- -Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's discussion and analysis reviews the consolidated financial condition of UNUM at December 31, 1997 and 1996, the consolidated results of operations for the past three years and, where appropriate, factors that may affect future financial performance. This discussion should be read in conjunction with the Consolidated Financial Statements, Notes to Consolidated Financial Statements and Selected Consolidated Financial Data.
Effective tax rates, which reflect income tax expense as a percentage of income before income taxes, were 31.0%, 30.3% and 26.4% for 1997, 1996 and 1995, respectively. Reported income tax expense was below the federal statutory tax rate of 35% primarily due to tax savings from investments in tax-exempt bonds and mortgages. The increase in the effective tax rate over the three year period was primarily due to reduced tax-exempt income as a percentage of income before income taxes.
A comparison of net income is impacted by the inclusion of realized investment gains (losses), and special items that occurred in 1997, 1996 and 1995. Operating income in 1997, 1996 and 1995, which excludes realized investment gains (losses) and the special items, was as follows:
During fourth quarter 1997, UNUM recognized $6.5 million of operating expenses related to a management and field office reorganization within its North American reinsurance operations, reducing income before income taxes in the Special Risk Insurance segment. Included in the $6.5 million of costs is a $6.0 million restructuring charge and $0.5 million of direct costs, primarily relocation expenses. The restructuring charge of $6.0 million was comprised of $4.0 million of lease exit costs, $1.4 million of severance related costs and $0.6 million of abandoned assets.
During the fourth quarter of 1996, UNUM executed a definitive reinsurance agreement between UNUM America and Centre Life Reinsurance Limited ("Centre Re"), a Bermuda based reinsurance specialist, for reinsurance coverage of the active life reserves of UNUM America's existing United States non-cancellable individual disability ("ID") block of business. As a result, UNUM recognized a pretax charge of $49.7 million, reflected as operating expenses 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 regarding the reinsurance agreement see the Disability Insurance segment discussion.
The total charges of $39.4 million included the write-off of certain intangible assets, primarily deferred acquisition costs, totaling $17.0 million. These intangible assets were deemed unrecoverable primarily due to the expectation of continued losses in the association group disability business. Additionally, in conjunction with the
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, discussed under the caption "Realized Investment Gains," 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.
In 1995, the association group disability business was negatively affected by unfavorable claims experience, which management attributed to certain geographical and occupational segments, particularly dentists and physicians. During the fourth quarter of 1995, UNUM increased reserves for unpaid claims related to association group disability, reported in the Disability Insurance segment, by $15.0 million. These increased reserves were based on management's expectations of slower than expected claim recoveries.
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 1997 and 1996. 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.
Reconciliation of Income (Loss) Before Income Taxes to Pretax Operating Income (Loss)
The following table reconciles income (loss) before income taxes to pretax operating income (loss) for the four business segments and Corporate for the years ended December 31, 1997, 1996 and 1995:
The following sections discuss the results of the four business segments and Corporate for the years ended December 31, 1997, 1996 and 1995. These discussions are based on pretax operating income (loss), which excludes realized investment gains (losses) and the special items previously described. The summary financial information provided prior to each segment discussion has been adjusted to exclude the impact of special items from all income statement line items, consistent with the discussion of results on a pretax operating income basis.
After adjusting for $255.4 million of premium ceded during 1997 under the ID reinsurance agreement and the effect of claim block acquisitions, the Disability Insurance segment reported premium growth of 9.4% compared with growth of 5.6% in 1996. The improvement in premium growth was driven by record sales levels and persistency improvements, primarily in group LTD and group STD. Investment income, adjusted for the effect of the reinsured ID business, increased in 1997, primarily as a result of the increased cash flow created by improved premium growth in group disability products.
During 1997, group LTD experienced increased pretax operating income that was driven primarily by strong premium growth of 11.4%. Premium growth in 1997 resulted from record sales levels and improved persistency,
Strong sales and improved persistency resulted in increased premium growth for group STD, driving improved pretax operating income in 1997. The strong sales levels reflect management's continuing efforts to cross-sell group STD products with other group products sold by UNUM. Additionally, premium growth and continued expense management contributed to a lower operating expense ratio, partially offset by a higher benefit ratio.
Pretax operating income for the disability reinsurance operations was adversely affected by unfavorable claims experience and decreased premium for the year ended December 31, 1997, as compared with the same period in 1996. Management continues to focus on improving risk management programs and strengthening underwriting standards to address this claims experience.
Pretax operating income for the Special Risk Insurance segment increased for the year ended December 31, 1997, as compared with 1996, primarily driven by strong premium growth in the group life business. Additionally, pretax operating income for this period was positively affected by favorable expense growth levels across most lines of business, increased investment income for the segment and additional fees and other income largely from reinsurance underwriting management operations. Higher benefit ratios in certain product lines partially offset these increases. Due to the nature of the risks underwritten and the relative size of the blocks of businesses, several of the products in the Special Risk Insurance segment can exhibit claims variability.
Solid sales results and improved persistency trends continued and were the primary drivers of group life premium growth of 20.1% in 1997. Claim block acquisitions generated one-time premiums for group life of $0.2 million, $3.6 million and $1.3 million, respectively, for 1997, 1996 and 1995, and for reinsurance operations of $16.3 million and $38.3 million, respectively, for 1996 and 1995. Management intends to pursue additional claim block acquisitions in the future.
The increase in pretax operating income for 1996, as compared with 1995, was primarily due to an improved benefit ratio in the group life business, increased investment income, and premium growth driven by strong sales. These favorable factors were partially offset by a higher operating expense ratio in group life, a higher benefit ratio in certain reinsurance pools and increased expenses in the reinsurance underwriting management operations.
During 1997, Colonial formed a strategic marketing alliance with The Lincoln National Life Insurance Company ("Lincoln Life") in order to create cross-selling opportunities in the worksite market. In addition, Colonial coinsures and administers Lincoln Life's existing block of worksite-marketed universal life insurance. This reinsurance agreement affects reported line items in Colonial's income statement, including premiums, investment income, operating expenses and interest credited, in relation to the amount of business coinsured. During 1996, Colonial entered into an agreement to reinsure a majority of the mortality risk on new and inforce universal life business. This reinsurance agreement has negatively affected reported premium growth and related operating expense ratios while positively affecting reported benefit ratios.
Excluding the impact of the Lincoln Life reinsurance agreement, Colonial's operating expense ratio improved in 1997, primarily because of management's continued efforts to control expenses. Colonial's benefit ratio increased in 1997 primarily as a result of unfavorable claims experience in the cancer product line. The decrease in Colonial's benefit ratio in 1996 was primarily driven by the effect of the universal life reinsurance agreement and improved benefit ratios in the life, and accident and sickness product lines.
The Retirement Products segment includes products no longer actively marketed by UNUM including: TSAs, guaranteed investment contracts ("GICs"), deposit administration accounts ("DAs"), 401(k) plans, individual life and group medical insurance. The segment reported decreased pretax operating income for 1997 as compared with 1996, primarily due to the sale of UNUM's TSA business in October 1996, as discussed below, partially offset by favorable volatility in the run-off of certain other discontinued products. UNUM expects these blocks of business to continue to decline in size over several years and experience some slight earnings volatility, reflecting their run-off nature.
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. The sale involved approximately 1,700 group contractholders and assets under management of approximately $3.3 billion. The contracts were initially reinsured on an indemnity basis. Upon consent of the TSA contractholders and participants, the contracts are considered reinsured on an assumption basis, legally releasing UNUM America and First UNUM from future contractual obligation to the respective contractholders and participants. The sale resulted in a deferred pretax gain of $80.8 million, which is being recognized in income, as a special item, in proportion to consents for assumption reinsurance. Through December 31, 1997, consent for assumption reinsurance has been provided by TSA contractholders and participants owning approximately 92% of assets under management.
UNUM's investment objective is to optimize total asset return within appropriate risk criteria established for each product line. UNUM seeks to meet this objective through its asset/liability management process and active asset management of the portfolios. Asset/liability management requires a balance between investment risk and business risk and is a key element for managing certain market risks (see
As discussed in Note 5, "Sale of Tax-Sheltered Annuity Business," consent for assumption reinsurance has been given by contractholders and participants owning approximately 92% of assets under management related to the tax-sheltered annuity business UNUM sold in 1996. In connection with the consents received during 1997, UNUM reduced its deposit assets by $2,317.8 million, policy loan assets by $104.8 million, other policyholder fund liabilities by $2,486.5 million and separate account assets and liabilities by $526.5 million.
[bullet] Equity securities available for sale (common stocks and non-redeemable preferred stocks)--at fair value.
[bullet] Other long-term investments--at cost plus UNUM's equity in undistributed net earnings since acquisition.
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.
Real estate held for sale is included in other assets in the Consolidated Balance Sheets and is valued net of a valuation allowance that reduces the carrying value to the lower of fair value less estimated costs to sell or cost. This valuation allowance is periodically adjusted based on subsequent changes in UNUM's estimate of fair value less costs to sell.
Participating policies issued by the former Union Mutual Life Insurance Company ("Union Mutual") prior to UNUM's conversion to a stock life insurance company on November 14, 1986, will remain participating as long as they remain in force. A Participation Fund Account ("PFA") was established for the benefit of all of Union Mutual's 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. This line of business participates in the experience of the PFA and its operations have been excluded from the Consolidated Statements of Income. The PFA represented approximately 2.8% and 2.3% of consolidated assets and 3.3% and 2.7% of consolidated liabilities at December 31, 1997, and 1996, respectively.
Effective December 31, 1997, UNUM adopted Financial Accounting Standards ("FAS") No. 128, "Earnings Per Share," which requires dual presentation of basic and diluted earnings per share ("EPS"). Basic EPS is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding. The weighted average number of shares outstanding used to calculate basic EPS was approximately 139,852,000, 145,939,000 and 145,354,000 in 1997, 1996 and 1995, respectively. Diluted EPS is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding while giving effect to all dilutive potential common shares outstanding. The weighted average number of shares outstanding used to calculate diluted EPS was approximately 142,923,000, 148,028,000 and 146,609,000, in 1997, 1996 and 1995, respectively. Outstanding options to purchase approximately 227,000 shares, 143,000 shares and 1,769,000 shares for 1997, 1996 and 1995, respectively, were not dilutive because the options' exercise prices were greater than the average market price. These options were excluded from the diluted EPS calculation.
older pool years and completed an analysis of recent claims experience deterioration. As a result of these factors, certain pools have strengthened claim reserves. The impact to UNUM in fourth quarter 1997 from these pool claim reserve increases was an $11.7 million reduction in fee income and a $6.7 million increase in benefits to policyholders reported in the Special Risk Insurance segment, reducing net income by $12.0 million in the Consolidated Statement of Income.
Effective December 31, 1997, UNUM adopted FAS No. 128 which changed the computation of EPS and requires dual presentation of "basic" and "diluted" EPS. FAS 128 supersedes Accounting Principles Board ("APB") Opinion No. 15, "Earnings Per Share."
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. The adoption of FAS 121 did not have a material effect on UNUM's results of operations or financial position.
In June 1997, the Financial Accounting Standards Board ("FASB") issued FAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components in a financial statement with the same prominence as other financial statements. Comprehensive income is defined as net income adjusted for changes in stockholders' equity resulting from events other than net income
or transactions related to an entity's capital instruments. UNUM is required to adopt FAS 130 effective January 1, 1998, with reclassification of financial statements for earlier years required.
In February 1998, the FASB issued FAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises current disclosure requirements for employers' pension and other retiree benefits. FAS 132 does not change the measurement or recognition of pension or other postretirement benefit plans. UNUM is required to adopt FAS 132 effective January 1, 1998, with restatement of disclosures for earlier years required.
In December 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting for insurance-related assessments. UNUM is required to adopt SOP 97-3 effective January 1, 1999. Previously issued financial statements should not be restated unless the SOP is adopted prior to the effective date and during an interim period. The adoption of SOP 97-3 is not expected to have a material impact on UNUM's results of operations, liquidity or financial position.
The following tables summarize the components of investment income, net realized investment gains (losses) and changes in unrealized gains, net:
During 1995, UNUM sold fixed maturities of two issuers classified as held to maturity due to evidence of significant deterioration of the issuers' creditworthiness, as evidenced by bankruptcy filings.
The marketable securities held in trust relate to the individual disability reinsurance agreement (see Note 6 "Reinsurance"). Changes in fair value of the assets and the related adjustment to unpaid claims are reflected in the equity section of UNUM's Consolidated Balance Sheet.
The amortized cost and fair values of fixed maturities available for sale at December 31, 1997, were as follows:
The amortized cost and fair values of fixed maturities available for sale at December 31, 1996, were as follows:
The amortized cost and fair value of fixed maturities available for sale at December 31, 1997, by contractual maturity date, are shown below. Expected maturities will differ from contractual maturities since certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
Restructured mortgage loans amounted to $39.3 million and $54.8 million at December 31, 1997, and 1996, respectively. Troubled debt restructurings represent loans that are refinanced with terms more favorable to the borrower. Interest lost on restructured loans was not material for the years ended December 31, 1997, 1996 or 1995.
Real estate acquired in satisfaction of debt cumulatively amounted to $78.8 million at December 31, 1997. Real estate held for sale amounted to $23.3 million at December 31, 1997, and $9.4 million at December 31, 1996.
Real estate with a depreciated cost of $3.5 million and no bonds or mortgages were non-income producing for the twelve months ended December 31, 1997. Interest lost on these investments was not material in 1997, 1996 or 1995.
Reserves for future policy benefits are calculated by the net-level premium method and are based on UNUM's expected morbidity, mortality and interest rate assumptions at the time a policy is issued. These reserves represent the portion of premiums received, accumulated with interest and held to provide for claims that have not yet been incurred. The reserve assumptions are periodically reviewed and compared with actual experience and may be revised if it is determined that future expected experience is different from the reserve assumptions. Reserves for group insurance policies consist primarily of unearned premiums. The interest rates used in the calculation of reserves for future policy benefits at December 31, 1997, and 1996, principally ranged from 5.0% to 9.5%. Certain reserve calculations are based on variable interest rates within these ranges.
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. Management periodically performs a review of reserve estimates and assumptions. If management determines reserve assumptions need to be updated, any resulting adjustment to reserves are reflected in current results. Given that insurance products contain inherent risks and uncertainties, the ultimate liability may be more or less than such estimates indicate.
The interest rate used to discount the disability reserves is a composite of the yields on assets specifically identified with each block of business. The discount rate may decline further depending on the interest rate
environment. UNUM periodically adjusts prices on both existing and new business in an effort to mitigate the impact of the current interest rate environment.
The additional reserves for amounts incurred related to prior years were primarily the result of interest accrued on reserves, changes in reserve estimates and assumptions of interest rates, morbidity, mortality and expense costs, and changes in foreign exchange rates, primarily related to the disability reserves of UNUM's United Kingdom-based affiliate, UNUM Limited. Due to the long term claims payment pattern of some of UNUM's businesses, certain reserves, particularly disability, are discounted for interest.
On October 1, 1996, UNUM America and First UNUM closed the sale of their respective group tax-sheltered annuity ("TSA") businesses to The Lincoln National Life Insurance Company and Lincoln Life & Annuity Company of New York ("Lincoln"), both subsidiaries of Lincoln National Corporation. The sale involved approximately 1,700 group contractholders and assets under management of approximately $3.3 billion. The contracts were initially reinsured on an indemnity basis. Upon consent of the TSA contractholders and participants, the contracts are
considered reinsured on an assumption basis, legally releasing UNUM America and First UNUM from future contractual obligation to the respective contractholders and participants.
The sale resulted in a deferred pretax gain of $80.8 million, which is being recognized in income in proportion to contractholder and participant consents for assumption reinsurance. Through December 31, 1997, consent for assumption reinsurance has been provided by TSA contractholders and participants owning approximately 92% of assets under management.
The agreement is a finite reinsurance arrangement that transfers liabilities to Centre Re based on the level of statutory reserves. Centre Re has an obligation to absorb losses within a defined risk layer, while UNUM must fund an experience layer representing the difference between reserves related to the reinsured block, based on generally accepted accounting principles ("GAAP"), and the bottom of Centre Re's defined risk layer. Within this experience layer, UNUM retains the earnings risk related to potential adverse experience from the reinsured block. Under the agreement, UNUM funds a trust account, initially established in late 1996, with assets equal to the amount of GAAP reserves related to the reinsured block plus the amount of its experience layer. The value of UNUM's experience layer increases or decreases in conjunction with the underlying operating results of the reinsured block. Additionally, realized gains or losses on assets sold, and unrealized gains or losses on marketable securities held in the trust and the related claim reserves, affect the valuation of the experience layer. UNUM reflects the carrying value of the experience layer in its Consolidated Balance Sheet as a deposit asset, which at December 31, 1997, totaled approximately $347 million. Changes in the experience layer derived from the underlying operating results of the reinsured block are reflected in fees and other income and realized gains or losses from sales of trust assets are reflected as realized investment gains (losses) in UNUM's Consolidated Statement of Income. Changes in the experience layer resulting from unrealized gains or losses on marketable securities held in the trust and the related claim reserves are reflected as unrealized gains or losses in the equity section of UNUM's Consolidated Balance Sheet.
For the years ended December 31, 1997, 1996 and 1995, recoveries recognized under reinsurance agreements offset benefits to policyholders by $309.7 million, $90.8 million and $58.9 million, respectively.
Charges of $6.0 million, $7.2 million and $8.4 million were recorded in 1997, 1996 and 1995, respectively. The charge in 1997 was related to a management and field office reorganization within the North American reinsurance operations, and consisted of $4.0 million of lease exit costs, $1.4 million of severance related costs, and $0.6 million of abandoned assets. The charge in 1996 was related to the merger of Commercial Life Insurance Company ("Commercial Life") into UNUM America. The charge in 1995 related to the acceleration of organizational changes within UNUM America and the decision to discontinue the individual disability non-cancellable product. Partially offsetting the charge recorded in 1995 was a curtailment gain, related to workforce reductions in UNUM Corporation's noncontributory defined benefit pension plan. As of December 31, 1997, the liability carried in the Consolidated Balance Sheet for all three charges was $5.7 million.
In connection with the merger of Commercial Life into UNUM America, the sale of the tax-sheltered annuity business (see Note 5 "Sale of 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 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. On an after-tax basis the charges reduced net income by $26.3 million.
The total charges of $39.4 million included the write-off of certain intangible assets, primarily deferred acquisition costs, totaling $17.0 million. These intangible assets were 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. Losses for these products are charged to the reserve at the time realized. The products incorporated in the charge consist of certain discontinued special risk, retirement and medical products.
At December 31, 1997, UNUM had a noncontributory defined benefit pension plan ("Lifecycle Plan") covering substantially all domestic UNUM employees, including employees of Duncanson & Holt, Inc. ("D&H") and Colonial Companies, Inc. ("Colonial Companies"). The Lifecycle Plan provides benefits based on the employee's age at retirement, years of service and earnings during the highest five of the last ten years of employment. UNUM funds its pension plan in accordance with the requirements of the Employee Retirement Income Security Act of
1974, as amended. Beginning in 1997, plan assets were transferred from UNUM's separate accounts into a trust for the exclusive benefit of plan participants, and include 448,784 shares of UNUM Corporation common stock.
In 1997, UNUM changed the measurement date for the valuation of its pension plan and postretirement benefit plan assets and actuarially determined obligations from December 31, to September 30. The change in measurement date had no effect on 1997 or prior years' net pension and periodic postretirement benefit costs.
The funded status of the plan and amounts recognized in UNUM's Consolidated Balance Sheets, as determined by the plan's actuaries, using the applicable measurement dates, were as follows:
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 7.25% and 4.75%, respectively, at September 30, 1997, and 7.50% and 5.00%, respectively, at December 31, 1996. The expected long-term rate of return on plan assets was 9.0% in 1997, 1996 and 1995. Prior year service costs are being amortized on a straight-line basis over expected employment periods for active employees.
UNUM also administers certain supplemental retirement plans for eligible employees and officers and certain other pension plans. The cost of these plans was not significant for the years ended December 31, 1997, 1996 and 1995.
UNUM provides certain health care and life insurance benefits for retired employees and covered dependents. Substantially all domestic employees of UNUM may become eligible for these benefits if they meet minimum age and service requirements, if they are eligible for retirement benefits and if they agree to contribute a portion of the cost. UNUM has the right to modify or terminate these benefits. The underlying plans are not currently funded. The cost of these plans was $4.3 million, $10.3 million and $10.0 million for the years ended December 31, 1997, 1996 and 1995, respectively. At December 31, 1997, and 1996 the liability associated with these plans was $83.2 million and $80.9 million, 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. Dependent upon the employee's annual earnings, eligible employees may contribute up to 15% of their annual compensation, including incentive payouts. UNUM matches 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. Expense for this plan and the former plans amounted to $9.6 million in 1997, and $8.4 million in 1996 and 1995, respectively.
UNUM has several annual incentive plans for certain employees and executive officers that provide additional compensation based on achievement of predetermined annual corporate and affiliate financial and non-financial goals. In 1997, 1996 and 1995, expense for these plans was $37.2 million, $41.7 million and $19.9 million, respectively.
At December 31, 1997, UNUM had four stock-based compensation plans, which are described below. Had compensation cost for options issued under UNUM's four stock-based compensation plans been determined based on the fair value at the grant dates consistent with the methods defined under FAS 123 (see Note 1 "Summary of Significant Accounting Policies"), UNUM's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
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 11,600 shares granted in 1996 and 40,400 shares granted in 1995, 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 1997, 1996 and 1995.
The number of shares subject to issuance under the Incentive Plan cannot exceed 13.6 million, including both options and shares of restricted stock. At December 31, 1997, 1996 and 1995, 1,603,580 shares, 1,385,036 shares and 3,360,470 shares, respectively, were available for grant under the Incentive Plan.
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.
The weighted-average exercise price of options outstanding at December 31, 1997, 1996 and 1995, was $26.32, $22.93 and $20.91 per share, respectively.
The number and weighted-average exercise price of exercisable shares as of December 31, 1997, 1996 and 1995 was 4,686,562 shares at $22.71 per share, 4,763,184 shares at $20.73 per share and 4,216,120 shares at $19.57 per share, respectively.
The weighted-average fair value of options granted during the years ended December 31, 1997, 1996, and 1995 was $8.56, $6.92 and $5.10, respectively.
UNUM's Consolidated Statements of Income for 1997, 1996 and 1995, included the following amounts of foreign income and related income tax expense:
Historically, all positions UNUM has taken in derivative contracts have qualified for hedge accounting in accordance with the criteria established by FAS 52, "Foreign Currency Translation," and FAS 80, "Accounting for Futures Contracts." Upon entering a derivative contract, UNUM uses this criteria to evaluate the correlation of risk protection provided by a derivative contract to the risk created by market fluctuations to ensure hedge accounting is appropriate for the contract. Accordingly, gains or losses related to qualifying hedges of firm commitments or anticipated transactions involving investment purchases and debt issuance are deferred and recognized as an adjustment to the carrying amount of the underlying asset or liability when the hedged transaction occurs. Gains or losses related to qualifying hedges of anticipated transactions involving the sale of investments are deferred and recognized in income when the hedged transaction occurs. No gains or losses related to qualifying hedges of anticipated transactions involving payments denominated in foreign currencies are recorded if the hedged transaction is likely to occur.
The amount of any deferred gains or losses on outstanding interest rate futures contracts, which require daily cash settlement, are included in fixed maturities in UNUM's Consolidated Balance Sheet. The fair values of any outstanding forward exchange rate contracts, options and swap agreements, which do not require daily cash settlement, are not recognized in UNUM's Consolidated Balance Sheet.
UNUM's markets for its insurance products are the United States, its principal market, Canada, the United Kingdom, the Pacific Rim and Argentina. Through its affiliates, UNUM is the leading provider of group long term disability insurance, its principal product, in the United States and the United Kingdom. Products are marketed through sales personnel, independent contractors and brokers, and specialty agents. UNUM targets sales of its disability products to executive, administrative and management personnel, and other professionals such as educators, consultants, health care providers, accountants and engineers.
The Disability Insurance segment includes disability products offered in North America, the United Kingdom and Japan including: group long term disability, group short term disability, individual disability, disability reinsurance operations and long term care insurance. The Special Risk Insurance segment includes group life, special risk accident insurance, non-disability reinsurance operations, reinsurance underwriting management operations and other special risk insurance products. The Colonial Products segment includes Colonial Life & Accident Insurance Company and subsidiaries, which offer, primarily through payroll deduction, accident and sickness, disability, cancer and life insurance products to employees at their worksites. The Retirement Products segment includes products no longer actively marketed by UNUM including: tax-sheltered annuities, guaranteed investment contracts, deposit administration accounts, 401(k) plans, individual life and group medical products. Corporate includes transactions that are generally non-insurance related.