 1.8 4.2 1.6 11.4
Other Income 89.0 68.0 150.4 148.8
-------- -------- -------- --------
Total Revenue 2,423.7 2,277.6 4,817.8 4,546.7
-------- -------- -------- --------
Benefits and Expenses
Policyholder Benefits 1,631.1 1,690.7 3,210.6 3,192.8
Commissions 188.9 219.6 384.5 462.1
Interest and Debt Expense 45.1 33.6 89.0 66.5
Deferral of Policy Acquisition Costs (148.5) (189.0) (295.7) (420.2)
Amortization of Deferred Policy Acquisition Costs 124.6 111.4 268.2 224.6
Amortization of Value of Business Acquired and Goodwill 17.8 17.5 34.5 60.2
Other Operating Expenses 345.1 668.4 700.7 1,072.1
-------- -------- -------- --------
Total Benefits and Expenses 2,204.1 2,552.2 4,391.8 4,658.1
-------- -------- -------- --------
Income (Loss) Before Federal Income Taxes 219.6 (274.6) 426.0 (111.4)
Federal Income Taxes (Credit) 76.5 (83.4) 148.4 (9.5)
-------- -------- -------- --------
Net Income (Loss) $ 143.1 $ (191.2) $ 277.6 $ (101.9)
======== ======== ======== ========
Net Income (Loss) Per Common Share
Basic $ 0.59 $ (0.80) $ 1.15 $ (0.43)
Assuming Dilution $ 0.59 $ (0.80) $ 1.15 $ (0.43)
Dividends Paid Per Common Share $ 0.1475 $ 0.1428 $ 0.2950 $ 0.2856
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Paid-in Comprehensive Retained Treasury Deferred
Stock Capital Income (Loss) Earnings Stock Compensation Total
(in millions of dollars)
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998 $23.8 $ 959.2 $ 914.7 $4,279.2 $(9.2) $(21.5) $ 6,146.2
Comprehensive Loss, Net of Tax
Net Loss (101.9) (101.9)
Change in Net Unrealized Gain
on Securities (657.0) (657.0)
Change in Foreign Currency
Translation Adjustment 7.6 7.6
---------
Total Comprehensive Loss (751.3)
---------
Common Stock Activity 0.1 43.3 21.5 64.9
Dividends to Stockholders (68.1) (68.1)
----- -------- ------- -------- ------ ------ ---------
Balance at June 30, 1999 $23.9 $1,002.5 $ 265.3 $4,109.2 $(9.2) $ - $ 5,391.7
===== ======== ======= ======== ===== ====== =========
Balance at December 31, 1999 $24.1 $1,028.6 $ (18.9) $3,957.6 $(9.2) $ - $ 4,982.2
Comprehensive Income, Net of Tax
Net Income 277.6 277.6
Change in Net Unrealized Gain (Loss)
on Securities (57.1) (57.1)
Change in Foreign Currency
Translation Adjustment (17.5) (17.5)
---------
Total Comprehensive Income 203.0
---------
Common Stock Activity 5.0 5.0
Dividends to Stockholders (106.4) (106.4)
----- -------- ------- -------- ----- ---- ---------
Balance at June 30, 2000 $24.1 $1,033.6 $ (93.5) $4,128.8 $(9.2) $ - $ 5,083.8
===== ======== ======= ======== ===== ==== =========
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
Six Months Ended June 30
2000 1999
(in millions of dollars)
----------------------------
<S> <C> <C>
Net Cash Provided by Operating Activities $ 533.0 $ 740.1
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments 1,010.2 1,472.9
Proceeds from Maturities of Investments 551.5 705.7
Purchase of Investments (2,050.7) (2,579.5)
Net Sales of Short-term Investments 159.9 48.1
Acquisition of Business (94.2) -
Disposition of Business (78.2) -
Other (34.9) (48.8)
--------- ---------
Net Cash Used by Investing Activities (536.4) (401.6)
--------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts 22.3 78.1
Maturities and Benefit Payments from Policyholder Accounts (99.9) (480.5)
Net Change in Short-term Borrowings (34.5) 166.2
Dividends Paid to Stockholders (70.9) (68.1)
Other 5.0 42.1
--------- ---------
Net Cash Used by Financing Activities (178.0) (262.2)
--------- ---------
Effect of Foreign Exchange Rate on Cash (0.7) (0.7)
--------- ---------
Net Increase (Decrease) in Cash and Bank Deposits (182.1) 75.6
Cash and Bank Deposits at Beginning of Period 292.4 111.2
--------- ---------
Cash and Bank Deposits at End of Period $ 110.3 $ 186.8
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
June 30, 2000
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 give effect to the merger as if it had been
completed at the beginning of the earliest period presented.
The condensed consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three month and six month periods ended June 30, 2000,
are not necessarily indicative of the results that may be expected for the year
ended December 31, 2000. Certain prior period amounts in the condensed
consolidated financial statements have been reclassified to conform with the
current period presentation. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended December 31, 1999.
Note 2--Merger
During the second and third quarters of 1999, the Company recognized before-tax
expenses of $184.7 million related to the merger and $125.9 million for the
early retirement offer to employees.
Employee related expense consisted 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 involuntarily terminated employees. Severance
benefits and change in control costs were $60.2 million, and costs associated
with the vesting of restricted stock were $17.5 million. The Company estimated
that in total approximately 1,615 positions would be eliminated over a twelve
month period beginning June 30, 1999. As of June 30, 2000, these positions have
been eliminated, and approximately $57.2 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 consisted of
closing of duplicate offices and write-off of redundant computer hardware and
software. The Company has closed approximately 90 duplicate field offices over
the twelve month period beginning June 30, 1999. 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 June 30, 2000, $5.3 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 and removed from service as a result of the merger. This
abandonment resulted in a write-down of the assets' book values by approximately
$41.8 million during 1999. As of June 30, 2000, the investment banking, legal,
and accounting fees of $39.6 million have been paid.
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 second quarter 1999
earnings $125.9 million before tax and $81.8 million after tax ($0.34 per common
share).
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2000
Note 2--Merger (Continued)
Additionally, during the second quarter of 1999, the Company conformed Unum's
process and assumptions used to calculate the discount rate for claim reserves
of certain disability businesses to the methodology used by Provident. The
impact on 1999 second quarter earnings related to the change in method of
calculating the discount rate for claim reserves was $240.7 million before tax
and $156.5 million after tax ($0.66 per common share).
The results of operations for the separate companies and the combined amounts
for the periods prior to the merger were as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1999 June 30, 1999
(in millions of dollars)
-----------------------------------------------
<S> <C> <C>
Revenue
Unum $1,277.1 $2,557.8
Provident 1,000.5 1,988.9
-------- --------
Combined Revenue $2,277.6 $4,546.7
======== ========
Net Income (Loss)
Unum $ (205.2) $ (189.7)
Provident 14.0 87.8
-------- --------
Combined Net Loss $ (191.2) $ (101.9)
======== ========
</TABLE>
Included in Unum's net loss for the three and six months ended June 30, 1999, is
$131.8 million after tax for expenses related to the merger and the early
retirement offer to employees and $156.5 million after tax for the reserve
discount rate change. Unum's net 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 operations. Included in Provident's net income for the three and
six months ended June 30, 1999, is $62.0 million after tax for expenses related
to the merger and the early retirement offer to employees. See the Company's
report on Form 10-K for the year ended December 31, 1999 for further discussion
of the merger and charges taken in 1999.
8
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
June 30, 2000
Note 3--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. No preferred stock has been issued to date.
Net income (loss) per common share is determined as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
2000 1999 2000 1999
(in millions, except share data)
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Numerator
Net Income (Loss) $ 143.1 $ (191.2) $ 277.6 $ (101.9)
========== ========== ========== ==========
Denominator (000s)
Weighted Average Common Shares - Basic 240,755.1 238,438.4 240,684.9 238,108.9
Dilutive Securities 890.4 - 844.6 -
---------- ---------- ---------- ----------
Weighted Average Common Shares -
Assuming Dilution 241,645.5 238,438.4 241,529.5 238,108.9
========== ========== ========== ==========
</TABLE>
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 options are out-of-
the-money or if a net loss is reported. Approximately 11.6 million and 11.9
million options for the three and six months period ended June 30, 2000, were
not considered dilutive due to the options being out-of-the-money. Options
which were not considered dilutive due to options being out-of-the-money were
immaterial for the three and six month periods ended June 30, 1999. In-the-
money options to purchase approximately 4.3 million common shares for both the
three and six month periods ended June 30, 1999, were not considered dilutive
due to net losses being reported for the periods.
9
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--Continued
UnumProvident Corporation and Subsidiaries
June 30, 2000
Note 4--Comprehensive Income (Loss)
The components of accumulated other comprehensive loss, net of deferred tax, are
as follows:
<TABLE>
<CAPTION>
June 30 December 31
2000 1999
(in millions of dollars)
----------------------------------------------
<S> <C> <C>
Net Unrealized Gain (Loss) on Securities $(37.3) $ 19.8
Foreign Currency Translation Adjustment (56.2) (38.7)
------ ------
Accumulated Other Comprehensive Loss $(93.5) $(18.9)
====== ======
</TABLE>
The components of comprehensive income (loss) and the related deferred tax are
as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
2000 1999 2000 1999
(in millions of dollars)
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Income (Loss) $ 143.1 $(191.2) $ 277.6 $(101.9)
------- ------- ------- -------
Change in Net Unrealized Gain (Loss) on Securities:
Change Before Reclassification Adjustment (186.6) (478.2) (89.1) (974.5)
Reclassification Adjustment for Net Realized Investment
Gains Included in Net Income (Loss) (1.8) (4.2) (1.6) (11.4)
Change in Foreign Currency Translation Adjustment (14.8) 12.2 (20.5) 15.1
------- ------- ------- -------
(203.2) (470.2) (111.2) (970.8)
Change in Deferred Tax (71.4) (146.7) (36.6) (321.4)
------- ------- ------- -------
Other Comprehensive Loss (131.8) (323.5) (74.6) (649.4)
------- ------- ------- -------
Comprehensive Income (Loss) $ 11.3 $(514.7) $ 203.0 $(751.3)
======= ======= ======= =======
</TABLE>
10
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--Continued
UnumProvident Corporation and Subsidiaries
June 30, 2000
Note 5--Segment Information
Selected data by segment is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
2000 1999 2000 1999
(in millions of dollars)
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Premium Income
Employee Benefits $1,008.2 $ 960.7 $2,014.1 $1,914.0
Individual 462.0 427.3 931.1 860.4
Voluntary Benefits 184.7 173.1 366.5 344.3
Other 135.0 126.3 259.0 250.2
-------- -------- -------- --------
1,789.9 1,687.4 3,570.7 3,368.9
Net Investment Income and Other Income
Employee Benefits 212.3 183.5 418.8 360.3
Individual 265.5 233.8 512.7 461.3
Voluntary Benefits 29.5 26.8 58.9 53.4
Other 113.1 135.0 232.5 276.4
Corporate 11.6 6.9 22.6 15.0
-------- -------- -------- --------
632.0 586.0 1,245.5 1,166.4
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Employee Benefits 1,220.5 1,144.2 2,432.9 2,274.3
Individual 727.5 661.1 1,443.8 1,321.7
Voluntary Benefits 214.2 199.9 425.4 397.7
Other 248.1 261.3 491.5 526.6
Corporate 11.6 6.9 22.6 15.0
-------- -------- -------- --------
2,421.9 2,273.4 4,816.2 4,535.3
Benefits and Expenses
Employee Benefits 1,099.1 1,191.5 2,203.4 2,156.1
Individual 647.7 614.1 1,280.6 1,194.0
Voluntary Benefits 174.8 168.8 346.4 335.1
Other 232.7 253.6 461.2 580.0
Corporate 49.8 324.2 100.2 392.9
-------- -------- -------- --------
2,204.1 2,552.2 4,391.8 4,658.1
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Employee Benefits 121.4 (47.3) 229.5 118.2
Individual 79.8 47.0 163.2 127.7
Voluntary Benefits 39.4 31.1 79.0 62.6
Other 15.4 7.7 30.3 (53.4)
Corporate (38.2) (317.3) (77.6) (377.9)
-------- -------- -------- --------
217.8 (278.8) 424.4 (122.8)
Net Realized Investment Gains 1.8 4.2 1.6 11.4
-------- -------- -------- --------
Income (Loss) Before Federal Income Taxes 219.6 (274.6) 426.0 (111.4)
Federal Income Taxes (Credit) 76.5 (83.4) 148.4 (9.5)
-------- -------- -------- --------
Net Income (Loss) $ 143.1 $ (191.2) $ 277.6 $ (101.9)
======== ======== ======== ========
</TABLE>
11
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--Continued
UnumProvident Corporation and Subsidiaries
June 30, 2000
Note 6--Debt
In April 2000, the Company issued $200.0 million of variable rate notes in a
privately negotiated transaction. The notes are due in April 2001 and were used
to refinance other short-term debt. The notes had an interest rate of 7.03
percent during the second quarter.
Note 7--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 The Paul Revere Corporation
(Paul Revere) whose employment relationships ended on June 30, 1997 and were
offered contracts to sell insurance policies as independent producers 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. A hearing to determine class certification was heard on
December 20, 1999 in Massachusetts state court. The court certified a class for
the independent brokers and has denied class certification for the career
agents. The Company appealed the class certification for the independent
brokers, but the appeal was denied. A tentative trial date of January 2001 has
been set. The Company has filed a conditional counterclaim in each action which
requests a substantial return of commissions should the Superior Court agree
with the plaintiffs' interpretation of the contracts. The Company has received
notice that career agent plaintiffs plan to re-file their class action and limit
it solely to the issues in the certified broker class action. The Company
believes that it has strong defenses to both lawsuits and plans to vigorously
defend its position.
In addition, the same plaintiffs' attorney who has filed the purported class
action lawsuits has filed 47 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 17 of the
plaintiffs who are licensed by the National Association of Securities Dealers
and have executed the Uniform Application for Registration or Transfer in the
Securities Industry (Form U-4). The federal court has denied 15 of those
motions and granted two. The Company is appealing the denial of the 15 motions,
and a hearing before the First Circuit Court of Appeals was held on August 1,
2000. 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 described above are in the early stages, management does
not currently expect these suits to materially affect the financial position or
results of operations of the Company.
During September and October 1999, the Company and several of its officers were
named as defendants in five class action lawsuits filed in the United States
District Court for the District of Maine. On January 3, 2000, the Maine
district court appointed a lead class action plaintiff and ordered plaintiffs to
file a consolidated amended complaint. On January 27, 2000, a sixth complaint
against the same defendants was filed in the Southern District of New York. On
March 7, 2000, the sixth action was transferred to the District of Maine, and
that action was voluntarily dismissed by the plaintiff on June 12, 2000. On
February 23, 2000, two consolidated amended class action complaints were filed
against the same defendants. The first amended class action complaint asserts a
variety of claims under the Securities Exchange Act of 1934, as amended, on
behalf of a putative class of shareholders who purchased or otherwise acquired
stock in the Company or Unum between February 4, 1998 and February 9, 2000. The
second amended complaint asserts a variety of claims under the Securities Act of
1933 and the Securities Exchange Act of 1934, as amended, on behalf of a
putative class of shareholders who exchanged the common stock of Unum or
Provident for the Company's stock pursuant to the joint proxy/registration
statement issued in connection with the merger between Unum and Provident. The
complaints allege that the defendants made false and misleading public
statements concerning, among other things, Unum's and the Company's reserves for
disability insurance and pricing policies, the Company's merger costs, and the
adequacy of the due diligence reviews performed in connection with the merger.
The complaints seek money damages on behalf of all persons
12
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--Continued
UnumProvident Corporation and Subsidiaries
June 30, 2000
who purchased or otherwise acquired Company or Unum stock in the class period or
who were issued Company stock pursuant to the merger. On April 10, 2000, the
defendants filed a motion to dismiss the complaints. The motion was fully
submitted on June 20, 2000, but no decision has yet been rendered by the court.
To date, no class has been certified, and no defendant has answered any
complaint. The Company disputes the claims alleged in the complaint and plans to
vigorously contest them.
13
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--Continued
UnumProvident Corporation and Subsidiaries
June 30, 2000
Note 7--Commitments and Contingent Liabilities (Continued)
In certain reinsurance pools associated with the Company's reinsurance
businesses there are disputes among the pool members and reinsurance
participants concerning the scope of their obligations and liabilities within
the complex pool arrangements, including pools for which subsidiaries of the
Company acted either as pool managers or underwriting agents, as pool members or
as reinsurers. The Company or the Company's subsidiaries either have been or
may in the future be brought into disputes, arbitration proceedings, or
litigation with other pool members or reinsurers of the pools in the process of
resolving the various claims, but it is unclear what exposure the Company or its
subsidiaries may ultimately have to share in the losses of pool members or
reinsurers because of the subsidiaries' activities in placing insurance or
otherwise.
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 8--Change in Accounting Principle and Accounting Pronouncements Outstanding
In 1998, the FASB issued Statement of Financial Accounting Standards No. 133
(SFAS 133), Accounting for Derivative Instruments and Hedging Activities, which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging activities. In June
2000, the FASB issued Statement of Financial Accounting Standards No. 138 (SFAS
138), Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an amendment of SFAS 133. SFAS 138 addresses several issues that
apply to derivative instruments and hedging activities and amends certain
accounting and reporting standards of SFAS 133. The Company will adopt the
provisions of SFAS 133 and SFAS 138 effective January 1, 2001. At this time the
Company has not determined the effects that the adoption of SFAS 133 and SFAS
138 will have on its financial statements.
In March 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 44 (Interpretation), Accounting for Certain Transactions
Involving Stock Compensation. This Interpretation clarifies the application of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. This Interpretation is effective July 1, 2000, but adoption of the
Interpretation is not expected to have a material impact on the Company's
financial position or results of operations.
Effective January 1, 2000, the Company adopted the provisions of Statement of
Position 98-7 (SOP 98-7), Deposit Accounting: Accounting for Insurance and
Reinsurance Contracts That Do Not Transfer Insurance Risk. SOP 98-7 provides
guidance on applying the deposit method of accounting to insurance and
reinsurance contracts that do not transfer insurance risk. The effect of the
adoption of SOP 98-7 on the Company's financial position and results of
operations was immaterial.
14
<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 June 30, 2000, the
related condensed consolidated statements of operations for the three and six
month periods ended June 30, 2000 and 1999, and the condensed consolidated
statements of stockholders' equity and cash flows for the six month periods
ended June 30, 2000 and 1999. The consolidated financial statements give
retroactive effect to the merger of Unum Corporation and Provident Companies,
Inc. on June 30, 1999, which has been accounted for using the pooling of
interests method as described in the notes to condensed consolidated financial
statements. 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
revenues for the three and six month periods ended June 30, 1999 constituted 56
percent 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 condensed
consolidated financial statements referred to above 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, 1999, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the year then ended not
presented herein, and in our report dated February 9, 2000, except for Note 17,
for which the date is March 7, 2000, we expressed an unqualified opinion on
those consolidated financial statements. In our opinion, the information set
forth in the accompanying condensed consolidated statement of financial
condition as of December 31, 1999, 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
August 9, 2000
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
On June 30, 1999, Unum Corporation (Unum) merged with and into Provident
Companies, Inc. (Provident) under the name UnumProvident Corporation (the
Company). The merger was accounted for as a pooling of interests. The
historical financial results discussed herein give effect to the merger as if it
had been completed at the beginning of the earliest period presented. See Notes
1 and 2 of the "Notes to Condensed Consolidated Financial Statements" for
further discussion.
The following should be read in conjunction with the condensed consolidated
financial statements and notes thereto in Part I, Item 1 contained herein and
the with the discussion, analysis, and consolidated financial statements and
notes thereto in Part I, Item I and Part II, Items 6, 7, 7A, and 8 of the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1999.
This discussion of consolidated operating results and operating results by
segment excludes net realized investment gains and losses from revenue and
income (loss) before taxes. The Company's investment focus has been on
investment income to support its insurance liabilities as opposed to the
generation of realized investment gains. Due to the nature of the Company's
business, a long-term focus is necessary to maintain profitability over the life
of the business. The realization of investment gains and losses will impact
future earnings levels as the underlying business is long-term in nature and
requires that the Company be able to sustain the assumed interest rates in its
liabilities. However, income excluding realized investment gains and losses
does not replace net income as a measure of the Company's profitability.
The trends in new annualized sales in the Employee Benefits, Individual, and
Voluntary Benefits segments are indicators of the Company's potential for growth
in its respective markets and the level of market acceptance of price changes
and new products. The Company has closely linked its various incentive
compensation programs to the achievement of its goals for new sales. The
Company's long-term financial objectives, which balance growth and
profitability, are to achieve sales growth of 10 to 12 percent per year,
earnings per share growth of 12 to 14 percent per year, and a return on equity
of 14 to 16 percent per year.
Consolidated Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
2000 1999 % Change 2000 1999 % Change
------------------------------------------ ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $1,789.9 $1,687.4 6.1% $3,570.7 $3,368.9 6.0%
Net Investment Income 543.0 518.0 4.8 1,095.1 1,017.6 7.6
Other Income 89.0 68.0 30.9 150.4 148.8 1.1
-------- -------- -------- --------
Total Revenue 2,421.9 2,273.4 6.5 4,816.2 4,535.3 6.2
Benefits and Expenses 2,204.1 2,552.2 (13.6) 4,391.8 4,658.1 (5.7)
-------- -------- -------- --------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains 217.8 (278.8) N.M. 424.4 (122.8) N.M.
Federal Income Taxes (Credit) 75.8 (84.9) N.M. 147.8 (13.5) N.M.
-------- -------- -------- --------
Income (Loss) Before Net Realized
Investment Gains 142.0 (193.9) N.M. 276.6 (109.3) N.M.
Net Realized Investment Gains 1.1 2.7 (59.3) 1.0 7.4 (86.5)
-------- -------- -------- --------
Net Income (Loss) $ 143.1 $ (191.2) N.M. $ 277.6 $ (101.9) N.M.
======== ======== ======== ========
</TABLE>
N.M. = not a meaningful percentage
16
<PAGE>
Prior to the June 30, 1999 merger, Unum's process and assumptions used to
calculate the discount rate for claim reserves of certain disability businesses
differed from that used by Provident. While Unum's and Provident's methods for
calculating the discount rate for disability claim reserves were both in
accordance with generally accepted accounting principles, management believed
that the combined entity should have consistent discount rate accounting
policies and methods for applying these policies for similar products. The
previous Unum methodology used the same investment strategy for assets backing
both liabilities and surplus. Provident's methodology, which allows for
different investment strategies for assets backing surplus than those backing
product liabilities, was determined by management to be the more appropriate
approach for the combined entity. Accordingly, at June 30, 1999, the Company
adopted Provident's method of calculating the discount rate for claim reserves.
The impact on second quarter and six months 1999 earnings related to the change
in method of calculating the discount rate for claim reserves was $240.7 million
before tax and $156.5 million after tax. The charge was reflected in the
Employee Benefits, Individual, and Other segments as an increase in benefits to
policyholders of $191.7 million, $38.9 million, and $10.1 million, respectively.
On June 30, 1999, 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 of 1999 a
before-tax expense of approximately $125.9 million ($81.8 million after tax)
related to the early retirement offer to the Company's employees. These
expenses are reported in the Corporate segment as other operating expenses.
Additionally, in the second quarter of 1999 the Company expensed $20.0 million
($13.0 million after tax) of incremental costs associated with the merger.
These incremental costs consisted primarily of compensation, training,
integration, and licensing costs.
See Note 2 of the "Notes to Condensed Consolidated Financial Statements"
contained herein and Note 2 of the "Notes to Consolidated Financial Statements"
of the Company's Form 10-K for the fiscal year ended December 31, 1999 for
further discussion of these second quarter charges.
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 and recognized a before-tax charge of $101.1 million ($88.0 million
after tax) in the first quarter of 1999. The charge was recorded in the Other
segment as a $72.6 million increase in the reserve for future benefits and a
$1.5 million reduction in other income and in the Corporate segment as a $27.0
million increase in other operating expenses related to the write-off of
goodwill.
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, reflected in the Corporate segment.
A portion of the losses recognized in 1999 relating to the Company's reinsurance
operations does not receive a tax benefit, which unfavorably impacted the 1999
effective tax rate. Additionally, a portion of the 1999 expenses related to the
merger was non-deductible for federal income tax purposes, resulting in a tax
rate that was less than the U.S. federal statutory tax rate of 35 percent.
In the second quarter of 1999, the Company recorded a refund from the Internal
Revenue Service relating to the settlement of an issue for the 1992 tax year.
The recorded refund of taxes was $5.1 million, and interest thereon was $1.4
million.
In the following discussion of operating results by segment, "revenue" includes
premium income, net investment income, and other income. "Income" excludes net
realized investment gains and losses and federal income taxes.
17
<PAGE>
Employee Benefits Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
2000 1999 % Change 2000 1999 % Change
--------------------------------------------- --------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income
Group Long-term Disability $ 515.6 $ 499.0 3.3% $1,033.6 $ 997.1 3.7%
Group Short-term Disability 128.5 115.9 10.9 252.9 227.1 11.4
Group Life 300.6 288.8 4.1 603.5 575.8 4.8
Accidental Death &
Dismemberment 48.2 46.2 4.3 95.1 93.9 1.3
Group Long-term Care 15.3 10.8 41.7 29.0 20.1 44.3
-------- -------- -------- --------
Total Premium Income 1,008.2 960.7 4.9 2,014.1 1,914.0 5.2
Net Investment Income 174.4 148.7 17.3 344.8 292.7 17.8
Other Income 37.9 34.8 8.9 74.0 67.6 9.5
-------- -------- -------- --------
Total Revenue 1,220.5 1,144.2 6.7 2,432.9 2,274.3 7.0
-------- -------- -------- --------
Benefits and Change in Reserves 847.0 952.1 (11.0) 1,678.4 1,684.1 (0.3)
Commissions 78.8 80.7 (2.4) 167.5 161.0 4.0
Deferral of Policy Acquisition Costs (55.2) (58.5) (5.6) (119.6) (134.1) (10.8)
Amortization of Deferred Policy
Acquisition Costs 36.6 24.6 48.8 84.9 49.7 70.8
Other Operating Expenses 191.9 192.6 (0.4) 392.2 395.4 (0.8)
-------- -------- -------- --------
Total Benefits and Expenses 1,099.1 1,191.5 (7.8) 2,203.4 2,156.1 2.2
-------- -------- -------- --------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 121.4 $ (47.3) N.M. $ 229.5 $ 118.2 94.2%
======== ======== ======== ========
</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.
New sales declined in the second quarter of 2000 compared to the second quarter
of 1999. Employee Benefits new annualized sales, on a submitted date basis,
decreased 26.2 percent to $193.8 million in the second quarter of 2000 from
$262.6 million in the second quarter of 1999. On an effective date basis, sales
decreased 31.1 percent to $132.5 million in the second quarter of 2000 from
$192.3 million in the second quarter of 1999. For the first six months, new
annualized sales on a submitted date basis were $327.8 million in 2000 compared
to $510.9 million in 1999. On an effective date basis, sales were $472.8
million in 2000 and $734.8 million in 1999. Sales that combine long-term
disability, short-term disability, and group life products increased from prior
year, showing continued strong integrated sales and collaboration in the field.
On a year-to-date basis, 31 percent of all new sales were with long-term
disability, short-term disability, and group life coverages combined.
Sales related to employee benefits can fluctuate significantly from quarter to
quarter due to large case size and timing of sales submissions. Several factors
contributed to the decrease in sales, including rate increases and turnover in
the field sales force. 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. In order to give the appropriate focus to the Company's primary
business markets, the Company has established national practice groups to focus
on large employers, executive benefits, and voluntary benefits. These national
practice groups work with the Company's sales force to present coverage
solutions to potential customers and to manage existing customer accounts. 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
originally planned.
The Company monitors persistency and reflects adverse changes in persistency in
the current period's amortization of deferred policy acquisition costs. Actual
persistency experienced during the first and second quarters of 2000 for group
disability, group life, and accidental death and dismemberment products compared
unfavorably to the persistency expected, resulting in additional amortization of
$7.3 million and $25.9 million, respectively, during the second quarter and
first six months of 2000. The adverse persistency was due to large case
terminations and an
18
<PAGE>
aggressive 2000 renewal program that is heavily concentrated in the first two
quarters. It is expected that persistency in 2000 will continue to be lower than
historical levels for group disability as well as group life. Through the second
quarter, the Company's 2000 renewal program has generally been successful at
retaining business that is relatively more profitable than business that
has terminated. It is expected that the additional premium and related profits
associated with this renewal activity will emerge during the remainder of 2000
and throughout 2001. The impact of the renewal program in the first and second
quarters of 2000 was a reduction in income due to the additional amortization
related to the resultant adverse persistency with little recognition of the
premium income that will occur over time from the renewal program. The Company
intends to maintain a disciplined approach in the re-pricing of renewal
business, while balancing the need to maximize persistency and retain producer
relationships. This approach may lead to lower profit margins than originally
planned.
Revenue from the managed disability line of business, which includes GENEX
Services, Inc. and Options and Choices, Inc., totaled $31.6 million in the
second quarter of 2000 compared to $27.4 million in the second quarter of 1999.
On a year-to-date basis, this revenue was $61.7 million in 2000 compared to
$53.2 million in 1999.
Group Disability
Group disability revenue was $796.0 million in the second quarter of 2000
compared to $743.0 million in the second quarter of 1999. Second quarter new
annualized sales for group long-term disability on a submitted date basis were
$68.2 million in 2000 and $101.4 million in 1999. New annualized sales for
group short-term disability were $29.6 million in the second quarter of 2000 as
compared to $50.3 million in the second quarter of 1999. On an effective date
basis, new annualized sales for long-term disability and short-term disability
were $63.2 million and $23.1 million in the second quarter of 2000 and $83.7
million and $38.4 million in the second quarter of 1999. A critical part of the
Company's strategy for group disability during 2000 involves executing its
renewal program and managing persistency, both of which management expects will
have a positive impact on future premium growth and profitability. However, the
high terminations and slow sales have decreased the earned premium growth
compared to that experienced during 1999. The Company is implementing pricing
changes in the group disability line. Prices will increase or decrease by
market segment, as appropriate, to respond to current claim experience and other
factors and assumptions. Net investment income is expected to continue to
increase due to the increase in the level of invested assets allocated to this
line of business, the increased duration on new investments, and the higher
interest rate environment.
Group disability reported income of $67.0 million for the second quarter of 2000
compared to a loss of $109.6 million for the second quarter of 1999. 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. Excluding the
1999 second quarter discount rate change, the benefit ratio for group disability
was 83.2 percent in the prior year second quarter compared to 87.6 percent in
the second quarter of 2000 and 87.4 percent in the first quarter of 2000. For
long-term disability, the ratio for second quarter 2000 compared unfavorably to
second quarter 1999, but showed slight improvement over first quarter 2000. The
increase over the prior year second quarter is due to stronger reserve factors
for new claims and to slower earned premium growth over the past few quarters.
The paid claim incidence for long-term disability compares favorably to the
second quarter of 1999 and the first quarter of 2000 due to lower claim
acceptance rates, and submitted claim incidence has moved upward only slightly
from the second quarter of 1999 and the first quarter of 2000. The benefit
ratio for short-term disability compares favorably to the second quarter of 1999
due to a fairly consistent paid claims ratio. Compared to the first quarter of
2000, the benefit ratio for short-term disability has increased due to an
increase in the average weekly indemnity and paid incidence. The submitted
claim incidence for short-term disability has improved from that experienced in
the second quarter of 1999 but is up slightly from the first quarter 2000 rate,
as expected due to seasonality. The fundamentals underlying risk results in the
group disability line continue to exhibit improvements as the integration of the
claims organization continues.
Additionally, the increase in the amortization of deferred policy acquisition
costs had a negative impact on second quarter 2000 income. This increase
resulted from $5.8 million of additional amortization necessitated by the higher
level of group long-term and short-term disability terminations experienced
during the second quarter of 2000 relative to that which was expected at the
time the business was written. Positive impacts on second quarter 2000 income
were the revenue increase and an improvement in the operating expense ratio due
to cost savings resulting from the merger.
19
<PAGE>
Group disability reported income of $123.3 million for the first six months of
2000 compared to a loss of $4.1 million for the same period of 1999. New
annualized sales, on a submitted date basis, for the first six months of 2000
were $131.7 million and $51.9 million for group long-term and short-term
disability, respectively, compared to $207.0 million and $94.9 million for the
comparable period in 1999. On an effective date basis, new annualized sales for
long-term disability and short-term disability were $198.0 million and $84.5
million in the first six months of 2000 and $315.5 million and $136.1 million in
the first six months of 1999. Income in 2000 was positively impacted by a
revenue increase of $107.4 million compared to the first six months of 1999 and
an improvement in the operating expense ratio. Excluding the 1999 second
quarter discount rate change, the benefit ratio for long-term disability was
higher in the first six months of 2000 compared to the same period of 1999 due
to stronger reserve factors for new claims and the slower earned premium growth.
The paid claim incidence for long-term disability compares favorably to the
first six months of 1999 due to the continued decline in claim acceptance rates.
Claim resolution experience has continued to improve in 2000. The benefit ratio
for short-term disability is slightly higher for the first six months of 2000
than the comparable period of 1999 due primarily to an increase in the average
weekly indemnity. The submitted claim incidence for short-term disability has
improved from that experienced in the first six months of 1999. Additional
amortization of deferred policy acquisition costs due to the higher than
expected level of terminations was $19.6 million for the first six months of
2000.
In the fourth quarter of 1998, the Company recorded a $50.3 million before-tax
charge for the group long-term disability line of business in the Employee
Benefits segment for the expected increase in claims durations due to
management's expectation that productivity in the claims organization will be
impacted as a result of planning, consolidation, and integration efforts related
to the merger. Management expects the claims integration efforts to have some
benefits, primarily related to claims incurred in future periods, as well as the
potential for improved customer satisfaction and lower ultimate claim costs as
best practices in return-to-work and claims management are implemented. As
benefits related to the integration become known, reserve assumptions will be
revised, if appropriate. Insurance policies that are impacted by the temporary
change in claim resolution rates will not perform as anticipated when priced.
However, since the cause of the additional claim cost is of a temporary nature,
it is not anticipated to have an effect on future policy pricing.
During the first and second quarters of 1999, those claim operations integration
activities progressed as assumed. At December 31, 1998, management assumed the
revised claim resolution rates for the first and second quarters of 1999 to be
90 percent of assumptions, before adjusting for the impact of the claim
operations integration activities. The actual experience was 89 percent for the
first quarter of 1999 and 90 percent for the second quarter. If the impact of
merger-related claim operations integration activities on claim durations had
not been anticipated at December 31, 1998, second quarter and six months 1999
before-tax income for the group long-term disability line of business would have
been negatively impacted by $11.8 million and $23.6 million, respectively. The
effect of integration activities on new claim resolution rates is not expected
to be material during 2000. See Notes 2 and 7 of the "Notes to Consolidated
Financial Statements" of the Company's Form 10-K for the fiscal year ended
December 31, 1999 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 levels
experienced in 1999 and 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 $51.6 million in the second quarter of 2000 compared to $61.0 million
in the second quarter of 1999. New annualized sales on a submitted date basis
decreased to $96.0 million in the second quarter of 2000 as compared to $110.9
million reported in the second quarter of 1999. However, this was a significant
increase over first quarter 2000 sales of $48.2 million due partially to a large
case sale that is effective in January 2001. On an effective date basis, new
annualized sales were $46.2 million in the second quarter of 2000 compared to
$70.2 million for the same period last year.
20
<PAGE>
The three lines of business reported an increase in revenue, primarily due to
increases in both premium income and net investment income. Offsetting the
revenue increase was an increase in the benefit ratio when compared to the
second quarter of 1999. Group life and accidental death and dismemberment
reported an unfavorable benefit ratio compared to the prior year second quarter
and the first quarter of 2000. The increase over second quarter 1999 was due to
an increase in the average paid claim size and waiver incidence for group life,
partially offset by favorable paid mortality incidence. Compared to the first
quarter, the second quarter 2000 paid mortality incidence for group life
improved, but was partially offset by an increase in average paid claim size and
increased waiver incidence.
Group long-term care reported an unfavorable benefit ratio for the second
quarter of 2000 compared to the second quarter of 1999 due primarily to an
increase in paid claim incidence and the growth in active life reserves that
results primarily from the interest component of the reserve change. Submitted
claim incidence improved slightly over the prior year second quarter, and the
net claim resolution rate was favorable. The second quarter of 2000 benefit
ratio improved from the first quarter of 2000 due primarily to an improvement in
the new claim rate. The long-term care net claim resolution rate for the second
quarter of 2000 compares unfavorably to the resolution rate for the first
quarter of 2000 but is at the average rate for the prior four quarters.
The amortization of deferred policy acquisition costs for the second quarter of
2000 includes $1.5 million of additional amortization due to the higher level of
terminations for group life and accidental death and dismemberment products
experienced during the second quarter of 2000 relative to that which was
expected at the time the policies were written. The operating expense ratio
compares favorably to the 1999 second quarter ratio due to cost savings
resulting from the merger.
On a year-to-date basis, income was $101.6 million in 2000 compared to $119.5
million in 1999. Revenue year-to-date increased $42.7 million to $785.2
million, and the operating expense ratio has improved from the first six months
of 1999. However, these positive impacts on income were offset by an
unfavorable benefit ratio and an increase in the amortization of deferred policy
acquisition costs during 2000. The increase in the benefit ratio results
primarily from the increase in the waiver incidence and the size of the average
paid claim for group life. During the first six months of 2000, additional
amortization due to the higher level of terminations was $6.3 million.
New annualized sales on a submitted date basis were $144.2 million during the
first half of 2000 as compared to $209.0 million reported for the same period of
1999. On an effective date basis, new annualized sales were $190.3 million for
the first half of 2000 compared to $283.2 million for the same period last year.
21
<PAGE>
Individual Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
2000 1999 % Change 2000 1999 % Change
------------------------------------------- ---------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income
Individual Disability $409.4 $383.9 6.6% $ 827.6 $ 775.2 6.8%
Individual Life 20.6 21.8 (5.5) 42.3 44.4 (4.7)
Individual Long-term Care 32.0 21.6 48.1 61.2 40.8 50.0
------ ------ -------- --------
Total Premium Income 462.0 427.3 8.1 931.1 860.4 8.2
Net Investment Income 229.6 222.7 3.1 462.2 432.0 7.0
Other Income 35.9 11.1 223.4 50.5 29.3 72.4
------ ------ -------- --------
Total Revenue 727.5 661.1 10.0 1,443.8 1,321.7 9.2
------ ------ -------- --------
Benefits and Change in Reserves 493.8 444.7 11.0 968.7 860.8 12.5
Commissions 63.4 70.0 (9.4) 130.4 139.6 (6.6)
Deferral of Policy Acquisition Costs (51.1) (48.2) 6.0 (103.6) (98.8) 4.9
Amortization of Deferred Policy
Acquisition Costs 25.1 21.5 16.7 50.7 44.5 13.9
Other Operating Expenses 116.5 126.1 (7.6) 234.4 247.9 (5.4)
------ ------ -------- --------
Total Benefits and Expenses 647.7 614.1 5.5 1,280.6 1,194.0 7.3
------ ------ -------- --------
Income Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 79.8 $ 47.0 69.8% $ 163.2 $ 127.7 27.8%
====== ====== ======== ========
</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 line of business were $29.7
million in the second quarter of 2000 compared to $31.4 million in the second
quarter of 1999. Year-to-date sales were $56.2 million in 2000 and $65.3
million in the comparable period of 1999. As discussed in the "Employee
Benefits Segment Operating Results," several factors have contributed to the
decrease in sales. However, the persistency of existing individual disability
income business continued to be favorable during 1999 and the first six months
of 2000. The Company is developing a new portfolio of individual disability
products for release in approved states during the fourth quarter of 2000. This
product line will consolidate the current offerings of the Company's insurance
subsidiaries into one new simplified product portfolio. The new portfolio will
utilize a modular approach offering customers a range of product options and
features. This portfolio has been designed to combine the best features from
prior Company offerings and will include return-to-work incentives and optional
long-term care conversion benefits and/or benefits for catastrophic
disabilities. Management expects that premium income in the individual
disability line will grow on a year-over-year basis as the portfolio transition
produces increasing levels of new sales of individual disability products and as
a result of an increased focus on integrated disability sales in group and
individual, as well as other sales initiatives discussed under "Employee
Benefits Segment Operating Results."
Revenue was $645.2 million for the second quarter of 2000 compared to $586.0
million in the same period of 1999. On a year-to-date basis, revenue was
$1,280.8 million in 2000 and $1,174.6 million in 1999. The growth in 2000
revenue was driven primarily by the growth in premium income as well as net
investment income. Premium income in the second quarter and first six months of
2000 included $24.9 million and $49.6 million, respectively, from an inforce
block of individual disability business reinsured effective January 1, 2000.
Income in the individual disability line of business was $69.6 million in the
second quarter of 2000, an increase of $34.4 million over the prior year second
quarter. For the first six months, income was $142.0 million in 2000 and $106.8
million in 1999. Individual disability second quarter and six months 1999
income decreased $38.9 million as a result of the change in method of
calculating the discount rate for claim reserves.
22
<PAGE>
Excluding the discount rate change, this line reported an increase in the
benefit ratio for the second quarter and six months of 2000 compared to the
comparable periods of last year. Submitted incidence has remained constant
during the first two quarters of 2000, but is higher than the average for the
year 1999. Paid incidence has remained relatively flat since the third quarter
of 1999, and the claim acceptance rate has been declining throughout 1999 and
2000. The incidence of new claims is higher for the second quarter and six
months of 2000 compared to the prior year comparable periods. The net claim
resolution rate for the second quarter and first six months of 2000 compares
favorably with the same periods of 1999 but is down slightly from the first
quarter of 2000. Individual disability benefited from an improved commission
and operating expense ratio for the second quarter and six months of 2000 as
compared to the same periods during 1999.
As noted in the "Employee Benefits Segment Operating Results," claim resolution
rates were revised downward in the fourth quarter of 1998 for claim operations
integration activities related to the merger. The Company recorded a $100.3
million before-tax charge in the fourth quarter of 1998 in the Individual
segment related to the revised claim resolution rates for individual disability.
At December 31, 1998, management assumed the revised claim resolution rates for
the first and second quarters of 1999 to be 90 percent of assumptions, before
adjusting for the impact of the claim operations integration activities. The
actual experience for the Company was 89 percent in the first quarter of 1999
and 90 percent in the second quarter. If the impact of merger-related claim
operations integration activities on claim durations had not been anticipated at
December 31, 1998, second quarter and six months 1999 before-tax operating
income for the individual disability line of business would have been negatively
impacted by $23.8 million and $47.6 million, respectively. The effect of
integration activities on new claim resolution rates is not expected to be
material during 2000. See Notes 2 and 7 of the "Notes to Consolidated Financial
Statements" of the Company's Form 10-K for the fiscal year ended December 31,
1999 for further discussion.
Individual Life and Long-term Care
The individual long-term care line of business reported increased premium income
for the second quarter of 2000 compared to the same period of 1999, primarily
due to new sales growth over the last several quarters. New annualized sales
for long-term care were $10.7 million for the second quarter of 2000. For the
comparable period of 1999, new sales were $10.5 million. On a year-to-date
basis, new sales were $21.5 million and $18.1 million for 2000 and 1999,
respectively. The Company expects the sales momentum in individual long-term
care to continue. Individual life reported both new sales and premium income
slightly lower than the prior year second quarter and six months.
Income in the individual life and long-term care lines of business was $10.2
million for the second quarter of 2000 compared to $11.8 million for the same
period of 1999. For the six months of 2000, income was $21.2 million compared
to $20.9 million for 1999. Individual long-term care reported an improvement in
the second quarter and year-to-date 2000 benefit ratios as compared to the same
periods last year. This improvement resulted primarily from a favorable net
resolution rate and a decrease in submitted claim incidence rates. The second
quarter and year-to-date 2000 benefit ratios for individual life compared
unfavorably to the 1999 second quarter and six months ratios due to a slight
increase in claim incidence and an increase in the average size of claim
payments. However, the operating expense ratios for both individual life and
individual long-term care improved relative to the 1999 second quarter and six
months ratios.
23
<PAGE>
Voluntary Benefits Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
2000 1999 % Change 2000 1999 % Change
------------------------------------------- -------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $184.7 $173.1 6.7% $366.5 $344.3 6.4%
Net Investment Income 27.7 25.2 9.9 55.6 50.1 11.0
Other Income 1.8 1.6 12.5 3.3 3.3 -
------ ------ ------ ------
Total Revenue 214.2 199.9 7.2 425.4 397.7 7.0
------ ------ ------ ------
Benefits and Change in Reserves 111.8 99.4 12.5 219.4 195.7 12.1
Commissions 38.9 36.5 6.6 69.6 71.4 (2.5)
Deferral of Policy Acquisition Costs (42.1) (37.1) 13.5 (72.1) (74.1) (2.7)
Amortization of Deferred Policy
Acquisition Costs 29.9 26.4 13.3 55.3 53.4 3.6
Other Operating Expenses 36.3 43.6 (16.7) 74.2 88.7 (16.3)
------ ------ ------ ------
Total Benefits and Expenses 174.8 168.8 3.6 346.4 335.1 3.4
------ ------ ------ ------
Income Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 39.4 $ 31.1 26.7% $ 79.0 $ 62.6 26.2%
====== ====== ====== ======
</TABLE>
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 $14.3 million in the second
quarter of 2000 compared to the second quarter of 1999 and increased $27.7
million year-to-date primarily due to the increase in premium income which was
attributable to sales growth during the last several quarters and continued
favorable persistency. New annualized sales for the second quarter of both 2000
and 1999 were $58.3 million. For the first six months, new sales were $121.6
million for 2000 and $117.1 million for 1999. Management continues its efforts
to increase sales through the sales initiatives discussed under "Employee
Benefits Segment Operating Results." The investment income growth for the
second quarter and six months of 2000 as compared to 1999 was due to the
repositioning of the investment portfolio subsequent to the merger.
Additional positive impacts on 2000 income were favorable commission and
operating expense ratios. The improvement in the operating expense ratio is
attributable to costs savings resulting from the merger. The second quarter and
six months 2000 benefit ratios were unfavorable compared to the same periods of
1999. The primary drivers were unfavorable results in the life product line and
an increase in the incurred and paid loss ratios for the disability product line
due to a slightly higher average claim payment per coverage.
Other Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
2000 1999 % Change 2000 1999 % Change
----------------------------------------- ------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $135.0 $126.3 6.9% $259.0 $250.2 3.5%
Net Investment Income 105.0 114.5 (8.3) 218.3 228.0 (4.3)
Other Income 8.1 20.5 (60.5) 14.2 48.4 (70.7)
------ ------ ------ ------
Total Revenue 248.1 261.3 (5.1) 491.5 526.6 (6.7)
Total Benefits and Expenses 232.7 253.6 (8.2) 461.2 580.0 (20.5)
------ ------ ------ ------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 15.4 $ 7.7 100.0% $ 30.3 $(53.4) N.M.
====== ====== ====== ======
</TABLE>
24
<PAGE>
The Other operating segment includes results from products no longer actively
marketed, including reinsurance pools and management operations, corporate-owned
life insurance, group pension, health insurance, and individual annuities. It
is expected that revenue and earnings in this segment will decline over time as
these business lines wind down. The run-off of the group pension line results in
a decline in assets under management and, in turn, a continued decline in the
net investment income produced by the assets. Management expects to reinvest
the capital supporting these lines of business in the future growth of the
Employee Benefits, Individual, and Voluntary Benefits segments. The closed
blocks of business have been segregated for reporting and monitoring purposes.
The reinsurance pools and management operations reported losses of $0.5 million
for the second quarter of 2000 and $12.6 million for the second quarter of 1999.
For the first six months of 2000, the loss was $0.4 million compared to a loss
of $86.6 million in 1999. The 1999 loss was the result of the $74.1 million
first quarter 1999 charge related to the decision to exit the reinsurance
operations and the $10.1 million second quarter 1999 charge to group long-term
disability reinsurance related to the change in method of calculating the
discount rate for claim reserves.
Premium income was $115.2 million and $216.3 million for the second quarter and
six months of 2000 compared to $99.8 million and $203.6 million for the same
periods of 1999. These results are consistent with the strategy which the
Company implemented during 1999 to limit participation in Lloyd's year 2000
underwriting risks, manage the run-off of the Company's risk participation in
open years of account of Lloyd's reinsurance syndicates, discontinue the
accident reinsurance business in London beginning in year 2000, sell the
reinsurance management operations of the A&H and LTC reinsurance facilities, and
reinsure the Company's risk participation in these facilities. See previous
discussion under "Consolidated Operating Results" and Note 13 of the "Notes to
Consolidated Financial Statements" of the Company's Form 10-K for the fiscal
year ended December 31, 1999.
In the fourth quarter of 1998, the Company recorded a $2.4 million before-tax
charge related to the revised claim resolution rates for group long-term
disability reinsurance. If the impact of merger-related claim operations
integration activities on claim duration had not been anticipated at December
31, 1998, second quarter and six months 1999 before-tax earnings for the
reinsurance pools and management operations line of business would have been
negatively impacted by $0.6 million and $1.2 million, respectively.
Corporate Segment Operating Results
The Corporate segment includes investment earnings on corporate assets not
specifically allocated to a line of business, corporate interest expense,
amortization of goodwill, and certain corporate expenses not allocated to a line
of business.
Revenue in the Corporate segment was $11.6 million in the second quarter of 2000
and $6.9 million in the second quarter of 1999. For the first six months,
revenue was $22.6 million in 2000 and $15.0 million in 1999. The Corporate
segment reported a loss of $38.2 million in the second quarter of 2000 compared
to a loss of $317.3 million in the second quarter of 1999. On a year-to-date
basis, the losses were $77.6 million for 2000 and $377.9 million for 1999.
Interest and debt expense was $45.1 million and $89.0 million for the second
quarter and six months of 2000 compared to $33.6 million and $66.5 million for
the comparable periods of 1999 due to increased corporate borrowings.
In the second quarter of 1999 the Company recorded before-tax expenses related
to the merger of approximately $142.2 million and a before-tax expense of
approximately $125.9 million related to the early retirement offer to the
Company's employees. In addition to these expenses, in the second quarter of
1999 the Company expensed $20.0 million of other incremental costs associated
with the merger, $17.1 million of which were included in the Corporate segment.
See previous discussion under "Consolidated Operating Results," Note 2 of the
"Notes to Condensed Consolidated Financial Statements" contained herein, and
Note 2 of the "Notes to Consolidated Financial Statements" of the Company's Form
10-K for the fiscal year ended December 31, 1999.
As previously discussed under "Consolidated Operating Results," the Company
recorded in the Corporate segment a before-tax write-down of goodwill of $27.0
million in the 1999 first quarter and an additional write-down of $2.0 million
in the 1999 second quarter related to its decision to exit the reinsurance
operations.
25
<PAGE>
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 1999 and continuing into the first six months of 2000, the Company
actively pursued its strategy of extending the duration of its investments and
shifting the mix of assets for approximately $2.1 billion of its investments.
This program was essentially complete as of June 30, 2000. 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 $40 million. Net investment income for the
second quarter of 2000 increased 4.8 percent over the second quarter of 1999,
and for the first six months, net investment income increased 7.6 percent over
the comparable period of 1999 due to increased yields and growth in the asset
base.
During the first six months of 2000, the Company reported net realized
investment gains of $1.6 million. Included in this amount were net gains of
$50.4 million from the sale of fixed maturity and equity securities, a gain of
$6.2 related to derivative activity, and a $20.0 million reduction in the
mortgage loan valuation allowance. Offsetting these gains was a $78.4 million
realized investment loss recognized as a result of management's determination
that the value of certain fixed maturity investments had other than temporarily
declined. The Company also recorded a loss on the sale of real estate of $11.9
million, with an approximate offsetting reduction in the real estate valuation
allowance.
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately $3.4
billion and $3.1 billion on an amortized cost basis at June 30, 2000, and
December 31, 1999, respectively. At June 30, 2000, the mortgage-backed
securities had an average life of 13.2 years and effective duration of 11.9
years. The mortgage-backed securities are valued on a monthly basis using
valuations supplied by the brokerage firms that are dealers in these securities.
The primary risk involved in investing in mortgage-backed securities is the
uncertainty of the timing of cash flows from the underlying loans due to
prepayment of principal. The Company uses models which incorporate economic
variables and possible future interest rate scenarios to predict future
prepayment rates. The Company has not invested in mortgage-backed derivatives,
such as interest-only, principal-only or residuals, where market values can be
highly volatile relative to changes in interest rates.
The Company's exposure to below-investment-grade fixed maturity securities at
June 30, 2000, was $1,965.9 million, representing 7.4 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 $2,147.4 million at December 31, 1999, representing 8.1
percent of invested assets.
Below-investment-grade bonds are inherently more risky than investment-grade
bonds since the risk of default by the issuer, by definition and as exhibited by
bond rating, is higher. Also, the secondary market for certain below-
investment-grade issues can be highly illiquid. Management does not anticipate
any liquidity problem caused by the investments in below-investment-grade
securities, nor does it expect these investments to adversely affect its ability
to hold its other investments to maturity.
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $1,231.3 million and $1,278.1 million
at June 30, 2000, and December 31, 1999, respectively. The Company uses a
comprehensive rating system to evaluate the investment and credit risk of each
mortgage loan and to identify specific properties for inspection and
reevaluation. The Company establishes an investment valuation allowance for
mortgage loans based on a review of individual loans and the overall loan
portfolio, considering the value of the underlying collateral.
The mortgage loan portfolio is well diversified geographically and among
property types. The incidence of new problem mortgage loans and foreclosure
activity has remained low in 2000 and 1999, reflecting improvements in
26
<PAGE>
overall economic activity and improving real estate markets in the geographic
areas where the Company has mortgage loans. Management expects the level of
delinquencies and problem loans to remain low in the future.
At June 30, 2000, and December 31, 1999, impaired loans totaled $17.9 million
and $18.1 million, respectively. Included in the impaired loans at June 30,
2000 were $6.6 million of loans which had a related, specific investment
valuation allowance of $2.4 million and $11.3 million of loans which had no
related, specific allowance. Impaired mortgage loans are not expected to have a
material impact on the Company's liquidity, financial position, or results of
operations.
27
<PAGE>
Restructured mortgage loans totaled $8.6 million and $8.7 million at June 30,
2000 and December 31, 1999, respectively, and represent loans that have been
refinanced with terms more favorable to the borrower. Interest lost on
restructured loans was immaterial for the six and twelve month periods ended
June 30, 2000, and December 31, 1999.
Real estate was $165.7 million and $211.2 million at June 30, 2000, and December
31, 1999. Investment real estate is carried at cost less accumulated
depreciation. Real estate acquired through foreclosure is valued at fair value
at the date of foreclosure and may be classified as investment real estate if it
meets the Company's investment criteria. If investment real estate is
determined to be permanently impaired, the carrying amount of the asset is
reduced to fair value. Occasionally, investment real estate is reclassified to
real estate held for sale when it no longer meets the Company's investment
criteria. Real estate held for sale, which is valued net of a valuation
allowance that reduces the carrying value to the lower of cost or fair value
less estimated cost to sell, amounted to $37.6 million at June 30, 2000, and
$79.4 million at December 31, 1999.
Investment valuation allowances for mortgage loans and real estate held for sale
are established based on a review of specific assets as well as on an overall
portfolio basis, considering the value of the underlying assets and collateral.
If a decline in value is considered to be other than temporary or if the asset
is deemed permanently impaired, the investment is reduced to estimated net
realizable value, and the reduction is recorded as a realized investment loss.
Management monitors the risk associated with the invested asset portfolio and
regularly reviews and adjusts the investment valuation allowance. As a result of
management's most recent review of the overall mortgage loan portfolio and based
on management's expectation that delinquencies and problem loans will remain
low, the valuation allowance on mortgage loans was reduced $20.0 during the
second quarter of 2000. At June 30, 2000, the balance in the valuation
allowance for mortgage loans and real estate was $12.9 million and $25.6
million, respectively.
Other
The Company's exposure to non-current investments totaled $46.5 million at June
30, 2000, or 0.2 percent of invested assets. These non-current investments are
comprised of bonds, foreclosed real estate, and mortgage loans that became more
than thirty days past due in principal and interest payments.
The Company utilizes interest rate futures contracts, current and forward
interest rate swaps, interest rate forward contracts, and options on forward
interest rate swaps, forward treasuries, or specific fixed income securities to
manage duration and increase yield on cash flows expected from current holdings.
All transactions are hedging in nature and not speculative. Almost all
transactions are associated with the individual and group disability product
portfolios. All other product portfolios are periodically reviewed to determine
if hedging strategies would be appropriate for risk management purposes.
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 $533.0 million for the
six months ended June 30, 2000, as compared to $740.1 million in the comparable
period in 1999.
The Company believes the cash flows from its operations will be sufficient to
meet its operating and financial cash flow requirements, excluding the strain
placed on capital as a result of the charges recorded in connection with the
merger. As a result of the effect on capital during 1999 of the merger related
charges, the Company raised approximately $500 million through the debt markets
during the fourth quarter of 1999 by securing $200 million of one-year bank debt
and by issuing commercial paper. The Company is exploring alternative financing
sources to further increase its financial flexibility. The Company intends to
file a shelf registration during the third quarter of 2000 in order to provide
funding alternatives for its maturing debt. Contingent upon market conditions
and corporate needs, funding will be used to refinance short-term debt on a
long-term basis and to fund internal expansion, acquisitions, and investment
opportunities.
The Company is involved in negotiations to reinsure or sell certain blocks of
business that are non-core or non-strategic to the Company's ongoing operations.
These transactions, when competed, are expected to increase equity, to support
the Company's present credit and claims-paying ratings, and to increase the
risk-based capital ratios of the insurance subsidiaries involved.
28
<PAGE>
In April 2000, the Company issued $200.0 million of variable
rate notes, due in April 2001, in a privately negotiated transaction. The notes
were used to refinance other short-term debt and had an interest rate of 7.03
percent during the second quarter. The current interest rate on these notes is
7.48 percent.
At June 30, 2000, the Company had short-term and long-term debt totaling
$1,039.2 million and $1,166.5 million, respectively. At June 30, 2000,
approximately $498.5 million was available for additional financing under the
existing revolving credit facilities.
Ratings
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's),
Fitch/Duff & Phelps (Fitch), and A.M. Best Company (AM Best) are among the third
parties that provide the Company assessments of its overall financial position.
Ratings from these agencies for financial strength are available for the
individual U.S. domiciled insurance company subsidiaries. Financial strength
ratings are based primarily on U.S. statutory financial information for the
individual U.S. domiciled insurance companies. Debt ratings for the Company are
based primarily on consolidated financial information prepared using generally
accepted accounting principles. Both financial strength ratings and debt
ratings incorporate qualitative analyses by rating agencies on an ongoing basis.
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.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
S&P Moody's Fitch AM Best
-----------------------------------------------------------------------------------------------------------------------------
UnumProvident Corporation
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Senior Debt A- (Strong ) A3 (Upper Medium A- (High Not Rated
Grade) Credit Quality)
-----------------------------------------------------------------------------------------------------------------------------
Junior Subordinated Debt BBB (Good ) Baa1 (Medium Grade) BBB+ (Good Not Rated
Credit Quality)
-----------------------------------------------------------------------------------------------------------------------------
Commercial Paper A-2 (Good) Prime-2 (Strong F2 (Good Not Rated
Ability) Credit Quality)
-----------------------------------------------------------------------------------------------------------------------------
U.S. Insurance Subsidiaries
-----------------------------------------------------------------------------------------------------------------------------
Provident Life & Accident AA- (Very Strong ) A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Provident Life & Casualty Not Rated Not Rated Not Rated A+ (Superior)
-----------------------------------------------------------------------------------------------------------------------------
Provident National Assurance Not Rated A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Unum Life of America AA- (Very Strong ) A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
First Unum Life AA- (Very Strong ) A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Colonial Life & Accident AA- (Very Strong ) A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Paul Revere Life AA- (Very Strong ) A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Paul Revere Variable AA- (Very Strong ) A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Paul Revere Protective AA- (Very Strong ) A1 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
29
<PAGE>
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 have adequately addressed and
substantially resolved year 2000 issues could have had, and as to mission
critical systems in certain circumstances would have had, a material adverse
effect on the Company's business, results of operations, or financial condition.
While there can be no assurance as to its long-term success, the Company
completed a project which was 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 was organized into a number of phases for rectifying its internal
computer systems, including assessment, code remediation, testing, and
deployment. The program continues to monitor systems for year 2000 issues,
including the ability to properly handle the dates of October 10 and December
31, 2000 and February 28 and December 31, 2001. To date, no material issues
have been identified.
There are numerous instances in which third parties having a relationship with
the Company had and may continue to 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. 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
continue to be year 2000 trouble free. As a result, the Company will continue
to monitor these dependencies for year 2000 problems.
Although there was a broad range of possibilities that could have occurred in
connection with non-compliance with year 2000 that might have affected the
Company, particularly as a consequence of third parties, the Company experienced
no material problems before, on, or after January 2, 2000. Consequently, the
Company has not experienced any material adverse impact on its business, results
of operations, or financial condition from year 2000 issues. With regard to any
subsequent non-compliance resulting from the Company's systems, which the
Company believes to be less likely than that resulting from third parties, the
Company will provide adequate financial and personnel resources to remediate the
problem as soon as possible. With regard to non-compliance resulting from third
party failure, the Company has 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.
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 $34
million in connection with incremental cost of the year 2000 project.
30
<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. With respect to the Company's exposure to
market risk, see the discussion in Part II, Item 7A of Form 10-K for the fiscal
year ended December 31, 1999. During the first six months of 2000, there was no
substantive change to the Company's market risk or the management of such risk.
31
<PAGE>
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of stockholders held on May 19, 2000 at 10:00 A.M., the
Company's stockholders approved, as recommended by the Board of Directors, the
election of four directors for terms expiring in 2003 as listed in the proxy
statement and set forth below:
<TABLE>
<CAPTION>
Election of Directors Votes For Votes Withheld
--------------------- --------- --------------
<S> <C> <C>
William L. Armstrong 180,764,977 2,801,570
A. S. (Pat) MacMillan 180,750,737 2,815,810
George J. Mitchell 180,728,486 2,838,061
Cynthia A. Montgomery 180,888,273 2,678,274
</TABLE>
No other matters to be voted upon were presented at the meeting.
32
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
Exhibit 3 Restated Certificate of Incorporation of UnumProvident
Corporation (incorporated by reference to Exhibit 2 to
Form 8-A/A of the Company filed June 30, 1999)
Exhibit 15 Letter re: Unaudited interim financial information
Exhibit 27 Financial data schedule (for SEC use only)
(b) Reports on Form 8-K
None
33
<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: August 11, 2000 /s/ J. Harold Chandler
--------------------------------------------
J. Harold Chandler
Chairman, President, and Chief Executive Officer
Date: August 11, 2000 /s/ Thomas R. Watjen
--------------------------------------------
Thomas R. Watjen
Executive Vice President, Finance and Risk Management
34
