UNUM owns home office property consisting of six office buildings and four service buildings located throughout the Portland, Maine, area. UNUM also owns an office building in the United Kingdom, which is the home office of UNUM Limited. The home office of the Colonial Companies, located in Columbia, South Carolina, is also owned by UNUM. In addition, UNUM leases, on periods principally from three to six years, office space for use by its home office, affiliates, and sales forces.
The decrease in pretax operating income in 1995 was primarily attributable to higher benefit ratios at UNUM Limited and in the group LTD and group life businesses, increased interest expense, and lower interest spread margins on the tax sheltered annuity business. Partially offsetting these items were increased investment income, a lower benefit ratio in the individual disability business, and lower expenses.
During the second quarter of 1995, UNUM sold virtually all of the common stock portfolio of its United States subsidiaries, primarily due to consideration of statutory capital requirements associated with investment in common stocks and to increase future investment income. The sale of the common stock portfolio contributed to significantly higher pretax realized investment gains for the year ended December 31, 1995, as compared with 1996 and 1994. UNUM reinvested the proceeds from the sale of the common stock portfolio primarily in investment grade fixed income assets, which decreased the required amount of statutory capital for regulatory purposes and increased investment income. Dependent on capital considerations and market conditions, UNUM may invest in equity securities in the future.
Bermuda based reinsurance specialist, for reinsurance coverage of the active life reserves of UNUM America's existing United States non-cancellable individual disability block of business. As a result, UNUM recognized a pretax charge of $49.7 million in the Disability Insurance segment, which represents the present value of the anticipated minimum amount of fees to be paid to Centre Re under the agreement. For additional information see the Disability Insurance segment discussion.
In connection with the merger of Commercial Life Insurance Company ("Commercial Life") into UNUM America, the sale of UNUM America's tax sheltered annuity business, as well as UNUM's continued efforts to strengthen its focus on its core products, the company initiated a review of certain products, which resulted in the recognition of pretax charges totaling $39.4 million during third quarter 1996. These charges reduced income before income taxes by $13.1 million in the Disability Insurance segment, $11.3 million in the Special Risk Insurance segment, and $15.0 million in the Retirement Products segment, for the year ended December 31, 1996.
The charges include the write-off of certain intangible assets, primarily deferred acquisition costs, totaling $17.0 million. These intangible assets have been deemed unrecoverable primarily due to the expectation of continued losses in the Association Group disability business. Additionally, in conjunction with the completion of a review of UNUM's discontinued product portfolio, a $22.4 million charge was taken to establish a reserve for the present value of expected future losses on certain discontinued products. Future losses for these products will be charged to the reserve at the time the losses are realized. The products incorporated in the charge consist of certain discontinued special risk, retirement and medical products. UNUM is pursuing the sale of some of these discontinued product lines.
During the third quarter of 1996, actions related to the merger of Commercial Life into UNUM America resulted in a $10.1 million increase in operating expenses for Corporate. The $10.1 million charge consisted of $2.9 million of direct costs incurred and the recording of a $7.2 million restructuring charge to recognize $2.8 million of future severance costs for 120 employees and $4.4 million of lease exit costs, primarily related to the merger.
Reserves for certain disability products are discounted using an interest rate which is a composite yield of assets identified with each product. As a result of the sale of the common stock portfolio, which had partially supported these disability reserves, and the subsequent reinvestment of the proceeds primarily in investment grade fixed income assets at yields below the average portfolio yield, certain reserve discount rates were lowered during second quarter 1995. For the year ended December 31, 1995, the effect of lowering these discount rates was an increase to the reserve liabilities and benefits to policyholders reported in the Disability Insurance segment of $128.6 million.
During the second quarter of 1995, UNUM increased the group LTD reserves for incurred but not reported ("IBNR") claims and benefits to policyholders reported in the Disability Insurance segment by $38.4 million. IBNR reserves, which are established to fund anticipated case reserves for claims which have been incurred but not reported to UNUM, are actuarially established based on various factors, including incidence levels and claims severity. The increased IBNR reserves were based on management's judgment that claims incurred but not yet reported would reflect increased levels of claims incidence and severity.
In the fourth quarter of 1994, UNUM recorded a pretax charge of $14.4 million related to the decision to discontinue the individual disability non-cancellable product and the acceleration of organizational changes within UNUM America, which increased operating expenses in the Disability Insurance segment for the year ended December 31, 1994. The charge consisted of $9.2 million for severance costs for 379 employees and $5.2 million for exit costs of certain leased facilities and equipment.
The Disability Insurance segment's pretax operating income increased in 1996, as compared with 1995. The increase was primarily attributable to increased investment income and lower benefit ratios in group LTD and at UNUM Limited, partially offset by increased operating expenses for the segment and higher benefit ratios in certain other disability businesses including individual disability, disability reinsurance operations and Association Group disability.
The agreement is a finite reinsurance arrangement that transfers liabilities to Centre Re based on the level of statutory reserves. At December 31, 1996, active life reserves of $427 million and reserves established for claims in 1996 of $137 million were ceded to Centre Re. Under the agreement, Centre Re has an obligation to fund a defined risk layer, while UNUM will retain the earnings risk related to potential adverse claims experience up to a certain threshold. This threshold amount represents the existence of an experience layer with a value of $195 million at December 31, 1996. UNUM has recorded the value of the experience layer on its Consolidated Balance Sheet as a deposit asset. UNUM funded its obligation under the agreement by transferring assets totaling approximately $403 million into a trust account in late December 1996. The assets transferred were equal to the experience layer plus reserves, determined under generally accepted accounting principles, net of related deferred acquisition costs. Future net cash flows of the block will be transferred to/from the trust account and, together with changes in reserve levels, will determine the value of UNUM's deposit asset. Changes in the deposit asset will flow through UNUM's results of operations. The agreement generated slightly more than $200 million of statutory capital, which will be available to repurchase UNUM common stock.
Deferrals of policy acquisition costs decreased in 1996 and 1995 primarily due to lower sales of the traditional, fixed price, non-cancellable individual disability product, as it was discontinued in each state during 1996 and 1995 following regulatory approval of the Lifelong Disability Protection product.
time. Additionally, UNUM Limited incurred increased operating expenses in 1996, which were primarily the result of increased investments in information systems technology and risk management programs. Due to the relative size of UNUM Limited's block of business, operating results can exhibit claims variability.
For the year ended December 31, 1996, pretax operating income for individual disability was favorably affected by increased investment income, partially offset by a higher benefit ratio as compared with the same period in 1995. The higher benefit ratio was primarily attributable to a decrease in premium growth and the inclusion of the Association Group disability business, which was affected by unfavorable claims experience. Premium growth continued to decline as a result of the transition to the guaranteed renewable Lifelong Disability Protection ("LDP") product as a result of management's decision in late 1994 to discontinue sales of the traditional, fixed price, non- cancellable product in the United States. Following the approval of the LDP product, sales of the non-cancellable individual disability product have been discontinued in the United States.
Group STD's contribution to the Disability Insurance segment's pretax operating income continued to increase in 1996, primarily due to strong premium growth, reflecting management's continuing efforts to cross-sell the group STD products with group LTD and group life products. Partially offsetting the effects of strong premium growth were higher operating expenses primarily relating to investments in risk management programs and the inclusion of certain office relocation expenses in 1996.
(a) For the definition of pretax operating income and a detailed description of special items see the Consolidated Overview.
The improved benefit ratio for group life was primarily attributable to favorable claims experience, coupled with pricing and risk management actions implemented in 1995. Solid sales results, improved persistency trends,
The decrease in pretax operating income for 1995, as compared with 1994, was primarily attributable to increased claims in the group life and special risk accident insurance businesses, combined with reduced fee income from the reinsurance underwriting management operations. Partially offsetting these decreases were continued premium growth, and favorable claims experience in certain reinsurance pools.
The Colonial Products segment reported increased pretax operating income for the year ended December 31, 1996, as compared with 1995. The increase in pretax operating income was primarily attributable to favorable benefit ratios in the life, and accident and sickness product lines, and increased investment income, partially offset by an increased operating expense ratio. During 1996, Colonial entered into an agreement to reinsure a majority of the mortality risk on new and inforce universal life business. The reinsurance agreement negatively affects reported premium growth and related expense ratios while positively affecting reported benefit ratios. Colonial's pretax operating income increased in 1995 as compared to 1994, primarily because of increased investment income and an improved benefit ratio.
The expense ratio increased in 1996 primarily due to the impact of the universal life reinsurance agreement. Excluding the impact of the universal life reinsurance agreement, the expense ratio declined slightly compared to 1995 as a result of continuing expense management efforts.
Fees and other income reported by the TSA business increased in 1996, reflecting a $38.2 million reimbursement of interest credited from Lincoln under the reinsurance agreement. UNUM will continue to report the amount of interest credited to TSA contracts for which the consent to transfer from indemnity reinsurance to assumption reinsurance has not been received, with an equivalent amount being reported in fees and other income for the reimbursement from Lincoln. The group TSA businesses accounted for $13.5 million, $16.4 million and $31.6 million of the Retirement Products segment's pretax operating income in 1996, 1995 and 1994, respectively.
Effective tax rates, which reflect income tax expense as a percentage of income before income taxes, were 30.3%, 26.4% and 22.1% for 1996, 1995 and 1994, respectively. Reported income tax expense was below the federal statutory tax rate of 35% primarily due to tax savings from investments in tax-exempt securities. The increase in the effective tax rate over the three year period was primarily due to reduced tax-exempt income, both in amount and as a percentage of income before income taxes. Beginning in late 1996, UNUM commenced a plan to increase purchases of tax-exempt bonds and mortgages.
UNUM's long term investment strategy is to invest primarily in investment grade bonds and commercial mortgages. UNUM evaluates total expected return after consideration of associated expenses and losses, within criteria established for each product line. Product line investment strategies are developed to complement business risks by meeting the liquidity and solvency requirements of each product. UNUM purchases assets with maturities, expected cash flows and prepayment conditions that are consistent with these strategies. The nature and quality of the types of investments comply with policies established by management, which are more stringent overall than the statutes and regulations imposed by the jurisdictions in which UNUM's insurance subsidiaries are licensed.
UNUM's invested assets were $8.7 billion and $11.7 billion at December 31, 1996, and 1995, respectively. The decrease from 1995 reflects asset transfers that occurred in the fourth quarter of 1996, as discussed below. The composition of UNUM's invested assets at December 31, 1996, was 79.6% fixed maturities, 13.0% mortgage loans, 2.8% real estate and 4.6% other invested assets.
In late December 1996, UNUM transferred approximately $403 million in cash into a trust account held for the benefit of Centre Life Reinsurance Limited ("Centre Re"), in accordance with the reinsurance agreement between UNUM America and Centre Re, which became effective December 31, 1996 (see Note 6 in Item 8). On October 1, 1996, UNUM transferred approximately $2,690 million of assets into a trust account held for the benefit of Lincoln to effect the sale of the TSA business (see Note 5 in Item 8). The assets transferred consisted of approximately $1,826 million of short-term investments, $589 million of fixed maturities and $275 million of cash.
During the second quarter of 1995, UNUM sold virtually all of the common stock portfolio of its United States subsidiaries, primarily due to consideration of statutory capital requirements associated with investment in common stocks and to increase future investment income. UNUM reinvested the proceeds from the sale of the common stock portfolio primarily in investment grade fixed income assets. Dependent on capital considerations and market conditions, UNUM may invest in equity securities in the future.
Gross realized investment gains were $40.2 million, $287.0 million and $117.0 million, and gross realized investment losses were $36.8 million, $61.9 million and $71.4 million for the years ended December 31, 1996, 1995 and 1994, respectively.
UNUM's fixed maturity portfolio is concentrated in high quality intermediate term bonds, which management believes are well diversified by company and industry sector. At December 31, 1996, over 80% of the bond portfolio was rated "A" or better. Fixed maturity ratings are obtained from external rating agencies or are determined by UNUM internally using similar methods if external ratings are not available. The bond portfolio is primarily composed of taxable corporate bonds. In late 1996, UNUM commenced a plan to increase purchases of tax-exempt bonds and mortgages due to after-tax yield considerations. Dependent on market conditions and tax considerations, these tax-exempt securities can provide attractive after-tax yields as compared with similarly rated taxable securities.
Bond Credit Quality Ratings 1996 1995 - ----------------------------- ---------- ---------- AAA ........................ 10.6% 12.0% AA ........................ 12.2 12.4 A ........................... 57.3 57.1 BAA ........................ 18.4 17.0 Below BAA .................. 1.5 1.5 ------ ------ Total ..................... 100.0% 100.0% ====== ======
Bond credit quality ratings are based on the capacity of the borrower to meet interest and principal payments as they come due. Capacity is considered extremely strong for AAA rated issues; AA very strong; A strong; and BAA adequate. Bonds rated below BAA are considered to have a vulnerability to default.
At December 31, 1996, and 1995, impaired loans totaled $50.4 million and $50.1 million, respectively. Included in the $50.4 million of impaired loans at December 31, 1996, were $38.9 million of loans which had a related allowance for probable losses of $5.7 million, and a loan of $11.5 million which had no related allowance for probable losses. Interest lost on impaired loans in 1996, 1995 and 1994, was not material.
Mortgage loans that were restructured prior to the adoption of FAS 114 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, 1996, restructured mortgage loans totaled $54.8 million, as compared with $59.9 million at December 31, 1995. Interest lost on restructured loans was not material in 1996, 1995 or 1994.
Additions to the allowance for probable losses related to real estate held for sale resulted in a realized investment gain of $0.4 million and realized investment losses of $6.3 million and $0.8 million for the years ended December 31, 1996, 1995 and 1994, respectively. Additions to the allowance represent charges to net realized investment gains less recoveries. Current and anticipated real estate acquired through foreclosure is not expected to have a significant affect on UNUM's results of operations, liquidity, or capital resources.
Effective January 1, 1996, UNUM adopted FAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which established accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long- lived assets and certain identifiable intangibles to be disposed of. FAS 121 applies to both real estate held for investment and real estate held for sale. The adoption of FAS 121 did not have a material affect on UNUM's results of operations or financial position.
from generally accepted accounting principles, are mandated by regulators in an insurance company's state of domicile.
On July 16, 1996, UNUM filed an omnibus shelf registration with the Securities and Exchange Commission, which became effective August 2, 1996, relating to $500 million of securities (including debt securities, preferred stock, common stock and other securities). On August 15, 1996, UNUM filed a prospectus supplement to establish a $250 million medium-term note program under the shelf registration.
In the normal course of business, UNUM enters into letters of credit, primarily to satisfy capital requirements related to certain subsidiary transactions. UNUM had outstanding letters of credit of $56.7 million and $12.3 million at December 31, 1996, and 1995, respectively.
Standard & Poor's Corporation ("Standard & Poor's"), Moody's Investors Service ("Moody's") and A.M. Best Company ("A.M. Best") 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 individual 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. Debt ratings for UNUM Corporation are based on consolidated financial information prepared using generally accepted accounting principles.
The Risk-Based Capital standards for life insurance companies, as prescribed by the National Association of Insurance Commissioners, 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.
UNUM periodically uses common derivative financial instruments such as options, futures and forward exchange contracts to hedge certain risks associated with anticipated purchases and sales of investments and certain payments denominated in foreign currencies, primarily British pound sterling, Canadian dollar and Japanese yen. These derivative financial instruments are used to protect UNUM from the effect of market fluctuations in interest and exchange rates between the contract date and the date on which the hedged transaction occurs. In using these instruments, UNUM is subject to the off-balance-sheet risk that the counterparties of the transactions will fail to perform as contracted. UNUM manages this risk by only entering into contracts with highly rated institutions and listed exchanges. UNUM does not hold derivative financial instruments for the purpose of trading.
At December 31, 1996, UNUM had open interest rate futures contracts with notional amounts of $178.2 million to hedge anticipated sales of investments in 1997. These contracts had a related net unrealized gain of $1.6 million. At December 31, 1995, UNUM had no open derivative financial instruments.
On December 29, 1993, UNUM filed suit in the United States District Court for the District of Maine, seeking a federal income tax refund. The suit is based on a claim for a deduction in certain prior tax years, for $652 million in cash and stock distributed to policyholders in connection with the 1986 conversion of Union Mutual Life Insurance Company to a stock company. UNUM has fully paid, and provided for in prior years' financial statements, the tax at issue in this litigation. On May 23, 1996, the District Court issued its decision that the distribution in question was not a deductible expenditure. UNUM believes its claims are meritorious, and has appealed the decision to the United States Court of Appeals for the First Circuit. The ultimate recovery, if any, cannot be determined at this time.
Changing interest rates, which are traditionally linked to changes in inflation, affect UNUM's level of discounted reserves. While rising interest rates are beneficial when the company is investing current cash flows, they can also reduce the fair value of existing fixed rate long-term investments. In addition, lower interest rates can lead to early payoffs and refinancing of some of UNUM's fixed rate investments. Management generally invests in fixed rate instruments that are structured to limit the exposure to such reinvestment risk.
[bullet] Short-term investments--are considered available for sale and are carried at cost which approximates fair value.
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. Unrealized gains and losses related to securities classified as available for sale are excluded from net income and reported in a separate component of stockholders' equity, net of applicable deferred taxes and related adjustments to unpaid claims and claim expenses. The unrealized gains and losses are determined based on estimated market values at the balance sheet date and are not necessarily the amounts which would be realized upon sale of the securities or representative of future market values. Changing interest rates affect the level of unrealized gains and losses related to securities classified as available for sale. While rising interest rates are beneficial when investing current cash flows, they can also reduce the fair value of existing fixed rate long-term investments. In addition, lower interest rates can lead to early payoffs and refinancing of some of UNUM's fixed rate investments. Management generally invests in fixed rate instruments that are structured to limit the exposure to such reinvestment risk.
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.
For individual disability, group disability, and group life and health business, the costs are amortized in proportion to expected future premiums. For universal life products, the costs are amortized in proportion to estimated gross profits from interest margins, mortality and other elements of performance under the contracts. Amortization is adjusted periodically to reflect differences between actual experience and original assumptions, with any resulting changes reflected in current operating results. The amounts deferred and amortized were as follows:
1996 1995 --------------- -------------- Individual disability ............... 6.0% to 9.5% 5.5% to 9.5% Individual life ..................... 5.0% to 9.0% 5.0% to 9.0% Individual accident and health ...... 5.0% to 9.0% 5.0% to 9.0% Individual and group annuities ...... 5.0% to 9.0% 5.0% to 9.0%
Unpaid claims and claim expense reserves represent the amount estimated to fund claims that have been reported but not settled and claims incurred but not reported. Reserves for unpaid claims are estimated based on UNUM's historical experience and other actuarial assumptions that 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 interest rates used in the calculation of disability claims reserves at December 31, 1996, and 1995, were principally as follows:
The interest rate used to discount the disability reserves is a composite of the yields on assets specifically identified with each block of business. Management expects the reserve discount rate for certain disability products will further decline, since current cash flows are invested in high quality assets at current yields, which are below the composite yield of the existing assets purchased in prior years. UNUM periodically adjusts prices on both existing and new business in an effort to mitigate the impact of the current interest rate environment.
During 1994, UNUM increased reserves for existing claims by $83.3 million and strengthened reserves for estimated future losses by $109.1 million. These increased reserves reflected management's expectations of morbidity trends for the existing non-cancellable individual disability business, reported in the Disability Insurance 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.
On October 1, 1996, UNUM America and First UNUM closed the sale of their respective TSA businesses to The Lincoln National Life Insurance Company and Lincoln Life & Annuity Company of New York ("Lincoln"), both subsidiaries of Lincoln National Corporation (see Note 5). For legal considerations, the separate account's TSA-related assets were not transferred on October 1, 1996. TSA-related assets will be transferred only upon receipt of a contractholder and/or participant's consent for assumption reinsurance. Beginning in 1997, the assets of UNUM's defined benefit plan are no longer held in the separate accounts (see Note 8).
The provision for income taxes includes amounts currently payable and deferred income taxes, which result from differences between financial reporting and tax bases of assets and liabilities, and are measured using enacted tax rates and laws. Deferred U.S. income taxes have not been provided on accumulated earnings of UNUM's foreign subsidiaries. These earnings could generate additional U.S. tax if remitted to UNUM Corporation. A valuation allowance is established for deferred tax assets when it is more likely than not that an amount will not be realized.
Foreign subsidiaries' balance sheet and income statement accounts expressed in local functional currencies are translated into U.S. dollars using ending and quarterly average exchange rates, respectively. The resulting translation adjustments are reported in a separate component of stockholders' equity.
In June 1996, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standard ("FAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," which establishes accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. The statement provides guidance for recognition or derecognition of assets and
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) liabilities, focusing on the concepts of control and extinguishment. UNUM is required to adopt FAS 125 effective January 1, 1997. The adoption of FAS 125 is not expected to have a material effect on UNUM's results of operations or financial position.
In March 1997, the FASB issued FAS No. 129, "Disclosures of Information About Capital Structure," which clarifies disclosure requirements related to the type, and nature, of securities contained in an entity's capital structure. UNUM is required to adopt FAS 129 effective December 31, 1997.
In November 1995, the FASB issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities," which provided a one-time opportunity to reassess the appropriateness of the classifications of securities described in FAS 115, and to reclassify fixed maturities from the held to maturity category without calling into question the intent to hold other debt securities to maturity in the future. On December 31, 1995, UNUM reassessed its fixed maturity portfolio and as allowed under the implementation guidance, reclassified fixed maturities with an amortized cost of $6,082.8 million and a related unrealized gain of $393.0 million from the held to maturity category to available for sale. The unrealized gain on the total available for sale fixed maturity portfolio was $551.9 million at December 31, 1995. In connection with the reclassification of the held to maturity fixed maturities to available for sale, on December 31, 1995, UNUM adjusted its unpaid claims by $261.2 million to reflect the changes that would have been necessary if the unrealized gains and losses related to fixed maturities classified as available for sale had been realized. At December 31, 1996, the unrealized gain on available for sale fixed maturities was $286.0 million and the related unpaid claims adjustment was $168.7 million.
The amortized cost and fair values of fixed maturities available for sale at December 31, 1995, were as follows:
Effective January 1, 1995, UNUM adopted Financial Accounting Standard ("FAS") No. 114, "Accounting by Creditors for Impairment of a Loan" and FAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures," which defined the principles to measure and record an impaired loan. When it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of a loan agreement, the loan is deemed impaired. Once a loan is determined to be impaired, an allowance for probable losses is established for the difference between the carrying amount of the loan and its estimated value. The estimated value is based on either the present value of expected future cash flows discounted using the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral. The adoption of FAS 114 and FAS 118 did not have a material effect on UNUM's results of operations or financial position.
At December 31, 1996, and 1995, impaired loans totaled $50.4 million and $50.1 million, respectively. Included in the $50.4 million were $38.9 million of loans which had a related allowance for probable losses of $5.7 million, and a loan of $11.5 million which had no related allowance for probable losses. Included in the $50.1 million of impaired loans at December 31, 1995, were $38.4 million of loans which had a related allowance for probable losses of $7.1 million, and a loan of $11.7 million which had no related allowance for probable losses.
Mortgage loans that were restructured prior to the adoption of FAS 114 amounted to $54.8 million and $59.9 million at December 31, 1996, and 1995, respectively. Troubled debt restructurings represent loans that are
Effective January 1, 1996, UNUM adopted FAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which established accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. FAS 121 applies to both real estate held for investment and real estate held for sale. The adoption of FAS 121 did not have a material effect on UNUM's results of operations or financial position.
NOTE 3. ALLOWANCE FOR PROBABLE LOSSES ON INVESTED ASSETS AND REAL ESTATE HELD FOR SALE
To effect the sale of the TSA business, UNUM transferred into a trust account held for the benefit of Lincoln approximately $2,690 million of assets. The assets transferred consisted of approximately $1,826 million of short- term investments, $589 million of fixed maturities, and $275 million of cash. The amount of assets in the trust will increase or decrease in conjunction with the on-going activity in participant accounts, and assets will be released from the trust to Lincoln upon consents for assumption reinsurance. UNUM has recorded a deposit asset in its Consolidated Balance Sheet representing the assets remaining in the trust, which supports the TSA contracts of those contractholders and/or participants that have not given consent for assumption reinsurance. At December 31, 1996, the deposit asset related to the TSA transaction was approximately $2,651 million.
In fourth quarter 1996, UNUM recognized a pretax charge of $49.7 million, which represents the present value of the anticipated minimum amount of fees to be paid to Centre Re under the agreement. UNUM has the right, but no obligation, to recapture the business after five years, with certain penalties.
Charges of $7.2 million, $8.4 million and $14.4 million were recorded in 1996, 1995 and 1994, respectively. The charge in 1996 was related to the merger of Commercial Life Insurance Company ("Commercial Life") into
At December 31, 1996, UNUM had a noncontributory defined benefit pension plan covering substantially all domestic employees, excluding employees of Colonial Companies, Inc. ("Colonial Companies") and Duncanson & Holt, Inc. ("D&H"), who were covered under separate plans through 1996. The plan provided benefits based on the employee's years of service and compensation during the highest five consecutive years out of the last ten years of employment. Plan assets, which were held in UNUM's separate accounts, consisted primarily of group annuity contracts and 224,392 shares of UNUM Corporation common stock. UNUM funds its pension plan in accordance with the requirements of the Employee Retirement Income Security Act of 1974, as amended.
The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.50% and 5.00%, respectively, at December 31, 1996, and 7.25% and 4.70%, respectively, at December 31, 1995. The expected long-term rate of return on plan assets was 9.0% in 1996, 1995 and 1994. Prior year service costs are being amortized on a straight-line basis over expected employment periods for active employees.
UNUM has several retirement savings and profit sharing plans for substantially all full-time and part-time employees who work 1,000 hours a year and have been employed for at least one year. Dependent upon which
NOTE 8. EMPLOYEE BENEFIT PLANS (Continued) plan the employee participates in, eligible employees may contribute primarily up to 10% of their annual base salary, and UNUM matches a portion of each employee's contribution up to 6% of the employee's compensation. Employees may become 100% vested immediately upon becoming eligible to participate, or incrementally over a five year period. Expense for these plans amounted to $8.4 million in 1996, 1995 and 1994, respectively.
Effective January 1, 1997, UNUM introduced a single retirement savings plan for all domestic employees who meet the eligibility requirement of one year of service, including all employees eligible under the former plans. Dependent upon the employee's annual earnings, eligible employees may contribute up to 15% of their annual compensation, including incentive payouts. UNUM will match 100% of the employee's contribution up to 3% of the employee's compensation, plus 50% of the employee's contribution on the next 2% of the employee's compensation, to a maximum of 4%. Employees become 100% vested immediately upon becoming eligible to participate.
Effective January 1, 1996, UNUM adopted FAS No. 123, "Accounting for Stock-Based Compensation." FAS 123 established financial accounting and reporting standards for stock-based employee compensation plans. The statement defines a new method of accounting for employee stock compensation plans using a fair value based method, under which compensation cost is measured and recognized in results of operations. Alternatively, FAS 123 allows an entity to retain the accounting for employee stock compensation plans defined under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." UNUM retained the accounting defined in APB No. 25, under which no compensation expense is recognized for fixed stock option grants. As required, UNUM will disclose the pro forma effects of stock-based compensation using the fair value based method defined under FAS 123.
The fair value of each option granted is estimated on the date of grant using a modified Black-Scholes option- pricing model with the following assumptions:
Because some options vest over several years and additional awards generally are made each year, the pro forma amounts above may not be representative of the effects on net income for future years.
The 1990 Long-Term Stock Incentive Plan ("Incentive Plan") 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. Options may be granted annually at the discretion of the Committee and vest in one to five years.
The Incentive Plan also provides for granting to key officers restricted stock awards whose vesting is contingent upon UNUM's achieving prescribed financial performance objectives, with the exception of 5,800 shares granted in 1996, 20,200 shares granted in 1995 and 10,000 shares granted in 1994, which will vest upon the grantee remaining in UNUM's employ for a specified period of time. Plan participants are entitled to voting rights on their respective shares at grant. The compensation cost related to restricted stock grants was not material in 1996, 1995 and 1994.
The number of shares subject to issuance under the Incentive Plan cannot exceed 6.8 million, including both options and shares of restricted stock. At December 31, 1996, 1995 and 1994, 692,518 shares, 1,680,235 shares and 2,511,145 shares, respectively, were available for grant under the Incentive Plan.
The 1998 Goals Stock Option Plan ("1998 Option Plan") provides for granting to all eligible employees up to 150 options to purchase UNUM Corporation common stock. The options will vest to the employee nine years from the date of grant. Vesting may be accelerated to an earlier date if it is determined that UNUM has attained the 1998 Goals. Grants of 102,500 shares and 1,105,350 shares were made in 1996 and 1995, respectively. Additional grants will be made in 1997. The number of shares subject to options under this plan cannot exceed 1.5 million.
For all of UNUM's stock based compensation plans, the exercise price of each option is not less than 100% of the fair market value of UNUM's stock on the date of grant.
A summary of the status of UNUM's four stock-based compensation plans as of December 31, 1996, 1995 and 1994, and changes during the years then ended is presented below:
The number and weighted-average exercise price of exercisable shares as of December 31, 1996, 1995 and 1994 was 2,381,592 shares at $41.45 per share, 2,108,060 shares at $39.13 per share, and 1,975,219 shares at $32.54 per share, respectively.
The weighted-average fair value of options granted during the years ended December 31, 1996, and 1995 was $13.83 and $10.20, respectively.
December 31, -------------------- (Dollars in millions) 1996 1995 - ------------------------------------------------------ --------- -------- Deferred tax liabilities: Deferred policy acquisition costs .................. $210.7 $321.6 Policy reserve adjustments ........................ 106.5 -- Net unrealized gains .............................. 101.7 174.0 Value of business acquired ........................ 19.8 17.7 Invested assets .................................... 9.6 10.9 Other ............................................. 11.0 16.0 ------- ------- Gross deferred tax liabilities .................. 459.3 540.2 ------- ------- Deferred tax assets: Alternative minimum tax credit carryforwards ...... 1.1 29.0 Policy reserve adjustments ........................ -- 65.9 Net realized losses .............................. 17.4 25.1 Postretirement benefits ........................... 26.7 22.1 Deferred gains .................................... 28.5 -- Accrued liabilities .............................. 27.0 -- Other ............................................. 26.8 12.1 ------- ------- Gross deferred tax assets ........................ 127.5 154.2 Less valuation allowance ........................... 10.0 6.0 ------- ------- Net deferred tax assets ........................... 117.5 148.2 ------- ------- Net deferred tax liability ........................ $341.8 $392.0 ======= =======
Prior to the Tax Reform Act of 1984 ("1984 Act"), half the excess of the tax basis gain from operations of a life insurance company over its taxable investment income was currently taxable. The other half was set aside in a Policyholders Surplus Account, together with certain special life insurance company deductions. The cumulative amount in the Policyholders Surplus Account as of December 31, 1983, was frozen by the 1984 Act and amounted to $31.8 million at December 31, 1996. Any direct or indirect distributions from this account would be taxed at current tax rates; however, no provision has been made for related taxes. If the amount set aside in this account were taxed at the current rate at December 31, 1996, for all life insurance subsidiaries, the tax would have amounted to $11.1 million.
UNUM's Consolidated Statements of Income for 1996, 1995 and 1994, included the following amounts of foreign income and related income tax expense:
Year Ended December 31, ------------------------------ (Dollars in millions) 1996 1995 1994 - ------------------------------ -------- --------- ------- Foreign income ............ $27.4 $ (1.2) $24.2 ====== ====== ====== Income tax expense (credit): Current .................. $10.4 $ 1.4 $ 0.7 Deferred .................. 1.8 (0.2) 9.7 ------ ------ ------ Total ..................... $12.2 $ 1.2 $10.4 ====== ====== ======
Notes payable consisted of the following at December 31, 1996, and 1995:
At December 31, 1996, UNUM Corporation had a $500 million committed revolving credit facility that expires on October 1, 2001. UNUM's commercial paper program is supported by the revolving credit facility and is available for general liquidity needs, capital expansion, acquisitions or stock repurchase. The committed revolving credit facility contains certain covenants which, among other provisions, require maintenance of certain levels of stockholders' equity and limits on debt levels.
Under UNUM's stock-based compensation plans and the plans of Colonial Companies (see Note 9), 730,561 shares, 612,138 shares and 329,579 shares were issued in 1996, 1995 and 1994, respectively.
UNUM adopted a Shareholder Rights Plan on March 13, 1992. Under the Plan, each Right, under certain specific circumstances, entitles the holder to purchase one one-hundredth of a share of Series A Junior Participating
NOTE 12. CAPITAL STOCK AND PREFERRED STOCK PURCHASE RIGHTS (Continued) Preferred Stock at a purchase price of $150. The Rights become exercisable at a specified time after (1) a person or group acquires 10% or more of UNUM Corporation common stock or (2) a tender or exchange offer for 10% or more of UNUM Corporation common stock. The Rights expire at the close of business on March 13, 2002, unless earlier redeemed by the Company under certain circumstances at a price of $0.01 per Right.
UNUM is subject to various state insurance regulatory restrictions that limit the maximum amount of dividends available from its United States domiciled insurance subsidiaries without prior approval. The amount available under current law for payment of dividends during 1997 to UNUM Corporation from all U.S. domiciled insurance subsidiaries without state insurance regulatory approval is approximately $153 million. Dividends in excess of this amount may only be paid with state insurance regulatory approval. The aggregate statutory capital and surplus of the United States domiciled insurance subsidiaries of UNUM Corporation was approximately $1,205 million and $1,149 million, at December 31, 1996, and 1995, respectively. The aggregate statutory net operating income, which excludes realized investment gains net of tax, of UNUM Corporation's United States domiciled insurance subsidiaries was approximately $167 million, $143 million and $33 million for 1996, 1995 and 1994, respectively. State insurance regulatory authorities prescribe statutory accounting practices that differ in certain respects from generally accepted accounting principles. The significant differences relate to deferred acquisition costs, deferred income taxes, non-admitted asset balances, required investment risk reserves and reserve calculation assumptions.
On December 29, 1993, UNUM filed a suit in the United States District Court for the District of Maine, seeking a federal income tax refund. The suit is based on a claim for a deduction in certain prior tax years, for $652 million in cash and stock distributed to policyholders in connection with the 1986 conversion of Union Mutual Life Insurance Company to a stock company. UNUM has fully paid, and provided for in prior years' financial statements, the tax at issue in this litigation. On May 23, 1996, the District Court issued its decision that the distribution in question was not a deductible expenditure. UNUM believes its claims are meritorious, and has appealed the decision to the United States Court of Appeals for the First Circuit. The ultimate recovery, if any, cannot be determined at this time.
Equity Securities Available for Sale: Fair values for equity securities available for sale are based on quoted market prices and are reported in the Consolidated Balance Sheets at these values.
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.
Notes Payable: Fair values of short-term borrowings approximate the carrying amount. Fair values of long-term notes are estimated using discounted cash flow analyses based on UNUM's current incremental borrowing rates for similar types of borrowing arrangements.
Investment income and net realized investment gains are allocated to the segments based on designation of ownership of assets identified to the products in each segment. Operating expenses are allocated to the segments based on direct association with a product whenever possible. If the expense cannot be readily associated with a particular product, the costs are allocated based on ratios of the relative time spent, extent of usage or varying volume of work performed for each segment.
Summarized financial information for the four business segments and Corporate is as follows:
Year Ended December 31, --------------------------------------- (Dollars in millions) 1996 1995 1994 - ------------------------------------ ----------- ----------- ----------- Revenues: Disability Insurance ............ $2,386.2 $2,472.8 $2,116.5 Special Risk Insurance ......... 811.9 750.7 647.8 Colonial Products ............... 545.5 527.3 473.9 Retirement Products ............ 283.0 357.8 369.4 Corporate ........................ 16.1 14.3 5.0 -------- -------- -------- Total revenues .................. $4,042.7 $4,122.9 $3,612.6 ======== ======== ======== Income (loss) before income taxes: Disability Insurance ............ $ 215.3 $ 217.0 $ 56.2 Special Risk Insurance ......... 79.2 60.3 65.9 Colonial Products ............... 92.4 87.7 62.7 Retirement Products ............ 1.4 45.5 42.0 Corporate ........................ (46.7) (28.6) (28.2) -------- -------- -------- Income before income taxes ...... 341.6 381.9 198.6 Income taxes ..................... 103.6 100.8 43.9 -------- -------- -------- Net income ..................... $ 238.0 $ 281.1 $ 154.7 ======== ======== ========
The following is a summary of unaudited quarterly results of operations for 1996 and 1995:
On March 14, 1997, UNUM's Board of Directors authorized a two-for-one common stock split. The split is subject to shareholder approval of a proposal to increase the number of authorized shares of common stock to 240 million from 120 million. UNUM's shareholders will vote on the proposal to increase the number of authorized shares at the Annual Meeting of Shareholders on May 9, 1997. Under the proposed split, on or about June 2, 1997, one additional share would be distributed for each share of common stock already issued, to holders of record on May 19, 1997. The financial information contained in this report has not been adjusted to reflect the impact of the proposed common stock split.