<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): November 22, 1998
UNUM CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 01-0405657
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
2211 Congress Street, Portland, Maine 04122
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including the area code: (207) 770-2211
<PAGE>
UNUM Corporation
Current Report on Form 8-K
Item 7. FINANCIAL STATEMENTS AND EXHIBITS
On November 22, 1998 UNUM Corporation ("UNUM") entered into an Agreement
and Plan of Merger dated as of November 22, 1998 between UNUM and Provident
Companies, Inc. ("Provident"), pursuant to which UNUM and Provident will merge
(the "Merger") under the name UNUMProvident Corporation ("UNUMProvident"). In
connection with this planned merger UNUM is filing the financial statements and
exhibits described below.
(a) Condensed Consolidated Financial Statements of Provident Companies, Inc.
and Subsidiaries (Unaudited):
Condensed Consolidated Statements of Financial Condition at September
30, 1998 and December 31, 1997
Condensed Consolidated Statements of Income for the three months and
nine months ended September 30, 1998 and 1997
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and 1997
Notes to Condensed Consolidated Financial Statements
Independent Auditors' Review Report
(b) Consolidated Financial Statements of Provident Companies, Inc. and
Subsidiaries (Audited):
Report of Ernst and Young LLP, Independent Auditors
Consolidated Statements of Financial Condition at December 31, 1997
and 1996
Consolidated Statements of Income for the three years ended December
31, 1997
Consolidated Statements of Stockholders' Equity for the three years
ended December 31, 1997
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<PAGE>
Consolidated Statements of Cash Flows for the three years ended
December 31, 1997
Notes to Consolidated Financial Statements
(c) Condensed Pro Forma Combined Financial Data of UNUM Corporation and
Subsidiaries and Provident Companies, Inc. and Subsidiaries (Unaudited):
Condensed Pro Forma Combined Statements of Income for the nine months
ended September 30, 1998 and 1997 and for each of the three years
ended December 31, 1997, 1996 and 1995
Condensed Pro Forma Combined Balance Sheet at September 30, 1998
Notes to Condensed Pro Forma Combined Financial Information
(d) Exhibits:
Acknowledgement of Independent Auditors
Consent of Independent Auditors
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<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
(in millions of dollars)
(Unaudited)
<S> <C> <C>
ASSETS
Investments
Fixed Maturity Securities
Available-for-Sale $14,946.5 $17,035.1
Held-to-Maturity 298.9 306.8
Equity Securities 12.7 10.0
Mortgage Loans 17.8 17.8
Real Estate 43.7 87.1
Policy Loans 2,101.4 1,983.9
Other Long-term Investments 33.9 22.6
Short-term Investments 44.0 57.5
--------- --------
Total Investments 17,498.9 19,520.8
Cash and Bank Deposits 42.3 37.7
Accounts and Premiums Receivable 109.8 166.4
Reinsurance Receivable 3,171.2 987.2
Accrued Investment Income 363.1 363.2
Deferred Policy Acquisition Costs 413.7 362.9
Value of Business Acquired 498.7 560.8
Goodwill 697.5 732.3
Property and Equipment 118.0 109.2
Miscellaneous 33.6 26.2
Separate Account Assets 320.2 310.9
--------- ---------
TOTAL ASSETS $23,267.0 $23,177.6
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
September 30 December 31
1998 1997
(in millions of dollars)
(Unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Policy and Contract Benefits $ 513.0 $ 531.2
Reserves for Future Policy and Contract Benefits
and Unearned Premiums 13,674.9 13,193.8
Policyholders' Funds and Experience Rating Refunds 3,482.6 4,328.0
Federal Income Tax Liability 347.0 190.1
Short-term Debt 98.9 150.7
Long-term Debt 600.0 725.0
Other Liabilities 481.9 468.6
Separate Account Liabilities 320.2 310.9
--------- ---------
TOTAL LIABILITIES 19,518.5 19,898.3
--------- ---------
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED
SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR
SUBORDINATED DEBT SECURITIES OF THE COMPANY 300.0 -
--------- ---------
COMMITMENTS AND CONTINGENT LIABILITIES - NOTE 6
STOCKHOLDERS' EQUITY
Preferred Stock - 156.2
Common Stock, $1 par 135.8 135.2
Additional Paid-in Capital 756.3 750.6
Retained Earnings 1,821.6 1,635.2
Accumulated Other Comprehensive Income--Note 7 745.7 603.6
Treasury Stock (10.9) (1.5)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 3,448.5 3,279.3
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $23,267.0 $23,177.6
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars, except share data)
<S> <C> <C> <C> <C>
REVENUE
Premium Income $ 593.2 $ 594.0 $ 1,759.8 $ 1,471.5
Net Investment Income 329.5 362.9 1,039.6 990.1
Net Realized Investment Gains 9.2 6.9 18.2 13.1
Other Income 43.4 33.3 134.3 87.5
------------ ------------ ------------ ------------
TOTAL REVENUE 975.3 997.1 2,951.9 2,562.2
------------ ------------ ------------ ------------
BENEFITS AND EXPENSES
Policy and Contract Benefits 445.7 451.8 1,377.8 1,212.2
Change in Reserves for Future
Policy And Contract Benefits
and Policyholders' Funds 163.8 197.3 486.2 507.7
Amortization
Deferred Policy Acquisition
Costs 19.3 21.4 58.2 57.9
Value of Business Acquired 7.9 9.1 25.2 19.3
Goodwill 5.2 4.2 16.1 8.6
Interest Expense on Debt 20.0 12.0 54.0 27.8
Salaries 57.1 55.1 168.5 132.1
Commissions 58.6 65.0 189.7 161.9
Other Operating Expenses 71.9 71.7 213.4 171.7
------------ ------------ ------------ ------------
TOTAL BENEFITS AND EXPENSES 849.5 887.6 2,589.1 2,299.2
------------ ------------ ------------ ------------
INCOME BEFORE FEDERAL INCOME TAXES 125.8 109.5 362.8 263.0
FEDERAL INCOME TAXES 43.9 38.5 135.0 91.5
------------ ------------ ------------ ------------
NET INCOME $ 81.9 $ 71.0 $ 227.8 $ 171.5
============ ============ ============ ============
NET INCOME PER COMMON SHARE
Basic $ 0.61 $ 0.50 $ 1.67 $ 1.34
Assuming Dilution $ 0.59 $ 0.49 $ 1.63 $ 1.31
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING
Basic 135,210,161 134,962,688 135,101,280 120,928,246
Assuming Dilution 138,491,624 137,939,702 138,589,198 123,492,809
DIVIDENDS PER COMMON SHARE $ 0.10 $ 0.10 $ 0.30 $ 0.28
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Nine Months Ended
September 30
1998 1997
(in millions of dollars)
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 631.7 $ 763.9
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sales of Investments 1,039.9 1,256.6
Proceeds from Maturities of Investments 923.1 1,334.7
Purchase of Investments (1,821.7) (2,195.1)
Net Sales of Short-term Investments 10.4 362.1
Acquisition of Business--Note 4 - (860.0)
Disposition of Business--Note 5 58.0 -
Other (19.4) (23.2)
--------- ---------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 190.3 (124.9)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits to Policyholder Accounts 66.0 415.7
Maturities and Benefit Payments from
Policyholder Accounts (802.5) (1,704.8)
Net Short-term Debt Repayments (51.8) -
Net Long-term Borrowings (Repayments) (125.0) 425.9
Issuance of Company Obligated Mandatorily
Redeemable Preferred Securities 300.0 -
Redemption of Preferred Stock (156.2) -
Issuance of Common Stock 6.3 388.4
Dividends Paid to Stockholders (44.6) (43.3)
Other (9.4) 0.5
--------- ---------
NET CASH USED BY FINANCING ACTIVITIES (817.2) (517.6)
--------- ---------
Effect of Foreign Exchange Rate Changes on Cash (0.2) (0.7)
--------- ---------
NET INCREASE IN CASH AND BANK DEPOSITS 4.6 120.7
CASH AND BANK DEPOSITS AT BEGINNING OF PERIOD 37.7 19.3
--------- ---------
CASH AND BANK DEPOSITS AT END OF PERIOD $ 42.3 $ 140.0
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited 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 and nine month periods ended September 30, 1998, are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998. 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, 1997.
NOTE 2--DEBT AND EQUITY SECURITIES
On February 24, 1998, the Company repaid the $725.0 million outstanding
borrowing on its revolving credit facility and redeemed its cumulative
preferred stock outstanding of $156.2 million at $150 per share equivalent to
$25 per depositary share. The debt repayment and preferred stock redemption
were funded through short-term borrowings.
In May 1997, the Securities and Exchange Commission declared effective a
shelf registration statement pursuant to which the Company could issue up to
$900.0 million in debt and/or equity securities. On March 16, 1998, the
Company completed a public offering of $200.0 million of 7.25% senior notes
due March 15, 2028. On March 16, 1998, Provident Financing Trust I, a
wholly-owned subsidiary trust of the Company, issued $300.0 million of 7.405%
capital securities in a public offering. These capital securities, which
mature on March 15, 2038, are fully and unconditionally guaranteed by the
Company, have a liquidation value of $1,000 per capital security, and have a
mandatory redemption feature under certain circumstances. The Company issued
$300.0 million of 7.405% junior subordinated deferrable interest debentures
which mature on March 15, 2038, to the subsidiary trust in connection with
the capital securities offering. The sole assets of the subsidiary trust are
the junior subordinated debt securities. On July 9, 1998, the Company
completed a public offering of $200.0 million of 6.375% senior notes due July
15, 2005, and $200.0 million of 7% senior notes due July 15, 2018.
-8-
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 3--SEGMENT INFORMATION
A summary by segment of the Company's revenue and income before federal income
taxes, excluding and including net realized investment gains and losses,
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars)
<S> <C> <C> <C> <C>
Revenue (Excluding Net Realized
Investment Gains and Losses)
Individual Disability and Life $565.4 $544.1 $1,683.9 $1,341.9
Employee Benefits 277.8 248.9 808.7 643.5
Other Operations 122.9 197.2 441.1 563.7
------ ------ -------- --------
Total $966.1 $990.2 $2,933.7 $2,549.1
====== ====== ======== ========
Income Before Net Realized Investment
Gains and Losses and Federal
Income Taxes
Individual Disability and Life $ 82.1 $ 64.9 $ 235.5 $ 150.8
Employee Benefits 32.0 20.3 90.5 44.6
Other Operations 2.5 17.4 18.6 54.5
------ ------ -------- --------
Total $116.6 $102.6 $ 344.6 $ 249.9
====== ====== ======== ========
</TABLE>
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<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 3--SEGMENT INFORMATION - CONTINUED
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars)
<S> <C> <C> <C> <C>
Revenue (Including Net Realized
Investment Gains and Losses)
Individual Disability and Life $568.6 $547.5 $1,
698.0 $1,351.7
Employee Benefits 277.7 251.1 810.3 645.3
Other Operations 129.0 198.5 443.6 565.2
------ ------ -------- --------
Total $975.3 $997.1 $2,951.9 $2,562.2
====== ====== ======== ========
Income Before Federal Income Taxes
Individual Disability and Life $ 85.3 $ 68.3 $ 249.6 $ 160.6
Employee Benefits 31.9 22.5 92.1 46.4
Other Operations 8.6 18.7 21.1 56.0
------ ------ -------- --------
Total $125.8 $109.5 $ 362.8 $ 263.0
====== ====== ======== ========
</TABLE>
Total revenue (excluding net realized investment gains and losses) includes
premium income, net investment income, and other income. Total revenue
(including net realized investment gains and losses) includes premium income,
net investment income, net realized investment gains and losses, and other
income.
-10-
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 4--ACQUISITION OF BUSINESS
GENEX SERVICES, INC.
On February 28, 1997, the Company acquired GENEX Services, Inc. and GENEX
Services of Canada, Inc. (GENEX) at a price of $70.0 million. GENEX is a
provider of case management, vocational rehabilitation, and related services
to corporations, third party administrators, and insurance companies. These
services are utilized in the management of disability and worker's
compensation cases. The acquisition was accounted for by the purchase
method. The fair values of the assets acquired and liabilities assumed were
$17.9 million and $8.9 million, respectively. The purchase price has been
allocated to goodwill and is being amortized on a straight-line basis over a
25 year period. The consolidated financial statements include the operating
results of GENEX from March 1, 1997.
THE PAUL REVERE CORPORATION
On March 27, 1997, the Company acquired The Paul Revere Corporation (Paul
Revere), a provider of life and disability insurance products, at a price of
approximately $1.2 billion. The transaction was financed through common
equity issued to Zurich Insurance Company, a Swiss insurer, and its
affiliates in the amount of $300.0 million, common equity of $437.5 million
and cash of $2.5 million issued to Paul Revere shareholders, internally
generated funds of $145.0 million, and borrowings on the Company's revolving
credit facility of $305.0 million. The acquisition was accounted for by the
purchase method. The fair values of the assets acquired and liabilities
assumed were $6,680.0 million and $6,675.4 million, respectively. The
purchase price has been allocated principally to the value of business
acquired with the remainder being allocated to goodwill. The value of
business acquired will be amortized with interest based on premium income for
the traditional individual life and disability income products and on the
estimates of future gross profits for interestsensitive individual life
products. Goodwill is being amortized on a straightline basis over a 40 year
period.
The following pro forma results of operations for the nine months ended
September 30, 1997, give effect to the acquisitions and the related financing
arrangements, including the acquisition of debt and issuance of common stock
equity. The pro forma results of operations, prepared from historical
financial results of operations of the Company, Paul Revere, and GENEX with
such adjustments as are necessary to present the results of operations as if
the acquisitions had occurred as of the beginning of the period presented,
are as follows:
<TABLE>
<CAPTION>
Nine Months Ended
September 30, 1997
(in millions of dollars,
except share data)
<S> <C>
Revenue $3,018.6
Income Before Federal Income Taxes 311.4
Net Income 200.5
Net Income per Common Share
Basic 1.42
Assuming Dilution 1.39
</TABLE>
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<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
PROVIDENT COMPANIES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
NOTE 4--ACQUISITION OF BUSINESS - CONTINUED
Revenue and income before federal income taxes include $36.4 million of
pre-tax net realized investment gains for the acquired companies for the 1997
period prior to acquisition. Net income includes $23.7 million ($0.18 per
common share) of after-tax net investment gains for the 1997 period prior to
acquisition.
NOTE 5--SALE OF A PORTION OF A LINE OF BUSINESS
In December 1997, the Company entered into an agreement with American General
Corporation (American General) under which various affiliates of American
General agreed to acquire certain assets and assume certain liabilities of
the Company's individual and tax-sheltered annuity business for approximately
$58.0 million in cash. In addition, American General acquired a number of
miscellaneous group pension lines of business which were no longer actively
marketed by the Company. The sale did not include the Company's Canadian
annuity business, traditional guaranteed investment contracts, or group
single premium annuities. The sale was completed during the second quarter of
1998. Assets transferred to American General in connection with the business
sold had a carrying value of approximately $2,413.3 million, and liabilities
assumed by American General totaled $2,493.1 million. In connection with the
sale, the Company wrote off $18.7 million of goodwill associated with the
annuity business acquired from Paul Revere. The gain recognized at the time
of the sale of this business increased 1998 operating earnings by $12.2 million
($0.09 per common share) before taxes and $1.4 million ($0.01 per common
share) after taxes.
Note 6--COMMITMENTS AND CONTINGENT LIABILITIES
Two alleged class action lawsuits have been filed in Superior Court in
Worcester, Massachusetts (the Court) against the Company - one purporting to
represent all career agents of Paul Revere whose employment relationships
ended on June 30, 1997 and were offered contracts to sell insurance policies
as independent producers, and the other purporting to represent independent
brokers who sold certain Paul Revere individual disability income policies
with benefit riders. Motions filed by the Company to dismiss most of the
counts in the complaints, which allege various breach of contract and
statutory claims, have been denied, but the cases remain at a preliminary
stage. To date, no class has been certified in either lawsuit. The Company
has filed a conditional counterclaim in each action which requests a
substantial return of commissions should the Court agree with the plaintiff's
interpretation of the contract. The Company has strong defenses to both
lawsuits and will vigorously defend its position and resist certification of
the classes. In addition, the same plaintiff's attorney who has filed the
purported class action lawsuits has filed 41 individual lawsuits on behalf of
current and former Paul Revere sales managers alleging various breach of
contract claims. The Company has filed a motion in federal court to compel
arbitration for 16 of the plaintiffs who are licensed by the National
Association of Securities Dealers and have executed the Uniform Application
for Registration or Transfer in the Securities Industry (Form U-4). The
Company has strong defenses and will vigorously defend its position in these
cases as well. Although the alleged class action lawsuits and the 41 individual
lawsuits are in the early stages, management does not currently expect these
suits to materially affect the financial position or results of operations of
the Company.
Various lawsuits against the Company have arisen in the normal course of
business. Contingent liabilities that might arise from litigation are not
deemed likely to materially affect the financial position or results of
operations of the Company.
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<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
Provident Companies, Inc. and Subsidiaries
SEPTEMBER 30, 1998
NOTE 7--COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income, which establishes standards for reporting and presentation of
comprehensive income and its components. SFAS 130 requires foreign currency
translation adjustments and unrealized holding gains and losses on the
Company's available-for-sale fixed maturity and equity securities, which
prior to adoption were reported separately in stockholders' equity, to be
reported as components of comprehensive income. Prior periods have been
reclassified to conform to the requirements of SFAS 130. SFAS 130 had no
impact on the Company's net income or stockholders' equity.
The components of accumulated other comprehensive income, net of related tax,
are as follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
(in millions of dollars)
<S> <C> <C>
Net Unrealized Gain on Securities $775.7 $624.3
Foreign Currency Translation Adjustment (30.0) (20.7)
------ ------
Accumulated Other Comprehensive Income $745.7 $603.6
------ ------
------ ------
</TABLE>
The components of comprehensive income, net of related tax, are as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
(in millions of dollars)
<S> <C> <C> <C> <C>
Net Income $ 81.9 $ 71.0 $227.8 $171.5
Change in Net Unrealized Gain
on Securities 35.5 217.3 151.4 365.0
Change in Foreign Currency
Translation Adjustment (3.8) (2.8) (9.3) (1.5)
------ ------ ------ ------
Comprehensive Income $113.6 $285.5 $3
69.9 $535.0
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
-13-
<PAGE>
INDEPENDENT AUDITORS' REVIEW REPORT
Board of Directors and Shareholders
Provident Companies, Inc.
We have reviewed the accompanying condensed consolidated statement of
financial condition of Provident Companies, Inc. and Subsidiaries as of
September 30, 1998, and the related condensed consolidated statements of
income for the three and nine month periods ended September 30, 1998 and
1997, and the condensed consolidated statements of cash flows for the nine
month periods ended September 30, 1998 and 1997. These financial statements
are the responsibility of the Company's management.
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, 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 Provident
Companies, Inc. and Subsidiaries as of December 31, 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for
the year then ended, not presented herein, and in our report dated February 3,
1998, 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,
1997, is fairly stated in all material respects in relation to the
consolidated statement of financial condition from which it has been derived.
Chattanooga, Tennessee
November 10, 1998
-14-
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Shareholders
Provident Companies, Inc.
We have audited the accompanying consolidated statements of financial
condition of Provident Companies, Inc. and Subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Provident Companies, Inc. and Subsidiaries at December 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
Ernst & Young LLP
Chattanooga, Tennessee
February 3, 1998
except for Note 18, as to which
the date is March 16, 1998
-15-
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Provident Companies, Inc. and Subsidiaries
<TABLE>
<CAPTION>
December 31
1997 1996
(in millions of dollars)
-------------------------------
<S> <C> <C>
Assets
Investments
Fixed Maturity Securities
Available-for-Sale - at fair value
(amortized cost: $15,491.4; $10,384.3) $17,035.1 $10,880.1
Held-to-Maturity - at amortized cost
(fair value: $336.6; $263.1) 306.8 264.5
Equity Securities - at fair value
(cost: $11.1; $7.2) 10.0 4.9
Mortgage Loans 17.8 -
Real Estate 87.1 151.1
Policy Loans 1,983.9 1,749.0
Other Long-term Investments 22.6 15.5
Short-term Investments 57.5 252.3
--------- ---------
Total Investments 19,520.8 13,317.4
Other Assets
Cash and Bank Deposits 37.7 19.3
Accounts Receivable 92.5 40.1
Premiums Receivable 73.9 72.3
Reinsurance Receivable 987.2 468.3
Accrued Investment Income 363.2 268.3
Deferred Policy Acquisition Costs 362.9 421.8
Value of Business Acquired 560.8 5.9
Goodwill 732.3 -
Property and Equipment - at cost
less accumulated depreciation 109.2 59.0
Miscellaneous 26.2 19.6
Separate Account Assets 310.9 300.5
--------- ---------
Total Assets $23,177.6 $14,992.5
========= =========
</TABLE>
-16-
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
Provident Companies, Inc. and Subsidiaries
<TABLE>
<CAPTION>
December 31
1997 1996
(in millions of dollars)
-----------------------------------
<S> <C> <C>
Liabilities and Stockholders' Equity
Policy and Contract Benefits $ 531.2 $ 411.7
Reserves for Future Policy and Contract Benefits 13,001.1 8,051.3
Unearned Premiums 192.7 58.8
Experience Rating Refunds 133.1 164.0
Policyholders' Funds 4,194.9 3,717.1
Federal Income Tax Liability
Current 40.3 34.6
Deferred 149.8 14.5
Short-term Debt 150.7 -
Long-term Debt 725.0 200.0
Other Liabilities 468.6 301.4
Separate Account Liabilities 310.9 300.5
--------- ---------
Total Liabilities 19,898.3 13,253.9
--------- ---------
Commitments and Contingent Liabilities--Note 16
Stockholders' Equity--Note 10
Preferred Stock 156.2 156.2
Common Stock
Authorized: 150,000,000 shares
Issued: 135,160,109 and 91,255,258 shares 135.2 45.6
Additional Paid-in Capital 750.6 11.4
Net Unrealized Gain on Securities 624.3 90.9
Foreign Currency Translation Adjustment (20.7) (5.2)
Retained Earnings 1,635.2 1,439.7
Treasury Stock - at cost:
40,200 shares (1.5) -
--------- ---------
Total Stockholders' Equity 3,279.3 1,738.6
--------- ---------
Total Liabilities and Stockholders' Equity $23,177.6 $14,992.5
========= =========
</TABLE>
See notes to consolidated financial statements.
-17-
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
Provident Companies, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars, except share data)
-------------------------------------------
<S> <C> <C> <C>
Revenue
Premium Income $2,053.7 $1,175.7 $1,251.9
Net Investment Income 1,354.7 1,090.1 1,221.3
Net Realized Investment Gains (Losses) 15.1 (8.6) (31.7)
Other Income 129.7 34.7 113.8
-------- -------- --------
Total Revenue 3,553.2 2,291.9 2,555.3
-------- -------- --------
Benefits and Expenses
Policy and Contract Benefits 1,687.8 1,216.5 1,419.7
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 670.3 444.7 484.9
Amortization
Deferred Policy Acquisition Costs 74.4 64.0 71.0
Value of Business Acquired 31.2 0.5 4.9
Goodwill 12.6 - -
Salaries 191.1 77.3 99.8
Commissions 220.9 124.0 131.9
Other Operating Expenses 284.6 138.7 167.1
-------- -------- --------
Total Benefits and Expenses 3,172.9 2,065.7 2,379.3
-------- -------- --------
Income Before Federal Income Taxes 380.3 226.2 176.0
Federal Income Taxes 133.0 80.6 60.4
-------- -------- --------
Net Income $ 247.3 $ 145.6 $ 115.6
======== ======== ========
Earnings Per Common Share $ 1.88 $ 1.46 $ 1.13
======== ======== ========
Earnings Per Common Share - Assuming Dilution $ 1.84 $ 1.44 $ 1.13
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
-18-
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Provident Companies, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
------------------------------
<S> <C> <C> <C>
Preferred Stock
Balance at Beginning and End of Year $ 156.2 $ 156.2 $ 156.2
-------- -------- --------
Common Stock
Balance at Beginning of Year 45.6 45.4 45.4
Issued During Year 22.1 0.2 -
Two-for-One Stock Split 67.5 - -
-------- -------- --------
Balance at End of Year 135.2 45.6 45.4
-------- -------- --------
Additional Paid-in Capital
Balance at Beginning of Year 11.4 5.8 4.8
Contributions During Year 806.7 5.6 1.0
Two-for-One Stock Split (67.5) - -
-------- -------- --------
Balance at End of Year 750.6 11.4 5.8
-------- -------- --------
Net Unrealized Gain (Loss) on Securities
Balance at Beginning of Year 90.9 101.9 (302.3)
Change During Year 533.4 (11.0) 404.2
-------- -------- --------
Balance at End of Year 624.3 90.9 101.9
-------- -------- --------
Foreign Currency Translation Adjustment
Balance at Beginning of Year (5.2) (4.8) (5.4)
Change During Year (15.5) (0.4) 0.6
-------- -------- --------
Balance at End of Year (20.7) (5.2) (4.8)
-------- -------- --------
Retained Earnings
Balance at Beginning of Year 1,439.7 1,347.8 1,270.4
Net Income 247.3 145.6 115.6
Dividends to Stockholders
(Paid Per Common Shares: $0.38; $0.36; $0.36) (51.8) (53.7) (38.2)
-------- -------- --------
Balance at End of Year 1,635.2 1,439.7 1,347.8
-------- -------- --------
Treasury Stock
Balance at Beginning of Year - - -
Purchased During Year (1.5) - -
-------- -------- --------
Balance at End of Year (1.5) - -
-------- -------- --------
Total Stockholders' Equity $3,279.3 $1,738.6 $1,652.3
======== ======== ========
</TABLE>
See notes to consolidated financial statements
-19-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Provident Companies, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
-----------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net Income $ 247.3 $ 145.6 $ 115.6
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities
Policy Acquisition Costs Capitalized (143.5) (71.4) (88.1)
Amortization of Policy Acquisition Costs 74.4 64.0 71.0
Amortization of Value of Business Acquired and
Goodwill 43.8 0.5 4.9
Depreciation 20.7 10.6 19.4
Net Realized Investment (Gains) Losses (15.1) 8.6 31.7
Premiums Receivable 6.4 3.2 (13.2)
Reinsurance Receivable 44.4 (33.0) 2.0
Accrued Investment Income (10.7) 9.1 4.1
Insurance Reserves and Liabilities 595.8 546.8 581.8
Federal Income Taxes 23.5 (11.9) (11.4)
Other (60.0) (11.5) (42.9)
--------- --------- --------
Net Cash Provided by Operating Activities 827.0 660.6 674.9
--------- --------- --------
Cash Flows from Investing Activities
Proceeds from Sales of Investments
Available-for-Sale Securities 1,872.6 1,592.6 1,359.9
Other Investments 92.9 141.8 1,172.5
Proceeds from Maturities of Investments
Available-for-Sale Securities 1,170.5 1,115.7 880.8
Held-to-Maturity Securities 1.1 100.5 0.7
Other Investments 295.9 13.0 248.7
Purchase of Investments
Available-for-Sale Securities (2,904.3) (1,630.7) (1,680.1)
Held-to-Maturity Securities (23.4) (48.6) (183.9)
Other Investments (180.5) (177.5) (236.6)
Net (Purchases) Sales of Short-term Investments 393.1 (21.5) 58.7
Acquisition of Business (860.3) - -
Disposition of Business - - (48.9)
Other (19.2) (75.5) (67.0)
--------- --------- --------
Net Cash Provided (Used) by Investing Activities $ (161.6) $ 1,009.8 $ 1,504.8
--------- --------- --------
</TABLE>
-20-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
Provident Companies, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
-------------------------------------------
<S> <C> <C> <C>
Cash Flows from Financing Activities
Deposits to Policyholder Accounts $ 528.7 $ 392.5 $ 530.6
Maturities and Benefit Payments from
Policyholder Accounts (2,081.9) (2,023.8) (2,663.5)
Net Short-term Debt Borrowings (Repayments) 150.7 (1.4) (13.0)
Net Long-term Borrowings 425.9 - -
Issuance of Common Stock 389.8 5.8 1.0
Dividends Paid to Stockholders (60.0) (45.5) (45.3)
Other 0.5 (3.5) -
--------- ---------- ---------
Net Cash Used by Financing Activities (646.3) (1,675.9) (2,190.2)
--------- ---------- ---------
Effect of Foreign Exchange Rate
Changes on Cash (0.7) - -
--------- ---------- ---------
Net Increase (Decrease) in Cash
and Bank Deposits 18.4 (5.5) (10.5)
Cash and Bank Deposits at Beginning of Year 19.3 24.8 35.3
--------- ---------- ---------
Cash and Bank Deposits at End of Year $ 37.7 $ 19.3 $ 24.8
========= ========== =========
</TABLE>
See notes to consolidated financial statements.
-21-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies
Basis of Presentation: The accompanying financial statements have been prepared
on the basis of generally accepted accounting principles. Such accounting
principles differ from statutory accounting practices prescribed or permitted by
state regulatory authorities (see Note 17). The consolidated financial
statements include the accounts of Provident Companies, Inc. and its
whollyowned subsidiaries (the Company). Material intercompany transactions have
been eliminated.
Operations: The Company does business in the fifty states, the District of
Columbia, Puerto Rico, and ten provinces and two territories of Canada. The
Company operates principally in the life and health insurance business.
Individual life products and individual disability income products are reported
in the Individual Life and Disability segment and are marketed primarily through
personal producing general agents, brokerage offices, and corporate marketing
arrangements. The Employee Benefits segment contains products that are sold to
or through corporate customers and certain affinity groups, including permanent
and term life insurance, disability, cancer, accident and sickness, and
accidental death and dismemberment protection. The Other Operations segment
reports corporate results, primarily investment earnings not specifically
allocated to a line of business, and also includes results from products no
longer actively marketed, including guaranteed investment contracts (GICs),
group single premium annuities, medical stop-loss, and corporate-owned life
insurance. This segment also includes the results of the group medical business
which was sold effective April 30, 1995 and the individual and tax-sheltered
annuities business expected to be sold in the second quarter of 1998 (see Notes
15 and 16).
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect amounts reported in the financial statements and
accompanying notes. Such estimates and assumptions could change in the future
as more information becomes known, which could impact the amounts reported and
disclosed herein.
Investments: Investments are reported in the consolidated statements of
financial condition as follows:
Available-for-Sale Fixed Maturity Securities are reported at fair value.
Held-to-Maturity Fixed Maturity Securities are generally reported at amortized
cost.
Equity Securities are reported at fair value.
Mortgage Loans are carried at the fair value of collateral.
Real Estate that the Company expects to hold and use is carried at cost less
accumulated depreciation which is calculated using principally the straight-line
method. Real estate to be disposed of is carried at the lower of cost less
accumulated depreciation or fair value less cost to sell.
Policy Loans are presented at unpaid balances.
Other Long-term Investments are carried at cost plus the Company's equity in
undistributed net earnings since acquisition.
Short-term Investments are carried at cost.
-22-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Fixed maturity securities include bonds and redeemable preferred stocks. Equity
securities include common stocks and nonredeemable preferred stocks. Fixed
maturity and equity securities not bought and held for the purpose of selling in
the near term but for which the Company does not have the positive intent and
ability to hold to maturity are classified as available-for-sale. Fixed
maturity securities that the Company has the positive intent and ability to hold
to maturity are classified as held-to-maturity. The Company determines the
appropriate classification of fixed maturity securities at the time of purchase.
Realized investment gains and losses, which are reported as a component of
revenue in the consolidated statements of income, are based upon specific
identification of the investments sold and do not include amounts allocable to
separate accounts. At the time a decline in the value of an investment is
determined to be other than temporary, a loss is recorded which is included in
realized investment gains and losses.
Derivative Financial Instruments:
Interest Rate Swap Agreements are agreements in which two parties agree to
exchange, at specified intervals, interest payment streams calculated on an
agreed-upon notional principal amount with at least one stream based on a
specified variable rate. The underlying notional principal is not exchanged
between the parties. The Company has certain forward interest rate swap
agreements where the exchange of interest payments does not begin until a
specified future date. The Company intends to settle the forward interest rate
swap agreements prior to the commencement of the exchange of interest payment
streams.
The fair values of interest rate swap agreements which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of interest rate swap
agreements which hedge liabilities are not reported in the consolidated
statements of financial condition. Amounts to be paid or received pursuant to
interest rate swap agreements are accrued and recognized in the consolidated
statements of income as an adjustment to net investment income for asset hedges
or as an adjustment to policy and contract benefits for liability hedges.
The Company accounts for all of its interest rate swap agreements as hedges.
Accordingly, any gains or losses realized on closed or terminated interest rate
swap agreements are deferred and amortized to net investment income for asset
hedges or policy and contract benefits for liability hedges over the expected
remaining life of the hedged item. If the hedged item matures or terminates
earlier than anticipated, the remaining unamortized gain or loss is amortized to
net investment income or policy and contract benefits in the current period.
Gains or losses realized on interest rate swap agreements which are terminated
when the hedged assets are sold or which are terminated because the hedged
anticipated transaction is no longer likely to occur are reported in the
consolidated statements of income as a component of net realized investment
gains and losses. The Company regularly monitors the effectiveness of its
hedging programs. In the event a hedge becomes ineffective, it is marked-
tomarket, resulting in a charge or credit to net investment income or policy and
contract benefits.
-23-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Futures and Forwards contracts are commitments to either purchase or sell a
financial instrument at a specific future date for a specified price. The
Company invests only in futures and forwards contracts which have U.S. Treasury
securities as the underlying investments. Changes in the market value of
contracts are generally settled on a daily basis. The notional amounts of
futures and forwards contracts represent the extent of the Company's involvement
but not the future cash requirements, as the Company intends to close out open
positions prior to settlement. All of the Company's futures and forwards
contracts are accounted for as hedges.
The fair values of futures and forwards which hedge available-for-sale
securities are reported in the consolidated statements of financial condition as
a component of fixed maturity securities. The fair values of open futures and
forwards which hedge liabilities are reported in the consolidated statements of
financial condition as a component of other liabilities. Gains or losses
realized on the termination of futures and forwards contracts are accounted for
in the same manner as interest rate swap agreements.
Options contracts give the owner the right, but not the obligation, to buy or
sell a financial instrument at an agreed-upon price on or before a specific
date. The purchasing counterparty pays a premium to the selling counterparty
for this right. The notional amounts of contracts represent the Company's
involvement but not the future cash requirements, as the Company intends to
close out contracts prior to the expiration date when the market price of the
underlying financial instrument exceeds the option price or allow contracts to
expire if the option price exceeds the market price. All of the Company's
options contracts are accounted for as hedges. The book and fair values of
options contracts are reported in the statements of financial condition in a
manner similar to the underlying hedged item. Gains or losses on the
termination of options contracts are accounted for in the same manner as
interest rate swap agreements.
Deferred Policy Acquisition Costs: Certain costs of acquiring new business
which vary with and are primarily related to the production of new business have
been deferred. Such costs include commissions, other agency compensation,
certain selection and policy issue expenses, and certain field expenses.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing subsequent to the year of
issue.
Deferred policy acquisition costs related to traditional individual life and
individual disability income are amortized over the premium paying period of the
related policies in proportion to the ratio of the present value of annual
expected premium income to the present value of total expected premium income.
Adjustments are made each year to recognize actual persistency experience as
compared to assumed experience.
Deferred policy acquisition costs related to interest-sensitive individual life
and individual annuity policies are amortized over the lives of the policies in
relation to the present value of estimated gross profits from surrender charges
and mortality, investment, and expense margins. Adjustments are made each year
to reflect actual experience for assumptions which deviate significantly
compared to assumed experience.
-24-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
The amortization periods do not exceed 25 years for traditional and
interestsensitive individual life policies, 20 years for individual disability
income policies, and 15 years for individual annuity policies. Loss recognition
is performed when, in the judgment of management, adverse deviations from
original assumptions have occurred and may be likely to continue such that
recoverability of deferred policy acquisition costs on a line of business is
questionable. Insurance contracts are grouped on a basis consistent with the
Company's manner of acquiring, servicing, and measuring profitability of the
contracts. If loss recognition testing indicates that deferred policy
acquisition costs are not recoverable, the deficiency is charged to expense.
Once a loss recognition adjustment is required, loss recognition testing is
generally performed on an annual basis using then current assumptions until the
line of business becomes immaterial or results improve significantly. The
assumptions used in loss recognition testing represent management's best
estimates of future experience.
Value of Business Acquired: Value of business acquired represents the present
value of future profits recorded in connection with the acquisition of a block
of insurance policies. The asset is amortized based upon expected future
premium income for traditional insurance policies and estimated future gross
profits for interest-sensitive insurance policies, with the accrual of interest
added to the unamortized balance at interest rates ranging from 5.55% to 7.60%.
The Company periodically reviews the carrying amount of value of business
acquired using the same methods used to evaluate deferred policy acquisition
costs.
Goodwill: Goodwill is the excess of the amount paid to acquire a business over
the fair value of the net assets acquired. Goodwill is amortized on a
straightline basis over a period not to exceed 40 years. The carrying amount of
goodwill is regularly reviewed for indicators of impairment in value.
Property and Equipment: Property and equipment is depreciated on the
straightline method over its estimated useful life. The accumulated
depreciation for property and equipment was $115.7 million and $84.4 million as
of December 31, 1997 and 1996, respectively.
Revenue Recognition: For traditional life and accident and health products, the
amounts collected from policyholders are recognized as premium income over the
premium paying period and are reported net of experience rating refunds and
unearned premiums. For interest-sensitive products, the amounts collected from
policyholders are considered deposits, and only the deductions during the period
for cost of insurance, policy administration, and surrenders are included in
revenue. Policyholders' funds represent funds deposited by contract holders and
are not included in revenue.
Policy and Contract Benefits: Policy and contract benefits, principally related
to accident and health insurance policies, are based on reported losses and
estimates of incurred but not reported losses for traditional life and accident
and health products. For interest-sensitive products, benefits are the amounts
paid and expected to be paid on insured claims in excess of the policyholders'
policy fund balances.
Reserves for Future Policy and Contract Benefits: Active life reserves for
future policy and contract benefits on traditional life and accident and health
products have been provided on the net level premium method. The reserves are
calculated based upon assumptions as to interest, withdrawal, morbidity, and
mortality that were appropriate at the date of issue. Withdrawal assumptions
are based on actual Company experience. Morbidity and mortality assumptions are
based upon industry standards adjusted as appropriate to reflect actual Company
experience. The assumptions vary by plan, year of issue, and policy duration
and include a provision for adverse deviation.
Disabled lives reserves for future policy and contract benefits on disability
income policies are calculated based upon assumptions as to interest and claim
termination rates that are currently appropriate. Termination rate assumptions
are based upon industry standards adjusted as appropriate to reflect actual
Company experience. The assumptions vary by year of claim incurral.
-25-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Reserves for future policy and contract benefits on group single premium
annuities have been provided on a net single premium method. The reserves are
calculated based upon assumptions as to interest, mortality, and retirement that
were appropriate at the date of issue. Mortality assumptions are based upon
industry standards adjusted as appropriate to reflect actual Company experience.
The assumptions vary by year of issue and include a provision for adverse
deviation.
The interest rate assumptions used to calculate reserves for future policy and
contract benefits are as follows:
<TABLE>
<CAPTION>
December 31
1997 1996
<S> <C> <C>
Active Life Reserves - Current Year Issues
Traditional Life 7.25% to 10.00% 7.25% to 10.00%
Individual Disability Income 7.00% to 7.75% 7.00% to 7.75%
Disabled Lives Reserves - Current Year Claims
Individual Disability Income 7.75% to 8.00% 8.00%
Group Disability Income 6.50% to 8.00% 7.00%
Disabled Lives Reserves - Prior Year Claims
Individual Disability Income 7.75% to 8.00% 8.00%
Group Disability Income 3.90% to 8.90% 6.00% to 7.00%
</TABLE>
Interest assumptions for active life reserves are generally graded downward over
a period of years. Reserves for future policy and contract benefits on
interest-sensitive products are principally policyholder account values
determined on the retrospective deposit method.
Policyholders' Funds: Policyholders' funds represent customer deposits plus
interest credited at contract rates. The Company controls its interest rate
risk by investing in quality assets which have an aggregate duration that
closely matches the expected duration of the liabilities. For GICs, which are
no longer marketed, the Company uses a cash flow matching investment strategy.
Synthetic GICs: The Company discontinued accepting new synthetic GIC deposits
in 1996 and in 1997 sold this block of business through an assumptive
reinsurance agreement. All remaining contracts were transferred in January
1998. Prior to this time, the Company issued synthetic GICs to trustees of
employee benefit plans pursuant to the terms of which the trustees owned and
retained the assets related to these contracts. Such assets were not included
in the Company's consolidated statements of financial condition. Accumulated
funds from the sale of synthetic GICs were $97.8 million and $2,176.6 million at
December 31, 1997 and 1996, respectively.
Federal Income Taxes: Deferred taxes have been recorded for significant
temporary differences between financial statement income and taxable income.
-26-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Separate Accounts: The separate account amounts shown in the accompanying
financial statements represent contributions by contract holders to
variable benefits and fixed-benefits pension plans. The contract purchase
payments and the assets of the separate accounts are segregated from other
Company funds for both investment and administrative purposes. Contract
purchase payments received under variable annuity contracts are subject to
deductions for sales and administrative fees. Also, the sponsoring company of
the separate accounts receives management fees which are based on the net asset
values of the separate accounts.
Translation of Foreign Currency: Revenues and expenses of the Company's
Canadian operations are translated at average exchange rates. Assets and
liabilities are translated at the rate of exchange on the balance sheet date.
The translation gain or loss is generally reported in stockholders' equity, net
of deferred tax credits of $5.0 million and $2.8 million at December 31, 1997
and 1996, respectively.
Changes in Accounting Principles:
Statement of Financial Accounting Standards No. 125 (SFAS 125), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
In 1997, the Company adopted the provisions of SFAS 125 which provide accounting
and reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial-components approach that focuses on control. SFAS
125 also establishes new rules for determining whether a transfer of financial
assets constitutes a sale and, if so, the determination of any resulting gain or
loss. The adoption of SFAS 125 did not have a material effect on the Company's
financial position or results of operations.
Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings Per
Share" In 1997, the Company adopted the provisions of SFAS 128 which
establish computation and reporting standards for earnings per share. SFAS
128 simplifies the standards for computing earnings per share and makes them
comparable to international earnings per share standards. SFAS 128 requires
dual presentation on the face of the income statement of earnings per share
and earnings per share assuming dilution and requires a reconciliation of the
numerator and denominator of the earnings per share computation to the
numerator and denominator of the earnings per share assuming dilution
computation (see Note 10). Earnings per share is computed using the weighted
average number of common shares outstanding and does not consider any
potential dilution. Earnings per share assuming dilution reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
Historical earnings per common share amounts have been restated in accordance
with the provisions of SFAS 128.
-27-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 1--Significant Accounting Policies - Continued
Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
In 1996, the Company adopted the provisions of SFAS 121 which require that
longlived assets and certain identifiable intangibles to be held and used by an
entity be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Measurement of an impairment loss for long-lived assets and identifiable
intangibles that an entity expects to hold and use should be based on the fair
value of the asset. SFAS 121 also requires that long-lived assets and certain
intangibles to be disposed of generally be reported at the lower of the carrying
amount or fair value less cost to sell.
The primary assets of the Company which are subject to SFAS 121 are investment
real estate, property and equipment, and goodwill. The effect of the adoption
of SFAS 121 on the Company's financial position and results of operations was
immaterial.
Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting
for Stock-Based Compensation"
SFAS 123 defines a fair value based method of accounting for stock-based
employee compensation plans. Under this method, compensation cost is
measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. SFAS 123 also
allows an entity to continue to measure compensation cost using the intrinsic
value based method of accounting prescribed by Accounting Principles Board
Opinion No. 25 (Opinion 25), "Accounting for Stock Issued to Employees."
Under this method, compensation cost is the excess, if any, of the quoted
market price of the stock at grant date or other measurement date over the
amount an employee must pay to acquire the stock. SFAS 123 requires entities
electing to continue accounting for stock-based employee compensation plans
under Opinion 25 to make pro forma disclosures of net income and earnings per
share as if the fair value based method of accounting defined under SFAS 123
had been applied. The Company adopted the disclosure provisions of SFAS 123
in 1996 (see Note 11), but elected to continue to measure compensation cost
for stock-based compensation under the expense recognition provisions of
Opinion 25. The adoption of SFAS 123, therefore, did not have an effect on
the Company's financial position or results of operations. Accounting
Pronouncements Outstanding:
Statement of Financial Accounting Standards No. 130 (SFAS 130),"Reporting
Comprehensive Income"
In 1997, the Financial Accounting Standards Board (FASB) issued SFAS 130
which establishes standards for reporting and presentation of comprehensive
income and its components (revenues, expenses, gains, and losses) in a full
set of financial statements. Comprehensive income is the change in equity of
an entity during a period from transactions and other events except those
resulting from investments by and distributions to stockholders. SFAS 130
requires all items recognized under accounting standards as components of
comprehensive income to be reported in a financial statement that is
displayed with the same prominence as other financial statements.
Application of SFAS 130 will not impact amounts reported for net income. The
Company plans to adopt SFAS 130 in 1998.
Statement of Financial Accounting Standards No. 131 (SFAS 131),"Disclosures
about Segments of an Enterprise and Related Information"
In 1997, the FASB issued SFAS 131 which establishes standards for reporting
information for segments of a business enterprise including, but not limited to,
profit or loss, assets, products and services, geographic areas of operation,
and major customers. The Company plans to adopt SFAS 131 in 1998.
-28-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 2--Fair Values of Financial Instruments
The carrying amounts and fair values of the Company's financial instruments are
as follows:
<TABLE>
<CAPTION>
December 31
(in millions of dollars)
1997 1996
Carrying Fair Carrying Fair
Amount Value Amount Value
<S> <C> <C> <C> <C>
Assets
Fixed Maturity Securities
Available-for-Sale $16,901.3 $16,901.3 $10,859.9 $10,859.9
Derivatives Hedging
Available-for-Sale 133.8 133.8 20.2 20.2
Held-to-Maturity 306.8 336.6 264.5 263.1
Equity Securities 10.0 10.0 4.9 4.9
Mortgage Loans 17.8 17.8 - -
Policy Loans 1,983.9 2,376.1 1,749.0 2,080.5
Short-term Investments 57.5 57.5 252.3 252.3
Cash and Bank Deposits 37.7 37.7 19.3 19.3
Liabilities
Policyholders' Funds
GICs 1,603.6 1,618.5 3,204.3 3,230.9
Deferred Annuity Products 2,321.0 2,281.0 281.4 266.0
Supplementary Contracts without
Life Contingencies 86.7 86.7 61.1 61.1
Short-term Debt 150.7 150.7 - -
Long-term Debt 725.0 725.0 200.0 200.0
Derivatives Hedging Liabilities (7.4) (7.7) - 3.0
</TABLE>
The following methods and assumptions were used by the Company in estimating the
fair values of its financial instruments:
Fixed Maturity Securities: Fair values for fixed maturity securities are based
on quoted market prices, where available. For fixed maturity securities not
actively traded, fair values are estimated using values obtained from
independent pricing services or, in the case of private placements, are
estimated by discounting expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments. See
Note 3 for the amortized cost and fair values of securities by security type and
by maturity date.
Equity Securities: Fair values for equity securities are based on quoted
market prices.
Mortgage Loans: Fair values for mortgage loans are based on estimated sales
prices at the balance sheet date.
Policy Loans: Fair values for policy loans are estimated using discounted cash
flow analyses, using interest rates currently being offered.
-29-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 2--Fair Values of Financial Instruments - Continued
Short-term Investments and Cash and Bank Deposits: Carrying amounts for
shortterm investments and cash and bank deposits approximate fair value.
Policyholders' Funds: Fair values of the Company's liability for GICs are
estimated using discounted cash flow calculations, based on current market
interest rates available for similar contracts with maturities consistent
with those remaining for the contracts being valued. Fair values of the
Company's liability for deferred annuity products are estimated using the
cash surrender values of the annuity contracts. The carrying amounts for
supplementary contracts without life contingencies approximate fair value.
Fair values for the Company's insurance contracts other than investment
contracts are not required to be disclosed. However, the fair values of
liabilities under all insurance contracts are taken into consideration in the
Company's overall management of interest rate risk, which minimizes exposure
to changing interest rates through the matching of investment maturities with
amounts due under insurance contracts.
Short-term and Long-term Debt: The carrying amounts for short-term and
longterm debt approximate fair value.
Derivatives: Fair values of the Company's derivative financial instruments
are based on market quotes, pricing models, or formulas using current
interest rates and assumptions and represent the net amount of cash the
Company would have received or paid if the contracts had been settled or
closed on December 31.
-30-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments
Securities
The amortized cost and fair values of securities by security type are as
follows:
<TABLE>
<CAPTION>
December 31, 1997
(in millions of dollars)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 336.6 $ 62.9 $ - $399.5
States, Municipalities, and Political
Subdivisions 13.6 1.2 - 14.8
Foreign Governments 526.3 109.9 - 636.2
Public Utilities 2,586.4 284.9 3.6 2,867.7
Mortgage-backed Securities 2,841.8 136.2 6.4 2,971.6
All Other Corporate Bonds 9,052.4 963.0 16.8 9,998.6
Redeemable Preferred Stocks 134.3 14.7 2.3 146.7
--------- -------- ----- ---------
Total Fixed Maturity Securities 15,491.4 1,572.8 29.1 17,035.1
Equity Securities 11.1 0.2 1.3 10.0
--------- -------- ----- ---------
$15,502.5 $1,573.0 $30.4 $17,045.1
========= ======== ===== =========
Held-to-Maturity Securities
United States Government and
Government Agencies and Authorities $ 13.1 $ 2.6 $ - $ 15.7
States, Municipalities, and Political
Subdivisions 2.9 0.2 - 3.1
Mortgage-backed Securities 276.9 23.7 - 300.6
All Other Corporate Bonds 13.9 3.3 - 17.2
--------- -------- ----- ---------
$ 306.8 $ 29.8 $ - $ 336.6
========= ======== ====== =========
</TABLE>
-31-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
<TABLE>
<CAPTION>
December 31, 1996
(in millions of dollars)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
Available-for-Sale Securities
United States Government and
Government Agencies and Authorities $ 6.4 $ 0.8 $ - $ 7.2
Foreign Governments 156.5 19.9 - 176.4
Public Utilities 2,421.5 206.4 7.4 2,620.5
Mortgage-backed Securities 2,156.9 28.4 33.3 2,152.0
All Other Corporate Bonds 5,595.6 306.2 26.8 5,875.0
Redeemable Preferred Stocks 47.4 2.1 0.5 49.0
--------- ------ ----- -------
Total Fixed Maturity Securities 10,384.3 563.8 68.0 10,880.1
Equity Securities 7.2 - 2.3 4.9
--------- ------ ----- -------
$10,391.5 $563.8 $70.3 10,885.0
========= ====== ===== ========
Held-to-Maturity Securities
United States Government and
Government Agencies and Authorities $ 13.5 $ 1.5 $ - $ 15.0
States, Municipalities, and Political
Subdivisions 3.2 0.2 - 3.4
Mortgage-backed Securities 234.9 3.3 8.1 230.1
All Other Corporate Bonds 12.9 1.7 - 14.6
--------- ------ ------ ------
$ 264.5 $ 6.7 $ 8.1 263.1
========= ====== ====== ======
</TABLE>
-32-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
The amortized cost and fair values of fixed maturity securities by maturity
date are shown below. The maturity dates have not been adjusted for possible
calls or prepayments.
<TABLE>
<CAPTION>
December 31, 1997
(in millions of dollars)
Amortized Fair
Cost Value
<S> <C> <C>
Available-for-Sale Securities
1 year or less $ 437.5 $ 515.3
Over 1 year through 5 years 1,341.0 1,528.7
Over 5 years through 10 years 2,973.4 3,150.5
Over 10 years 7,897.7 8,869.0
--------- ---------
12,649.6 14,063.5
Mortgage-backed Securities 2,841.8 2,971.6
--------- ---------
$15,491.4 $17,035.1
========= =========
Held-to-Maturity Securities
1 year or less $ 0.5 $ 0.5
Over 1 year through 5 years 2.2 2.4
Over 5 years through 10 years 0.3 0.3
Over 10 years 26.9 32.8
--------- ---------
29.9 36.0
Mortgage-backed Securities 276.9 300.6
--------- ---------
$ 306.8 $ 336.6
========= =========
</TABLE>
The adjustments associated with reporting securities at fair value and the
changes that would have been necessary if the unrealized investment gains and
losses related to the securities had been realized are as follows:
<TABLE>
<CAPTION>
December 31
1997 1996
(in millions of dollars)
<S> <C> <C>
Assets
Fixed Maturity Securities $1,543.7 $ 495.8
Equity Securities (1.1) (2.3)
Deferred Policy Acquisition Costs (362.8) (240.9)
Value of Business Acquired (59.6) -
Liabilities
Reserve for Future Policy and Contract Benefits 161.2 112.8
Deferred Federal Income Taxes 334.7 48.9
Stockholders' Equity
Net Unrealized Gain on Securities 624.3 90.9
</TABLE>
-33-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
At December 31, 1997, the total investment in below-investment-grade fixed
maturity securities (securities rated below Baa3 by Moody's Investors Service
or an equivalent internal rating) was $1,297.1 million or 6.6 percent of
invested assets. The amortized cost of these securities was $1,232.4 million.
Mortgage Loans
Changes in the mortgage loan loss reserve are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Balance at January 1 $ 1.0 $ 12.0 $ 49.0
Additions Charged to Realized
Investment Losses - - 3.0
Release Due to Sale or Direct
Write-Down of Loans - (11.0) (40.0)
----- ------ ------
Balance at December 31 $ 1.0 $ 1.0 $ 12.0
===== ====== ======
</TABLE>
In 1997, the Company sold mortgage loans with a principal amount of $268.1
million and a book value of $258.4 million. The sale of the mortgage loans,
which were acquired through an acquisition of business (see Note 14),
resulted in a before-tax realized investment gain of $10.9 million.
In 1996, the Company sold mortgage loans with a principal amount of $81.6
million and a book value of $75.9 million which resulted in a before-tax
realized investment loss of $5.7 million.
In October 1995, the Company sold commercial mortgage loans with a principal
amount and a book value of $962.4 million through a securitization
collateralized by 366 loans. In May 1995, the Company sold restructured
mortgage loans with a principal amount of $147.5 million and a book value of
$122.6 million. The transactions resulted in before-tax realized investment
gains (losses) of $8.9 million and $(23.1) million, respectively.
Real Estate
Accumulated depreciation on real estate was $23.3 million and $28.5 million as
of December 31, 1997 and 1996, respectively.
-34-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
Net Investment Income
Sources for net investment income are as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Fixed Maturity Securities $1,120.7 $ 900.2 $ 961.4
Equity Securities 0.4 0.4 0.4
Mortgage Loans 10.5 2.6 100.7
Real Estate 17.4 25.8 29.6
Policy Loans 192.0 182.8 163.9
Other Long-term Investments 24.5 3.9 4.3
Short-term Investments 13.6 7.4 6.9
-------- -------- --------
Gross Investment Income 1,379.1 1,123.1 1,267.2
Investment Expenses 24.4 33.0 45.9
-------- -------- --------
Net Investment Income $1,354.7 $1,090.1 $1,221.3
======== ======== ========
</TABLE>
Realized Investment Gains and Losses
Realized investment gains (losses) are as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Fixed Maturity Securities $18.1 $ 37.1 $ 14.9
Equity Securities (0.1) (1.3) 0.2
Mortgage Loans and Real Estate 1.0 (3.7) (26.9)
Other Invested Assets (0.7) 0.1 -
Derivatives (3.2) (40.8) (19.9)
----- ------ ------
$15.1 $ (8.6) $(31.7)
===== ====== ======
</TABLE>
Net realized investment gains and losses include writedowns and changes in
the reserve for losses on mortgage loans and foreclosed real estate of $1.4
million, $(5.0) million, and $(29.0) million for 1997, 1996, and 1995,
respectively.
-35-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 3--Investments - Continued
Proceeds from sales of fixed maturity and equity securities and the related
gross gains and losses realized on those sales are as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Proceeds from Sales
Available-for-Sale Fixed Maturity Securities $1,871.7 $1,592.0 $1,353.1
Equity Securities 0.9 0.6 6.8
Gross Gains
Available-for-Sale Fixed Maturity Securities 63.7 50.1 35.3
Equity Securities - - 1.3
Gross Losses
Available-for-Sale Fixed Maturity Securities 45.6 13.0 20.4
Equity Securities 0.1 1.3 1.1
</TABLE>
Note 4--Derivative Financial Instruments
The Company uses interest rate swaps, exchange-traded interest rate futures
contracts, and options to hedge interest rate risks and to match assets with
its insurance liabilities. Interest rate forward contracts are also used to
some extent in the hedging process.
Derivative Risks
The basic types of risks associated with derivatives are market risk (that
the value of the derivative will be adversely impacted by changes in the
market, primarily the change in interest rates) and credit risk (that the
counterparty will not perform according to the terms of the contract). The
market risk of the derivatives should generally offset the market risk
associated with the hedged financial instrument or liability.
To help limit the credit exposure of the derivatives, the Company has entered
into master netting agreements with its counterparties whereby contracts in a
gain position can be offset against contracts in a loss position. The
Company also typically enters into bilateral, cross-collateralization
agreements with its counterparties to help limit the credit exposure of the
derivatives. These agreements require the counterparty in a loss position to
submit acceptable collateral with the other counterparty in the event the net
loss position meets or exceeds an agreed upon amount. The Company's current
credit exposure on derivatives, which is limited to the value of those
contracts in a net gain position, was $50.9 million at December 31, 1997.
-36-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Hedging Activity
The table below summarizes by notional amounts the activity for each category of
derivatives.
<TABLE>
<CAPTION>
Interest Rate Swaps
Receive Receive
Variable/ Fixed/
Pay Pay
Fixed Variable Forwards Futures Options Total
(in millions of dollars)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $800.0 $ 726.0 $ - $ 205.0 $ - $1,731.0
Additions 300.0 495.0 - 947.5 820.0 2,562.5
Terminations 200.0 359.8 - 1,137.5 820.0 2,517.3
------ -------- ------ -------- -------- --------
Balance at December 31, 1995 900.0 861.2 - 15.0 - 1,776.2
Additions - 400.0 - 477.0 - 877.0
Terminations 600.0 463.6 - 482.0 - 1,545.6
------ -------- ------ -------- -------- --------
Balance at December 31, 1996 300.0 797.6 - 10.0 - 1,107.6
Acquisition of Business--
Note 14 - 9.4 390.0 - - 399.4
Additions - 420.0 - 1,257.3 2,034.5 3,711.8
Terminations 300.0 114.6 250.0 823.8 1,625.0 3,113.4
------ -------- ------ -------- -------- --------
Balance at December 31, 1997 $ - $1,112.4 $140.0 $ 443.5 $ 409.5 $2,105.4
====== ======== ====== ======== ======== ========
</TABLE>
Additions and terminations reported above for futures and options include
roll activity, which is the closing out of an old contract and initiation of
a new one when the futures contract is about to mature but the need for it
still exists.
The following table summarizes the timing of anticipated settlements of
interest rate swaps outstanding at December 31, 1997, and the related
weighted average interest receive rate or pay rate assuming current market
conditions.
<TABLE>
<CAPTION>
1998 1999 2000 2001 2002 Total
(in millions of dollars)
<S> <C> <C> <C> <C> <C> <C>
Receive Fixed/Pay Variable
Notional Value $13.0 $420.0 $249.4 $280.0 $150.0 $1,112.4
Weighted Average Receive Rate 5.00% 7.30% 7.76% 7.70% 7.54% 7.51%
Weighted Average Pay Rate 5.72 5.79 5.86 5.81 5.81 5.81
</TABLE>
-37-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Derivative activity falls under seven hedging programs as follows:
Program 1
The Company routinely uses forwards and futures to protect margins by
reducing the risk of changes in interest rates between the time of asset
purchase and the associated sale of an asset or sale of new business. The
majority of the 1995 activity ($500.0 million) was a hedge of the
reinvestment of the proceeds from the securitization of the Company's
commercial mortgage loan portfolio (see Note 3).
Gains or losses on termination of these forwards and futures are deferred and
reported as an adjustment of the carrying amount of the hedged asset or
liability and amortized into earnings over the lives of the hedged items.
The net deferred gain associated with this activity was $30.2 million and
$29.3 million at December 31, 1997 and 1996, respectively. The deferred gain
from this program was amortized into income in the consolidated statements of
income as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Net Investment Income $ 1.0 $ 1.0 $ 0.2
Policy and Contract Benefits 1.0 1.2 3.8
----- ----- -----
$ 2.0 $ 2.2 $ 4.0
===== ===== =====
</TABLE>
At December 31, 1997, the Company had no open futures contracts under this
program.
Program 2
In 1994 and 1993, the Company created $101.0 million of synthetic fixed rate
assets consisting of variable rate mortgage-backed securities combined with
index amortizing swaps (receive fixed/pay variable). These synthetic fixed
rate assets back fixed rate GICs. During this time, the Company also created
$625.0 million of synthetic variable rate GICs consisting of fixed rate GICs
combined with index amortizing swaps (receive fixed/pay variable), which were
then backed by variable rate mortgage-backed securities. The notional amount
of index amortizing swaps associated with this program was $113.0 million and
$197.6 million at December 31, 1997 and 1996, respectively. The notional
amount of these swaps reduces based on an amortization schedule indexed to a
constant maturity treasury rate. Under market conditions at December 31,
1997, the remaining swaps are expected to amortize fully over the next two
years.
-38-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Income (expense) from settlements of payment streams on these interest rate
swap agreements as reported in the consolidated statements of income was as
follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Net Investment Income $ - $ - $ 0.9
Policy and Contract Benefits 0.2 0.3 (4.7)
----- ----- -----
$ 0.2 $ 0.3 $(3.8)
===== ===== =====
</TABLE>
Program 3
In December 1994, the Company announced that it would discontinue the sale of
traditional GICs. At that time, the Company decided to convert from a
duration matching investment approach to a cash flow matching investment
approach for its GIC business. The Company hedged the risk that a rise in
interest rates would reduce the price on future sales of assets which would
be necessary to fund maturing liabilities by entering into $1.1 billion
notional amount of forward interest rate swaps (receive variable/pay fixed)
and $205.0 million notional amount of short interest rate futures contracts.
The majority of this hedge was initiated in 1994, with the last $300.0
million of swaps initiated in 1995.
The $205.0 million futures position was terminated in 1995 as planned when
$208.7 million of fixed maturity securities were sold to fund maturing GICs.
The Company realized a $0.1 million before-tax investment gain on the futures
and a $5.6 million before-tax investment loss on the fixed maturity
securities, a net result which was consistent with the original hedge
expectations. The first $200.0 million swap position was terminated in 1995;
however, fixed maturity securities sales did not occur as originally
anticipated because the Company had adequate cash flow from other sources to
fund the maturing GICs. The primary source of this other cash flow was the
securitization of the commercial mortgage loan portfolio which had not been
anticipated at the time this hedge was initiated (see Note 3). The Company
realized a $20.0 million before-tax investment loss on the termination of
this swap position in 1995.
During 1996, the Company terminated $600.0 million of these forward swaps as
scheduled, realizing a $36.1 million before-tax investment loss. In
addition, the Company used offsetting futures contracts to partially remove
the hedge as fixed maturities were sold prior to the termination date of the
interest rate swaps. The Company realized a $5.3 million before-tax
investment loss on the termination of these futures contracts. The Company
sold $423.0 million of fixed maturity securities associated with this hedge,
realizing a $19.6 million before-tax investment gain.
During 1997, the Company terminated the remaining $300.0 million of these
forward swaps as scheduled, realizing a $4.1 million before-tax investment
loss. In addition, the Company used offsetting futures contracts to partially
remove the hedge as fixed maturity securities were sold prior to the
termination date of the interest rate swaps. The Company realized a $0.1
million before-tax investment gain on the termination of these futures
contracts. The Company sold $302.0 million of fixed maturity securities
associated with this hedge, realizing a $4.3 million before-tax investment
gain.
Program 4
In 1995, the Company purchased $820.0 million in put options on treasury
securities to hedge the risk that a rise in interest rates would reduce the
price realized on the securitization of the commercial mortgage loan
portfolio. The options expired without value, and the $7.6 million price of
the option was reported as an adjustment to the net realized investment gain
from the mortgage loan sale.
-39-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
Program 5
The Company has executed a series of cash flow hedges in the individual
disability income portfolio and the group single premium annuities portfolio.
The purpose of these hedges is to lock in the reinvestment rates on future
cash flows and protect the Company from the potential adverse impact of
declining interest rates on the associated policy reserves. The Company uses
futures contracts to partially offset hedges on fixed maturity securities
purchased prior to the termination date of interest rate swaps and forwards.
The Company also uses futures contracts to replace terminated forwards and
interest rate swaps in order to maintain hedges until the fixed maturity
securities are purchased. The following table summarizes the hedging
activity under this program:
<TABLE>
<CAPTION>
Notional Before-Tax
Amount Realized
Outstanding Investment Deferred
Additions Terminations at December 31 Gain (Loss) Gain
(in millions of dollars)
<S> <C> <C> <C> <C> <C>
Individual Disability Income
1995
Interest Rate Swaps $ 495.0 $ - $ 495.0 $ - $ -
======== ======== ======== ===== =====
1996
Interest Rate Swaps $ 200.0 $ 225.0 $ 470.0 $ 0.6 $ 3.6
Futures 144.5 134.5 10.0 - 3.6
-------- -------- -------- ----- -----
Total $ 344.5 $ 359.5 $ 480.0 $ 0.6 $ 7.2
======== ======== ======== ===== =====
1997
Interest Rate Swaps $ 420.0 $ 30.0 $ 860.0 $ - $ 1.7
Forwards 390.0 250.0 140.0 - 23.2
Futures 247.5 214.0 43.5 - 2.4
Options - U.S. Treasury
Interest Rate 550.0 195.0 355.0 0.1 0.1
Options - Interest Rate Swaps 850.0 850.0 - 0.7 3.3
-------- -------- -------- ----- -----
Total $2,457.5 $1,539.0 $1,398.5 $ 0.8 $30.7
======== ======== ======== ===== =====
Group Single Premium Annuities
1996
Interest Rate Swaps $ 200.0 $ 70.0 $ 130.0 $(0.1) $ -
======== ======== ======== ===== =====
1997
Interest Rate Swaps $ - $ - $ 130.0 $ - $ -
Options - Interest Rate Swaps 300.0 300.0 - - 0.5
-------- -------- -------- ----- -----
Total $ 300.0 $ 300.0 $ 130.0 $ - $ 0.5
======== ======== ======== ===== =====
</TABLE>
-40-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 4--Derivative Financial Instruments - Continued
In 1997 and 1996, the Company amortized into net investment income $0.6 million
and $0.1 million, respectively, of the deferred gains from this program. At
December 31, 1997, the Company had an unrealized gain of $133.8 million on the
open interest rate swaps, forwards, and futures. These derivatives are
scheduled to be terminated in the years 1998 through 2002 as assets are
purchased with the future anticipated cash flows.
Program 6
In 1997, the Company began selling indexed annuity products whereby a portion of
the crediting rate on the annuity is based on the performance of the S&P 500
stock index. In order to hedge this fluctuating credit rate, the Company
purchased options with the S&P 500 stock index as the underlying item. These
options will be settled with a net cash payment to the Company at the expiration
date if the S&P 500 index moves above the option contract's strike price;
otherwise, no cash payment will take place at expiration. At December 31, 1997,
the outstanding notional amount of these options was $4.5 million, and the fair
value and carrying amount were $1.6 million.
Program 7
In 1997, the Company opened $400.0 million of interest rate futures contracts
and wrote $50.0 million of options on interest rate futures in order to hedge
the borrowing rate on the anticipated refinancing of long-term debt (see Note
18). The Company realized a $2.9 million before-tax investment loss when $250.0
million of the interest rate futures contracts were terminated and rolled into
1998. The loss on the interest rate futures contracts and the $0.7 million
option premium received were deferred and will be amortized as an adjustment to
interest expense on long-term debt.
-41-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 5--Value of Business Acquired
A reconciliation of value of business acquired for the year ended 1997 is as
follows (in millions of dollars):
<TABLE>
<S> <C>
Balance at January 1 $ 5.9
Acquisition of Business--Note 14 645.7
Interest Accrued 33.1
Amortization (64.3)
Adjustment for Unrealized Investment Gains (59.6)
-----
Balance at December 31 $560.8
======
</TABLE>
The carrying amounts of value of business acquired in 1996 and 1995 were
immaterial. The estimated net amortization of value of business acquired for
each of the next five years is as follows (in millions of dollars):
<TABLE>
<S> <C>
1998 $40.7
1999 39.4
2000 38.3
2001 36.9
2002 35.6
</TABLE>
-42-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 6--Liability for Unpaid Claims and Claim Adjustment Expenses
Changes in the liability for unpaid claims and claim adjustment expenses were as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Balance at January 1 $3,047.5 $2,824.7 $2,472.9
Less Reinsurance Recoverables 372.1 343.2 237.6
-------- -------- --------
Net Balance at January 1 2,675.4 2,481.5 2,235.3
Acquisition of Business--Note 14 2,295.4 - -
Incurred Related to:
Current Year 1,537.3 910.6 960.0
Prior Years
Interest 285.0 173.3 155.0
Incurred (30.5) (65.5) (31.1)
-------- -------- --------
Total Incurred 1,791.8 1,018.4 1,083.9
-------- -------- --------
Paid Related to:
Current Year 337.2 322.4 359.0
Prior Years 1,011.3 502.1 478.7
-------- -------- --------
Total Paid 1,348.5 824.5 837.7
-------- -------- --------
Net Balance at December 31 5,414.1 2,675.4 2,481.5
Plus Reinsurance Recoverables 857.7 372.1 343.2
-------- -------- --------
Balance at December 31 $6,271.8 $3,047.5 $2,824.7
======== ======== ========
</TABLE>
The majority of the net balances are related to disabled lives claims with
long-tail payouts on which interest earned on assets backing liabilities is
an integral part of pricing and reserving. Interest accrued on prior year
reserves has been calculated on the opening reserve balance less one-half
year's cash payments at the average rate at which the Company's reserves were
discounted during 1997, 1996, and 1995.
-43-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 7--Federal Income Taxes
A reconciliation of the income tax attributable to continuing operations
computed at U.S. federal statutory tax rates to the income tax expense as
included in the consolidated statements of income follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
<S> <C> <C> <C>
Statutory Federal Income Tax Rate 35.0% 35.0% 35.0%
Tax-preferred Investment Income (0.6) (1.1) (2.1)
Net Prior Years Tax Refunds - (0.1) (0.8)
Other Items, Net 0.6 1.8 2.2
---- ---- ----
Effective Tax Rate 35.0% 35.6% 34.3%
==== ==== ====
</TABLE>
-44-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 7--Federal Income Taxes - Continued
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
statement purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred federal income tax liability are as
follows:
<TABLE>
<CAPTION>
December 31
1997 1996
(in millions of dollars)
<S> <C> <C>
Deferred Tax Liability
Deferred Policy Acquisition Costs $ 68.0 $133.6
Bond Market Discount 4.3 11.2
Net Unrealized Investment Gains 334.7 48.9
Value of Business Acquired 217.6 2.3
Property and Equipment 10.5 9.8
Other 34.5 13.4
------ ------
Total Deferred Tax Liability 669.6 219.2
------ ------
Deferred Tax Asset
Reserves 367.4 105.5
Realized Investment Gains and Losses 53.1 44.7
Postretirement Benefits 26.8 20.9
Other Employee Benefits 29.3 24.4
Other 43.2 9.2
------ ------
Total Deferred Tax Asset 519.8 204.7
------ ------
Net Deferred Tax Liability $149.8 $ 14.5
====== ======
</TABLE>
The Company is required to establish a valuation allowance for any portion of
the deferred tax asset that management believes will not be realized. In the
opinion of management, it is more likely than not that the Company will realize
the benefit of the deferred tax asset and, therefore, no such valuation
allowance has been established.
-45-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 7--Federal Income Taxes - Continued
Under the Life Insurance Company Tax Act of 1959, life companies were
required to maintain a policyholders' surplus account containing the
accumulated portion of current income which had not been subjected to income
tax in the year earned. The Deficit Reduction Act of 1984 requires that no
future amounts be added after 1983 to the policyholders' surplus account.
Further, any future distributions from the account would become subject to
federal income taxes at the general corporate federal income tax rate then in
effect. The amount of the policyholders' surplus account at December 31,
1997, is approximately $202.0 million. Future distributions from the
policyholders' surplus account are deemed to occur if a statutorily
prescribed maximum for the account is less than the value of the account or
if dividend distributions exceed the total amount accumulated as currently
taxable income in the year earned. If the entire policyholders' surplus
account were deemed distributed in 1998, this would result in a tax of
approximately $70.7 million. No current or deferred federal income taxes
have been provided on these amounts because management considers the
conditions under which such taxes would be paid to be remote.
During 1997, the Company held an appellate conference with the Internal
Revenue Service for tax years 1986 through 1992 and is awaiting a response to
its comprehensive settlement proposal covering all issues for such years.
The Internal Revenue Service continued its examination of the Company's
federal income tax returns for tax years 1993 through 1995. Management
believes this appellate conference and examination will have no material
adverse impact on the Company's financial statements.
In 1996, the Company received a refund that had been accrued in 1995 relating
to the final settlement of litigation for tax years 1980 through 1983. The
refund of taxes was $1.5 million and interest on the refund was $4.2 million.
The Company also received a refund that had been accrued in 1994 relating to
a final settlement of the remaining issues in dispute for the 1984 and 1985
tax years. The refund of taxes was $3.1 million and related interest was $5.9
million. During 1996, the Internal Revenue Service concluded its examination
of the Company's federal income tax returns for tax years 1990 through 1992
and issued a Revenue Agent's Report proposing a tax deficiency of $26.0
million for these years. Although this proposed deficiency has been
appealed, the Company made an additional payment for these years of $13.0
million tax and $5.2 million interest to preclude the accrual of interest at
punitive rates on any portion of the proposed deficiency that the Company
could possibly lose. Net income for 1996 was increased by $0.9 million as a
result of these tax refunds and payments.
In 1995, the Company received a refund that was previously accrued in 1994
relating to a final settlement of the remaining issues in litigation for the
1966 through 1979 tax years. The refund of taxes was $1.1 million and
interest on the refund was $4.8 million. The Company also accrued refunds of
federal income tax of $1.5 million and related interest of $3.5 million
attributable to a final settlement of the remaining issues in litigation for
tax years 1980 through 1983. Overall, including interest received, net
income in 1995 was increased by $4.0 million as a result of the receipt and
accrual of these refunds.
Federal income taxes paid during 1997, 1996, and 1995 were $122.7 million,
$92.5 million, and $71.8 million, respectively.
-46-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 8--Debt
Short-term debt at December 31, 1997, was $150.7 million and consisted of
reverse repurchase agreements with a weighted average interest rate of 6.38
percent. At December 31, 1996, there was no short-term debt outstanding.
During 1996, the Company entered into an $800.0 million five-year revolving
credit facility with various domestic and international banks. The purpose
of this arrangement was to provide partial financing for the purchase of The
Paul Revere Corporation and GENEX Services, Inc. (see Note 14), to refinance
the existing bank term notes of $200.0 million, and for general corporate
uses. Interest is variable based upon a London Interbank Offered Rate (LIBOR)
plus a margin. At December 31, 1997, the outstanding borrowing under the
revolving credit facility was $725.0 million (see Note 18).
During 1996, the Company repaid the $200.0 million bank term notes which were
due on or before December 1, 1996.
Interest paid on short-term and long-term debt during 1997, 1996, and 1995
was $41.4 million, $17.1 million, and $22.4 million, respectively. Interest
expense during 1997, 1996, and 1995 was $42.5 million, $17.8 million, and
$22.3 million, respectively.
Note 9--Retirement Benefits
Pension Plans
The Company provides noncontributory defined benefit pension plans for eligible
employees. The benefits are based on years of service and the employee's
highest consecutive five years of compensation. The Company's funding policy is
to contribute amounts to the plans sufficient to meet the minimum funding
requirements set forth in the Employee Retirement Income Security Act of 1974,
plus such additional amounts as the Company may determine to be appropriate.
Plan assets are invested in two separate accounts of a subsidiary of the
Company, one of which invests in listed equity securities and the other in
corporate obligations and U.S. bonds, and in an unrelated trust consisting of
bonds and equity securities.
-47-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 9--Retirement Benefits - Continued
The pension plans' funded status and the amount recognized in the Company's
consolidated statements of financial condition are as follows:
<TABLE>
<CAPTION>
December 31
1997 1996
(in millions of dollars)
<S> <C> <C>
Actuarial present value of benefit
obligation - vested $252.2 $160.8
====== ======
Accumulated benefit obligation $255.2 $161.6
====== ======
Projected benefit obligation $308.2 $189.8
Plan assets at fair value 380.8 220.2
------ ------
Plan assets in excess of projected benefit obligation 72.6 30.4
Unrecognized net actuarial gains (72.1) (29.9)
Unrecognized prior service cost 2.7 2.4
Unrecognized net transition obligation 0.6 0.6
------ ------
Accrued pension asset $ 3.8 $ 3.5
======= =======
Weighted average discount rate used in determining
the projected benefit obligation 7.25% 7.25%
Weighted average rate of compensation increase 4.65% 4.50%
</TABLE>
Net periodic pension cost (benefit) included the following components:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Service cost $ 9.1 $ 4.0 $ 5.7
Interest cost 20.5 12.6 12.6
Actual return on plan assets (83.1) (28.1) (43.1)
Net amortization and deferral 53.0 7.5 26.5
Curtailment cost - - 1.0
------ ------ ------
$ (0.5) $ (4.0) $ 2.7
====== ====== ======
Expected long-term rate of return
on plan assets 8.65% 8.50% 7.75%
</TABLE>
-48-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 9--Retirement Benefits - Continued
Postretirement Plans
The Company sponsors two types of defined benefit postretirement plans other
than pensions for full-time employees who have ten years of credited service
with the Company and have reached age 55. One plan provides medical and dental
benefits, and the other provides life insurance benefits. The postretirement
health care plan is contributory, with retiree contributions adjusted
periodically, and contains other cost-sharing features such as deductibles and
coinsurance. It is the Company's expressed intent to increase the health care
plan's retiree contribution rate as the cost of health care increases. The life
insurance plan is noncontributory and is partially funded through life insurance
contracts issued by the Company. The health care plan is unfunded.
The following tables show the accumulated postretirement benefit obligation, the
amount recognized in the Company's consolidated statements of financial
condition, and the net periodic postretirement benefit cost.
<TABLE>
<CAPTION>
December 31
1997 1996
(in millions of dollars)
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees $50.8 $43.2
Fully eligible active plan participants 3.0 1.7
Other active plan participants 14.2 14.3
----- -----
68.0 59.2
Plan assets at fair value 9.0 8.5
----- -----
Accumulated postretirement benefit obligation
in excess of plan assets 59.0 50.7
Unrecognized net gain 11.0 7.6
----- -----
Accrued postretirement benefit liability $70.0 $58.3
===== =====
Weighted average discount rate used in determining the
accumulated postretirement benefit obligation 7.25% 7.25%
</TABLE>
-49-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 9--Retirement Benefits - Continued
Net periodic postretirement benefit cost included
the following components:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Service cost $ 1.5 $ 1.5 $ 1.9
Interest cost 4.4 4.0 4.6
Actual return on plan assets (0.5) (0.5) (0.5)
Net amortization and deferral (3.2) (3.0) (3.4)
----- ----- -----
$ 2.2 $ 2.0 $ 2.6
===== ===== =====
Expected long-term rate of return on plan assets 8.50% 8.50% 8.50%
</TABLE>
The postretirement benefit costs for 1997, 1996, and 1995 assume a weighted
average annual rate of increase in the per capita cost of covered health care
benefits of 8 percent, 9 percent, and 12 percent, respectively, decreasing
gradually to 5 percent for 2004 and thereafter. The health care cost trend rate
assumption has a significant effect on the amounts reported. Increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation as of December 31,
1997, by $4.5 million and the aggregate of net periodic postretirement benefit
cost for 1997 by $0.5 million.
Curtailment Gains
During 1995, the Company recognized curtailment gains of $16.6 million and $7.7
million in its pension and postretirement plans, respectively. The gains
resulted from the sale of the group medical business (see Note 15) and the
consequent termination of participation in the Company's benefit plans of
certain employees. The gains were included in the determination of the total
gain recognized on the sale.
-50-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 10--Stockholders' Equity and Earnings Per Share
Preferred Stock
In 1993, the Company issued 1,041,667 shares of 8.10% cumulative preferred
stock, liquidation preference $150 per share evidenced by depositary receipts
for 6,250,002 depositary shares each representing a one-sixth interest of a
preferred share, of which 6,249,202 were issued and outstanding as of December
31, 1997 and 1996 (see Note 18).
Common Stock
On July 30, 1997, the Board of Directors authorized a two-for-one stock split
effected in the form of a stock dividend distributed on September 30, 1997, to
stockholders of record on August 28, 1997. The common stock par value of $1 per
share remained unchanged. Historical share and per share amounts in the
consolidated financial statements and notes thereto have been restated to
reflect the stock split.
In 1996, the Company's shareholders approved an amendment to the Company's
Amended and Restated Certificate of Incorporation to increase from 65,000,000 to
150,000,000 the number of shares of common stock which the Company is authorized
to issue.
Earnings Per Common Share
The computations of earnings per common share and earnings per common share
assuming dilution are as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars, except share data)
<S> <C> <C> <C>
Numerator:
Net Income $ 247.3 $ 145.6 $ 115.6
Preferred Stock Dividends 12.7 12.7 12.7
------------ ----------- -----------
Income Available to Common Stockholders $ 234.6 $ 132.9 $ 102.9
============ =========== ===========
Denominator (000s):
Weighted Average Common Shares 124,505.4 91,044.8 90,762.7
Dilution for Assumed Exercise of Stock Options 2,747.8 1,109.7 169.1
------------ ----------- -----------
Weighted Average Common Shares -
Assuming Dilution 127,253.2 92,154.5 90,931.8
============ =========== ===========
Earnings Per Common Share $ 1.88 $ 1.46 $ 1.13
============ =========== ===========
Earnings Per Common Share - Assuming Dilution $ 1.84 $ 1.44 $ 1.13
============ =========== ===========
</TABLE>
-51-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans
Incentive Compensation
The Company has in effect a two-part management incentive compensation plan, the
first part of which is cash-based and is designed to encourage achievement of
specific annual goals in which key employees participate. The compensation cost
recognized in the consolidated statements of income for this part of the plan is
$6.4 million, $3.6 million, and $2.9 million for 1997, 1996, and 1995,
respectively. The second part of this plan is a stock option plan. The Company
applies Opinion 25 and related interpretations in accounting for the stock
option plan. For stock options subject to stock price performance, the
compensation cost recognized in the consolidated statements of income was $2.0
million and $2.4 million for 1996 and 1995, respectively. All price performance
requirements were met by December 31, 1996, for these stock options.
Under the 1994 stock plan, the Company may grant options of up to 10,000,000
shares of common stock. The exercise price of each option equals the market
price of the Company's stock on the date of grant. The options cannot be
exercised until at least one year after the date of grant and have a maximum
term of ten years after the date of grant. Options granted prior to 1994 were
granted under the 1989 stock option plan. Under that plan, the Company could
grant options of up to 1,400,000 shares of common stock over the five year
term of the plan which ended effective December 31, 1993. The exercise price
of each option equaled the market price of the Company's stock on the date of
grant. The options outstanding under this plan are currently exercisable and
have a maximum term of ten years after the date of grant.
-52-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans - Continued
Summaries of the Company's stock options are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
Weighted Weighted Weighted
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
(000s) Price (000s) Price (000s) Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding at January 1 4,239 $13.38 3,297 $12.41 1,771 $13.67
Granted 3,454 24.50 1,347 15.57 2,006 11.35
Exercised (562) 14.49 (322) 12.08 (98) 10.36
Forfeited (193) 24.36 (62) 15.40 (206) 13.02
Expired - - (21) 14.65 (176) 13.45
----- ----- -----
Outstanding at December 31 6,938 18.52 4,239 13.38 3,297 12.41
===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
December 31
1997 1996 1995
(shares in thousands)
<S> <C> <C> <C>
Exercisable 3,728 2,954 953
Exercisable based on
additional service 3,210 1,285 1,950
Exercisable based on
stock price performance 0 0 394
----- ----- -----
Outstanding 6,938 4,239 3,297
===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Shares Contractual Exercise Shares Exercise
Prices (000s) Life Price (000s) Price
<S> <C> <C> <C> <C> <C>
$ 9.00 to 13.99 1,960 3.8 years $11.40 1,960 $11.40
14.00 to 18.99 1,724 5.1 15.30 1,724 15.30
19.00 to 23.99 2,587 9.0 23.72 4 20.58
24.00 to 28.99 635 9.1 27.38 21 26.37
29.00 to 35.99 32 7.4 32.34 19 33.03
----- -----
9.00 to 35.99 6,938 6.6 18.52 3,728 13.41
===== =====
</TABLE>
In 1997, the Company granted 267,040 shares of nonvested stock to certain key
employees with a weighted average grant date fair value of $28.12 per common
share. The compensation cost recognized in the consolidated statements of
income for the year ended December 31, 1997 was $1.2 million.
-53-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans - Continued
Employee Stock Purchase Plan
In 1995, the Company established an employee stock purchase plan to promote and
maintain widespread employee stock ownership. The plan became effective in the
fourth quarter of 1995 and conforms to Internal Revenue Code Section 423. Under
the plan, the Company is authorized to issue up to 2,000,000 shares of common
stock to its employees, nearly all of whom are eligible to participate. Under
the terms of the plan, eligible employees may purchase common stock of the
Company at the end of each three-month financial quarter. The purchase price of
the stock is 85 percent of the lower of its beginning of the quarter or end of
the quarter market price. The maximum amount of stock a participating employee
may purchase under the plan in any one calendar year is limited to $25,000 in
fair market value of the stock as determined at the beginning of each purchase
period. The Company sold 108,799, 68,622, and 63,870 shares to employees with a
weighted average exercise price of $24.63, $14.68, and $11.53 per share in 1997,
1996, and 1995, respectively. The Company applies Opinion 25 and related
interpretations in accounting for the stock purchase plan. Accordingly, no
compensation cost has been recognized.
Compensation Cost Under the Fair Value Approach (SFAS 123)
Compensation cost for the Company's management incentive compensation plan and
employee stock purchase plan under the fair value approach was estimated as of
the grant date using the Black-Scholes option pricing model with the following
weighted average assumptions:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
<S> <C> <C> <C>
Volatility 18.0% 18.2% 19.1%
Risk-free rate of return 6.5% 5.7% 7.6%
Dividend payout rate per share $0.36 $0.36 $0.36
Time of exercise
Management Incentive Compensation
Plan
Executives 7 years 7 years 5 years
Non-executives 6 years 6 years 4 years
Employee Stock Purchase Plan 3 months 3 months 3 months
Weighted average fair value of
options granted during the year
Management Incentive
Compensation Plan $7.36 $3.68 $2.46
Employee Stock Purchase Plan $5.62 $3.38 $2.63
</TABLE>
-54-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 11--Incentive Compensation and Stock Purchase Plans - Continued
Had compensation cost for the two plans been determined in accordance with the
provisions of SFAS 123, the Company's pro forma net income and earnings
per common share would have been as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars, except share data)
<S> <C> <C> <C>
Net Income $241.6 $143.6 $114.2
Earnings Per Common Share 1.84 1.44 1.12
Earnings Per Common Share - Assuming Dilution 1.81 1.42 1.12
</TABLE>
Note 12--Reinsurance
The Company routinely assumes and cedes reinsurance with other insurance
companies. The primary purpose of ceded reinsurance is to limit losses from
large exposures; however, if the reinsurer is unable to meet its obligations,
the originating issuer of the insurance coverage retains the liability.
Premium income, policy and contract benefits, and change in reserves for
future policy and contract benefits and policyholders' funds are presented in
the consolidated statements of income net of reinsurance ceded.
In May 1995, the Company entered into an indemnity and assumption reinsurance
agreement with Healthsource Insurance Company in connection with the sale of
the group medical business (see Note 15). Under the terms of the reinsurance
agreement, the Company ceded to Healthsource Insurance Company premium income
and associated obligations and liabilities arising with respect to medical
indemnity and dental and vision insurance issued by the Company in certain
states where Healthsource Insurance Company was not licensed and approved to
transact this type of business. Total premium income and policy and contract
benefits ceded under this reinsurance agreement were $182.9 million and
$153.8 million, respectively, for the year ended December 31, 1997, $224.6
million and $188.5 million, respectively, for the year ended December 31,
1996, and $170.6 million and $137.5 million, respectively, for the year ended
December 31, 1995. In 1997, the reinsurance agreement was assigned by
Healthsource Insurance Company, with the consent of the Company, to
Connecticut General Life Insurance Company. It is anticipated that this
business will be assumed by Connecticut General Life Insurance Company
beginning April 1998.
The total amounts deducted for reinsurance ceded are as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
<S> <C> <C> <C>
Premium Income $270.4 $305.5 $249.2
Policy and Contract Benefits 282.7 265.5 202.7
Change in Reserves for Future Policy and
Contract Benefits and Policyholders' Funds 3.6 26.4 44.7
</TABLE>
-55-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 12--Reinsurance - Continued
Reinsurance ceded and assumed consists of the following:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
Reclassified
<S> <C> <C> <C>
Ceded
Life Insurance in Force (Amount of Insurance) $6,184.7 $4,347.9 $4,258.5
Premium Income
Individual Life and Disability 40.6 48.2 47.8
Employee Benefits 39.8 16.1 14.8
Other Operations 190.0 241.2 186.6
Assumed
Life Insurance in Force (Amount of Insurance) $ 416.2 $ 437.0 $ 460.2
Premium Income
Individual Life and Disability 167.2 35.3 36.9
Employee Benefits 1.0 0.5 0.4
Other Operations 6.2 15.7 15.0
</TABLE>
Segment information for 1996 and 1995 has been reclassified to conform to
current year reporting.
-56-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 13--Segment Information
Selected data by segment is as follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996 1995
(in millions of dollars)
Reclassified
<S> <C> <C> <C>
Revenue (Excluding Net Realized Investment
Gains and Losses)
Individual Life and Disability $ 1,902.3 $ 1,025.0 $ 999.1
Employee Benefits 883.7 555.5 520.3
Other Operations 752.1 720.0 1,067.6
--------- --------- ---------
Total $ 3,538.1 $ 2,300.5 $ 2,587.0
========= ========= =========
Income Before Net Realized Investment
Gains and Losses and Federal Income Taxes
Individual Life and Disability $ 232.3 $ 115.4 $ 34.0
Employee Benefits 63.3 46.1 32.2
Other Operations 69.6 73.3 141.5
--------- --------- ---------
Total $ 365.2 $ 234.8 $ 207.7
========= ========= =========
Revenue (Including Net Realized Investment
Gains and Losses)
Individual Life and Disability $ 1,910.2 $ 1,033.0 $ 1,003.2
Employee Benefits 887.3 555.5 524.2
Other Operations 755.7 703.4 1,027.9
--------- --------- ---------
Total $ 3,553.2 $ 2,291.9 $ 2,555.3
========= ========= =========
Income Before Federal Income Taxes
Individual Life and Disability $ 240.2 $ 123.4 $ 38.1
Employee Benefits 66.9 46.1 36.1
Other Operations 73.2 56.7 101.8
--------- --------- ---------
Total $ 380.3 $ 226.2 $ 176.0
========= ========= =========
Assets
Individual Life and Disability $11,051.1 $ 5,735.0 $ 5,443.9
Employee Benefits 2,145.2 1,490.0 1,407.8
Other Operations 9,981.3 7,767.5 9,449.6
--------- --------- ---------
Total $23,177.6 $14,992.5 $16,301.3
========= ========= =========
</TABLE>
Total revenue (excluding net realized investment gains and losses) includes
premium income, net investment income, and other income. Total revenue
(including net realized investment gains and losses) includes premium income,
net investment income, net realized investment gains and losses, and other
income. Assets have been allocated to the segments based upon identifiable
liabilities and allocated stockholders' equity. Segment information for 1996
and 1995 has been reclassified to conform to current year reporting. The
reclassification, which reflects the Company's current marketing and operational
structure, did not change total Revenue, total Income Before Federal Income
Taxes, or total Assets.
-57-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 14--Acquisition of Business
GENEX Services, Inc.
On February 28, 1997, the Company acquired GENEX Services, Inc. and GENEX
Services of Canada, Inc. (GENEX) at a price of $70.0 million. GENEX is a
provider of case management, vocational rehabilitation, and related services to
corporations, third party administrators, and insurance companies. These
services are utilized in the management of disability and worker's compensation
cases. The acquisition, financed through borrowings on the Company's revolving
credit facility, was accounted for by the purchase method. The fair values of
the assets acquired and liabilities assumed were $17.9 million and $8.9 million,
respectively. The purchase price has been allocated to goodwill and will be
amortized on a straight-line basis over a 25 year period. The consolidated
financial statements include the operating results of GENEX from March 1, 1997.
The Paul Revere Corporation
On March 27, 1997, the Company acquired The Paul Revere Corporation (Paul
Revere), a provider of life and disability insurance products, at a price of
approximately $1.2 billion. The transaction was financed through common equity
issued to Zurich Insurance Company, a Swiss insurer, and its affiliates in the
amount of $300.0 million (19,047,620 shares of common stock), common equity of
$437.5 million (23,340,000 shares of common stock) and cash of $2.5 million
issued to Paul Revere shareholders, internally generated funds of $145.0
million, and borrowings on the Company's revolving credit facility of $305.0
million. The acquisition was accounted for by the purchase method. The fair
values of the assets acquired and liabilities assumed were $6,680.0 million and
$6,675.4 million, respectively. The purchase price has been allocated
principally to the value of business acquired with the remainder being allocated
to goodwill. The value of business acquired will be amortized with interest
based on premium income for the traditional individual life and disability
income products and on the estimates of future gross profits for
interestsensitive individual life and individual annuity products. Goodwill
will be amortized on a straight-line basis over a 40 year period. The
consolidated financial statements include the operating results of Paul Revere
from April 1, 1997.
Pro Forma Results
The following pro forma results of operations for the years ended December 31,
1997 and 1996, give effect to the acquisitions and the related financing
arrangements, including the acquisition of debt and issuance of common stock
equity. The pro forma results of operations, prepared from historical financial
results of operations of the Company, Paul Revere, and GENEX with such
adjustments as are necessary to present the results of operations as if the
acquisitions had occurred as of the beginning of each year presented, are as
follows:
<TABLE>
<CAPTION>
Year Ended December 31
1997 1996
<S> <C> <C>
(in millions of dollars, except share data)
Revenue Excluding Net Realized Investment
Gains and Losses $3,958.1 $3,930.2
Revenue Including Net Realized Investment
Gains and Losses 4,009.6 3,970.2
Income (Loss) Before Net Realized Investment
Gains and Losses and Federal Income Taxes 377.2 (81.3)
Income (Loss) Before Federal Income Taxes 428.7 (41.3)
Net Income (Loss) 276.3 (37.1)
Earnings Per Common Share 1.96 (0.37)
</TABLE>
-58-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 14--Acquisition of Business - Continued
In 1996, Paul Revere strengthened reserves in its individual disability segment
by $380.0 million before income taxes which resulted in a decrease in net income
of $244.3 million ($1.83 per common share). The reserve strengthening resulted
from a comprehensive study, completed in October 1996, of the adequacy of the
individual disability reserves under generally accepted accounting principles.
Note 15--Sale of a Portion of a Line of Business
In December 1994, the Company entered into an Asset and Stock Purchase Agreement
with Healthsource, Inc. (Healthsource) whereby Healthsource agreed to acquire
certain assets and assume certain liabilities of the Company's group medical
business. The sale was completed on May 31, 1995, effective April 30, 1995.
The Company received $131.0 million in cash and $100.0 million of a new issue of
Healthsource 6.25% preferred stock which was redeemed at par in the first
quarter of 1996. Pursuant to the Asset and Stock Purchase Agreement, assets
were transferred to Healthsource which had a carrying value of approximately
$297.5 million. Liabilities assumed by Healthsource in connection with the
transferred business totaled $221.5 million. Total revenue and income before
federal income taxes for the group medical business were $146.2 million and $3.3
million, respectively, for the four month period ended April 30, 1995. The gain
on sale of the Company's group medical business increased 1995 operating
earnings by $21.8 million ($0.24 per common share) before taxes and $14.2
million ($0.16 per common share) after taxes.
Note 16--Commitments and Contingent Liabilities
Commitments
In December 1997, the Company entered into a definitive agreement with American
General Corporation (American General) under which various affiliates of
American General will acquire the Company's individual and tax-sheltered annuity
business for approximately $58.0 million in cash. In addition, American General
is acquiring a number of miscellaneous group pension lines of business which are
no longer actively marketed. The sale does not include the Company's Canadian
annuity business, traditional GICs, or group single premium annuities. The
transaction is expected to close in the second quarter of 1998. The Company
expects to record a gain when the transaction is closed.
Contingent Liabilities
Two alleged class action lawsuits have been filed in Superior Court in
Worcester, Massachusetts against the Company. One of the alleged lawsuits
purports to represent all career agents of Paul Revere whose employment
relationships ended on June 30, 1997, and who were offered contracts to sell
insurance policies as independent producers, and the other purports to represent
independent brokers who sold certain Paul Revere individual disability income
policies with benefit riders. Motions have been filed by the Company to dismiss
most of the counts in the complaints, which allege various breach of contract
and statutory claims. To date no class has been certified in either lawsuit.
The Company has strong defenses to both lawsuits and will vigorously defend its
position and resist certification of the classes. In addition, the same
plaintiff's attorney who has filed the purported class action lawsuits has filed
41 individual lawsuits on behalf of current and former Paul Revere sales
managers alleging various breach of contract claims. The Company has strong
defenses and will vigorously defend its position in these cases as well.
Although the alleged class action lawsuits and the 41 individual lawsuits are in
the early stages, management does not currently expect these suits to materially
affect the financial position or results of operations of the Company.
Various lawsuits against the Company have arisen in the normal course of
business. Contingent liabilities that might arise from litigation are not
deemed likely to materially affect the financial position or results of
operations of the Company.
-59-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 17--Statutory Financial Information
Statutory Net Income, Capital and Surplus, and Dividends
The Company's insurance subsidiaries' statutory net income, as reported in
conformity with statutory accounting practices prescribed by state regulatory
authorities, for the years ended December 31, 1997, 1996, and 1995, was $76.1
million, $104.9 million, and $67.1 million, respectively. Statutory capital and
surplus at December 31, 1997 and 1996, was $1,128.2 million and $674.2 million,
respectively.
Regulatory restrictions limit the amount of dividends available for distribution
to the Company from its insurance subsidiaries, without prior approval by
regulatory authorities, to the greater of ten percent of an insurer's statutory
surplus as regards policyholders as of the preceding year end or the statutory
net gain from operations, excluding realized investment gains and losses, of the
preceding year. The payment of dividends is further limited to the amount of
statutory unassigned surplus. Based on these restrictions, it is anticipated
that $151.9 million will be available for the payment of dividends to the
Company from its top-tier insurance subsidiaries during 1998.
Permitted Statutory Accounting Practices
The Company's insurance subsidiaries prepare their statutory-basis financial
statements in accordance with accounting practices prescribed or permitted by
the National Association of Insurance Commissioners (NAIC) and the applicable
state regulatory authorities. Prescribed statutory accounting practices include
state laws, regulations, and general administrative rules, as well as a variety
of publications of the NAIC. Permitted statutory accounting practices encompass
all accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. At December 31, 1997, the Company had not applied any
permitted accounting practices that differed from prescribed statutory
accounting practices that had a material impact on the financial position or
results of operations of the insurance subsidiaries.
The NAIC currently is in the process of recodifying statutory accounting
practices, the result of which is expected to standardize prescribed statutory
accounting practices. Accordingly, that project, which is expected to be
completed in 1998, will likely change, to some extent, prescribed statutory
accounting practices and may result in changes to the accounting practices that
the Company's insurance subsidiaries use to prepare their statutory financial
statements.
Deposits
At December 31, 1997, the Company's insurance subsidiaries had on deposit with
regulatory authorities securities with a book value of $902.3 million held for
the protection of policyholders.
Note 18--Subsequent Events
On February 24, 1998, the Company repaid the $725.0 million outstanding
borrowing on its revolving credit facility and redeemed its cumulative preferred
stock outstanding of $156.2 million at $150 per share equivalent to $25 per
depositary share. The debt repayment and preferred stock redemption were funded
through short-term borrowings.
-60-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Provident Companies, Inc. and Subsidiaries
Note 18--Subsequent Events - Continued
In May 1997, the Securities and Exchange Commission declared effective a
shelf registration statement pursuant to which the Company may issue up to
$900.0 million in debt and/or equity securities. On March 16, 1998, the
Company completed a public offering of $200.0 million of 7.25% senior notes
due March 15, 2028. On March 16, 1998, Provident Financing Trust I, a
subsidiary trust of the Company, issued $300.0 million of 7.405% capital
securities in a public offering. These capital securities, which mature on
March 15, 2038, are fully and unconditionally guaranteed by the Company, have
a liquidation value of $1,000 per capital security, and have a mandatory
redemption feature under certain circumstances. The Company issued 7.405%
junior subordinated deferrable interest debentures which mature on March 15,
2038, to the subsidiary trust in connection with the capital securities
offering. The Company has $400.0 million available for debt and/or equity
securities under its shelf registration statement following the issuance of
the senior notes and capital securities.
Note 19--Supplemental Data on Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations for
1997 and 1996:
<TABLE>
<CAPTION>
1997
4th 3rd 2nd 1st
(in millions of dollars, except share data)
<S> <C> <C> <C> <C>
Premium Income $582.2 $594.0 $590.0 $287.5
Net Investment Income 364.6 362.9 364.7 262.5
Net Realized Investment Gains 2.0 6.9 1.5 4.7
Total Revenue 991.0 997.1 993.8 571.3
Income Before Federal Income Taxes 117.3 109.5 90.7 62.8
Net Income 75.8 71.0 59.7 40.8
Earnings Per Common Share .54 .50 .42 .40
Earnings Per Common Share -
Assuming Dilution .53 .49 .41 .39
<CAPTION>
1996
4th 3rd 2nd 1st
(in millions of dollars, except share data)
<S> <C> <C> <C> <C>
Premium Income $292.4 $287.4 $291.3 $304.6
Net Investment Income 268.0 269.5 274.1 278.5
Net Realized Investment
Gains (Losses) 1.4 (4.1) (5.3) (0.6)
Total Revenue 568.5 562.7 569.0 591.7
Income Before Federal
Income Taxes 67.8 51.8 53.2 53.4
Net Income 43.9 33.2 34.1 34.4
Earnings Per Common Share .45 .33 .34 .34
Earnings Per Common Share -
Assuming Dilution .44 .33 .34 .34
</TABLE>
-61-
<PAGE>
Unaudited Pro Forma Combined Condensed Financial Statements
The following unaudited pro forma combined condensed financial
statements and explanatory notes are presented to show the impact of the
Merger on the historical financial positions and results of operations of
UNUM and Provident under the "pooling of interests" method of accounting.
The unaudited pro forma combined condensed financial statements combine the
historical financial information of UNUM and Provident as of September 30,
1998 and for the nine months ended September 30, 1998 and 1997 and for each
of the three years ended December 31, 1997, 1996 and 1995, respectively. The
unaudited pro forma combined condensed balance sheet assumes the Merger was
consummated on September 30, 1998. The unaudited pro forma combined condensed
statements of income give effect to the Merger as if it had been consummated
at the beginning of the earliest period presented.
Immediately prior to the Merger, each issued and outstanding share of
Provident common stock will be reclassified and (assuming the effectiveness
of the Merger) converted into 0.73 of a share of UNUMProvident common stock.
In connection with the above reclassification and Merger, the par value of
Provident common stock will be reduced from $1.00 per share to $.10 per
share. Upon consummation of the Merger, each share of issued and outstanding
UNUM common stock will be converted into one share of UNUMProvident common
stock. The Merger, which is expected to be completed in the second quarter of
1999, is subject to regulatory approval and UNUM and Provident stockholder
approval. The unaudited pro forma combined condensed financial statements as
of September 30, 1998 and for the nine months ended September 30, 1998 and
1997 and each of the three years ended December 31, 1997, 1996 and 1995 are
based on and derived from, and should be read in conjunction with, (i) the
historical consolidated financial statements and related notes thereto of
UNUM, which are incorporated by reference herein, and (ii) the historical
consolidated financial statements and related notes thereto of Provident,
which are incorporated by reference herein.
The pro forma data are presented for comparative purposes only and are
not necessarily indicative of the future financial position or the results of
operations that would have been realized had the Merger been consummated
during the periods or as of the date for which the pro forma data are
presented.
Management of UNUM and Provident are currently assessing non-recurring
merger charges which would be material to the combined company's results of
operations and financial condition for the period in which the charge occurs.
As such, no estimate has been reflected in the unaudited pro forma combined
condensed financial statements.
-62-
<PAGE>
UNUMProvident Corporation
<TABLE>
<CAPTION>
Unaudited Pro Forma Combined Condensed Statements of Income
- ------------------------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30, 1998
------------------------------------------------------------------------
Pro Forma
UNUMProvident
UNUM Provident Adj Combined
- ------------------------------------------------------------------------------------------------------------------------
(in millions of dollars, except per share data)
<S> <C> <C> <C> <C>
Premium Income $ 2,857.8 $ 1,759.8 $ -- $ 4,617.6
Net Investment Income 493.4 1,039.6 -- 1,533.0
Net Realized Investment Gains 12.6 18.2 30.8
Other Income 96.8 134.3 -- 231.1
------------------------------------------------------------------------
Total Revenue 3,460.6 2,951.9 -- 6,412.5
------------------------------------------------------------------------
Policyholder Benefits 2,141.9 1,864.0 -- 4,005.9
Commissions 384.4 251.2 -- 635.6
Operating Expenses 638.3 406.2 -- 1,044.5
Increase in Deferred Policy Acquisition Costs (175.1) (27.6) (202.7)
Amortization of Value of Business Acquired 3.8 25.2 29.0
Amortization of Goodwill 4.8 16.1 20.9
Interest Expense 36.6 54.0 -- 90.6
------------------------------------------------------------------------
Total Benefits and Expenses 3,034.7 2,589.1 -- 5,623.8
------------------------------------------------------------------------
Income Before Income Taxes 425.9 362.8 -- 788.7
Income Taxes 129.3 135.0 -- 264.3
------------------------------------------------------------------------
Net Income $ 296.6 $ 227.8 $ -- $ 524.4
------------------------------------------------------------------------
Net Income Per Common Share
Basic $ 2.15 $ 1.67 $ 2.21
Diluted $ 2.10 $ 1.63 $ 2.15
- ------------------------------------------------------------------------------------------------------------------------
Average Shares Outstanding - Basic 138,270,633 135,101,280 (36,477,346) 236,894,567
Average Shares Outstanding - Diluted 141,456,246 138,589,198 (37,419,083) 242,626,361
</TABLE>
-63-
<PAGE>
UNUMProvident Corporation
<TABLE>
<CAPTION>
Unaudited Pro Forma Combined Condensed Statements of Income
- ------------------------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30, 1997
------------------------------------------------------------------------
Pro Forma
UNUMProvident
UNUM Provident Adj Combined
- ------------------------------------------------------------------------------------------------------------------------
(in millions of dollars, except per share data)
<S> <C> <C> <C> <C>
Premium Income $ 2,403.2 $ 1,471.5 $ -- $ 3,874.7
Net Investment Income 495.5 990.1 -- 1,485.6
Net Realized Investment Gains (Losses) (2.5) 13.1 10.6
Other Income 200.5 87.5 -- 288.0
------------------------------------------------------------------------
Total Revenue 3,096.7 2,562.2 -- 5,658.9
------------------------------------------------------------------------
Policyholder Benefits 1,871.8 1,719.9 -- 3,591.7
Commissions 306.1 225.6 -- 531.7
Operating Expenses 567.2 326.2 -- 893.4
Increase in Deferred Policy Acquisition Costs (115.7) (28.2) (143.9)
Amortization of Value of Business Acquired 2.5 19.3 21.8
Amortization of Goodwill 4.1 8.6 12.7
Interest Expense 31.2 27.8 -- 59.0
------------------------------------------------------------------------
Total Benefits and Expenses 2,667.2 2,299.2 -- 4,966.4
------------------------------------------------------------------------
Income Before Income Taxes 429.5 263.0 -- 692.5
Income Taxes 135.4 91.5 -- 226.9
------------------------------------------------------------------------
Net Income $ 294.1 $ 171.5 $ -- $ 465.6
------------------------------------------------------------------------
Net Income Per Common Share
Basic $ 2.10 $ 1.34 $ 2.00
Diluted $ 2.05 $ 1.31 $ 1.95
- ------------------------------------------------------------------------------------------------------------------------
Average Shares Outstanding - Basic 140,327,518 120,928,246 (32,650,626) 228,605,138
Average Shares Outstanding - Diluted 143,239,589 123,492,809 (33,343,058) 233,389,340
</TABLE>
-64-
<PAGE>
UNUMProvident Corporation
Unaudited Pro Forma Combined Condensed Statements of Income
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Year Ended
December 31, 1997
---------------------------------------------------------------------------
Pro Forma
UNUMProvident
UNUM Provident Adj Combined
- ---------------------------------------------------------------------------------------------------------------------------
(in millions of dollars, except per share data)
<S> <C> <C> <C> <C>
Premium Income $ 3,263.7 $ 2,053.7 $ -- $ 5,317.4
Net Investment Income 661.0 1,354.7 -- 2,015.7
Net Realized Investment Gains (Losses) (3.6) 15.1 11.5
Other Income 227.3 129.7 -- 357.0
---------------------------------------------------------------------------
Total Revenue 4,148.4 3,553.2 -- 7,701.6
---------------------------------------------------------------------------
Policyholder Benefits 2,522.3 2,358.1 -- 4,880.4
Commissions 410.5 305.7 -- 716.2
Operating Expenses 794.8 460.7 -- 1,255.5
Increase in Deferred Policy Acquisition Costs (166.9) (37.9) (204.8)
Amortization of Value of Business Acquired 3.3 31.2 34.5
Amortization of Goodwill 5.6 12.6 18.2
Interest Expense 42.4 42.5 -- 84.9
---------------------------------------------------------------------------
Total Benefits and Expenses 3,612.0 3,172.9 -- 6,784.9
---------------------------------------------------------------------------
Income Before Income Taxes 536.4 380.3 -- 916.7
Income Taxes 166.1 133.0 -- 299.1
---------------------------------------------------------------------------
Net Income $ 370.3 $ 247.3 $ -- $ 617.6
---------------------------------------------------------------------------
Net Income Per Common Share
Basic $ 2.65 $ 1.88 $ 2.62
Diluted $ 2.59 $ 1.84 $ 2.57
- ---------------------------------------------------------------------------------------------------------------------------
Average Shares Outstanding - Basic 139,852,234 124,505,397 (33,616,457) 230,741,174
Average Shares Outstanding - Diluted 142,923,361 127,253,246 (34,358,376) 235,818,231
</TABLE>
-65-
<PAGE>
UNUMProvident Corporation
Unaudited Pro Forma Combined Condensed Statements of Income
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Year Ended
December 31, 1996
---------------------------------------------------------------------------
Pro Forma
UNUMProvident
UNUM Provident Adj Combined
- ---------------------------------------------------------------------------------------------------------------------------
(in millions of dollars, except per share data)
<S> <C> <C> <C> <C>
Premium Income $ 3,151.5 $ 1,175.7 $ -- $ 4,327.2
Net Investment Income 803.3 1,090.1 -- 1,893.4
Net Realized Investment Gains (Losses) 3.4 (8.6) (5.2)
Other Income 113.5 34.7 -- 148.2
---------------------------------------------------------------------------
Total Revenue 4,071.7 2,291.9 -- 6,363.6
---------------------------------------------------------------------------
Policyholder Benefits 2,542.8 1,661.2 -- 4,204.0
Commissions 386.9 168.3 -- 555.2
Operating Expenses 861.8 224.8 -- 1,086.6
Increase in Deferred Policy Acquisition Costs (109.3) (6.9) (116.2)
Amortization of Value of Business Acquired 0.9 0.5 1.4
Amortization of Goodwill 6.3 -- 6.3
Interest Expense 40.7 17.8 -- 58.5
---------------------------------------------------------------------------
Total Benefits and Expenses 3,730.1 2,065.7 -- 5,795.8
---------------------------------------------------------------------------
Income Before Income Taxes 341.6 226.2 -- 567.8
Income Taxes 103.6 80.6 -- 184.2
---------------------------------------------------------------------------
Net Income $ 238.0 $ 145.6 $ -- $ 383.6
---------------------------------------------------------------------------
Net Income Per Common Share
Basic $ 1.63 $ 1.46 $ 1.75
Diluted $ 1.61 $ 1.44 $ 1.72
- ---------------------------------------------------------------------------------------------------------------------------
Average Shares Outstanding - Basic 145,938,794 91,044,834 (24,582,105) 212,401,523
Average Shares Outstanding - Diluted 148,028,296 92,154,470 (24,881,707) 215,301,059
</TABLE>
-66-
<PAGE>
UNUMProvident Corporation
Unaudited Pro Forma Combined Condensed Statements of Income
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Year Ended
December 31, 1995
---------------------------------------------------------------------------
Pro Forma
UNUMProvident
UNUM Provident Adj Combined
- ---------------------------------------------------------------------------------------------------------------------------
(in millions of dollars, except per share data)
<S> <C> <C> <C> <C>
Premium Income $ 3,018.2 $ 1,251.9 $ -- $ 4,270.1
Net Investment Income 806.3 1,221.3 -- 2,027.6
Net Realized Investment Gains (Losses) 225.1 (31.7) 193.4
Other Income 73.3 113.8 -- 187.1
---------------------------------------------------------------------------
Total Revenue 4,122.9 2,555.3 -- 6,678.2
---------------------------------------------------------------------------
Policyholder Benefits 2,720.4 1,904.6 -- 4,625.0
Commissions 369.9 187.6 -- 557.5
Operating Expenses 721.3 277.0 -- 998.3
Increase in Deferred Policy Acquisition Costs (114.7) (17.1) (131.8)
Amortization of Value of Business Acquired 3.2 4.9 8.1
Amortization of Goodwill 3.7 -- 3.7
Interest Expense 37.2 22.3 -- 59.5
---------------------------------------------------------------------------
Total Benefits and Expenses 3,741.0 2,379.3 -- 6,120.3
---------------------------------------------------------------------------
Income Before Income Taxes 381.9 176.0 -- 557.9
Income Taxes 100.8 60.4 -- 161.2
---------------------------------------------------------------------------
Net Income $ 281.1 $ 115.6 $ -- $ 396.7
---------------------------------------------------------------------------
Net Income Per Common Share
Basic $ 1.93 $ 1.13 $ 1.81
Diluted $ 1.92 $ 1.13 $ 1.80
- ---------------------------------------------------------------------------------------------------------------------------
Average Shares Outstanding - Basic 145,353,576 90,762,746 (24,505,941) 211,610,381
Average Shares Outstanding - Diluted 146,608,572 90,931,790 (24,551,583) 212,988,779
</TABLE>
-67-
<PAGE>
UNUMProvident Corporation
Unaudited Pro Forma Combined Condensed Balance Sheet
(in millions of dollars)
<TABLE>
<CAPTION>
Pro Forma
UNUM Provident UNUMProvident
September 30,1998 Historical Historical Adjustments Combined
------------ ------------ ------------- ---------------
<S> <C> <C> <C> <C>
Fixed Maturity Securities
Available-for-sale $ 7,697.1 $ 14,946.5 $ -- $ 22,643.6
Held-to-maturity -- 298.9 -- 298.9
Equity Securities 28.5 12.7 -- 41.2
Mortgage Loans 1,215.5 17.8 -- 1,233.3
Real Estate 248.2 43.7 -- 291.9
Policy Loans 138.0 2,101.4 -- 2,239.4
Other Long-term Investments 1.7 33.9 -- 35.6
Short-term Investments 295.4 44.0 -- 339.4
------------ ------------ ------------- ---------------
Total Investments 9,624.4 17,498.9 -- 27,123.3
Cash 56.8 42.3 -- 99.1
Premiums Receivable 584.0 47.9 -- 631.9
Reinsurance Receivable 1,779.8 3,171.2 -- 4,951.0
Deposit Assets 768.4 -- -- 768.4
Accrued Investment Income 153.0 363.1 -- 516.1
Deferred Policy Acquisition Costs 1,205.4 413.7 -- 1,619.1
Value of Business Acquired 81.3 498.7 -- 580.0
Goodwill 121.8 697.5 -- 819.3
Property and Equipment 225.9 118.0 -- 343.9
Miscellaneous 299.4 95.5 -- 394.9
Separate Account Assets 30.4 320.2 -- 350.6
------------ ------------ ------------- ---------------
Total Assets $ 14,930.6 $ 23,267.0 $ -- $ 38,197.6
------------ ------------ ------------- ---------------
-68-
<PAGE>
UNUMProvident Corporation
Unaudited Pro Forma Combined Condensed Balance Sheet (continued)
(in millions of dollars)
<CAPTION>
Pro Forma
UNUM Provident UNUMProvident
September 30,1998 Historical Historical Adjustments Combined
------------ ------------ ------------- ---------------
<S> <C> <C> <C> <C>
Policy and Contract Benefits $ 6,641.0 $ 513.0 $ -- $ 7,154.0
Reserves for Future Policy and Contract
Benefits and Unearned Premiums 2,436.9 13,674.9 -- 16,111.8
Other Policyholders' Funds 895.1 3,482.6 -- 4,377.7
Federal Income Tax Liability 632.8 347.0 -- 979.8
Short-term Debt 196.1 98.9 295.0
Long-term Debt 544.0 600.0 -- 1,144.0
Other Liabilities 807.2 481.9 -- 1,289.1
Separate Account Liabilities 30.4 320.2 -- 350.6
------------ ------------ ------------- ---------------
Total Liabilities 12,183.5 19,518.5 -- 31,702.0
------------ ------------ ------------- ---------------
Company Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary Trust
Holding Solely Junior Subordinated Debt
Securities of the Company -- 300.0 -- 300.0
------------ ------------ ------------- ---------------
Preferred Stock -- -- -- --
Common Stock 20.0 135.8 (132.1) 23.7
Additional Paid-in Capital 1,138.9 756.3 (959.6) 935.6
Net Unrealized Gain on Securities 312.7 775.7 -- 1,088.4
Foreign Currency Translation Adjustment (16.3) (30.0) -- (46.3)
Retained Earnings 2,398.6 1,821.6 -- 4,220.2
Treasury Stock (1,091.7) (10.9) 1,091.7 (10.9)
Restricted Stock Deferred Compensation (15.1) -- -- (15.1)
------------ ------------ ------------- ---------------
Total Stockholders' Equity 2,747.1 3,448.5 -- 6,195.6
------------ ------------ ------------- ---------------
Total Liabilities and Stockholders' Equity $ 14,930.6 $ 23,267.0 $ -- $ 38,197.6
------------ ------------ ------------- ---------------
</TABLE>
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<PAGE>
Notes To Unaudited Pro Forma Combined Condensed Financial Statements
1. Basis of Presentation
The unaudited pro forma combined condensed financial statements has
been prepared using the pooling-of-interests method of accounting,
giving effect to the Merger as if it had occurred (a) in the case of
balance sheet information, on September 30, 1998 and (b) in the case of
statement of income information, as of the beginning of the earliest
period presented. The pro forma financial statements presented are not
necessarily indicative of the results of operations had the Merger been
consummated as of the date or at the beginning of the periods presented,
nor are they necessarily indicative of the results of operations in
future periods or the future financial position of the combined entities.
Certain historical financial information has been reclassified to
conform with the current presentation. Immediately prior to the Merger,
each issued and outstanding share of Provident common stock will be
reclassified and (assuming the effectiveness of the Merger) converted
into 0.73 of a share of UNUMProvident common stock. In connection with the
above reclassification and Merger, the par value of Provident common
stock will be reduced from $1.00 per share to $.10 per share. Upon
consummation of the Merger, each share of issued and outstanding UNUM
common stock will be converted into one share of UNUMProvident common
stock. The Merger is subject to regulatory approval and UNUM and
Provident stockholder approval.
On March 27, 1997, Provident completed the acquisition of Paul Revere for
approximately $1.2 billion. The fair values of assets acquired and
liabilities assumed were $6,680.0 million and $6,675.4 million,
respectively. The acquisition was accounted for by the purchase method of
accounting, and accordingly, is included in Provident's historical
financial statements from the date of acquisition.
2. Accounting Policies and Financial Statements Classifications
UNUM and Provident are in the process of reviewing their accounting
policies and financial statement classifications and, as a result of
this review, it may be necessary to restate either or both UNUM's or
Provident's financial statements to conform to those accounting policies
and classifications that are determined to be most appropriate. If
adjustments are necessary, they could be material.
3. Non-Recurring Merger Charge
Management of UNUM and Provident are currently assessing non-recurring
merger charges which could be material to the combined company's results
of operations and financial condition for the period in which the charge
occurs. As such, no estimate has been reflected in the unaudited
condensed pro forma combined financial information.
The unaudited pro forma combined condensed financial statements do not
reflect any benefits expected from revenue enhancements or derived from
potential cost savings related to the Merger. Although management
anticipates revenue enhancements and costs savings will result from
the Merger, there can be no assurance these items will be achieved.
4. Pro Forma Adjustments
The following pro forma adjustments have been reflected in the unaudited
pro forma combined condensed financial statements:
The pro forma adjustments to common stock, additional paid-in capital
and treasury stock reflect the retirement of 6.2 million shares of UNUM
common stock held in treasury, the reclassification of Provident common
stock on a 0.73 to 1 basis and the related reduction in par value from
$1.00 per share to $.10 per share. Based on the number of shares of
Provident common stock issued at September 30, 1998, the 0.73 to 1
reclassification ratio results in 135.5 million shares of Provident
common stock being reclassified into 98.9 million shares of
UNUMProvident common stock.
Because the number of shares of UNUM common stock and Provident common
stock outstanding may have increased or decreased by the time of the
reclassification and Merger, the ultimate number of shares of
UNUMProvident common stock resulting from the reclassification and
Merger cannot be determined at this time.
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<PAGE>
As discussed in Note 3, no estimates have been made, nor are such
estimates included in the unaudited pro forma combined condensed
financial statements, for non-recurring merger charges.
5. Pro Forma Earnings Per Share
The number of combined average shares outstanding and the adjustments
for dilutive securities reflects the exchange of each share of Provident
Common Stock for .73 of a share of UNUMProvident. Amounts used in the
determination of pro forma basic and dilutive earnings per share are as
follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------
For the Nine Months Ended
September 30 For the Year Ended December 31
--------------------------- ------------------------------------
1998 1997 1997 1996 1995
----------- ------------ --------- --------- ---------
(in millions of dollars)
<S> <C> <C> <C> <C> <C>
Net income $524.4 $465.6 $617.6 $383.6 $396.7
Less dividends
accrued on preferred
stock 1.9 9.5 12.7 12.7 12.7
----------- ------------ --------- --------- ---------
Total available to
common
shareholders $522.5 $456.1 $604.9 $370.9 $384.0
=========== ============ ========= ========= ==========
Combined average
shares outstanding-basic 236.9 228.6 230.7 212.4 211.6
Adjustments for
dilutive securities 5.7 4.8 5.1 2.9 1.4
----------- ------------ --------- --------- ---------
Combined average
shares outstanding-diluted 242.6 233.4 235.8 215.3 213.0
=========== ============ ========= ========= ==========
</TABLE>
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<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
UNUM CORPORATION
By: /s/ Robert E. Broatch
Robert E. Broatch
Senior Vice President & Chief
Financial Officer
Dated: December 10, 1998
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<PAGE>
ACKNOWLEDGMENT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Provident Companies, Inc.
We are aware of the incorporation by reference in the Registration Statement
Form S-3 No. 333-08187 dated August 2, 1996 of UNUM Corporation and in the
related Prospectus of our report dated November 10, 1998 relating to the
unaudited condensed consolidated interim financial statements of Provident
Companies, Inc. that are included in this Form 8-K.
Pursuant to Rule 436(c) of the Securities Act of 1933 our reports are not a
part of the registration statement prepared or certified by accountants
within the meaning of Section 7 or 11 of the Securities Act of 1933.
/s/ERNST & YOUNG LLP
Chattanooga, Tennessee
December 10, 1998
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
Form S-3 No. 333-08187 dated August 2, 1996 of UNUM Corporation and in the
related Prospectus of our report dated February 3, 1998 except for Note 18
as to which the date is March 16, 1998, with respect to the consolidated
financial statements of Provident Companies, Inc. included in this Form 8-K.
/s/ERNST & YOUNG LLP
Chattanooga, Tennessee
December 10, 1998
