Limited. The home office of the Colonial Companies is located in Columbia, South Carolina, and is also owned by UNUM. In addition, UNUM leases, on periods principally from five to ten years, office and warehouse space for use by its home office affiliates and sales forces.
During 1994, several of UNUM's businesses were contending with various proposals to reform the health care delivery system in the United States. While proposed federal health care legislation was not enacted in 1994, structural reform is under way, which UNUM believes has and will continue to alter the medical profession, as well as the social and economic environment of the health care industry. Management believes the uncertainties as to how the health care industry will emerge from such structural reform, as well as changes in and consolidation of the health care delivery system, contributed to a higher incidence of new and larger claims for physicians.
Economic indicators at the end of 1994 and in early 1995 were predicting modest growth in 1995 for UNUM's major markets: the United States, Canada and the United Kingdom. In February 1995, the Federal Reserve Board tightened credit policy, due to continued concerns about inflation, by raising the federal funds rate to 6%, the highest level in four years. This represents an increase of three full percentage points since the Federal Reserve Board started raising rates in February 1994. Also in 1994, the central banks in Canada and the United Kingdom increased interest rates. During 1994, long-term yields increased; however, since long-term yields are based on market dynamics, management cannot predict the impact of a higher short-term rate on future long- term yields.
Effective January 1, 1993, UNUM adopted FAS 106, which changed the method for recognition of the cost of postretirement benefits other than pensions from a cash basis to an accrual basis over the years in which employees render the related services. UNUM elected to recognize the FAS 106 liability at January 1, 1993, of $48.8 million as a cumulative effect of an accounting change which decreased net income by $32.1 million, or $0.40 per share, in 1993. The incremental effect of FAS 106 for 1993 was increased operating expenses of approximately $6.0 million from 1992.
UNUM also adopted FAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," effective January 1, 1993, which resulted in an increase in other assets of $80.0 million and a corresponding increase in future policy benefits and unpaid claims and claim expenses, but did not affect 1993 net income.
The Employee Benefits segment includes group long term disability ("group LTD"), group life and other employee benefits products including short term disability, accidental death and dismemberment and dental insurance, which are sold by UNUM Life Insurance Company of America ("UNUM America") and First UNUM Life Insurance Company ("First UNUM").
Increased sales and selected price increases on new and inforce cases contributed to the premium growth of 6.5% in the Employee Benefits segment in 1994. Rate increases to address unfavorable experience on selected segments of the inforce business contributed to the decline in both the group LTD and group life premium persistency rates in 1994. In general, case terminations resulting from rate increases have occurred in less profitable segments of these businesses. Management expects to continue to seek inforce case rate increases, as appropriate, given claims experience, to improve profitability. However, such rate actions may increase case terminations and decrease persistency rates for these businesses. In 1994 and 1993, group LTD was active in acquiring closed blocks of claims which generated one-time premiums totaling $8.6 million and $58.3 million, respectively. Management intends to pursue additional claim block acquisitions in the future.
Reserves for unpaid claims are estimates based on UNUM's historical experience and other actuarial assumptions, which consider the effects of current developments, anticipated trends, risk management programs and renewal actions. Many factors affect actuarial calculations of claim reserves, including but not limited to interest rates, and current and anticipated incidence rates, recovery rates, and economic and societal conditions. Reserve estimates and assumptions are periodically reviewed and updated with any resulting adjustments to reserves reflected in current operating results. Given the complexity of the reserving process, the ultimate liability may be more or less than such estimates indicate.
The ratio of operating expenses to premiums was 20.2%, 21.0%, and 23.4% in 1994, 1993 and 1992, respectively. The decreases in 1994 and 1993 were attributable to continued efforts to manage expense growth and increased premium from claim block purchases in 1993, which do not have proportionally higher expenses. Deferred policy acquisition costs increased in 1994 and 1993 due primarily to deferrals of higher marketing costs associated with increased sales and renewal activity.
In summary, the improvement in income before income taxes for the Employee Benefits segment in 1994 was primarily due to favorable claims experience in the group life and short term disability businesses, a lower operating expense ratio, and increased realized investment gains, which were partially offset by unfavorable claims experience in the group LTD business. Strong premium growth and a lower operating expense ratio, which were partially offset by unfavorable claims experience in the group life business and lower realized investment gains, resulted in increased income before income taxes for 1993 as compared with 1992.
The Related Businesses segment includes: UNUM Limited, the United Kingdom's leader in group disability insurance; Commercial Life Insurance Company ("Commercial"), a leader in special risk insurance and professional association insurance marketing; and Reinsurance Operations, which includes Duncanson & Holt, Inc. ("D&H"), a leading accident and health reinsurance underwriting manager, and other special risk reinsurance operations.
UNUM LIMITED The depressed economic environment that affected the United Kingdom in 1992 and 1993 experienced a modest recovery in 1994, which positively affected UNUM Limited's ability to sell long term disability insurance. UNUM Limited experienced strong premium growth in 1994 as sales increased and persistency rates improved. Also in 1994, claim block acquisitions generated one-time premium of $25.8 million. A reallocation of capital from UNUM Limited in 1992, and a decreasing interest rate environment, resulted in decreased investment income for the Related Businesses segment in 1993.
On April 1, 1995, the United Kingdom's new Social Security (Incapacity for Work) Act of 1994 will be effective, and will shift a greater financial responsibility for disability benefits from the U.K. government to the private sector. Management believes this legislation will increase awareness of the need for disability insurance and expand the U.K. insurance market for long term disability products, which could favorably affect UNUM Limited's sales. However, it is unclear when the effects of this legislation will be evidenced.
During 1994, the U.S. dollar weakened slightly against the British pound sterling, increasing UNUM Limited's earnings as reported in U.S. dollars. This reversed the trend in 1993 and 1992 when the U.S. dollar strengthened against the British pound sterling, decreasing earnings as reported in U.S. dollars. The weighted average exchange rate was approximately $1.53, $1.51 and $1.78 for the years ended December 31, 1994, 1993 and 1992. At December 31, 1994, the spot rate had increased to $1.56.
SUMMARY Income before income taxes increased in 1994 for the Related Businesses segment, primarily due to strong premium growth and favorable claims experience at UNUM Limited, partially offset by unfavorable claims experience in Commercial's association group disability business and in certain reinsurance pools. The principal reason for the increase in income before income taxes for the Related Businesses segment in 1993 was the inclusion of D&H results for a full year, which was partially offset by less favorable earnings for UNUM Limited due to a lower weighted average exchange rate.
The Colonial Companies segment includes Colonial Life & Accident Insurance Company and affiliates, which offer payroll-deducted, voluntary employee benefits to employees at their worksites. The Colonial Companies segment ("Colonial") markets accident and sickness, cancer, and life insurance products primarily through independent sales representatives.
Income before income taxes decreased in 1994 primarily because of reduced realized investment gains and increased expenses, partially offset by favorable claims experience. For 1993, Colonial's income before income taxes increased primarily through continued expense control and a higher level of realized investment gains attributed to the investment portfolio realignment.
The Individual Disability segment includes disability income products sold in the United States and Canada through UNUM America and First UNUM, as well as private label agreements through these companies.
The loss before income taxes of $(188.2) million for the Individual Disability segment for 1994 is primarily due to the $192.4 million reserve strengthening recorded in the third quarter of 1994 and a $12.3 million restructuring charge incurred in the fourth quarter as a result of the decision to stop selling non- cancellable disability income policies in the United States. During 1994, the Individual Disability segment experienced a higher incidence of new claims and a disproportionate number of large claims that management has attributed to certain geographic and occupational segments of the business, particularly physicians. Management believes that changes in and consolidation of the health care delivery system in the United States and the increased prevalence of emerging and often subjective types of disabilities have contributed to increased benefit costs.
During the third quarter of 1994, management concluded that the deterioration of claims experience was not a temporary fluctuation in certain segments of the business, but was indicative of expected claim trends for the future. Unlike the group long term disability product, management has limited ability to manage the claims risk associated with non-cancellable individual disability business, since UNUM is contractually unable to reprice or cancel inforce policies that have become unprofitable because of changes in claims experience that were unforeseen when the policy was sold. The combination of these factors prompted UNUM to assess the adequacy of future premiums to provide for future benefits and expenses and the assumptions used in the existing claim reserves for the Individual Disability segment. As a result, in third quarter 1994, UNUM increased reserves for existing claims by $83.3 million and established a reserve for estimated future losses of $109.1 million. These increased reserves reflect management's current expectations for morbidity trends and record the estimated future losses for the existing individual disability business, as reported in the Individual Disability segment.
It is not possible to predict whether future morbidity trends will be consistent with UNUM's current assumptions. During the fourth quarter of 1994, excess-of- loss reinsurance totaling $60 million over three years was purchased through a Lloyd's of London syndicate to cover UNUM's exposure to claims exceeding levels assumed in the strengthened reserves. Management continues to evaluate its financial options for this business, including reinsurance opportunities.
UNUM has further tightened underwriting rules and practices, and made other product design limitations for the interim sales of the existing product. As a result of the tightened underwriting of the existing product and the time needed to develop the new products, management expects that sales of the Individual Disability segment will decrease significantly in 1995 from levels in 1994.
UNUM is in continuing discussions with its private label partners as it develops the new disability products to determine the future course of its private label agreements. Private label agreements allow other insurance companies to market UNUM's individual disability product under their own names.
In the fourth quarter of 1994, UNUM recorded a pretax charge of $12.3 million related to the restructuring of the individual disability business and resulting consolidation of home office operations in UNUM America, which was comprised of $7.1 million for severance costs for 150 field and 150 home office employees and $5.2 million for exit costs of certain leased facilities and equipment, expiring through 1998. The severance costs are expected to be paid by the end of 1995.
The increase in income before income taxes for the Individual Disability segment in 1993 from 1992 was primarily due to more favorable claims experience and continued expense management.
During 1994 and 1993, UNUM offered the holders of certain types of TSA contracts the opportunity to modify such contracts. The proposed contract amendments provide for UNUM to increase the minimum guaranteed credited rates in return for contractholders relinquishing the right to make lump-sum withdrawals without an associated fee. As expected, certain contractholders elected to withdraw their funds rather than convert to the modified contract provisions, which affected the overall growth of invested assets under management. Management expects these types of withdrawals to continue, which may affect future growth of invested assets under management for TSAs.
Management believes the failure of the last Congress to pass health care reform legislation positively affected long term care insurance products, which experienced premium and sales growth during 1994 after lower than expected growth in 1993 due to the announcement of President Clinton's health care reform proposal that included long term care coverage. During 1994, block acquisitions generated one-time net premiums for long term care insurance products of $15.0 million. Management may pursue additional block acquisitions in the future. Long term care insurance products experienced an increased incidence of new claims during 1994, which management has addressed by implementing new underwriting guidelines.
Income before income taxes increased in 1994 reflecting continued premium growth and expense reductions in the long term care insurance products partially offset by unfavorable claims experience. Additionally, during 1994 UNUM continued its investment in the development of long term care and lifestyle security protection products, and in a TSA business initiative which management expects will improve customer acquisition and service functions as well as reduce future operating expenses. Unusually favorable interest spread margins on tax sheltered annuities were the primary reason for increased income before income taxes in 1993.
During 1992, UNUM released the remaining restructuring reserve for the costs of withdrawal from the 401(k) business since actual costs were less than expected, resulting in increased pretax income of $5.3 million. The gain associated with the release of this restructuring reserve reduced operating expenses in the 1992 Consolidated Statement of Income.
Corporate includes transactions that are generally non-insurance related, expenses incurred in conjunction with UNUM's long-term strategic investment in Japan and interest expense on corporate borrowings. The increased loss before income taxes in 1994 in Corporate was primarily due to increased interest expense and increased costs related to the investment in Japan. The increased loss before income taxes in 1993 was primarily due to the expenses incurred in connection with the March 26, 1993, merger of UNUM Corporation and Colonial Companies, Inc., decreased interest income and increased investment in Japan.
On June 20, 1994, the Japanese Ministry of Finance granted UNUM a provisional operating license which allowed UNUM to establish a non-life insurance company, UNUM Japan Accident Insurance Company Limited ("UNUM Japan"), to market disability and other accident products in Japan. UNUM Japan has subsequently received an official license and began selling group long term disability products in the fourth quarter of 1994, with the first policies effective January 1, 1995.
UNUM Japan formed a cooperative relationship with Japan's leading short term disability insurer, Yasuda Fire & Marine Insurance Co., Ltd. to develop the new long term disability products and introduce them in Japan. The two companies continue to work together on market and product development and will also market their own separate long term disability products. UNUM expects to continue incurring costs to develop UNUM Japan's distribution network, advertising and risk management programs.
Effective January 1, 1994, UNUM adopted Financial Accounting Standard ("FAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which specified the accounting and reporting for certain investments in equity securities and for all investments in debt securities. UNUM adopted the provisions of FAS 115 for these investments held as of or acquired after January 1, 1994, which are classified and accounted for as follows:
majority of UNUM's fixed maturities have been classified as "held to maturity" to match the longer term nature of UNUM's products.
- Fixed maturities and equity securities classified as "available for sale" are reported at fair value. Related unrealized holding gains and losses, net of deferred taxes, are reported in a separate component of stockholders' equity. Fair values of fixed maturities are generally obtained from external quoted market sources, and if not externally quoted, are determined by UNUM primarily by using discounted cash flow models.
Restructured loans are defined by UNUM as loans whose terms have been modified to interest rates less than market at the time of restructure and are currently expected to perform pursuant to such modified terms. UNUM modifies loans to protect its investment and only when it is anticipated that the borrower will be able to meet the modified terms. As of December 31, 1994, restructured mortgage loans totaled $73.6 million, as compared with $65.9 million at December 31, 1993. Interest lost on restructured loans was not material in 1994, 1993 or 1992.
Potential problem loans are defined by UNUM as current and performing loans with which management has some concerns about the ability of the borrower to comply with present loan terms and whose book value exceeds the market value of the underlying collateral. Loans in this category amounted to $36.2 million at December 31, 1994, versus $92.7 million at December 31, 1993. Active asset management contributed to the decline in this category during 1994.
Realized investment losses related to restructured and problem mortgage loans in 1994 amounted to $8.5 million, compared with $4.8 million and $26.5 million for 1993 and 1992, respectively. Problem and potential problem mortgage loans as of December 31, 1994, are not expected to have a significant impact on UNUM's results of operations, liquidity, or capital resources.
At December 31, 1994, investment real estate and real estate held for sale amounted to $190.8 million and $31.0 million, respectively. This compares with $193.5 million of investment real estate and $24.7 million of real estate held for sale at December 31, 1993. UNUM has limited the growth of its real estate exposure, as a percentage of invested assets, through an active sales program. UNUM sold $25.4 million and $40.5 million of real estate at 103% and 105% of carrying value during 1994 and 1993, respectively.
Real estate which meets certain investment criteria and is intended to be held long-term is carried at cost less accumulated depreciation. Real estate that has been acquired through foreclosure is valued at fair value at the date of foreclosure. Real estate held for sale is included in other assets in the Consolidated Balance Sheets and is valued net of an allowance which reduces the carrying value to the lower of fair value less estimated costs to sell, or cost. Occasionally, investment real estate is reclassified and revalued as real estate held for sale when it no longer meets UNUM's investment criteria. Additions to allowances for probable losses related to real estate held for sale resulted in realized investment losses of $0.8 million, $18.8 million and $7.2 million for the years ended December 31, 1994, 1993 and 1992, respectively.
UNUM's businesses produce positive cash flows, which are invested primarily in intermediate, fixed maturity investments intended to reflect the nature of anticipated cash obligations of insurance benefit payments and insurance contract maturities and to optimize investment returns at appropriate risk levels. To meet unexpected cash requirements and liquidity needs, UNUM maintains part of its investment portfolio in fixed maturities classified as available for sale, equity securities, cash and short-term investments.
In September 1993, UNUM announced the filing of an omnibus shelf registration statement with the Securities and Exchange Commission which became effective on October 8, 1993, relating to $450 million of securities (including debt securities, preferred stock, common stock and other securities). On October 8, 1993, UNUM filed a prospectus supplement to establish a $250 million medium-term note program under the shelf registration. The medium-term note program and the unsold portion of the shelf registration carry ratings of "A1" (Medium Quality) and "(P)A1" (Medium Quality), respectively, from Moody's Investors Service, and "A+" (Strong) from Standard & Poor's Corporation. The unsold portion of the shelf registration relating to subordinated debt and preferred stock carries ratings of "(P)A2" (Medium Quality) and "(P)"a1"" (Upper-Medium Quality), respectively, from Moody's Investors Service.
During 1994 and 1993, withdrawals of contracts reported in the Other Operations segment, including contract terminations, payments to participants and transfers to other carriers, were approximately $130 million and $309 million, respectively. Withdrawals during 1994 and 1993 were at levels expected by management and reflect the run-off nature of these closed blocks of businesses. UNUM manages liquidity objectives by including certain conditions in pension contracts which prohibit or restrict availability of funds.
UNUM was committed at December 31, 1994, to purchase fixed maturities and other invested assets in the amount of $37.5 million. Independent of the cash flows of UNUM Corporation, management anticipates that the operating cash flows of the subsidiaries of UNUM Corporation will be sufficient to meet benefit obligations, planned investment commitments and operational needs of those companies.
Inflation is one of the factors that has increased the need for insurance. Many policyholders who once had adequate insurance programs at lower coverage levels have increased their disability insurance coverage to provide the same relative financial benefits and protection.
A.M. Best Company ("Best's"), Moody's Investors Service ("Moody's") and Standard & Poor's Corporation ("S&P") are among the third parties that provide UNUM independent assessments of its overall financial position. Ratings from these agencies for financial strength and claims-paying ability are available for the United States domiciled insurance company subsidiaries rather than on a consolidated basis, since the financial information used to develop the ratings is based on statutory accounting practices in the United States.
rating to "Aa2" (Excellent) from "Aa1" (Excellent) citing the outlook for UNUM's group long term disability business as well as UNUM's increasing leverage and moderately reduced financial flexibility.
First UNUM Life Insurance Company ("First UNUM") also had its financial strength rating reaffirmed by Best's in May 1994, at "A+" (Superior). In January 1995, S&P lowered First UNUM's claims-paying ability rating to "AA" (Excellent) from "AA+" (Excellent). In March 1995, Moody's confirmed First UNUM's "Aa2" (Excellent) financial strength rating.
UNUM Corporation has the following debt ratings based on consolidated financial information under generally accepted accounting principles. In January 1995, S&P lowered the senior debt rating of UNUM Corporation to "A+" (Strong) from "AA" (Very Strong), and lowered the commercial paper rating to "A-1" (Strong) from "A-1+" (Extremely Strong). In March 1995, Moody's lowered UNUM Corporation's senior debt rating to "A1" (Medium Quality) from "Aa3" (High Quality) and confirmed the commercial paper rating of "P-1" (Superior Ability).
The National Association of Insurance Commissioners adopted a set of Risk-Based Capital standards for the life and health insurance industry, which became effective in 1993. These Risk-Based Capital standards are one way to measure the risk that insurance companies assume in the course of conducting insurance and investment activities.
The Risk-Based Capital standards for life insurance companies are based on a formula that establishes capital requirements relating to existing asset default risk, insurance risk, interest rate (asset/liability mismatch) risk and business risk. A company's Total Adjusted Capital (statutory capital, surplus, and Asset Valuation Reserve plus certain other adjustments) is compared to the Authorized Control Level ("ACL") of Risk-Based Capital produced by the formula. Subject to certain trend tests to determine the change in the ACL ratio from year to year, companies with Total Adjusted Capital above 200% of ACL are assumed to be adequately capitalized. Companies below 200% of ACL are identified as requiring various levels of regulatory action ranging from increased information requirements for companies between 150% and 200% of ACL, to mandatory control by the domiciliary insurance department for companies below 70% of ACL.
At December 31, 1994, UNUM had no open derivative financial instruments. At December 31, 1993, UNUM held interest rate futures contracts with commitments to purchase government securities with total par values of $207.0 million. In using these instruments, UNUM is subject to the off-balance-sheet risk that the counterparties to the transactions will fail to completely perform as contracted. UNUM manages this risk by only entering into contracts with highly rated institutions and listed exchanges.
In May 1993, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standard ("FAS") No. 114 "Accounting by Creditors for Impairment of a Loan," which defines the principles to measure and record a loan when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.
The accompanying consolidated financial statements of UNUM Corporation and subsidiaries ("UNUM") have been prepared on the basis of generally accepted accounting principles for stock life insurance companies.
The consolidated financial statements include the accounts of UNUM Corporation and subsidiaries. Significant intercompany accounts and transactions have been eliminated.
Certain December 31, 1993, and 1992 amounts have been reclassified in 1994 for comparative purposes.
Certain fixed maturities and equity securities are classified as available for sale as they may be sold in response to changes in interest rates, resultant prepayment risk, liquidity and capital needs, or other similar economic factors. Related unrealized holding gains and losses, net of deferred taxes, are reported in a separate component of stockholders' equity.
Gains or losses on hedges of existing assets or liabilities are deferred and included in the carrying amounts of those assets or liabilities. Gains or losses related to qualifying hedges of firm commitments or anticipated transactions are also deferred and recognized in the carrying amount of the underlying asset or liability when the hedged transaction occurs.
Group insurance premiums are recognized as income over the period to which the premiums relate. Individual disability premiums are recognized as income when due. Benefits and expenses are associated with earned premiums to result in recognition of profits over the life of the contracts. This association is accomplished by recording a provision for future policy benefits and unpaid claims and claim expenses, and amortizing deferred policy acquisition costs.
The costs of acquiring new business that vary with and are related primarily to the production of new business, have been deferred to the extent such costs are deemed recoverable from future profits. Such costs include commissions, certain costs of policy issue and underwriting, and certain variable field office expenses.
Reserves for future policy benefits are calculated by the net-level premium method, and are based on UNUM's expected morbidity, mortality and interest rate assumptions at the time a policy is issued. These reserves represent the portion of premiums received, accumulated with interest and held to provide for claims that have not yet been incurred. Reserves for group insurance policies consist primarily of unearned premiums.
The interest rates used in the calculation of reserves for future policy benefits at December 31, 1994, and 1993, principally ranged from:
The interest rates used in the calculation of disability product reserves at December 31, 1994, and 1993, were principally as follows:
The interest rate used to discount the disability reserves is a composite of the yields on assets specifically matched with each block of business.
Interest accrued on reserves increased prior years' incurrals by approximately $267 million, $237 million and $225 million in 1994, 1993 and 1992, respectively. Approximately $154 million of the increase in prior years' incurrals in 1994 was primarily related to changes in reserve estimates and assumptions of morbidity, mortality and expense costs of the group long term and individual disability reserves, which were affected by the third quarter 1994 reserve strengthening. Changes in estimates of morbidity, mortality and expense costs caused an increase in prior years' incurrals of approximately $6 million in 1993 and a decrease of approximately $46 million in 1992.
Foreign exchange translations, primarily related to the disability reserves of UNUM's United Kingdom based affiliate, UNUM Limited, caused prior years' incurrals to increase by approximately $15 million in 1994, and decrease by approximately $5 million and $52 million in 1993 and 1992, respectively.
During 1994, UNUM increased reserves for existing claims by $83.3 million and established a reserve for estimated future losses of $109.1 million. These increased reserves reflect management's current expectations of morbidity trends for the existing individual disability business, as reported in the Individual Disability segment. This change in accounting estimate resulted in an increase to benefits to policyholders in the Consolidated Statement of Income of $192.4 million, and a decrease to net income of $125.1 million, or $1.69 per share.
Other policyholder funds are liabilities for investment-type contracts and represent customer deposits plus interest credited to those deposits at various rates.
MORTGAGE LOANS: Fair values for mortgage loans are estimated based on discounted cash flow analyses using interest rates currently being offered for similar mortgage loans to borrowers with similar credit ratings and maturities. Mortgage loans with similar characteristics are aggregated for purposes of the calculations.
SHORT-TERM INVESTMENTS, CASH AND ACCRUED INVESTMENT INCOME: Fair values for these instruments approximate the carrying amounts reported in the Consolidated Balance Sheets.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS: Fair values for off-balance-sheet financial instruments are based on current settlement values.
In May 1993, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standard ("FAS") No. 114, "Accounting by Creditors for Impairment of a Loan" which defines the principles to measure and record a loan when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.
On December 3, 1992, UNUM and Colonial Companies, Inc. ("Colonial"), signed a definitive merger agreement. On March 26, 1993, Colonial Class A common stock shareholders voted to approve the merger. Under the agreement, UNUM exchanged 0.731 shares of its common stock for each share of Colonial Class A and Class B common stock outstanding on March 26, 1993. UNUM issued approximately 11.4 million shares of common stock from treasury in connection with the merger. In addition, outstanding options to acquire shares of Colonial Class B common stock were converted into options to acquire shares of UNUM common stock. The merger was accounted for as a pooling of interests.
- Fixed maturities that UNUM has the positive intent and ability to hold to maturity are classified as "held to maturity" and are reported at amortized cost, less an allowance for probable losses. - Fixed maturities and equity securities classified as "available for sale" are reported at fair value. Related unrealized holding gains and losses, net of deferred taxes, are reported in a separate component of stockholders' equity.
The following tables summarize the components of investment income, realized investment gains (losses) and changes in unrealized investment gains (losses):
The amortized cost and estimated fair values of fixed maturities at December 31, 1993, were as follows:
Gross gains of $12.4 million and $18.9 million, and gross losses of $1.3 million and $3.5 million, were realized on sales of fixed maturities in 1993 and 1992, respectively.
During fourth quarter 1994, UNUM sold fixed maturities of five issuers classified as held to maturity with an amortized cost of $49.8 million due to evidence of significant unexpected deterioration of the issuers' creditworthiness. These sales resulted in a net realized loss of $3.0 million.
Restructured mortgage loans at amortized cost amounted to $73.6 million and $65.9 million at December 31, 1994, and 1993, respectively. Troubled debt restructurings represent loans that are refinanced with terms more favorable to the borrower. Interest foregone on these loans was not material for the years ended December 31, 1994, 1993 or 1992.
Real estate acquired in satisfaction of debt cumulatively amounts to $119.3 million at December 31, 1994. Real estate held for sale amounted to $31.0 million at December 31, 1994, and $24.7 million at December 31, 1993.
UNUM was committed at December 31, 1994, to purchase fixed maturities and other invested assets in the amount of $37.5 million.
NOTE 4. ALLOWANCE FOR PROBABLE LOSSES ON INVESTED ASSETS AND REAL ESTATE HELD FOR SALE
Additions represent charges to net realized investment gains less recoveries, and deductions represent reserves released upon disposal or restructuring of the related asset.
UNUM, through its life insurance subsidiaries, is involved in both the cession and assumption of reinsurance with other companies. Risks are reinsured with other companies to reduce UNUM's exposure to large losses and permit recovery of a portion of direct losses. UNUM remains liable to the insured for the payment of policy benefits if the reinsurers cannot meet their obligations under the reinsurance agreements. Deferred policy acquisition costs, premiums and expenses are stated net of reinsurance ceded to other companies.
Effective January 1, 1993, UNUM adopted Financial Accounting Standard No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," which eliminated the practice by insurance enterprises of reporting assets and liabilities relating to reinsured contracts net of the effects of reinsurance. The standard required prepaid reinsurance premiums and reinsurance receivables, for amounts to be recovered, to be reported as assets. It also prescribed conditions required for a contract with a reinsurer to be accounted for as reinsurance and defined accounting standards for short-duration and long-duration reinsurance contracts. As permitted, consolidated financial statements prior to adoption have not been restated. The effect of the adoption on the Consolidated Balance Sheet was an increase in other assets of $80.0 million and a corresponding increase in future policy benefits and unpaid claims and claim expenses.
For the years ended December 31, 1994, and 1993, recoveries recognized under reinsurance agreements reduced benefits to policyholders by $53.3 million and $28.9 million, respectively.
Reinsurance premiums ceded and assumed were $51.5 million and $136.2 million, respectively, for 1992.
Effective January 1, 1993, UNUM adopted Financial Accounting Standard ("FAS") No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," which changed the method for recognition of the cost of these benefits from a cash basis to an accrual basis over the years in which the employees render the related services. UNUM elected to immediately recognize the FAS 106 liability at January 1, 1993, of $48.8 million as a cumulative effect of an accounting change, which decreased net income by $32.1 million, or $0.40 per share, during 1993.
Under UNUM's plans, the cost of covered health care benefits is assumed to increase 10.00% and 10.75% for retirees less than 65 years old, and 7.50% and 8.25% for retirees 65 years and older for 1995. These rates are assumed to decrease incrementally to 5.50% and 6.25% by 2001, and remain at that level thereafter. The weighted average discount rates used in determining the accumulated postretirement benefits obligation were 8.00% and 8.25%, at December 31, 1994, and 7.25% and 7.50%, at December 31, 1993. The rates of increase in future compensation levels used in determining the accumulated postretirement benefits obligation were 5.2% and 4.7%, at December 31, 1994 and 1993, respectively.
At December 31, 1994, a 1% increase in the trend rate for health care costs would increase the accumulated postretirement benefits obligation by $13.4 million and postretirement benefits expense by $1.8 million.
The 1990 Long-Term Stock Incentive Plan ("Incentive Plan") provides for granting of restricted shares of UNUM Corporation common stock to key officers. The Incentive Plan also provides for granting of options to officers, non-employee directors of UNUM Corporation and key employees, to purchase UNUM Corporation common stock over ten years at a price not less than 100% of the fair market value on the date of grant. The maximum number of shares reserved for issuance under the Incentive Plan was 6,800,000 in 1994 and 1993, and 3,500,000 in 1992. At December 31, 1994, 1993 and 1992, 2,511,145 shares, 3,316,734 shares, and 1,006,684 shares, respectively, were available for grant under the Incentive Plan.
The restriction period for each restricted stock award under the Incentive Plan is in excess of three years, with the restrictions lapsing as a result of the achievement of prescribed financial performance objectives during each three year period, with the exception of 10,000 shares of restricted stock granted in 1994 on which restrictions will lapse on January 6, 1998, provided the grantee remains continuously in the employ of UNUM. Plan participants are entitled to cash dividends and voting rights on their respective shares. In 1994, restrictions lapsed on 80,800 shares granted for the 1991 - 1993 performance period. All other restricted stock shares issued remained subject to restrictions.
The 1987 Executive Stock Option Plan ("Option Plan") provided for granting to officers and key employees options to purchase UNUM Corporation common stock over ten years at a price not less than 100% of the fair market value on the date of grant. Options outstanding under the Option Plan are included in the summary of stock options.
Beginning in 1991, certain officers were granted limited stock appreciation rights ("LSARs") in tandem with their outstanding options. LSARs afford the optionee the right to receive payment upon a change in control as defined in the plans equal to the higher of the excess of the highest price per share paid in connection with such change in control or the fair market value per share, over the option price per share. As an underlying stock option is exercised, the LSARs are automatically canceled. At December 31, 1994, 1993 and 1992, there were 590,275 LSARs, 556,500 LSARs, and 685,550 LSARs outstanding, respectively.
The following is a summary of stock options and restricted stock information:
The 1998 Goals Stock Option Plan ("1998 Option Plan") was introduced in January 1995. The 1998 Option Plan provides for granting to all eligible employees up to 150 options to purchase UNUM Corporation common stock at a price not less than 100% of the fair market value on the date of the grant. The options will vest to the employee in January 2004; however, if UNUM achieves its 1998 goals, vesting will be accelerated to early 1999.
Effective January 1, 1993, UNUM adopted Financial Accounting Standard No. 109, "Accounting for Income Taxes," which changed the method for calculating and reporting deferred income taxes in the financial statements from the deferred method to the liability method. The liability method of accounting for income taxes requires that deferred tax liabilities or assets at the end of each period be determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Under this method, income tax will increase or decrease in the same period in which a change in tax rate is enacted. The cumulative effect of this accounting change amounted to a $20.0 million increase in net income, or $0.25 per share, for the year ended December 31, 1993.
Deferred income tax liabilities and assets were comprised of the following:
As of December 31, 1994, deferred U.S. income taxes have not been provided on the accumulated earnings of UNUM's foreign subsidiaries. These earnings would become subject to U.S. tax if remitted to UNUM Corporation.
Aggregate maturities of long-term debt are as follows: 1995-$0; 1996-$16.2 million; 1997-$48.2 million; 1998-$29.8 million; 1999-$21.4 million; thereafter-$66.5 million.
On February 28, 1995, UNUM borrowed $100 million under the revolving credit facility, which was infused into UNUM America in exchange for surplus debentures. Repayment of principal and interest on the surplus debentures is subject to state insurance regulatory approval.
In September 1993, UNUM announced the resumption of a program to repurchase its common stock pursuant to an existing Board of Directors' resolution. On February 11, 1994, UNUM's Board of Directors voted to expand UNUM's authorization to repurchase an additional 5.0 million shares, bringing the total number of shares authorized for repurchase to 44.0 million shares. Since the resumption of the stock repurchase program, UNUM has acquired approximately 7.6 million shares of its common stock through December 31, 1994, in the open market at an aggregate cost of $375.8 million. No shares were acquired in the open market during 1992 or 1991. At December 31, 1994, approximately 2.7 million shares remained authorized for repurchase.
Under the Long-Term Stock Incentive Plan and Executive Stock Option Plan and the plans of Colonial Companies, Inc. (see Note 9 "Option and Incentive Plans"), 329,579 shares, 687,825 shares, and 894,747 shares were issued in 1994, 1993 and 1992, respectively.
UNUM Corporation also has the ability to draw a dividend of approximately $30 million from its United Kingdom based affiliate, UNUM Limited, subject to certain U.S. tax consequences.
UNUM reports its operations principally in six business segments: Employee Benefits, Related Businesses, Colonial Companies, Individual Disability, Retirement Security and Other Operations.
The Employee Benefits segment includes group long term disability, group life and other employee benefits products, including short term disability, accidental death and dismemberment and dental insurance. The Related Businesses segment includes UNUM Limited in the United Kingdom, Commercial Life Insurance Company, and reinsurance operations including Duncanson & Holt, Inc. The Colonial Companies segment includes Colonial Companies, Inc. and subsidiaries, which offer payroll-deducted, voluntary employee benefits to employees at their worksites. The Individual Disability segment includes disability income products. The Retirement Security segment includes tax sheltered annuities, long term care insurance and lifestyle security protection products. The Other Operations segment includes individual life insurance business of UNUM Life Insurance Company of America, group medical operations, guaranteed investment contracts, deposit administration accounts, and 401(k) plans, all of which are no longer actively marketed by UNUM. Corporate includes transactions which are generally non-insurance related and expenses incurred to effect the March 26, 1993, merger of UNUM and Colonial.