The Company also owns office buildings in the United Kingdom and Argentina, which serve as the home offices of Unum Limited and Boston Compania Argentina de Seguros SA, respectively. The property in the United Kingdom is located in Dorking, with approximately 70,000 square feet of office space located on approximately 55 acres with a portion developed for employee parking. The facility in Argentina is approximately 23,000 square feet of space within a condominium in Buenos Aries.
The trends in new annualized sales in the Employee Benefits, Individual, and Voluntary Benefits segments are indicators of the Company's potential for growth in its respective markets and the level of market acceptance of price changes and new products. The Company emphasizes integrated selling that combines employee benefit coverages, individual products, and voluntary workplace products. The Company has closely linked its various incentive compensation programs to the achievement of its goals for new sales and persistency.
The two primary categories of liabilities for policy and contract benefits are policy reserves for claims not yet incurred and claim reserves for claims that have been incurred and have future benefits to be paid. Policy reserves equal the present value of the difference between future policy benefits and expenses and future premiums, allowing a margin for profit. These reserves are applicable for the majority of the Company's business, which is traditional non-interest sensitive in nature. The claim payments are estimated using assumptions established when the policy was issued. Generally accepted accounting principles require that these assumptions not be subsequently modified unless the policy reserves are determined to be inadequate. Throughout the life of the policy, the reserve is based on the original assumptions used for the policy's issue year.
A claim reserve is established when a claim is incurred or is estimated to have been incurred but not yet reported to the Company. Policy reserves for a particular policy continue to be maintained after a claim reserve has been established. Claim reserves generally equal the Company's estimate, at the current reporting period, of the present value of the liability for future benefits to be paid on a claim. A claim reserve for a specific claim is based on assumptions derived from the Company's actual historical experience as to claim duration as well as the specific circumstances of the claimant such as benefits available under the policy, the covered benefit period and the age and occupation of the claimant. Consideration is given to historical trends in the Company's experience and to expected deviations from historical experience that result from changes in benefits available, changes in the Company's risk management policies and procedures, and other economic, environmental, or societal factors. Reserves for claims that are estimated to have already been incurred but that have not yet been reported to the Company are based on factors such as historical claim reporting patterns, the average cost of claims, and the expected volumes of incurred claims.
Claim reserves, unlike policy reserves, are subject to revision as current claim experience and projections of future factors impacting claim experience change. The Company reviews annually, or more frequently as appropriate, emerging experience to ensure that its claim reserves provide the Company's current estimate of adequate and reasonable provision for future benefits. This review includes the determination of a range of reasonable estimates within which the reserve must fall.
In determining when a decline in fair value below amortized cost of a fixed maturity security is other than temporary, the Company evaluates market conditions, relevant industry conditions and trends, rating agency actions, offering prices, trends of earnings, and other key measures for the related security. When a decline in value is determined to be other than temporary, the Company recognizes an impairment loss in the current period results to the extent of the decline in value.
Private placement fixed maturity securities with a carrying value of approximately $4.2 billion, or 17.0 percent of total fixed maturity securities at December 31, 2001, do not have readily determinable market prices. For these securities, the Company uses internally prepared valuations combining matrix pricing with vendor purchased software programs, including valuations based on estimates of future profitability, to estimate the fair value. All such investments are classified as available for sale. The Company's ability to liquidate its positions in some of these securities could be impacted to a significant degree by the lack of an actively traded market, and the Company may not be able to dispose of these investments in a timely manner. Although the Company believes its estimates reasonably reflect the fair value of those securities, the key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral (if any), and other factors may not reflect those of an active market. The Company believes that generally these private placement securities carry a credit quality comparable to companies rated Baa by major credit rating organizations.
As of December 31, 2001, the key assumptions used to estimate the fair value of private placement fixed maturity securities included the following:
Reinsurance is a contractual agreement whereby the Company's reinsurance partners assume a defined portion of the risk for future benefits payable under reinsurance contracts. The reinsurance receivable reported as an asset in the Company's consolidated statements of financial condition includes amounts due from the Company's reinsurers on current claims and estimates of amounts that will be due on future claims. Policy reserves and claim reserves reported in the Company's consolidated statements of financial condition are not reduced for reinsurance. The reinsurance receivable is generally equal to the policy reserves and claim reserves related to the risk being reinsured. The Company reduces the reinsurance receivable if recovery is not likely due to the financial position of the reinsurer or if there is disagreement between the Company and the reinsurer regarding the liability of the reinsurer.
During 2001, the Company wrote off the remaining goodwill balance related to its operations in Argentina, resulting in a decrease in before-tax and after-tax operating income of $5.4 million.
result of tax legislation enacted in the United Kingdom during 2000 that allows additional group tax relief among companies with common ownership, the Company began recognizing foreign tax benefits during 2001.
During 2000, the Company completed a series of strategic transactions designed to more closely focus its operations on its core businesses, increase its financial flexibility, support its present credit and claims-paying ratings, increase the risk-based capital ratios of the insurance subsidiaries involved, and lower its leverage ratios. The primary transaction involved agreements under which the Company reinsured on a 100 percent indemnity coinsurance basis substantially all of the individual life insurance and corporate-owned life insurance policies written by the Company's insurance subsidiaries, as well as a small block of individually underwritten group life insurance. The reinsurance agreements were effective as of July 1, 2000.
Separately, the Company reinsured on a 100 percent indemnity coinsurance basis the future claim payments on one of the Company's insurance subsidiaries' long duration group long-term disability claims that were incurred prior to January 1, 1996. The agreement was effective January 1, 2000.
Generally, because of the effort and time involved, reviews and updates of assumptions related to benefit liabilities are periodically undertaken over time and are reflected in the calculation of benefit liabilities as completed. Many
Subsequent to the merger date, the Company began to integrate the valuation procedures of the two organizations to provide for a more effective linking of pricing and reserving assumptions and to facilitate a more efficient process for adjusting liabilities to emerging trends. Included in this integration activity were a review and an update of assumptions that underlie policy and contract benefit liabilities. The purpose of the study was to confirm or update the assumptions which were viewed as likely to affect the ultimate liability for contract benefits. Accordingly, as a result of the merger, the Company accelerated the performance of its normal reviews of the assumptions underlying reserves to determine the assumptions that the newly merged Company will use in the future for pricing, performance management, and reserving.
The Employee Benefits segment includes group long-term and short-term disability insurance, group life insurance, accidental death and dismemberment coverages, group long-term care, and the results of managed disability.
The Company has adjusted its focus within the Employee Benefits segment to integrated selling that combines long-term disability, short-term disability, and group life products. During 2001, 28 percent of all new sales included long-term disability, short-term disability, and group life combined coverage. This compares to 32 percent and 26 percent for 2000 and 1999, respectively.
Sales related to employee benefits can fluctuate significantly due to large case size and timing of sales submissions. The Company implemented a number of initiatives throughout 2000 which helped maintain the sales momentum achieved during the last half of 2000 and continuing into 2001, including targeted incentive plans, organizational changes to create a greater focus on the customer, and enhanced communication with producers. In order to give the appropriate focus to the Company's primary business markets, the Company has national practice groups that focus on large employers, executive benefits, and voluntary benefits. These national practice groups partner with the Company's sales force and representatives from claims, customer service, and underwriting to present coverage solutions to potential customers and to manage existing customer accounts. The Company expects that these actions will continue to favorably impact sales growth, but management intends to maintain pricing discipline to balance sales growth and profitability, which may slow the rate of long-term sales growth.
Group disability revenue was $3,352.7 million in 2001 compared to $3,200.4 million in 2000. Group disability reported income of $336.9 million for 2001 compared to $211.0 million for 2000. Group disability results for 2001 include $7.3 million for losses related to September 11, 2001, with estimated gross ultimate losses from reported and unreported claims of $9.0 million less an estimated $1.7 million recoverable from the Company's reinsurers. The income for 2000 includes an increase of $65.6 million in group long-term disability claim reserves, discussed more fully below.
A critical part of the Company's strategy for group disability involves executing its renewal program and managing persistency, both of which management expects will have a positive impact on future premium growth and profitability. The Company has implemented pricing changes in the group disability line wherein prices may increase or decrease by market segment, as appropriate, to respond to current claim experience and other factors and assumptions. Persistency during 2001 on the overall block of group disability improved over 2000, with long-term disability persistency at 84.9 percent compared to 81.6 percent last year and short-term disability at 82.1 percent versus 80.7 percent in 2000. However, persistency on business sold in 1999 and 2000 has been unfavorable when compared to what was expected when the business was sold, resulting in additional amortization of the deferred policy acquisition costs that have a relatively high remaining asset balance.
The fundamentals underlying risk results in the group disability line continued to exhibit overall improvement in 2001, as demonstrated by the lower benefit ratio. Claim recovery rates in 2001 continued to be above historical levels but the increase in the claim recovery rates has slowed, as expected, as the Company has now fully implemented the improvements to its claim processes. Both submitted and paid claim incidence for long-term disability increased over recent years, with a portion of the increase attributable to industries impacted by the weaker economy. However, in comparing 2001 results with 2000, there was no significant increase in the types of claims normally associated with a weaker economy.
Excluding the adjustments to the disability claim liabilities discussed in the preceding paragraph, the benefit ratio for group disability was 83.5 percent in 1999 compared to 87.1 percent in 2000. For long-term disability, the ratio for 2000 was higher than in 1999. The paid claim incidence for long-term disability was lower than 1999 due to lower claim acceptance rates, and the rate of net claim resolutions continued to increase during 2000. The 2000 submitted claim incidence rate for long-term disability was higher than the rate for 1999.
The claims disruption charge taken in the fourth quarter of 1998 resulted in a $50.3 million charge for the group long-term disability line of business for the expected increase in claims durations due to management's expectation that productivity in the claims organization would be impacted as a result of planning, consolidation, and integration efforts related to the merger. If the impact of merger-related claim operations integration activities on claim durations had not been anticipated at December 31, 1998, the 1999 loss for the group long-term disability line of business would have been negatively impacted by $50.3 million. However, the shortfall of the actual 1999 experience below that assumed resulted in a negative effect on 1999 results of $18.1 million.
The benefit ratio for short-term disability decreased marginally during 2000 from the 1999 ratio. The incidence of submitted claims for short-term disability remained relatively constant throughout 2000 and 1999, declining slightly in 2000 compared to the 1999 rate. Negative impacts on the benefit ratio in 2000 were the average claim duration, which increased to its highest level in recent periods during 2000, and an increase in the average weekly indemnity.
Income in 2000 was positively impacted by a 5.7 percent revenue increase and an improvement in both the commission and operating expense ratios relative to 1999.
Group life, accidental death and dismemberment, and long-term care reported an increase in revenue for 2001 compared to 2000 due to increases in both premium income and net investment income. Premium growth was attributable to strong sales results in 2001 and improvements in persistency. Persistency for group life was 84.6 percent in 2001, an increase over the 81.5 percent for 2000. For accidental death and dismemberment, persistency was 83.0 percent and 79.5 percent for 2001 and 2000, respectively.
Group life 2001 benefits include estimated gross ultimate losses from reported and unreported claims of $17.0 million less an estimated $14.0 million recoverable from the Company's reinsurers, for a net increase in benefits of $3.0 million related to the September 11, 2001 tragedy.
The Company has implemented several actions in the group life line of business, including tighter underwriting guidelines and pricing changes, and is developing case specific remedial plans for under performing business. The Company believes these actions will improve profitability in group life, but it is uncertain whether these actions will restore the profitability that this line of business has historically reported. As a result of the actions implemented, it is expected that the sales growth rate in this business will slow from that experienced in recent years. This was evidenced by the rate of growth reported for group life sales in the fourth quarter of 2001, with a 15.2 percent and 27.0 percent decline, compared to the fourth quarter of 2000, reported for submitted and effective date basis sales, respectively.
The 2000 benefit ratio for accidental death and dismemberment was higher than 1999 due to an increase in the average paid claim size. Submitted incidence for accidental death and dismemberment improved relative to 1999.
Revenue was $2,615.8 million for 2001 compared to $2,585.6 million in 2000. Income in the individual disability line of business was $274.8 million in 2001, a decrease of 3.7 percent over the prior year. Included in the results for 2001 was $14.0 million of estimated gross ultimate losses related to September 11, 2001, less an estimated recoverable from reinsurers of $4.0 million. Excluding this $10.0 million loss, income would have been essentially level with 2000.
The benefit ratio of 107.7 percent for 2001 was slightly higher than the 2000 ratio of 106.6 percent. The interest adjusted loss ratio was 63.6 percent and 63.4 percent for 2001 and 2000, respectively. Submitted and paid claim incidence rates for the overall individual disability line of business increased from 2000 and are higher than recent historical incidence rates. The claim recovery rate for 2001 increased compared to the 2000 results. Individual disability also benefited from a slightly improved commission ratio for 2001 as compared to 2000, but the operating expense ratio increased.
The overall individual disability results for 2001 were negatively impacted by the business issued during the mid-1990s and prior years. The interest adjusted loss ratios for later issue years are significantly below the overall ratio of 63.6 percent, even in the more poorly performing market segments and product lines. The improvement in the later issue year business reflects the substantial product, distribution, and underwriting changes made during that time period. The Company is reviewing internal and external alternatives, including reinsurance, for improving the overall results in its individual disability line of business, particularly as related to business issued prior to the mid-1990s.
Income in the individual disability line of business was $285.3 million in 2000, an increase of $28.6 million from the prior year. As discussed in the preceding "Results of Operations," in the second quarter of 1999 the Company lowered the discount rate used to calculate certain of Unum's disability claim reserves to conform with Provident's process and assumptions, which decreased individual disability income by $38.9 million in 1999. Excluding this 1999 adjustment, individual disability income decreased $10.3 million in 2000 compared to 1999. See Note 2 of the "Notes to Consolidated Financial Statements" for further discussion.
The individual long-term care line of business reported a 35 percent increase in premium income for 2001 compared to 2000, primarily due to new sales growth. New annualized sales for long-term care were $53.8 million for 2001, $47.7 million for 2000, and $40.0 million for 1999. The Company expects the strong sales momentum in individual long-term care to continue. Net investment income continues to increase due to the growth in this line of business.
Income in the individual long-term care line of business was $15.9 million in 2001 compared to $12.8 million for 2000, primarily due to an increase in revenue and an improvement in the commission and operating expense ratios. The benefit ratio increased when compared to 2000. The increase over the prior year resulted primarily from an increase in the active life reserve. Paid incidence was essentially unchanged from 2000, and the claim recovery rate increased.
The individual long-term care line of business reported increased premium income for both 2000 and 1999 as compared to the previous years, primarily due to continued new sales growth. Income for 2000 was $12.8 million, compared to a loss of $2.6 million in 1999. The increase in revenue, as well as improvements in both the benefit ratio and operating expense ratios, contributed to the year over year increase.
As previously discussed, during 2001 the Company reinsured on a 100 percent indemnity coinsurance basis certain cancer policies written by the Company's subsidiary, Colonial Life & Accident Insurance Company. The transaction closed during the fourth quarter with an effective date of November 1, 2001. The Company ceded approximately $113.6 million of reserves to the reinsurer. The $12.3 million before-tax gain on this transaction was deferred and is being amortized into income based upon expected future premium income on the policies ceded. The Company will continue to market its other cancer products.
Income for 2000 increased 12.4 percent over 1999, primarily due to revenue growth of $54.8 million. An additional positive impact on 2000 income was a favorable operating expense ratio attributable to costs savings resulting from the merger. The 2000 benefit ratio was higher than the ratio reported in 1999. The primary drivers were an increase in benefits in the life product line and an increase in the incurred and paid loss ratios for the cancer product line.
The Company's reinsurance operations include the reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk assumption, which includes reinsurance pool participation; direct reinsurance which includes accident and health (A&H), long-term care (LTC), and long-term disability coverages; and Lloyd's of London (Lloyd's) syndicate participations. During 1999, the Company concluded that these operations were not solidly aligned with the Company's strength in the disability insurance market and decided to exit these operations through a combination of a sale, reinsurance, and/or placing certain components in run-off. In 1999, the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities and reinsured the Company's risk participation in these facilities. The Company also decided to discontinue its London accident reinsurance pool participation beginning in year 2000. With respect to Lloyd's, the Company implemented a strategy which limited participation in year 2000 underwriting risks, ceased participation in Lloyd's underwriting risks after year 2000, and managed the run-off of its risk participation in open years of account of Lloyd's reinsurance syndicates.
In 1999, an additional $57.7 million was recorded in the Corporate segment related to the write-off of goodwill. See "Results of Operations" contained herein in Item 7 and Note 13 of the "Notes to Consolidated Financial Statements" in Item 8 for further discussion of the 1999 and 2000 charges related to the reinsurance operations.
Also, as previously discussed in the preceding "Results of Operations," during 1999 the Company lowered the discount rate used to calculate certain of Unum's disability claim reserves to conform with Provident's process and assumptions, which decreased the group long-term disability reinsurance income reported in this line of business by $10.1 million in 1999.
In the fourth quarter of 1998, the Company recorded a $2.4 million charge related to the revised claim resolution rates for group long-term disability reinsurance. If the impact of merger-related claim operations integration activities on claim duration had not been anticipated at December 31, 1998, 1999 income for the reinsurance pools and management line of business would have been negatively impacted by $2.4 million.
Group pension, health insurance, individual annuities, and other closed lines of business had revenue of $201.3 million, $219.4 million, and $279.1 million in 2001, 2000, and 1999 and income of $14.3 million, $26.4 million, and $35.6 million. Decreases in revenue and income are expected to continue as these lines of business wind down. Included in these amounts are the Company's operating results for its operations in Argentina, which produced revenue of $47.1 million, $40.2 million, and $32.9 million in 2001, 2000, and 1999 and income (losses) of $1.1 million, $2.7 million, and $(0.8) million in each of those three years. As previously mentioned, the Company in 2001 wrote off the remaining goodwill balance of $5.4 million related to its operations in Argentina. The goodwill write-off is included in the Corporate segment operating results. The net assets related to the Argentina operations were approximately $9.2 million at December 31, 2001.
Revenue in the Corporate segment was $44.6 million in 2001, $48.1 million in 2000, and $67.7 million in 1999. As previously discussed under "Results of Operations," during 1999 the Company recorded refunds from the Internal Revenue Service relating to the final settlement of remaining issues for the 1986 through 1992 tax years. The interest on the refunds was $35.4 million and is included in 1999 revenue.
As previously discussed, during 1999 the Company recognized $310.6 million of before-tax expenses related to the merger and the early retirement offer to employees. These expenses are as follows (in millions of dollars):
Employee related expense consists of employee severance costs, change in control costs, restricted stock costs which fully vested upon stockholder adoption of the merger agreement or upon completion of the merger, and outplacement costs to assist employees who are involuntarily terminated. Severance benefits and change in control costs were $60.2 million, and costs associated with the vesting of restricted stock were $17.5 million.
In addition to the expenses described above, in 1999 the Company expensed $24.7 million of other incremental costs associated with the merger, $21.8 million of which are included in the Corporate segment. These expenses consist primarily of compensation, training, integration, and licensing costs.
Investment activities are an integral part of the Company's business, and profitability is significantly affected by investment results. Invested assets are segmented into portfolios, which support the various product lines. Generally, the investment strategy for the portfolios is to match the effective asset cash flows and durations with related expected liability cash flows and durations and to maximize investment returns, subject to constraints of quality, liquidity, diversification, and regulatory considerations. See Notes 4 and 5 of the "Notes to Consolidated Financial Statements" for further discussion of the Company's investments and derivative financial instruments.
Excluding the net investment income reported in the Other segment, which continues its expected decline as these product lines are sold, reinsured, or wind down, 2001 net investment income increased 8.1 percent over the previous year. The overall yield in the portfolio remains relatively stable at 8.02 percent as of the end of 2001 compared to 8.06 percent at the end of 2000. The Company is actively marketing its real estate investments and presently evaluating the possible sale of all or a portion of the mortgage loan portfolio for replacement with longer duration securities.
The Company's exposure to below-investment-grade fixed maturity securities at December 31, 2001, was $2,261.7 million, representing 8.7 percent of invested assets excluding ceded policy loans, below the Company's internal limit of 10.0 percent of invested assets for this type of investment. The Company's exposure to below-investment-grade fixed maturities totaled $1,760.8 million at December 31, 2000, representing 7.2 percent of invested assets. The year over year increase resulted from downgrades of existing securities that were previously investment grade rather than the purchase of additional below-investment-grade securities.
Below-investment-grade bonds are inherently more risky than investment-grade bonds since the risk of default by the issuer, by definition and as exhibited by bond rating, is higher. Also, the secondary market for certain below-investment-grade issues can be highly illiquid. The Company expects additional downgrades to occur during 2002, with resulting realized investment losses. The Company does not anticipate any liquidity problem caused by the investments in below-investment-grade securities, nor does it expect these investments to adversely affect its ability to hold its other investments to maturity.
The Company has investments in four special purpose entities whose purposes are to support the Company's investment objectives. These entities are for asset collateralization and contain specific investment securities that do not include the Company's common stock or debt. These investments are described as follows:
During 2001, the Company invested in two special purpose entity trusts that have underlying assets consisting of unrelated equity securities. The investments in these trusts qualify as fixed maturity securities under generally accepted accounting principles and were reported at fair value in the consolidated statements of financial condition contained herein in Item 8. The fair value of these investments was derived from the fair value of the underlying assets based on quoted market prices. The fair value and amortized cost of these investments were $50.5 million and $58.1 million, respectively, at December 31, 2001.
At December 31, 2001 and 2000, impaired loans totaled $13.1 million and $17.7 million, respectively. Included in the impaired mortgage loans at December 31, 2001 were $6.4 million of loans which had a related, specific investment valuation allowance of $2.4 million and $6.7 million of loans which had no related, specific allowance. Impaired mortgage loans are not expected to have a material impact on the Company's liquidity, financial position, or results of operations.
The Company uses a comprehensive rating system to evaluate the investment and credit risk of each mortgage loan and to identify specific properties for inspection and reevaluation. The Company establishes an investment valuation allowance for mortgage loans based on a review of individual loans and the overall loan portfolio, considering the value of the underlying collateral. Investment valuation allowances for real estate held for sale are established based on a review of specific assets. If a decline in value of a mortgage loan or real estate investment is considered to be other than temporary or if the asset is deemed permanently impaired, the investment is reduced to estimated net realizable value, and the reduction is recognized as a realized investment loss. Management monitors the risk associated with these invested asset portfolios and regularly reviews and adjusts the investment valuation allowance. As a result of management's most recent review of the overall mortgage loan portfolio and based on management's expectation that delinquencies and problem loans will remain low, the valuation allowance on mortgage loans was reduced $10.5 million during 2001. The real estate valuation allowance was reduced $5.7 million during 2001 in conjunction with the sale of the associated property. At December 31, 2001, the balance in the valuation allowance for mortgage loans and real estate was $2.4 million and $19.9 million, respectively.
The payment of ordinary dividends to the Company from its insurance subsidiaries is further limited to the amount of statutory surplus as it relates to policyholders. Based on the restrictions under current law, during 2002 $384.9 million is available for the payment of ordinary dividends to the Company from its domestic insurance subsidiaries. Of this amount, $121.8 million is conditional upon approval from the Maine Bureau.
The amount available during 2001 for the payment of ordinary dividends from the Company's domestic insurance subsidiaries was $359.9 million, including $149.2 million available with approval from the Maine Bureau. Of the total available, $148.6 million was utilized, including $50.0 million as requested by the Company and approved by the Maine Bureau. The amount available during 2001 from Unum Limited was $20.9 million, none of which was utilized.
During the third quarter of 2000, the Company filed with the Securities and Exchange Commission a shelf registration on Form S-3 covering the issuance of up to $1.0 billion of securities in order to provide funding alternatives for its maturing debt. The shelf registration became effective in September 2000. In March 2001, the Company completed a long-term debt offering, issuing $575.0 million of 7.625% senior notes due March 1, 2011. Contingent upon market conditions and corporate needs, remaining funding under the shelf registration will be used to refinance debt on a longer-term basis and/or to fund other corporate needs.
In 1998, the Company completed a public offering of $200.0 million of 7.25% senior notes due March 15, 2028. In 1998, Provident Financing Trust I, a wholly-owned subsidiary trust of the Company, issued $300.0 million of 7.405% capital securities in a public offering. These capital securities, which mature on March 15, 2038, are fully and unconditionally guaranteed by the Company, have a liquidation value of $1,000 per capital security, and have a mandatory redemption feature under certain circumstances. The Company issued $300.0 million of 7.405% junior subordinated deferrable interest debentures, which mature on March 15, 2038, to the subsidiary trust in connection with the capital securities offering. The sole assets of the subsidiary trust are the junior subordinated debt securities.
As previously discussed, at December 31, 2001, the Company had capital commitments of $21.7 million to fund a special purpose entity trust in which the Company has a retained interest. The Company also has capital commitments of $36.6 million to fund certain of its private placement fixed maturity securities. The funds are due upon satisfaction of contractual notice from the issuer. These amounts may or may not be funded during the term of the security.
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's), Fitch, Inc. (Fitch), and A.M. Best Company (AM Best) are among the third parties that provide the Company assessments of its overall financial position. Ratings from these agencies for financial strength are available for the individual U.S. domiciled insurance company subsidiaries. Financial strength ratings are based primarily on U.S. statutory financial information for the individual U.S. domiciled insurance companies. Debt ratings for the Company are based primarily on consolidated financial information prepared using generally accepted accounting principles. Both financial strength ratings and debt ratings incorporate qualitative analyses by rating agencies on an ongoing basis. If the Company were to experience negative operating trends, it could result in a downgrade of the current ratings, which might impact the Company's ability to sell and retain its business.
We have audited the accompanying consolidated statements of financial condition of UnumProvident Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. The consolidated financial statements give retroactive effect to the merger of Unum Corporation and Provident Companies, Inc. on June 30, 1999, which has been accounted for using the pooling of interests method as described in the notes to the consolidated financial statements. Our audits also included the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, based on our audits, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of UnumProvident Corporation and subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 after giving retroactive effect to the merger of Unum Corporation, as described in the notes to the consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, based on our audits, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Chattanooga, Tennessee February 6, 2002, except for Note 15, for which the date is March 21, 2002
Basis of Presentation: The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Such accounting principles differ from statutory accounting practices (see Note 16). The consolidated financial statements include the accounts of UnumProvident Corporation and its subsidiaries (the Company). Material intercompany transactions have been eliminated.
On June 30, 1999, Unum Corporation (Unum) merged with and into Provident Companies, Inc. (Provident) under the name UnumProvident Corporation. The merger was accounted for as a pooling of interests. The historical financial results presented herein give effect to the merger as if it had been completed at the beginning of the earliest period presented.
Operations: The Company does business primarily in North America and operates principally in the life and health insurance business. The Employee Benefits segment includes group long-term and short-term disability insurance, group life insurance, accidental death and dismemberment coverages, group long-term care, and the results of managed disability. The Individual segment includes results from the individual disability and individual long-term care lines of business. The Voluntary Benefits segment includes the results of products sold to employees through payroll deduction at the work site. These products include life insurance and health products, primarily disability, accident and sickness, and cancer. The Other operating segment includes results from products no longer actively marketed, including individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities. The Corporate segment includes investment earnings on corporate assets not specifically allocated to a line of business, corporate interest expense, amortization of goodwill, and certain corporate expenses not allocated to a line of business. See Note 14 for further information on the operating segments.
Changes in the fair value of available-for-sale fixed maturity securities and equity securities are reported as a component of other comprehensive income. These amounts are net of federal income tax and valuation adjustments to reserves for future policy and contract benefits which would have been recorded had the related unrealized gain or loss on these securities been realized.
Disabled lives reserves for future policy and contract benefits on disability policies are calculated based upon assumptions as to interest and claim termination rates that are currently appropriate. Claim termination rate assumptions are based on Company experience. The assumptions vary by year of claim incurral and may include a provision for adverse deviation. The interest rate assumptions used for discounting claim reserves are based on projected portfolio yield rates, after consideration for defaults and investment expenses, for the assets supporting the liabilities for the various product lines. The assets for each product line are selected according to the specific investment strategy for that product line to produce asset cash flows that follow similar timing and amount patterns to those of the anticipated liability payments.
Accounting for Participating Individual Life Insurance: Participating policies issued by one of the Company's subsidiaries prior to its 1986 conversion from a mutual to a stock life insurance company will remain participating as long as the policies remain in force. A Participation Fund Account (PFA) was established for the benefit of all such individual participating life and annuity policies and contracts. The assets of the PFA provide for the benefit, dividend, and certain expense obligations of the participating individual life insurance policies and annuity contracts. The PFA was $408.6 million and $361.6 million at December 31, 2001, and 2000, respectively, and represented approximately 1.0 percent and 0.9 percent of consolidated assets and 1.1 percent and 1.0 percent of consolidated liabilities for December 31, 2001 and 2000, respectively.
At the adoption date of SFAS 133, the Company designated anew all of its hedging relationships and formally documented these relationships. The Company reclassified all of its held-to-maturity fixed maturity securities to available-for-sale fixed maturity securities. These held-to-maturity securities had an amortized cost of $346.6 million and a fair value of $369.8 million on the date of reclassification. The resulting before-tax unrealized gain of $23.2 million was reported as a component of accumulated other comprehensive income in stockholders' equity as a cumulative effect transition adjustment. No transition adjustment was reported in net income as a result of the adoption of SFAS 133 and SFAS 138. See Note 5.
Prior to the adoption of SFAS 133, the Company accounted for all derivatives as hedges. The fair values of the derivatives which hedged available-for-sale securities were reported in the consolidated statements of financial condition as a component of fixed maturity securities with the corresponding change in fair value being reported in accumulated other comprehensive income (loss). The fair values of interest rate swap agreements which hedged liabilities were not reported in the consolidated statements of financial condition.
SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets.
SFAS 144 supercedes Statement of Financial Accounting Standards No. 121 (SFAS 121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 (Opinion 30), Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Two accounting models existed for long-lived assets to be disposed of under SFAS 121 and Opinion 30. SFAS 144 represents a single accounting model for long-lived assets to be disposed of by sale. The Company will adopt the provisions of SFAS 144 effective January 1, 2002. The adoption of this pronouncement is not expected to have a material impact on the Company's financial position or results of operations.
On June 30, 1999, Unum merged with and into Provident under the name UnumProvident Corporation. Merger expenses, accounting policy changes, and operating results for the six month period prior to the merger are discussed as follows.
Exit activities related to duplicate facilities/asset abandonments consisted of closing of duplicate offices and the write off of redundant computer hardware and software. The cost associated with these office closures was approximately $25.6 million, which represents the cost of future minimum lease payments less any estimated amounts recovered under subleases. Also, certain physical assets, primarily computer equipment, redundant systems, and systems incapable of supporting the combined entity, were abandoned as a result of the merger, resulting in a write down of the assets' book values by approximately $41.8 million.
Additionally during 1999, 0.5 million shares of outstanding restricted stock became unrestricted, and stock options on 5.3 million shares became immediately exercisable effective with the merger, in accordance with Unum's and Provident's restricted stock and stock option plan provisions concerning a change in control. The expense related to restricted stock vesting has been included in merger related expenses. The Company applies Opinion 25 and related interpretations in accounting for the stock option plans. Accordingly, no compensation cost was recognized for stock option vesting.
Generally, because of the effort and time involved, reviews and updates of assumptions related to benefit liabilities are periodically undertaken over time and are reflected in the calculation of benefit liabilities as completed. Many factors influence assumptions underlying reserves, and considerable judgment is required to interpret current and historical experience underlying all of the assumptions and to assess the future factors that are likely to influence the ultimate cost of settling existing claims.
The discount rates affected by this change in Unum's methodology were as follows:
The previous review of mortality performed by the Company did not indicate a need to change mortality assumptions. However, recent analysis indicates that the improved mortality trend is sustainable and that rehabilitation of afflicted individuals to return to work has been minimally successful to date. AIDS related disabilities are approximately 2 percent of the Company's total disability claims. In addition to the AIDS mortality trend, the recent review demonstrates that survival from other frequently fatal diseases such as cancer and heart disease has improved over recent periods and is now judged to be more permanent due to advances in medical sciences and treatments. While the treatment advances have lengthened life expectancies, they do not always result in the claimant being able to return to work; thus, the ultimate level of payments to be made on a disability claim increases. Of the total increase in benefit liabilities for revised mortality assumptions, $85.4 million is related to AIDS related disabilities and $92.4 million to cancer and other disabilities.
The third component of the change in benefit liabilities is the change in the rate used to discount claim reserves, including IBNR reserves, which resulted in a decrease of $114.8 million in benefit liabilities. Subsequent to the merger, the Company significantly restructured the investment portfolio backing these liabilities with the objective of improving asset and liability management and improving yield. As part of this strategy, during the third quarter of 1999, the Company sold $426.1 million of assets with a book yield of 5.98 percent and purchased $546.6 million of assets with a yield of 8.87 percent, improving the overall yield on the assets backing liabilities. As a result of this investment restructuring and consistent with its policy, the Company increased the annual effective interest rate used to discount claim reserves to 7.35 percent, resulting in a decrease of $114.8 million in benefit liabilities.
Six Months Ended June 30, 1999 ---------------- Revenue Unum $ 2,557.8 Provident 1,988.9 ---------- Combined Revenue $ 4,546.7 ========== Net Income (Loss) Unum $ (189.7) Provident 87.8 ---------- Combined Net Loss $ (101.9) ==========
Included in Unum's net loss for the six months ended June 30, 1999, is $131.8 million after tax for expenses related to the merger and the early retirement offer to employees and $156.5 million after tax for the reserve discount rate change. Unum's net loss for the six months ended June 30, 1999 also includes an after-tax first quarter charge of $88.0 million related to its reinsurance businesses. Included in Provident's net income for the six months ended June 30, 1999, is $62.0 million after tax for expenses related to the merger and the early retirement offer to employees.
Policy Loans, Short-term Investments, Cash and Bank Deposits, and Deposit Assets: Carrying amounts approximate fair value.
At December 31, 2001, the total investment in below-investment-grade fixed maturity securities (securities rated below Baa3 by Moody's Investors Service or an equivalent internal rating) was $2,261.7 million or 8.7 percent of invested assets excluding ceded policy loans. The amortized cost of these securities was $2,738.3 million.
Deposit assets in the form of marketable securities held in trust are reported in miscellaneous assets in the consolidated statements of financial condition. Unrealized gains on these securities were $44.2 million and $23.6 million, respectively, at December 31, 2001 and 2000.
Mortgage loans are impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The reported investment in mortgage loans considered to be impaired was $13.1 million and $17.7 million, respectively, at December 31, 2001 and 2000. Included in the impaired loans at December 31, 2001 were loans of $6.4 million that had a related allowance for losses of $2.4 million and loans of $6.7 million that had no related allowance for losses. Included in the impaired loans at December 31, 2000 were loans of $6.5 million that had a related allowance for losses of $2.4 million and loans of $11.2 million which had no related allowance for losses.
The Company has executed a series of cash flow hedges in the group disability, individual disability, group and individual long-term care, and group single premium annuities portfolios using forward starting interest rate swaps. The purpose of these hedges is to lock in the reinvestment rates on future anticipated cash flows through the year 2005 and protect the Company from the potential adverse impact of declining interest rates on the associated policy reserves. The Company plans on terminating these forward interest rate swaps at the time the projected cash flows are used to purchase fixed income securities.
The Company also used forward starting swaps to hedge the interest rate on its anticipated issuance of debt. This hedge was initiated in the first quarter of 2001 and was terminated in March 2001 when the debt was issued. The deferred gain of $2.8 million is being amortized into earnings as a component of interest expense over the expected remaining life of the hedged debt instrument. See Note 9.
During 2001, the Company recognized net gains of $87.6 million upon the termination of cash flow hedges and reported $85.6 million of these gains in other comprehensive income. In 2001, the Company reported $2.0 million in operating earnings as realized investment gains in conjunction with hedges that were terminated.
For the year ended December 31, 2001, there was no material ineffectiveness related to the Company's derivative holdings, and there was no component of the derivative instruments' gain or loss excluded from the assessment of hedge effectiveness.
The majority of the net balances are related to disabled lives claims with long-tail payouts on which interest earned on assets backing liabilities is an integral part of pricing and reserving. Interest accrued on prior year reserves has been calculated on the opening reserve balance less one-half year's cash payments at the average reserve discount rate used by the Company during 2001, 2000, and 1999. During 1999, unpaid claims incurred for prior years increased primarily due to changes in reserves as disclosed in Notes 2 and 13.
A reconciliation of the income tax (benefit) attributable to continuing operations computed at U.S. federal statutory tax rates to the income tax expense as included in the consolidated statements of operations follows:
Under the Life Insurance Company Tax Act of 1959, life companies were required to maintain a policyholders' surplus account containing the accumulated portion of current income which had not been subjected to income tax in the year earned. The Deficit Reduction Act of 1984 requires that no future amounts be added after 1983 to the policyholders' surplus account. Further, any future distributions from the account would become subject to federal income tax at the general corporate federal income tax rate then in effect. The amount of the policyholders' surplus account at December 31, 2001, is approximately $228.8 million. Future distributions from the policyholders' surplus account are deemed to occur if a statutorily prescribed maximum for the account is less than the value of the account or if dividend distributions exceed the total amount accumulated as currently taxable income in the year earned. If the entire policyholders' surplus account were deemed distributed in 2002, this would result in a tax of approximately $80.1 million. No current or deferred federal income taxes have been provided on these amounts because management considers the conditions under which such taxes would be paid to be remote.
The Company has not provided for deferred taxes on basis differences in its foreign subsidiaries that are permanent in duration or on the unremitted earnings of its domestic subsidiaries which are not expected to result in taxable or deductible amounts.
The Company's consolidated statements of operations include the following amounts of income (loss) subject to foreign taxation and the related foreign income tax expense (credit):
In 2001 the Company redeemed its $172.5 million par value 8.8% monthly income debt securities. This early extinguishment of debt resulted in a write-off of the remaining deferred debt costs of $4.5 million associated with the issuance of the securities. The write-off is reported as an extraordinary loss, net of a $1.6 million tax benefit, in 2001.
Note 9 - Debt and Company-Obligated Mandatorily Redeemable Preferred Securities - - Continued
Also in 2000, the Company filed with the Securities and Exchange Commission a shelf registration statement on Form S-3 covering the issuance of up to $1.0 billion of securities in order to provide funding alternatives for its maturing debt. In 2001, the Company completed a long-term debt offering, issuing $575.0 million of 7.625% senior notes due March 1, 2011. The proceeds were used to refinance short-term debt on a long-term basis and to fund other corporate needs. At December 31, 2001, $425.0 million was available under the shelf registration.
Commercial paper debt is due within one year, but a portion has been classified as long term because the Company has the ability through the senior revolving credit facilities to convert this obligation into longer-term debt. The Company intends to refinance the commercial paper either by issuing additional commercial paper or by replacing commercial paper debt with long-term debt issued under the currently effective shelf registration statement.
Interest costs related to these securities are reported in the consolidated statements of operations as a component of interest and debt expense. Interest paid on these securities during each of the years ended December 31, 2001, 2000, and 1999 was $22.2 million.
During 2000, the Company, through its defined benefit pension plan, purchased a single premium annuity to fund the Company's retirement benefit obligation for approximately 3,000 retirees. This transaction resulted in a gain of $116.1 million before tax, or $75.5 million after tax.
For measurement purposes at December 31, 2001, the annual rate of increase in the per capita cost of covered health care benefits assumed for 2002 was 11.0 percent. The rate range was assumed to change gradually to a rate of 5.0 percent for 2008 and remain at that level thereafter. For measurement purposes at December 31, 2000, the annual rate of increase in the per capita cost of covered health care benefits for 2001 was 7.5 percent, and was assumed to gradually decrease to a rate of 5.5 percent in 2004 and remain at that level thereafter.
Under the broad-based stock plan of 2001, the Company has available up to 2,000,000 shares of common stock for awards to its employees, consultants, and producers, excluding certain senior officers and directors. For both the stock plan of 1999 and the broad-based stock plan of 2001, the exercise price for stock options issued shall not be less than the fair market value of the Company's stock as of the grant date.
The weighted average assumptions used in estimating compensation cost for the Company during 2001, 2000 and 1999 are as follows:
In the normal course of business, the Company assumes reinsurance from and cedes reinsurance to other insurance companies. The primary purpose of ceded reinsurance is to limit losses from large exposures; however, if the assuming reinsurer is unable to meet its obligations, the Company remains contingently liable. The Company evaluates the financial condition of reinsurers and monitors concentration of credit risk to minimize this exposure. The reinsurance receivable at December 31, 2001 relates to approximately 315 reinsurance relationships. Of the seven major relationships which account for approximately 78 percent of the reinsurance receivable amount at December 31, 2001, all are with companies rated A or better by A.M. Best Company or are fully securitized by investment-grade fixed maturity securities held in trust.
Premium income assumed was $513.3 million, $618.1 million, and $576.7 million during 2001, 2000, and 1999, respectively.
In 1996, the Company executed a definitive reinsurance agreement with Centre Life Reinsurance Limited (Centre Re), a Bermuda-based reinsurance specialist, for reinsurance coverage of the existing United States noncancelable individual disability active life reserves of one of the Company's insurance subsidiaries, Unum Life Insurance Company of America. This agreement reinsures all claims incurred on or after January 1, 1996. The Company has the right, but no obligation, to recapture the business after six years without penalty. Under the agreement, Centre Re has an obligation to absorb losses within a defined risk layer. The Company retains the risk for all experience up to Centre Re's defined risk layer, or attachment point. Once the attachment point is reached, Centre Re assumes the risk for all experience up to a contractually defined risk limit. Any experience above Centre Re's defined risk limit reverts back to the Company. As of December 31, 2001, the attachment point had not been reached.
This reinsurance agreement transfers risk and is accounted for as a long-duration reinsurance contract in accordance with the provisions of Statement of Financial Accounting Standards No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. The underlying operating results of this contract are reflected in other income, and any realized gain or loss from the sale of assets is reflected as a realized investment gain or loss in the Company's consolidated statements of operations.
Included in miscellaneous assets in the consolidated statements of financial condition at December 31, 2001, is a deposit asset for this reinsurance arrangement of approximately $367.4 million. The deposit asset is comprised of the Company's experience layer and unrealized gains or losses on the marketable securities held in the trust. Unrealized gains or losses on marketable securities held in the trust and the related effects on claim reserves are included in other comprehensive income (loss) in the equity section of the Company's consolidated statements of financial condition.
The Company's reinsurance operations include the reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk assumption, which includes reinsurance pool participation; direct reinsurance which includes accident and health (A&H), long-term care (LTC), and long-term disability coverages; and Lloyd's syndicate participations. During 1999, the Company concluded that these operations were not solidly aligned with the Company's strength in the disability insurance market and decided to exit these operations through a combination of a sale, reinsurance, and/or placing certain components in run-off. In 1999, the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities and reinsured the Company's risk participation in these facilities. The Company also decided to discontinue its London accident reinsurance pool participation beginning in year 2000. With respect to Lloyd's, the Company implemented a strategy which limited participation
During 2001, the Company entered into an agreement to limit its liabilities pertaining to the Lloyd's syndicate participations. Separately, the Company also reinsured 100 percent of the group disability reinsurance reserves and all future business underwritten and managed by Duncanson and Holt Services, Inc., a subsidiary of D&H. The transaction, in which reserves of approximately $323.8 million were ceded to the reinsurer, had an effective date of January 1, 2001. In a separate but related transaction, the Company also sold the reinsurance management operations of Duncanson and Holt Services, Inc. and divested the remaining assets of that facility during 2001. The gains on the reinsurance and sale transactions were immaterial.
The table below summarizes the charges recognized by the Company during 2000 and 1999 related to the reinsurance operations. There were no significant charges recognized during 2001.
The periodic method of accounting is followed for Lloyd's syndicate participation, which requires premiums to be recognized as revenue over the policy term and claims, including the estimate of claims incurred but not reported, to be recognized as incurred. Throughout 1999, the Company received updated estimates and information about the Lloyd's market from various sources, including managing agents and underwriters of syndicates and published information from Moody's Investors Service. Consistent with overall market trends, the information and loss estimates received indicated significant deterioration in the loss experience of open years of account. The deterioration in loss experience related primarily to significant losses in certain syndicates (space and aviation, accident and health, and other non-marine classes of business) and continued pressure on the pricing of insurance coverage provided by the Lloyd's market. The Company also discussed projected results of the Lloyd's market with the underwriters of the syndicates that are managed through a subsidiary of the Company. These projected results also indicated future deterioration of the open years of account. Market conditions were not expected to improve dramatically in the near term.
Because an event or change in circumstance occurred that indicated the recoverability of an asset should be assessed for impairment, a recoverability test was performed to determine if impairment had occurred. Following the poor results of the reinsurance operations in the first quarter of 1999, the Company updated the goodwill recoverability test using the most current results and forecasts. The goodwill recoverability test used the held-for-use model that compares the undiscounted cash flows of these operations to determine whether those cash flows can recover the unamortized goodwill. The tests indicated that future undiscounted cash flows were insufficient to recover the entire goodwill amount, indicating that the goodwill was impaired. As a result of the impairment, the Company calculated the estimated fair value of these operations. In estimating the fair value, two valuation techniques were utilized, a discount free cash flow model and a multiple of earnings model. The estimated fair value was compared to the book value for the investment, resulting in a write-down of goodwill in the amount of $27.0 million in the first quarter of 1999.
The Company has provided its best estimate of the cost of known losses, but has retained certain risks, including the exposure associated with disputes arising from reinsurance pools disclosed in Note 15.
Included in benefits and expenses above is amortization of deferred policy acquisition costs, value of business acquired, and goodwill. Amortization of these items by segment is as follows:
In 1997 two alleged class action lawsuits were filed in Superior Court in Worcester, Massachusetts (Superior Court) against UnumProvident Corporation (UnumProvident) and several of its subsidiaries, The Paul Revere Corporation (Paul Revere), The Paul Revere Life Insurance Company, The Paul Revere Variable Annuity Insurance Company, The Paul Revere Protective Life Insurance Company, and Provident Life and Accident Insurance Company. One
purported to represent independent brokers who sold certain individual disability income policies with benefit riders that were issued by subsidiaries of Paul Revere. The trial for the independent broker class action commenced in March 2001. In April 2001, the jury returned a complete defense verdict. The court subsequently entered judgement on that verdict. The plaintiffs have not given an indication as to whether or not they will appeal the jury verdict. The plaintiffs have a pending motion seeking a new trial. Notwithstanding the jury verdict, the judge is obligated to rule separately on the claim that UnumProvident and its affiliates violated the Massachusetts Consumer Protection Act. The bench trial for the alleged violation commenced in October 2001 and concluded in November 2001 with closing briefs submitted to the judge in December 2001 and closing arguments heard in January 2002. A decision is expected by May 2002.
The career agent class action purports to represent all career agents of subsidiaries of Paul Revere whose employment relationships ended on June 30, 1997 and were offered contracts to sell insurance policies as independent producers. At the hearing to determine class certification heard in December 1999 in Superior Court, class certification was denied for the career agents. Summary judgment motions were heard in November 2000 and all motions from plaintiffs and defendants were denied pertaining to the two class representatives whose cases survived. The career agent plaintiffs have re-filed their complaint seeking a class action status by limiting the issues to those in the certified broker class action. The court has not ruled on the re-filing.
During September and October 1999, the Company and several of its officers were named as defendants in five class action lawsuits filed in the United States District Court for the District of Maine. On January 3, 2000, the Maine district court appointed a lead class action plaintiff and ordered plaintiffs to file a consolidated amended complaint. On January 27, 2000, a sixth complaint against the same defendants was filed in the Southern District of New York. On March 7, 2000, the sixth action was transferred to the District of Maine, and that action was voluntarily dismissed by the plaintiff on June 12, 2000. On February 23, 2000, two consolidated amended class action complaints were filed against the same defendants. The first amended class action complaint asserts a variety of claims under the Securities Exchange Act of 1934, as amended, on behalf of a putative class of shareholders who purchased or otherwise acquired stock in the Company or Unum Corporation (Unum) between February 4, 1998 and February 9, 2000. The second amended complaint asserts a variety of claims under the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended, on behalf of a putative class of shareholders who exchanged the common stock of Unum or Provident Companies, Inc. (Provident) for the Company's stock pursuant to the joint proxy/registration statement issued in connection with the merger between Unum and Provident. The complaints allege that the defendants made false and misleading public statements concerning, among other things, Unum's and the Company's reserves for disability insurance and pricing policies, the Company's merger costs, and the adequacy of the due diligence reviews performed in connection with the merger. The complaints seek money damages on behalf of all persons who purchased or otherwise acquired Company or Unum stock in the class period or who were issued Company stock pursuant to the merger.
On February 16, 2001, each defendant answered the complaint by denying generally the material allegations of the complaint. The Company disputes the claims alleged in the complaint and denies any liability to plaintiffs.
In October 2001, the parties reached an agreement in principle to settle this litigation. Under the terms of the settlement, which is subject to, among other things, final approval by the court, the Company has agreed to pay $45 million to settle all claims that were or could have been asserted by the class in the litigation. The parties agreed that, for purposes of the settlement only, the litigation may be maintained as a class action on behalf of all persons who exchanged the stock of Unum or Provident for the common stock of the Company pursuant to the joint proxy/registration statement or otherwise acquired Company common stock traceable to the joint proxy/registration statement on or before August 3, 1999, other than the defendants and their officers, directors, affiliates, and subsidiaries. On January 9, 2002, the district court entered an order that, among other things, approved preliminarily the terms of the proposed settlement. On March 21, 2002, the district court held a hearing to determine, among other things, whether the settlement should be finally approved by the court. The district court has not yet entered its ruling on the motion to finally approve the settlement.
The Company has received confirmation from its insurance carriers that, apart from a $1.0 million deductible, the entire amount to be paid under the proposed settlement, as well as the attorneys' fees and expenses incurred by the Company defending the litigation, will be covered under the Company's insurance policies. Management is of the opinion that, if the settlement is finally approved by the court, this matter will not have any material adverse affect on the Company's financial position or results of operations.
In certain reinsurance pools associated with the Company's reinsurance businesses there are disputes among the pool members and reinsurance participants concerning the scope of their obligations and liabilities within the complex pool arrangements, including pools for which subsidiaries of the Company acted either as pool managers or underwriting agents, as pool members or as reinsurers. The Company or the Company's subsidiaries either have been or may in the future be brought into disputes, arbitration proceedings, or litigation with other pool members or reinsurers of the pools in the process of resolving the various claims. See the reinsurance pools and management section contained in the segment results discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained herein in Item 7.
The National Association of Insurance Commissioners and the Company's insurance subsidiaries' states of domicile approved a codification of statutory accounting practices effective January 1, 2001, which serves as a comprehensive and standardized guide to statutory accounting principles. The codification changed, to some extent, the accounting practices that the Company's insurance subsidiaries used to prepare their statutory financial statements. The cumulative effect of the changes in accounting principles adopted to conform to the codification of statutory accounting principles for the Company's insurance subsidiaries was approximately $45.6 million and was recognized as an increase to statutory surplus as of January 1, 2001.
At December 31, 2001, the Company's insurance subsidiaries had on deposit with regulatory authorities securities with a book value of $1,313.0 million held for the protection of policyholders.