<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended September 30, 2000.
Commission file number 1-11834
UnumProvident Corporation
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 62-1598430
(State of other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
1 FOUNTAIN SQUARE 2211 CONGRESS STREET
CHATTANOOGA, TENNESSEE 37402 PORTLAND, MAINE 04122
</TABLE>
(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.
Class Outstanding at September 30, 2000
----- ---------------------------------
Common stock, $0.10 par value 240,857,240
<PAGE>
TABLE OF CONTENTS
PART I
<TABLE>
<S> <C>
Cautionary Statement Regarding Forward-Looking Statements..................................... 1
1 Financial Statements (Unaudited):
Condensed Consolidated Statements of Financial Condition at September 30, 2000 and
December 31, 1999...................................................................... 2
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2000 and 1999............................................................ 4
Condensed Consolidated Statements of Stockholders' Equity for the nine months ended
September 30, 2000 and 1999............................................................ 5
Condensed Consolidated Statements of Cash Flows for the nine months ended September
30, 2000 and 1999...................................................................... 6
Notes to Condensed Consolidated Financial Statements.................................... 7
Independent Auditors' Review Report..................................................... 15
2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 16
3. Quantitative and Qualitative Disclosure about Market Risk................................. 32
PART II
6. Exhibits and Reports on Form 8-K.......................................................... 33
Signatures................................................................................ 34
</TABLE>
<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, and reserves and related
assumptions. Forward-looking statements are those not based on historical
information, but rather relate to future operations, strategies, financial
results, or other developments. These statements may be made directly in this
document or may be made part of this document by reference to other documents
filed with the Securities and Exchange Commission by the Company, which is known
as "incorporation by reference." You can find many of these statements by
looking for words such as "may," "should," "believes," "expects," "anticipates,"
"estimates," "intends," "projects," "goals," "objectives," or similar
expressions in this document or in documents incorporated herein.
These forward-looking statements are subject to numerous assumptions, risks, and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by the forward-looking statements include, among others, the
following possibilities:
. Insurance reserve liabilities can fluctuate as a result of changes in
numerous factors, and such fluctuations can have material positive or
negative effects on net income.
. Actual persistency may be lower than projected persistency, resulting
in lower than expected revenue and higher than expected amortization
of deferred policy acquisition costs.
. Incidence and recovery rates may be influenced by, among other
factors, the emergence of new diseases, new trends and developments in
medical treatments, and the effectiveness of risk management programs.
. Retained risks in the Company's reinsurance operations 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.
. Field force effectiveness in supporting new product offerings and
providing customer service may not meet expectations.
. Sales growth may be less than planned, which will impact revenue and
profitability.
. 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.
. Legislative or regulatory changes may adversely affect the businesses
in which the Company is engaged.
. 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.
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>
September 30 December 31
2000 1999
(in millions of dollars)
---------------------------------------
(Unaudited)
<S> <C> <C>
Assets
Investments
Fixed Maturity Securities
Available-for-Sale $22,061.7 $22,033.2
Held-to-Maturity 341.0 323.5
Mortgage Loans 1,158.0 1,278.1
Real Estate 162.0 211.2
Policy Loans 2,348.7 2,316.9
Short-term Investments 251.6 321.5
Other Investments 55.6 64.9
--------- ---------
Total Investments 26,378.6 26,549.3
Cash and Bank Deposits 100.4 292.4
Accounts and Premiums Receivable 1,938.5 1,144.3
Reinsurance Receivable 5,836.6 4,741.2
Accrued Investment Income 586.9 543.6
Deferred Policy Acquisition Costs 2,352.9 2,391.2
Value of Business Acquired 585.8 534.1
Goodwill 689.2 706.4
Other Assets 1,305.6 1,085.9
Separate Account Assets 428.0 459.1
--------- ---------
Total Assets $40,202.5 $38,447.5
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
September 30 December 31
2000 1999
(in millions of dollars)
-------------------------------------------
(Unaudited)
<S> <C> <C>
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 1,781.1 $ 1,722.1
Reserves for Future Policy and Contract Benefits and
Unearned Premiums 25,636.7 23,719.7
Other Policyholders' Funds 2,780.1 3,521.8
Federal Income Tax 370.1 271.6
Short-term Debt 1,021.3 1,075.0
Long-term Debt 1,166.5 1,166.5
Other Liabilities 1,542.0 1,229.5
Separate Account Liabilities 428.0 459.1
--------- ---------
Total Liabilities 34,725.8 33,165.3
--------- ---------
Commitments and Contingent Liabilities - Note 8
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: 241,033,535 and 240,515,180 shares 24.1 24.1
Additional Paid-in Capital 1,036.3 1,028.6
Accumulated Other Comprehensive Loss (104.7) (18.9)
Retained Earnings 4,230.2 3,957.6
Treasury Stock at Cost: 176,295 shares (9.2) (9.2)
--------- ---------
Total Stockholders' Equity 5,176.7 4,982.2
--------- ---------
Total Liabilities and Stockholders' Equity $40,202.5 $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 Nine Months Ended
September 30 September 30
2000 1999 2000 1999
(in millions of dollars, except share data)
-------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue
Premium Income $1,754.6 $1,736.2 $5,325.3 $5,105.1
Net Investment Income 482.4 513.4 1,577.5 1,531.0
Net Realized Investment Gains (Losses) (14.0) 77.9 (12.4) 89.3
Other Income 88.7 105.6 239.1 254.4
-------- -------- -------- --------
Total Revenue 2,311.7 2,433.1 7,129.5 6,979.8
-------- -------- -------- --------
Benefits and Expenses
Policyholder Benefits 1,556.7 2,053.1 4,767.3 5,245.9
Commissions 188.6 217.6 573.1 679.7
Interest and Debt Expense 47.2 34.3 136.2 100.8
Deferral of Policy Acquisition Costs (138.1) (182.8) (433.8) (603.0)
Amortization of Deferred Policy Acquisition Costs 95.2 107.4 363.4 332.0
Amortization of Value of Business Acquired and Goodwill 18.8 43.4 53.3 103.6
Other Operating Expenses 334.8 422.9 1,035.5 1,495.0
-------- -------- -------- --------
Total Benefits and Expenses 2,103.2 2,695.9 6,495.0 7,354.0
-------- -------- -------- --------
Income (Loss) Before Federal Income Taxes 208.5 (262.8) 634.5 (374.2)
Federal Income Taxes (Credit) 71.5 (45.8) 219.9 (55.3)
-------- -------- -------- --------
Net Income (Loss) $ 137.0 $ (217.0) $ 414.6 $ (318.9)
======== ======== ======== ========
Net Income (Loss) Per Common Share
Basic $ 0.57 $ (0.91) $ 1.72 $ (1.34)
Assuming Dilution $ 0.57 $ (0.91) $ 1.72 $ (1.34)
Dividends Paid Per Common Share $ 0.1475 $ 0.1475 $ 0.4425 $ 0.4331
</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 (318.9) (318.9)
Change in Net Unrealized Gain
on Securities (847.6) (847.6)
Change in Foreign Currency
Translation Adjustment 13.9 13.9
---------
Total Comprehensive Loss (1,152.6)
---------
Common Stock Activity 0.2 61.7 21.5 83.4
Dividends to Stockholders (138.6) (138.6)
------ -------- -------- -------- ----- -------- ---------
Balance at September 30, 1999 $24.0 $1,020.9 $ 81.0 $3,821.7 $(9.2) $ - $ 4,938.4
====== ======== ======== ======== ===== ======== =========
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 414.6 414.6
Change in Net Unrealized Gain (Loss)
on Securities (57.2) (57.2)
Change in Foreign Currency
Translation Adjustment (28.6) (28.6)
---------
Total Comprehensive Income 328.8
---------
Common Stock Activity 7.7 7.7
Dividends to Stockholders (142.0) (142.0)
------ -------- -------- -------- ----- -------- ---------
Balance at September 30, 2000 $24.1 $1,036.3 $(104.7) $4,230.2 $(9.2) $ - $ 5,176.7
====== ======== ======== ======== ===== ======== =========
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
<TABLE>
<CAPTION>
Nine Months Ended September 30
2000 1999
(in millions of dollars)
-------------------------------
<S> <C> <C>
Net Cash Provided by Operating Activities $ 897.3 $ 1,153.2
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Investments 1,529.2 3,106.3
Proceeds from Maturities of Investments 801.4 946.5
Purchase of Investments (2,977.0) (4,536.9)
Net (Purchases) Sales of Short-term Investments 68.8 (289.7)
Acquisition of Business (94.2) -
Disposition of Business (78.2) -
Other (45.7) (54.2)
--------- ---------
Net Cash Used by Investing Activities (795.7) (828.0)
--------- ---------
Cash Flows from Financing Activities
Deposits to Policyholder Accounts 30.8 156.1
Maturities and Benefit Payments from Policyholder Accounts (170.4) (598.5)
Net Change in Short-term Borrowings (53.7) 198.4
Dividends Paid to Stockholders (106.5) (103.4)
Other 7.7 48.1
-------- ---------
Net Cash Used by Financing Activities (292.1) (299.3)
-------- ---------
Effect of Foreign Exchange Rate on Cash (1.5) 2.0
-------- ---------
Net Increase (Decrease) in Cash and Bank Deposits (192.0) 27.9
Cash and Bank Deposits at Beginning of Period 292.4 111.2
-------- ---------
Cash and Bank Deposits at End of Period $ 100.4 $ 139.1
======== =========
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UnumProvident Corporation and Subsidiaries
September 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 nine month periods ended September 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 three and nine month periods ended September 30, 1999, the Company
recognized before-tax expenses of $42.5 million and $184.7 million,
respectively, for employee related expenses, exit activities, and investment
banking, legal, and accounting fees related to the merger. On an after-tax
basis, the impact on earnings was $27.6 million and $139.6 million for the three
and nine month periods. The expense related to the early retirement offer to
employees reduced second quarter and nine month 1999 earnings $125.9 million
before tax and $81.8 million after tax. As of June 30, 2000, the exit plan had
been completed.
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 Nine Months Ended
September 30 September 30
2000 1999 2000 1999
(in millions, except share data)
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Numerator
Net Income (Loss) $ 137.0 $ (217.0) $ 414.6 $ (318.9)
========== ========== ========== ==========
Denominator (000s)
Weighted Average Common Shares - Basic 240,929.5 239,739.8 240,766.3 238,670.2
Dilutive Securities 1,258.9 - 982.8 -
---------- ---------- ---------- ----------
Weighted Average Common Shares -
Assuming Dilution 242,188.4 239,739.8 241,749.1 238,670.2
========== ========== ========== ==========
</TABLE>
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2000
Note 3--Stockholders' Equity and Earnings Per Common Share (Continued)
In computing earnings per share assuming dilution, only potential common shares
that are dilutive (those that reduce earnings per share) are included.
Potential common shares are not used when computing earnings per share assuming
dilution if the result would be antidilutive, such as when options are out-of-
the-money or if a net loss is reported. Approximately 10.3 million and 11.4
million options for the three and nine month periods ended September 30, 2000,
and approximately 5.4 million and 2.0 million options for the three and nine
month periods ended September 30, 1999, were not considered dilutive due to the
options being out-of-the money. In-the-money options to purchase approximately
2.4 million and 3.7 million common shares for the three and nine month periods
ended September 30, 1999, were not considered dilutive due to net losses being
reported for the periods.
Note 4--Comprehensive Income (Loss)
The components of accumulated other comprehensive loss, net of deferred tax, are
as follows:
<TABLE>
<CAPTION>
September 30 December 31
2000 1999
(in millions of dollars)
------------------------------------------
<S> <C> <C>
Net Unrealized Gain (Loss) on Securities $ (37.4) $ 19.8
Foreign Currency Translation Adjustment (67.3) (38.7)
------- ------
Accumulated Other Comprehensive Loss $(104.7) $(18.9)
======= ======
</TABLE>
The components of comprehensive income (loss) and the related deferred tax are
as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
2000 1999 2000 1999
(in millions of dollars)
------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Income (Loss) $137.0 $(217.0) $ 414.6 $ (318.9)
------ ------- ------- ---------
Change in Net Unrealized Gain (Loss) on Securities:
Change Before Reclassification Adjustment (10.8) (194.2) (99.9) (1,168.7)
Reclassification Adjustment for Net Realized Investment
(Gains) Losses Included in Net Income (Loss) 14.0 (77.9) 12.4 (89.3)
Change in Foreign Currency Translation Adjustment (15.8) 4.6 (36.3) 19.7
------ ------- ------- ---------
(12.6) (267.5) (123.8) (1,238.3)
Change in Deferred Tax (1.4) (83.2) (38.0) (404.6)
------ ------- ------- ---------
Other Comprehensive Loss (11.2) (184.3) (85.8) (833.7)
------ ------- ------- ---------
Comprehensive Income (Loss) $125.8 $(401.3) $ 328.8 $(1,152.6)
====== ======= ======= =========
</TABLE>
8
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2000
Note 5--Segment Information
The Employee Benefits segment includes group long-term and short-term disability
insurance, group life insurance, accidental death and dismemberment coverages,
group long-term care, and the results of managed disability. The Individual
segment includes results from the individual disability and individual long-term
care lines of business. The Voluntary Benefits segment includes the results of
products sold to employees through payroll deduction at the work site. These
products include life insurance and health products, primarily disability,
accident and sickness, and cancer. The Other operating segment includes results
from products no longer actively marketed, including individual life and
corporate-owned life insurance, reinsurance pools and management operations,
group pension, health insurance, and individual annuities. The Corporate
segment includes investment earnings on corporate assets not specifically
allocated to a line of business, corporate interest expense, amortization of
goodwill, and certain corporate expenses not allocated to a line of business.
Individual life, which was previously included in the Individual segment, is no
longer actively marketed and is now reported in the Other segment. Historical
by segment results have been reclassified to conform to current period
reporting.
9
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2000
Note 5--Segment Information (Continued)
Selected data by segment is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
2000 1999 2000 1999
(in millions of dollars)
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Premium Income
Employee Benefits $1,015.0 $ 984.8 $3,029.1 $2,898.8
Individual 444.9 418.1 1,333.7 1,234.1
Voluntary Benefits 187.6 172.4 554.1 516.7
Other 107.1 160.9 408.4 455.5
-------- -------- -------- --------
1,754.6 1,736.2 5,325.3 5,105.1
Net Investment Income and Other Income
Employee Benefits 211.6 186.4 630.4 546.7
Individual 243.0 205.0 704.7 611.1
Voluntary Benefits 30.2 28.1 89.1 81.5
Other 70.3 159.9 353.8 491.5
Corporate 16.0 39.6 38.6 54.6
-------- -------- -------- --------
571.1 619.0 1,816.6 1,785.4
Total Revenue (Excluding Net Realized
Investment Gains and Losses)
Employee Benefits 1,226.6 1,171.2 3,659.5 3,445.5
Individual 687.9 623.1 2,038.4 1,845.2
Voluntary Benefits 217.8 200.5 643.2 598.2
Other 177.4 320.8 762.2 947.0
Corporate 16.0 39.6 38.6 54.6
-------- -------- -------- --------
2,325.7 2,355.2 7,141.9 6,890.5
Benefits and Expenses
Employee Benefits 1,103.2 1,384.5 3,306.6 3,540.6
Individual 615.9 544.6 1,819.7 1,660.9
Voluntary Benefits 182.2 168.3 528.6 503.4
Other 151.5 483.6 689.5 1,141.3
Corporate 50.4 114.9 150.6 507.8
-------- -------- -------- --------
2,103.2 2,695.9 6,495.0 7,354.0
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Employee Benefits 123.4 (213.3) 352.9 (95.1)
Individual 72.0 78.5 218.7 184.3
Voluntary Benefits 35.6 32.2 114.6 94.8
Other 25.9 (162.8) 72.7 (194.3)
Corporate (34.4) (75.3) (112.0) (453.2)
-------- -------- -------- --------
222.5 (340.7) 646.9 (463.5)
Net Realized Investment Gains (Losses) (14.0) 77.9 (12.4) 89.3
-------- -------- -------- --------
Income (Loss) Before Federal Income Taxes 208.5 (262.8) 634.5 (374.2)
Federal Income Taxes (Credit) 71.5 ( 45.8) 219.9 (55.3)
-------- -------- -------- --------
Net Income (Loss) $ 137.0 $ (217.0) $ 414.6 $ (318.9)
======== ======== ======== ========
</TABLE>
10
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2000
Note 6--Debt
In October 2000, the Company entered into $1.0 billion senior revolving credit
facilities with a group of banks. The facilities, which are split into five-year
revolver and 364-day portions, replaced the 364-day revolver which expired in
October 2000 and the five-year revolver which has been canceled. The new
facilities will be available for general corporate purposes, including support
of the Company's $1.0 billion commercial paper program. Interest is variable
based upon a London Interbank Offered Rate (LIBOR) plus a margin or an alternate
base rate.
Additionally, the Company filed a $1.0 billion universal shelf registration
during the third quarter of 2000 in order to provide funding alternatives for
its maturing 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 and had an interest rate of 7.48 percent
during the third quarter.
Note 7--Reinsurance
In the third quarter of 2000, the Company entered into various reinsurance
agreements with Reassure America Life Insurance Company (Reassure America), an
affiliate of Swiss Re Life & Health America Inc., under which Reassure America
will reinsure on a 100 percent indemnity coinsurance basis substantially all of
the individual life insurance and corporate-owned life insurance policies
written by the Company's insurance subsidiaries, as well as a small block of
individually underwritten group life insurance. Reassure America has a current
A.M. Best rating of A++ (superior). The reinsurance agreements for each of the
Company's insurance subsidiaries are subject to regulatory approval.
Certain of the Company's insurance subsidiaries received regulatory approval,
and the transactions for those subsidiaries closed during the third quarter,
with an effective date of July 1, 2000. In consideration for the transfer of
reserves, Reassure America paid the Company a ceding commission of $489.9
million. Total liabilities of $3,003.6 million and policy loans of $1,996.5
million were assumed by Reassure America. The $351.3 million before-tax gain on
these transactions was deferred and is being amortized into income based upon
expected future premium income on the traditional insurance policies ceded and
estimated future gross profits on the interest-sensitive insurance policies
ceded.
The remaining reinsurance agreements with Reassure America are expected to
receive approval and close during the fourth quarter of 2000.
Separately, during the third quarter of 2000, the Company entered into a
reinsurance agreement with Max Re Ltd. (Max Re) whereby Max Re reinsured on a
100 percent indemnity coinsurance basis the future claim payments on long
duration long-term disability claims which were incurred prior to January 1,
1996, of The Paul Revere Life Insurance Company, a subsidiary of the Company.
Max Re has a current A.M. Best rating of A- (excellent). Total policy reserves
ceded were approximately $177.9 million. The gain on the transaction, which
closed in the third quarter of 2000 with an effective date of January 1, 2000,
was immaterial.
11
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2000
Note 8--Commitments and Contingent Liabilities
Commitments
In the third quarter of 2000, the Company entered into an agreement to sell
Provident National Assurance Company (Provident National), an inactive
subsidiary of the Company, to Allstate Life Insurance Company. Prior to closing
of the sale, Provident National's general account liabilities will be reinsured
by another subsidiary of the Company. The transaction, which is subject to
regulatory approval, is expected to close by year-end 2000.
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. A hearing to
determine class certification was heard on December 20, 1999 in Superior Court.
The Superior 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 for the class action. 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. Summary judgment motions have been
filed, and a hearing was held on November 10, 2000, with a continuance set for
December 1, 2000. The career agent plaintiffs have re-filed, but not served,
their complaint seeking class action status by limiting the issues to those 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 had initially filed the 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 appealed the denial of the 15 motions
before the First Circuit Court of Appeals, but the District Court decision was
affirmed. The two cases set for arbitration should be heard late this year or
early in 2001. Eight of the other cases are tentatively set to begin trials in
2002. The Company believes that it has strong defenses and plans to vigorously
defend its position in these cases. Although the individual lawsuits described
above are in the early stages, management does not currently expect these suits
to materially affect the financial position or results of operations of the
Company.
During September and October 1999, the Company and several of its officers were
named as defendants in five class action lawsuits filed in the United States
District Court for the District of Maine. On January 3, 2000, the Maine
district court appointed a lead class action plaintiff and ordered plaintiffs to
file a consolidated amended complaint. On January 27, 2000, a sixth complaint
against the same defendants was filed in the Southern District of New York. On
March 7, 2000, the sixth action was transferred to the District of Maine, and
that action was voluntarily dismissed by the plaintiff on June 12, 2000. On
February 23, 2000, two consolidated amended class action complaints were filed
against the same defendants. The first amended class action complaint asserts a
variety of claims under the Securities Exchange Act of 1934, as amended, on
behalf of a putative class of shareholders who purchased or otherwise acquired
stock in the Company or Unum between February 4, 1998 and February 9, 2000. The
second amended complaint asserts a variety of claims under
12
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2000
Note 8--Commitments and Contingent Liabilities (Continued)
the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended,
on behalf of a putative class of shareholders who exchanged the common stock of
Unum or Provident for the Company's stock pursuant to the joint
proxy/registration statement issued in connection with the merger between Unum
and Provident. The complaints allege that the defendants made false and
misleading public statements concerning, among other things, Unum's and the
Company's reserves for disability insurance and pricing policies, the Company's
merger costs, and the adequacy of the due diligence reviews performed in
connection with the merger. The complaints seek money damages on behalf of all
persons who purchased or otherwise acquired Company or Unum stock in the class
period or who were issued Company stock pursuant to the merger. On April 10,
2000, the defendants filed a motion to dismiss the complaints. On July 13, 2000,
the motion was referred by the Maine district court to a magistrate judge for a
report and recommendation. On November 8, 2000, the magistrate issued a report
and recommendation, which recommended to the district judge that the motion be
granted as to the claims alleged under sections 10(b) and 20(a) of the
Securities Exchange Act, and recommended that the motion be granted in part and
denied in part as to the claims alleged under sections 11, 12(a)(2) and 15 of
the Securities Act and under sections 14(a) and 20(a) of the Securities Exchange
Act. The report and recommendation is subject to de novo review by the district
court, and the parties must file any objections to the report and recommendation
with the district court on or before November 24, 2000. 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.
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.
13
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
UnumProvident Corporation and Subsidiaries
September 30, 2000
Note 9--Change in Accounting Principles and Accounting Pronouncements
Outstanding
Change in Accounting Principles
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.
Effective July 1, 2000, the Company adopted the provisions of Financial
Accounting Standards Board (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. The adoption of the
Interpretation did not have an effect on the Company's financial position or
results of operations.
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. The adoptions of
these pronouncements are not expected to have a material impact on the Company's
financial position or results of operations.
In September 2000, the FASB issued Statement of Financial Accounting Standards
No. 140 (SFAS 140), Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities, which replaces Statement of Financial
Accounting Standards No. 125. SFAS 140 revises the standards for accounting and
reporting for transfers and servicing of financial assets and extinguishments of
liabilities. SFAS 140 is effective for transfers occurring after March 31, 2001.
The adoption of SFAS 140 is not expected to have a material impact on the
Company's financial position or results of operations.
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 September 30,
2000, the related condensed consolidated statements of operations for the three
and nine month periods ended September 30, 2000 and 1999, and the condensed
consolidated statements of stockholders' equity and cash flows for the nine
month periods ended September 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 month and nine month periods ended September 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
November 13, 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 Note 1 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
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 objectives, which balance growth and profitability, are to
achieve sales growth of 10 to 12 percent per year.
Strategic Transactions
During the third quarter of 2000, the Company announced the signing of
definitive agreements for a series of strategic transactions designed to more
closely focus its operations on its core businesses and increase its financial
flexibility. These transactions, when completed, 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. The primary transaction involves the signing of an agreement under
which an affiliate of Swiss Re Life & Health America Inc. (Swiss Re) will
reinsure the Company's in-force individual life insurance and corporate-owned
life insurance blocks of business. In addition, the Company announced the sale
of an inactive subsidiary, Provident National Assurance Company, to Allstate
Life Insurance Company and an agreement with Max Re Ltd. to reinsure a portion
of its long duration group long-term disability claims.
Under the terms of one set of agreements, Reassure America Life Insurance
Company (Reassure America), a Swiss Re affiliate, will reinsure on a 100 percent
indemnity coinsurance basis substantially all of the individual life insurance
and corporate-owned life insurance policies written by the Company's insurance
subsidiaries, as well as a small block of individually underwritten group life
insurance. Reassure America will also assume responsibility for the
administration of the policies on a phased-in basis over the course of the next
year. The capital generated from the transaction will remain in the insurance
subsidiaries to increase the risk-based capital ratios. The agreements will be
effective as of July 1, 2000 and are subject to regulatory approvals. Certain of
the agreements received such approval and closed during the third quarter. The
remaining agreements are expected to receive approval and close during the
fourth quarter of 2000. The gain from this reinsurance transaction will be
deferred and amortized into income over time based on the life of the business.
The transaction is expected to be slightly dilutive to earnings in 2001. See
"Other Segment Operating Results" and "Investments" for further discussion of
this transaction.
16
<PAGE>
Separately, The Paul Revere Life Insurance Company, a subsidiary of the Company,
and Max Re Ltd. entered into an agreement whereby Max Re Ltd. reinsured on a 100
percent indemnity coinsurance basis the future claim payments on long duration
group long-term disability claims which were incurred prior to January 1, 1996.
Policy reserves ceded in this transaction, which closed in the third quarter of
2000 with an effective date of January 1, 2000, were approximately $177.9
million.
The Company has also agreed to sell Provident National Assurance Company, an
inactive insurance subsidiary, to Allstate Life Insurance Company. Provident
National Assurance Company's general account liabilities will be reinsured by
another subsidiary of the Company. The excess capital and surplus released will
be used to reduce the Company's short-term borrowings. This transaction, which
is subject to certain regulatory approval, is expected to close by year-end
2000.
Consolidated Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
2000 1999 % Change 2000 1999 % Change
------------------------------------ ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $1,754.6 $1,736.2 1.1% $5,325.3 $5,105.1 4.3%
Net Investment Income 482.4 513.4 (6.0) 1,577.5 1,531.0 3.0
Other Income 88.7 105.6 (16.0) 239.1 254.4 (6.0)
-------- -------- -------- --------
Total Revenue 2,325.7 2,355.2 (1.3) 7,141.9 6,890.5 3.6
Benefits and Expenses 2,103.2 2,695.9 (22.0) 6,495.0 7,354.0 (11.7)
-------- -------- -------- --------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains 222.5 (340.7) N.M. 646.9 (463.5) N.M.
Federal Income Taxes (Credit) 77.0 (73.1) N.M. 224.8 (86.6) N.M.
-------- -------- -------- --------
Income (Loss) Before Net Realized
Investment Gains (Losses) 145.5 (267.6) N.M. 422.1 (376.9) N.M.
Net Realized Investment Gains
(Losses) (8.5) 50.6 N.M. (7.5) 58.0 N.M.
-------- -------- -------- --------
Net Income (Loss) $ 137.0 $ (217.0) N.M. $ 414.6 $ (318.9) N.M.
======== ======== ======== ========
</TABLE>
N.M. = not a meaningful percentage
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 nine 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.
Subsequent to the merger date, the Company began to integrate the valuation
procedures of the two organizations to provide for a more effective linking of
pricing and reserving assumptions and to facilitate a more efficient process for
adjusting liabilities to emerging trends. Included in this integration activity
were a review and an update of assumptions that underlie policy and contract
benefit liabilities. The purpose of the study was to confirm or update the
assumptions which were viewed as likely to affect the ultimate liability for
contract benefits. Accordingly, as a result of the merger, the Company
accelerated the performance of its normal reviews of the assumptions underlying
reserves to determine the assumptions that the newly merged Company will use in
the future for pricing, performance management, and reserving.
17
<PAGE>
The review resulted in an increase in the benefits and reserves for future
benefits for the Company's domestic group long-term disability unpaid claim
liabilities. As a result of the review, the Company increased its policy and
contract benefit liabilities $359.2 million in the third quarter of 1999, which
reduced third quarter and nine months 1999 results $359.2 million before tax and
$233.5 million after tax.
The increase in policy and contract benefit liabilities primarily resulted from
revisions to assumptions in the following three key components: claim
termination rates, incurred but not reported factors, and discount rates. These
components are summarized as follows (in millions):
Claim termination rates $ 372.6
Incurred but not reported factors 101.4
Discount rates (114.8)
-------
Net change $ 359.2
=======
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. During the
third quarter of 1999, the Company recorded additional before-tax expenses of
$42.5 million ($27.6 after tax) related to the merger. These expenses are
reported in the Corporate segment as other operating expenses. Additionally, in
the three and nine months ended September 30, 1999 the Company expensed $4.7
million and $24.7 million, respectively, ($3.1 million and $16.1 million after
tax) of incremental costs associated with the merger. These incremental costs
consist primarily of compensation, training, integration, and licensing costs.
See 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 and third quarter 1999 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 recorded a first quarter 1999 charge of $74.1 million in the
Other segment. During the first and second quarters of 1999, the Company also
recorded $27.0 million and $2.0 million, respectively, in the Corporate segment
related to the write-off of goodwill.
During the third quarter of 1999, the Company continued its efforts to sell its
reinsurance management operations. No potential buyers expressed interest in
acquiring the entire domestic and international reinsurance management
operations. However, in October 1999, the Company entered into an agreement to
sell the reinsurance management operations of its A&H and LTC reinsurance
facilities and to reinsure the Company's risk participation in these facilities.
18
<PAGE>
Because of the limited interest expressed by potential buyers in the reinsurance
management operations, the Company reevaluated its strategy to exit the
reinsurance operations. The Company decided to continue to operate its North
America long-term disability reinsurance operation and to refocus it with the
objective of improving profitability. With respect to Lloyd's, the Company
decided to implement a strategy which limits participation in year 2000
underwriting risks, ceases participation in Lloyd's underwriting risks after
year 2000, and manages the run-off of its risk participation in open years of
account of Lloyd's reinsurance syndicates. The Company also decided to
discontinue its accident reinsurance business in London beginning in year 2000.
During the third quarter of 1999, the Company recognized a charge of $193.3
million in the Other segment and $28.7 million in the Corporate segment related
to the write-off of goodwill. See Note 13 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 the 1999 charges related to the
reinsurance businesses.
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 third quarter of 1999, the Company recorded a refund from the
Internal Revenue Service relating to the final settlement of remaining issues
for the 1986 through 1992 tax years. The refund of taxes was $25.3 million, and
interest on the refunds was $31.5 million. Overall, including interest and the
tax provision thereon, third quarter and nine month 1999 after tax results
increased $29.2 million and $35.2 million, respectively, due to settlements of
prior year tax issues.
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.
Employee Benefits Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
2000 1999 % Change 2000 1999 % Change
--------------------------------------- ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income
Group Long-term Disability $ 527.2 $ 514.7 2.4% $1,560.8 $1,511.8 3.2%
Group Short-term Disability 127.6 120.6 5.8 380.5 347.7 9.4
Group Life 298.1 290.6 2.6 901.6 866.4 4.1
Accidental Death &
Dismemberment 45.3 48.0 (5.6) 140.4 141.9 (1.1)
Group Long-term Care 16.8 10.9 54.1 45.8 31.0 47.7
-------- -------- -------- --------
Total Premium Income 1,015.0 984.8 3.1 3,029.1 2,898.8 4.5
Net Investment Income 173.9 152.3 14.2 518.7 445.0 16.6
Other Income 37.7 34.1 10.6 111.7 101.7 9.8
-------- -------- -------- --------
Total Revenue 1,226.6 1,171.2 4.7 3,659.5 3,445.5 6.2
-------- -------- -------- --------
Benefits and Change in Reserves 844.7 1,155.9 (26.9) 2,523.1 2,840.0 (11.2)
Commissions 80.5 80.9 (0.5) 248.0 241.9 2.5
Deferral of Policy Acquisition Costs (52.1) (59.4) (12.3) (171.7) (193.5) (11.3)
Amortization of Deferred Policy
Acquisition Costs 32.8 24.9 31.7 117.7 74.6 57.8
Other Operating Expenses 197.3 182.2 8.3 589.5 577.6 2.1
-------- -------- -------- --------
Total Benefits and Expenses 1,103.2 1,384.5 (20.3) 3,306.6 3,540.6 (6.6)
-------- -------- -------- --------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 123.4 $ (213.3) N.M. $ 352.9 $ (95.1) N.M.
======== ======== ======== ========
</TABLE>
19
<PAGE>
The Employee Benefits segment includes group long-term and short-term disability
insurance, group life insurance, accidental death and dismemberment coverages,
group long-term care, and the results of managed disability.
Employee Benefits new annualized sales, on a submitted date basis, increased 9.6
percent to $232.7 million in the third quarter of 2000 from $212.4 million in
the third quarter of 1999, driven primarily by large case sales. On an effective
date basis, sales decreased 26.4 percent to $149.2 million in the third quarter
of 2000 from $202.8 million in the third quarter of 1999, consistent with the
second quarter 2000 submitted date basis decline from prior year as reported in
the second quarter of 2000 and reflecting the time lag between the submitted
date and effective date reporting basis. For the first nine months, new
annualized sales on a submitted date basis were $560.5 million in 2000 compared
to $723.3 million in 1999. On an effective date basis, sales were $622.0 million
in 2000 and $937.6 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, 32 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 year-to-date decrease in sales compared to 1999, including
rate increases and turnover in the field sales force during the first half of
2000. The Company has a number of initiatives underway to help maintain the
third quarter 2000 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 third quarter and nine months of 2000 for
group disability, group life, and accidental death and dismemberment products
compared unfavorably to the persistency expected, resulting in additional
amortization of $5.7 million and $31.6 million, respectively, during the third
quarter and first nine months of 2000. However, third quarter 2000 persistency
for group disability improved from second quarter 2000 persistency, and group
life persistency, while deteriorating slightly from the second quarter, has
improved relative to the first quarter of 2000. The adverse persistency during
2000 relates to large case terminations and an aggressive 2000 renewal program
that was heavily concentrated in the first half of the year. It is expected that
persistency for the foreseeable future will continue to be lower than historical
levels for group disability as well as group life. Through the first nine months
of the year, 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 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 $31.9 million in the third
quarter of 2000 compared to $27.2 million in the third quarter of 1999. On a
year-to-date basis, this revenue was $93.6 million in 2000 compared to $80.4
million in 1999, with the growth primarily attributable to medical case
management services.
20
<PAGE>
Group Disability
Group disability revenue was $803.5 million in the third quarter of 2000
compared to $764.0 million in the third quarter of 1999. Third quarter new
annualized sales for group long-term disability on a submitted date basis were
$100.7 million in 2000 and $91.9 million in 1999. New annualized sales for group
short-term disability were $35.2 million in the third quarter of 2000 as
compared to $32.9 million in the third quarter of 1999. On an effective date
basis, new annualized sales for long-term disability and short-term disability
were $64.8 million and $22.5 million in the third quarter of 2000 and $80.9
million and $36.7 million in the third 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 $72.7 million for the third quarter of 2000
compared to a loss of $277.8 million for the third quarter of 1999. As discussed
in the preceding "Consolidated Operating Results," the loss in the third quarter
of 1999 was the result of a $359.2 million increase in the benefits and reserves
for future benefits for the Company's domestic group long-term disability unpaid
claim liabilities. Excluding this 1999 third quarter revision to the disability
claim liabilities, the benefit ratio for group disability was 84.7 percent in
the prior year third quarter compared to 86.1 percent in the third quarter of
2000 and 87.6 percent in the second quarter of 2000.
For long-term disability, the ratio for third quarter 2000 compared unfavorably
to third quarter 1999, but showed slight improvement over both first and second
quarter 2000. The paid claim incidence for long-term disability compares
favorably to the third quarter of 1999 as well as the first quarter of 2000 due
to lower claim acceptance rates and has moved up only slightly from the second
quarter of 2000. The submitted claim incidence rate for long-term disability is
higher than the rate for both the third quarter of 1999 and the first two
quarters of 2000.
The benefit ratio for short-term disability compares favorably to the second
quarter of 2000 and has increased only marginally from the third quarter of
1999. The paid claim ratio is relatively flat with the second quarter of 2000
but has increased slightly from the third quarter of 1999. The incidence of
submitted claims for short-term disability has improved from that experienced in
the first and second quarters of 2000, but is up slightly compared to the third
quarter 1999 rate. The paid claim incidence rate has improved from the rate
reported for the second quarter of 2000 as well as the third quarter of 1999.
However, the average claim duration has increased to its highest level in recent
periods, and the average weekly indemnity compared unfavorably to the second
quarter of 2000 and the third quarter of 1999.
Additionally, the increase in the amortization of deferred policy acquisition
costs had a negative impact on third quarter 2000 income. This increase resulted
from $3.7 million of additional amortization necessitated by the higher level of
group long-term and short-term disability terminations experienced during the
third quarter of 2000 relative to that which was expected at the time the
business was written. The commission and operating expense ratio for group
disability improved from the first quarter of 2000 and is relatively flat when
compared to the second quarter of 2000.
As previously discussed under "Strategic Transactions," during the third quarter
of 2000 the Company entered into a 100 percent indemnity coinsurance agreement
to cede the future claim payments on one of its insurance subsidiaries' long
duration group long-term disability claims which were incurred prior to January
1, 1996.
21
<PAGE>
Group disability reported income of $196.0 million for the first nine months of
2000 compared to a loss of $281.9 million for the same period of 1999. As
previously discussed, the 1999 loss relates to the second quarter $191.7 million
charge and the third quarter $359.2 million charge. New annualized sales, on a
submitted date basis, for the first nine months of 2000 were $232.4 million and
$87.1 million for group long-term and short-term disability, respectively,
compared to $298.9 million and $127.8 million for the comparable period in 1999.
On an effective date basis, new annualized sales for long-term disability and
short-term disability were $262.8 million and $107.0 million in the first nine
months of 2000 and $396.4 million and $172.8 million in the first nine months of
1999. Income in 2000 was positively impacted by a 6.6 percent revenue increase
of $146.9 million compared to the first nine months of 1999 and an improvement
in the commission and operating expense ratio. Additional amortization of
deferred policy acquisition costs due to the higher than expected level of
terminations was $23.3 million for the first nine months of 2000.
Excluding the 1999 second quarter discount rate change and the 1999 third
quarter revision in the underlying assumptions used to estimate the ultimate
cost of unpaid group long-term disability claims, the benefit ratio for long-
term disability was higher in the first nine months of 2000 compared to the same
period of 1999. The paid claim incidence for long-term disability compares
favorably to the first nine months of 1999 due to lower 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 nine 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 nine months of 1999.
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 would be
impacted as a result of planning, consolidation, and integration efforts related
to the merger. Management expected the claims integration efforts to have some
benefits, primarily related to claims incurred in future periods, as well as the
potential for improved customer satisfaction and lower ultimate claim costs as
best practices in return-to-work and claims management 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 nine months of 1999, those claim operations integration
activities progressed as assumed. At December 31, 1998, management assumed the
revised group disability claim resolution rates for the first, second, and third
quarters of 1999 to be 90, 90, and 81 percent of assumptions, respectively,
before adjusting for the impact of the claim operations integration activities.
The actual experience was 89 percent for the first quarter of 1999, 90 percent
for the second quarter, and 67 percent for the third quarter. If the impact of
merger-related claim operations integration activities on claim durations had
not been anticipated at December 31, 1998, the third quarter and nine months
1999 loss for the group long-term disability line of business would have been
negatively impacted by $15.5 million and $39.1 million, respectively. However,
the shortfall of the actual 1999 experience below that assumed resulted in a
negative effect on 1999 third quarter results of $11.8 million. As previously
discussed, the Company increased the benefits and reserves for future benefits
for the Company's domestic group long-term disability unpaid claim liabilities
$359.2 million during the third quarter of 1999. A portion of that increase
related to the claim resolution assumptions underlying existing claim reserves.
In selecting the revised claim resolution assumptions, consideration was given
to claims operations integration activities referenced here as well as other
factors expected to impact the future effectiveness of the claims operations.
See Notes 2 and 7 of the "Notes to Consolidated Financial Statements" of the
Company's Form 10-K for the fiscal year ended December 31, 1999 for further
discussion.
22
<PAGE>
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 $48.1 million in the third quarter of 2000 compared to $63.3 million
in the third quarter of 1999. New annualized sales on a submitted date basis
increased to $96.8 million in the third quarter of 2000 as compared to $87.6
million reported in the third quarter of 1999. On an effective date basis, new
annualized sales were $61.9 million in the third quarter of 2000 compared to
$85.2 million for the same period last year.
The three lines of business reported an increase in revenue for the third
quarter of 2000 compared to the same period in 1999 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 third quarter of 1999.
Group life reported an unfavorable benefit ratio compared to the prior year
third quarter, but the ratio improved slightly from the second quarter of 2000.
The increase over third 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 second quarter, the third quarter
2000 waiver incidence and paid mortality incidence for group life improved, but
the line reported an increase in average paid claim size.
The benefit ratio for accidental death and dismemberment compared unfavorably to
the second quarter of 2000 but is up only slightly from the third quarter of
1999. The increase in the average paid claim size contributed to the
unfavorable comparison to second quarter 2000. Submitted incidence for
accidental death and dismemberment has improved relative to both the third
quarter of 1999 and the second quarter of 2000. Paid incidence was relatively
flat compared to the second quarter of 2000 but increased over the third quarter
of 1999.
The reinsurance transaction discussed under "Strategic Transactions" lowered
third quarter 2000 group life and accidental death and dismemberment premium
income and benefits approximately $6.6 million and $4.4 million, respectively.
Group long-term care reported an unfavorable benefit ratio for the third quarter
of 2000 compared to the third quarter of 1999 and the second quarter of 2000.
The long-term care net claim resolution rate for the third quarter of 2000
compares unfavorably to the resolution rate for the second quarter of 2000 and
is below the average rate for the prior four quarters, primarily due to a
decrease in recoveries. However, the incidence rates for both submitted and
paid claims improved over the prior year third quarter and the second quarter of
2000.
The amortization of deferred policy acquisition costs for the third quarter of
2000 includes $2.0 million of additional amortization due to the higher level of
terminations for group life and accidental death and dismemberment products
experienced during the third quarter of 2000 relative to that which was expected
at the time the policies were written.
On a year-to-date basis, income was $149.7 million in 2000 compared to $182.8
million in 1999. Revenue year-to-date increased $53.9 million to $1,176.4
million, and the commission and operating expense ratio has improved from the
first nine 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 nine months of 2000,
additional amortization due to the higher level of terminations was $8.3
million.
23
<PAGE>
New annualized sales on a submitted date basis were $241.0 million during the
first nine months of 2000 as compared to $296.6 million reported for the same
period of 1999. On an effective date basis, new annualized sales were $252.2
million for the first nine months of 2000 compared to $368.4 million for the
same period last year.
Individual Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
2000 1999 % Change 2000 1999 % Change
------------------------------------- ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income
Individual Disability $410.6 $393.7 4.3 % $1,238.2 $1,168.9 5.9 %
Individual Long-term Care 34.3 24.4 40.6 95.5 65.2 46.5
------ ------ -------- --------
Total Premium Income 444.9 418.1 6.4 1,333.7 1,234.1 8.1
Net Investment Income 210.0 193.4 8.6 621.0 574.5 8.1
Other Income 33.0 11.6 184.5 83.7 36.6 128.7
------ ------ -------- --------
Total Revenue 687.9 623.1 10.4 2,038.4 1,845.2 10.5
------ ------ -------- --------
Benefits and Change in Reserves 467.4 394.4 18.5 1,376.3 1,197.7 14.9
Commissions 64.5 68.6 (6.0) 192.7 202.2 (4.7)
Deferral of Policy Acquisition Costs (48.2) (52.5) (8.2) (148.4) (145.6) 1.9
Amortization of Deferred Policy
Acquisition Costs 21.9 20.5 6.8 66.4 58.9 12.7
Other Operating Expenses 110.3 113.6 (2.9) 332.7 347.7 (4.3)
------ ------ -------- --------
Total Benefits and Expenses 615.9 544.6 13.1 1,819.7 1,660.9 9.6
------ ------ -------- --------
Income Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 72.0 $ 78.5 (8.3)% $ 218.7 $ 184.3 18.7 %
====== ====== ======== ========
</TABLE>
The Individual segment includes results from the individual disability and
individual long-term care lines of business. Individual life, which was
previously included in the Individual segment, is no longer actively marketed
and is now reported in the Other segment. Historical by segment results have
been reclassified. See "Other Segment Operating Results" for further discussion
of the individual life line of business.
Individual Disability
New annualized sales in the individual disability line of business were $27.5
million in the third quarter of 2000 compared to $27.9 million in the third
quarter of 1999. Year-to-date sales were $83.7 million in 2000 and $93.2
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 nine months
of 2000. The Company has developed a new individual disability product
portfolio which was released for sale in approved states early in the fourth
quarter of 2000. This product line consolidates the current offerings of the
Company's insurance subsidiaries into one new simplified product portfolio. The
new portfolio utilizes a modular approach offering customers a range of product
options and features. This portfolio was designed to combine the best features
from prior Company offerings and includes return-to-work incentives and optional
long-term care conversion benefits and/or benefits for catastrophic
disabilities. Management expects that premium income in the individual
disability line will grow on a year-over-year basis 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 $649.0 million for the third quarter of 2000 compared to $595.3
million in the same period of 1999. On a year-to-date basis, revenue was
$1,929.8 million in 2000 and $1,769.9 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 third quarter and first nine months of
2000 included $23.6 million and $73.2 million, respectively, from an inforce
block of individual disability business reinsured effective January 1, 2000.
24
<PAGE>
Income in the individual disability line of business was $69.2 million in the
third quarter of 2000, a decrease of $12.5 million from the prior year third
quarter but relatively flat compared with the second quarter of 2000. For the
first nine months, income was $211.2 million in 2000 and $188.5 million in 1999.
Individual disability nine months 1999 income decreased $38.9 million as a
result of the change in method of calculating the discount rate for claim
reserves.
Excluding the discount rate change, this line reported an increase in the
benefit ratio for the third quarter and nine months of 2000 compared to the
comparable periods of last year. Submitted incidence for the third quarter of
2000 is lower than the first two quarters of 2000, but the year-to-date
submitted incidence is higher than the average for the year 1999. Paid
incidence has improved relative to the first two quarters of the year as well as
the prior year annual. The claim acceptance rate has been declining throughout
1999 and 2000, but the incidence of new claims is higher for the third quarter
and nine months of 2000 compared to the prior year comparable periods. However,
the new claim rate for the third quarter of 2000 has improved relative to the
first and second quarters of 2000. The net claim resolution rate for the third
quarter is flat relative to the third quarter of 1999, and the rate for the
first nine months of 2000 compares favorably with the same period of 1999 but is
down slightly from the second quarter of 2000. Offsetting these favorable
trends was an increase in reserves for existing claims and claims in dispute.
Individual disability benefited from an improved commission and operating
expense ratio for the third quarter and nine 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, second, and third quarters of 1999 to be 90 percent, 90 percent, and
85 percent of assumptions, before adjusting for the impact of the claim
operations integration activities. The actual experience for the Company was 89
percent in the first quarter of 1999, 90 percent in the second quarter, and 93
percent in the third quarter. If the impact of merger-related claim operations
integration activities on claim durations had not been anticipated at December
31, 1998, third quarter and nine months 1999 before-tax operating income for the
individual disability line of business would have been negatively impacted by
$31.5 million and $79.1 million, respectively. In addition, the excess of the
actual third quarter experience over that assumed resulted in a positive effect
on income of $16.4 million. 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 Long-term Care
The individual long-term care line of business reported increased premium income
for the third 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 $11.8 million for the third quarter of 2000. For the
comparable period of 1999, new sales were $10.0 million. On a year-to-date
basis, new sales were $33.3 million and $28.1 million for 2000 and 1999,
respectively. The Company expects the sales momentum in individual long-term
care to continue.
Income in the individual long-term care line of business was $2.8 million for
the third quarter of 2000 compared to a loss of $3.2 million for the same period
of 1999. For the nine months of 2000, income was $7.5 million compared to a
loss of $4.2 million for 1999. Individual long-term care reported an
improvement in the third 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 and paid claim
incidence rates. The commission and operating expense ratio for individual
long-term care improved relative to the 1999 third quarter and nine months
ratios due to the cost savings related to the merger and the growth in premium
income.
25
<PAGE>
Voluntary Benefits Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
2000 1999 % Change 2000 1999 % Change
------------------------------------- --------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $187.6 $172.4 8.8 % $ 554.1 $ 516.7 7.2 %
Net Investment Income 28.6 26.7 7.1 84.2 76.8 9.6
Other Income 1.6 1.4 14.3 4.9 4.7 4.3
------ ------ ------- -------
Total Revenue 217.8 200.5 8.6 643.2 598.2 7.5
------ ------ ------- -------
Benefits and Change in Reserves 116.1 102.0 13.8 335.5 297.7 12.7
Commissions 40.4 32.8 23.2 110.0 104.2 5.6
Deferral of Policy Acquisition Costs (37.6) (33.7) 11.6 (109.7) (107.8) 1.8
Amortization of Deferred Policy
Acquisition Costs 29.1 25.1 15.9 84.4 78.5 7.5
Other Operating Expenses 34.2 42.1 (18.8) 108.4 130.8 (17.1)
------ ------ ------- -------
Total Benefits and Expenses 182.2 168.3 8.3 528.6 503.4 5.0
------ ------ ------- -------
Income Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 35.6 $ 32.2 10.6 % $ 114.6 $ 94.8 20.9 %
====== ====== ======= =======
</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 $17.3 million in the third
quarter of 2000 compared to the third quarter of 1999 and increased $45.0
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 third quarter were $57.3
million in 2000 and $52.0 million in 1999. For the first nine months, new sales
were $178.9 million for 2000 and $169.1 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 third quarter and nine months of 2000 as compared to 1999 was due to the
repositioning of the investment portfolio subsequent to the merger.
An additional positive impact on 2000 income was a favorable operating expense
ratio attributable to costs savings resulting from the merger. The third
quarter and nine 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 cancer
product line.
Other Segment Operating Results
(in millions of dollars)
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
2000 1999 % Change 2000 1999 % Change
------------------------------------- -------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premium Income $107.1 $ 160.9 (33.4)% $408.4 $ 455.5 (10.3)%
Net Investment Income 61.6 135.8 (54.6) 331.1 414.7 (20.2)
Other Income 8.7 24.1 (63.9) 22.7 76.8 (70.4)
------ ------- ------ --------
Total Revenue 177.4 320.8 (44.7) 762.2 947.0 (19.5)
Total Benefits and Expenses 151.5 483.6 (68.7) 689.5 1,141.3 (39.6)
------ ------- ------ --------
Income (Loss) Before Federal
Income Taxes and Net Realized
Investment Gains and Losses $ 25.9 $(162.8) N.M. $ 72.7 $ (194.3) N.M.
====== ======= ====== ========
</TABLE>
26
<PAGE>
The Other operating segment includes results from products no longer actively
marketed, including individual life and corporate-owned life insurance,
reinsurance pools and management operations, group pension, health insurance,
and individual annuities. It is expected that revenue and income in this
segment will decline over time as these business lines wind down. Management
expects to reinvest the capital supporting these lines of business in the future
growth of the Employee Benefits, Individual, and Voluntary Benefits segments.
The closed blocks of business have been segregated for reporting and monitoring
purposes.
Individual Life and Corporate-Owned Life
As previously discussed under "Strategic Transactions," during the third quarter
of 2000 the Company entered into agreements to reinsure substantially all of the
individual life and corporate-owned life insurance blocks of business. The
reinsurance agreements for each of the Company's insurance subsidiaries are
subject to regulatory approval. Certain of the Company's insurance subsidiaries
received regulatory approval, and the transactions for those subsidiaries closed
during the third quarter, with an effective date of July 1, 2000.
The reinsurance agreements that were approved and closed during the third
quarter of 2000 ceded approximately $3.0 billion of reserves to the reinsurer.
The $351.3 million before-tax and $228.3 million after-tax gain on these
transactions was deferred and is being amortized into income based upon expected
future premium income on the traditional insurance policies ceded and estimated
future gross profits on the interest-sensitive insurance policies ceded. The
Company recognized a third quarter 2000 before-tax realized investment loss of
$19.0 million on the fixed maturity securities transferred to the reinsurer and
retrospectively adjusted deferred policy acquisition costs related to interest-
sensitive individual life policies with a $9.4 million credit to current period
amortization to reflect investment experience. See "Investments" for further
discussion of the realized investment loss.
Total revenue and income for individual life and corporate-owned life insurance
was $20.4 million and $17.3 million, respectively, in the third quarter of 2000
compared to $109.3 million in revenue and $20.9 million in income for the third
quarter of 1999.
The remaining agreements, which will cede policies with reserves of
approximately $340.0 million, are expected to receive approval and close during
the fourth quarter of 2000.
Reinsurance Pools and Management
The reinsurance pools and management operations reported income of $3.0 million
for the third quarter of 2000 compared to a loss of $191.6 million for the third
quarter of 1999. For the first nine months of 2000, income was $2.6 million
compared to a loss of $278.3 million in 1999. The 1999 loss was the result of
the $74.1 million first quarter 1999 charge and $193.3 million third quarter
1999 charge related to the decision to exit the reinsurance operations as
previously discussed under "Consolidated Operating Results." Also negatively
impacting 1999 results was 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 $91.2 million and $307.5 million for the third quarter and
nine months of 2000 compared to $114.1 million and $317.6 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, third quarter and nine 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 $1.8 million, respectively.
27
<PAGE>
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 $16.0 million in the third quarter of 2000
and $39.6 million in the third quarter of 1999. For the first nine months,
revenue was $38.6 million in 2000 and $54.6 million in 1999. Revenue in the
third quarter and nine months of 1999 included $31.5 million and $32.9 million,
respectively, of interest income recorded on a refund of federal income taxes.
The Corporate segment reported a loss of $34.4 million in the third quarter of
2000 compared to a loss of $75.3 million in the third quarter of 1999. On a
year-to-date basis, the losses were $112.0 million for 2000 and $453.2 million
for 1999. Interest and debt expense was $47.2 million and $136.2 million for
the third quarter and nine months of 2000 compared to $34.3 million and $100.8
million for the comparable periods of 1999 due to increased corporate
borrowings.
In the second quarter and third quarters of 1999 the Company recorded before-tax
expenses related to the merger of approximately $142.2 million and $42.5
million, respectively, and a second quarter 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 three and nine months ended September 30,
1999, the Company expensed $4.7 million and $24.7 million, respectively, of
other incremental costs associated with the merger, $4.7 million and $21.8
million of which 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 before-tax write-downs of goodwill of $27.0
million, $2.0 million, and $28.7 million in the 1999 first, second, and third
quarters, respectively, related to its decision to exit the reinsurance
operations.
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.
Subsequent to the June 30, 1999 merger and continuing through the first two
quarters of 2000, the Company actively pursued its strategy of extending the
duration of its investments and shifting the mix of assets for approximately
$2.1 billion of its investments in order to reduce vulnerability to interest
rate risk in the future and increase investment income. Net investment income
for the third quarter and nine months of 2000, excluding net investment income
attributable to the individual life and corporate-owned life insurance blocks of
business ceded effective as of July 1, 2000, increased 8.8 percent and 8.6
percent, respectively, over the comparable periods of 1999 due to increased
yields and growth in the asset base.
During the first nine months of 2000, the Company reported net realized
investment losses before tax of $12.4 million, including the realized investment
loss of $19.0 million on the investment grade fixed maturity securities
transferred to the reinsurer during the third quarter in connection with the
individual life and corporate-owned life reinsurance transactions. The loss on
these transferred securities was driven by a change in market interest rates and
was not attributable to any credit deterioration. Excluding the reinsurance
transaction related loss, the Company reported year-to-date net gains of $48.7
million from the sale of fixed maturity and equity securities, a gain of $11.1
million related to derivative activity, and a $20.0 million reduction in the
mortgage loan valuation allowance. Offsetting these gains was a second quarter
$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 in the second quarter, with an approximate offsetting
reduction in the real estate valuation allowance. During the third quarter of
2000, there were no further declines in value in the investment portfolios that
were other than temporary and no further changes in valuation allowances.
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<PAGE>
Fixed Maturity Securities
The Company's investment in mortgage-backed securities was approximately $3.5
billion and $3.1 billion on an amortized cost basis at September 30, 2000, and
December 31, 1999, respectively. At September 30, 2000, the mortgage-backed
securities had an average life of 12.7 years and effective duration of 11.2
years. The mortgage-backed securities are valued on a monthly basis using
valuations supplied by the brokerage firms that are dealers in these securities.
The primary risk involved in investing in mortgage-backed securities is the
uncertainty of the timing of cash flows from the underlying loans due to
prepayment of principal. The Company uses models which incorporate economic
variables and possible future interest rate scenarios to predict future
prepayment rates. The Company has not invested in mortgage-backed derivatives,
such as interest-only, principal-only or residuals, where market values can be
highly volatile relative to changes in interest rates.
The Company's exposure to below-investment-grade fixed maturity securities at
September 30, 2000, was $1,883.0 million, representing 7.8 percent of invested
assets excluding ceded policy loans, below the Company's internal limit of 10.0
percent of invested assets for this type of investment. The Company's exposure
to below-investment-grade fixed maturities totaled $2,147.4 million at December
31, 1999, representing 8.1 percent of invested assets.
Below-investment-grade bonds are inherently more risky than investment-grade
bonds since the risk of default by the issuer, by definition and as exhibited by
bond rating, is higher. Also, the secondary market for certain below-
investment-grade issues can be highly illiquid. Management does not anticipate
any liquidity problem caused by the investments in below-investment-grade
securities, nor does it expect these investments to adversely affect its ability
to hold its other investments to maturity.
Mortgage Loans and Real Estate
The Company's mortgage loan portfolio was $1,158.0 million and $1,278.1 million
at September 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 overall
economic activity and improving real estate markets in the geographic areas
where the Company has mortgage loans. Management expects the level of
delinquencies and problem loans to remain low in the future. No new mortgage
loans have been added to the Company's investment portfolio during 2000.
At September 30, 2000, and December 31, 1999, impaired loans totaled $17.8
million and $18.1 million, respectively. Included in the impaired loans at
September 30, 2000 were $6.6 million of loans which had a related, specific
investment valuation allowance of $2.4 million and $11.2 million of loans which
had no related, specific allowance. Impaired mortgage loans are not expected to
have a material impact on the Company's liquidity, financial position, or
results of operations.
Restructured mortgage loans totaled $8.6 million and $8.7 million at September
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 nine and twelve month periods ended
September 30, 2000, and December 31, 1999.
Real estate was $162.0 million and $211.2 million at September 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 $34.2 million at September 30, 2000,
and $79.4 million at December 31, 1999.
29
<PAGE>
Investment valuation allowances for mortgage loans and real estate held for sale
are established based on a review of specific assets as well as on an overall
portfolio basis, considering the value of the underlying assets and collateral.
If a decline in value is considered to be other than temporary or if the asset
is deemed permanently impaired, the investment is reduced to estimated net
realizable value, and the reduction is recorded as a realized investment loss.
Management monitors the risk associated with the invested asset portfolio and
regularly reviews and adjusts the investment valuation allowance. As a result
of management's most recent review of the overall mortgage loan portfolio and
based on management's expectation that delinquencies and problem loans will
remain low, the valuation allowance on mortgage loans was reduced $20.0 million
during the second quarter of 2000. At September 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 $37.1 million at
September 30, 2000, or 0.2 percent of invested assets excluding ceded policy
loans. 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
and products. All transactions are hedging in nature and not speculative.
Almost all transactions are associated with the individual and group disability
product portfolios. All other product portfolios are periodically reviewed to
determine if hedging strategies would be appropriate for risk management
purposes.
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 $897.3 million for the
nine months ended September 30, 2000, as compared to $1,153.2 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 filed a $1.0 billion universal shelf registration during the third
quarter of 2000 in order to provide funding alternatives for its maturing debt.
The registration statement became effective on September 1, 2000. Contingent
upon market conditions and corporate needs, funding will be used to refinance
short-term debt on a long-term basis and to fund other corporate needs.
As previously discussed, during the third quarter of 2000, the Company announced
several transactions which 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. The Company is
currently pursuing additional initiatives which will further increase the
Company's financial strength. These initiatives are expected to be executed and
completed during the fourth quarter of 2000.
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 7.48 percent during
the third quarter. The current interest rate on these notes is 7.52 percent.
30
<PAGE>
At September 30, 2000, the Company had short-term and long-term debt totaling
$1,021.3 million and $1,166.5 million, respectively. At September 30, 2000,
approximately $472.2 million was available for additional financing under the
existing revolving credit facilities.
In October 2000, the Company entered into $1.0 billion senior revolving credit
facilities with a group of banks. The facilities, which are split into five-
year revolver and 364-day portions, replaced the 364-day revolver which expired
in October 2000 and the five-year revolver which has been canceled.
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.
On August 23, 2000, Moody's lowered the senior debt rating of the Company to
Baa1 from A3, lowered the financial strength ratings of the Company's insurance
subsidiaries to A2 from A1, and confirmed the short-term rating at Prime-2. The
Company has not experienced a material impact on its new sales or persistency of
existing business as a result of these ratings changes.
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
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
UnumProvident Corporation
-----------------------------------------------------------------------------------------------------------------------------
Senior Debt A- (Strong ) Baa1 (Medium Grade) A- (High Not Rated
Credit Quality)
-----------------------------------------------------------------------------------------------------------------------------
Junior Subordinated Debt BBB (Good ) Baa2 (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 ) A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Provident Life & Casualty Not Rated Not Rated Not Rated A+ (Superior)
-----------------------------------------------------------------------------------------------------------------------------
Provident National Assurance Not Rated A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Unum Life of America AA- (Very Strong ) A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
First Unum Life AA- (Very Strong ) A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Colonial Life & Accident AA- (Very Strong ) A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Paul Revere Life AA- (Very Strong ) A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Paul Revere Variable AA- (Very Strong ) A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
Paul Revere Protective AA- (Very Strong ) A2 (Good Financial AA-(Very Strong) A+ (Superior)
Security)
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
31
<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 nine months of 2000, there was
no substantive change to the Company's market risk or the management of such
risk.
32
<PAGE>
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
Exhibit 12.1 Statement Regarding Computation of Ratio of Earnings to
Fixed Charges
Exhibit 12.2 Statement Regarding Computation of Ratio of Earnings to
Combined Fixed Charges and Preferred Stock Dividends
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: November 14, 2000 /s/ J. Harold Chandler
-------------------------------------------------
J. Harold Chandler
Chairman, President, and Chief Executive Officer
Date: November 14, 2000 /s/ Thomas R. Watjen
-------------------------------------------------
Thomas R. Watjen
Executive Vice President, Finance and Risk
Management
34
