(b) Effective January 1, 1993, UNUM adopted Financial Accounting Standard No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," which decreased net income by $32.1 million, or $0.40 per share, and Financial Accounting Standard No. 109, "Accounting for Income Taxes," which increased net income by $20.0 million, or $0.25 per share.
December 31, --------------------------------------------------- Balance Sheet Data 1996 1995 1994 1993 ------------ ------------ ------------ ------------ Assets ............... $15,467.5 $14,787.8 $13,127.2 $12,437.3 Long-term debt ......... $ 409.2 $ 457.3 $ 182.1 $ 128.6 Stockholders' equity ... $ 2,263.1 $ 2,302.9 $ 1,915.4 $ 2,102.7 Shares outstanding ... 71.8 73.0 72.4 76.0 Weighted average shares outstanding during the year .................. 73.0 72.7 74.2 78.8
This management's discussion and analysis reviews the consolidated financial condition of UNUM at December 31, 1996, the consolidated results of operations for the past three years and, where appropriate, factors that may affect future financial performance are identified and discussed. Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements, Notes to Consolidated Financial Statements, and Selected Consolidated Financial Data.
To more clearly reflect UNUM's management of its businesses and to more appropriately group its product portfolios, UNUM began reporting its operations, effective January 1, 1995, principally in four business segments: Disability Insurance, Special Risk Insurance, Colonial Products and Retirement Products. Corporate includes transactions that are generally non-insurance related. For comparative purposes, 1994 information was previously restated to reflect the new reporting segments.
In 1996, net income decreased by $43.1 million to $238.0 million, or $3.26 per share, from $281.1 million, or $3.87 per share, in 1995. Net income was $154.7 million, or $2.09 per share, for the year ended December 31, 1994. A comparison of net income is impacted by the inclusion of realized investment gains, which were significantly higher in 1995, and several special items that occurred in 1996, 1995 and 1994. This management's discussion and analysis discusses the results of operations on a pretax operating income basis, which is defined as income (loss) before income taxes exclusive of realized investment gains (losses) and certain special items. Special items are excluded from pretax operating income as management considers them to be unusual, and also believes a discussion of the results on a pretax operating income basis provides a better understanding of the results of operations. The following table summarizes pretax operating income (loss) for the four business segments and Corporate for the years ended December 31, 1996, 1995 and 1994, and is followed by a discussion of the special items for those periods and a reconciliation of income (loss) before income taxes to pretax operating income (loss).
During the fourth quarter of 1996, UNUM executed a definitive reinsurance agreement between UNUM Life Insurance Company of America ("UNUM America") and Centre Life Reinsurance Limited ("Centre Re"), a
During the second quarter of 1995, UNUM recorded an additional charge for costs associated with the previously announced decision to discontinue the individual disability non-cancellable product and organizational changes within UNUM America, which increased operating expenses by $5.0 million. This charge reduced income before income taxes by $2.9 million in the Disability Insurance segment, $1.1 million in the Special Risk Insurance segment, and $1.0 million in the Retirement Products segment for the year ended December 31, 1995.
Throughout 1994, UNUM's individual disability business experienced a higher incidence of new claims and a disproportionate number of large claims, which management attributed to certain geographic and occupational segments of the business, particularly physicians. During the third quarter of 1994, management concluded that the deterioration of claims experience was not a temporary fluctuation in certain segments of the business, but was indicative of expected claim trends for the future. As a result, in third quarter 1994, UNUM increased reserves for existing claims by $83.3 million and strengthened reserves for estimated future losses by $109.1 million, resulting in an increase to benefits to policyholders reported in the Disability Insurance segment of $192.4 million. These increased reserves reflected management's expectations of morbidity trends for the existing non-cancellable individual disability business. It is not possible to predict whether morbidity trends will be consistent with UNUM's assumptions; however, as of December 31, 1996, management believes that the strengthened reserve levels continue to be adequate.
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, 1996, 1995 and 1994:
The following sections discuss the results of the four business segments and Corporate for the years ended December 31, 1996, 1995 and 1994. These business segment discussions are based on pretax operating income (loss), which excludes realized investment gains (losses) and the special items noted above.
The Disability Insurance segment includes disability products offered through: UNUM Life Insurance Company of America ("UNUM America") and First UNUM Life Insurance Company ("First UNUM") in North America; UNUM Limited in the United Kingdom; and UNUM Japan Accident Insurance Company Limited ("UNUM Japan"). The products included in this segment are group LTD, group short term disability ("group STD"), individual disability, Association Group disability, disability reinsurance operations and long term care insurance.
Reserves for unpaid claims are estimates 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 continuously monitors claim trends and responds by periodically adjusting prices on selected new and inforce business, refining underwriting guidelines, and strengthening risk management programs. In addition, reserve estimates and assumptions are periodically reviewed and updated with any resulting adjustments to reserves
Pretax operating income decreased slightly in 1995, as compared with 1994, primarily attributable to higher benefit ratios at UNUM Limited and in group LTD, and the inclusion of the results of UNUM Japan's operations in the Disability Insurance segment effective January 1, 1995. Partially offsetting these decreases were increased investment income, a lower benefit ratio in the individual disability business, and decreased operating expenses for the segment.
During 1996, pretax operating income for group LTD was favorably affected by increased investment income and a lower benefit ratio, partially offset by increased operating expenses primarily from continued investment in benefit management practices and product distribution. The lower benefit ratio was primarily the result of lower claims incidence and higher claim recoveries, which management primarily attributes to the continued success of its risk management programs.
During 1995 and 1994, management implemented and strengthened various risk management programs to address the unfavorable claims experience in group LTD during those periods. In addition to the selected price increases on new and inforce business, more stringent underwriting practices, and the reduction of benefit options for certain segments of the business, management established special claims units for both its group LTD and individual disability businesses to address specific aspects of disability claims, including complex and fraudulent claims. Additionally, management implemented new group LTD contract provisions that provide risk management features and claimant rehabilitation incentives. Management continually reviews the benefits management process to identify and strengthen risk management policies and procedures.
For the year ended December 31, 1996, UNUM Limited's pretax operating income was favorably affected by a lower benefit ratio and increased investment income, as compared with the corresponding period in 1995. The lower benefit ratio was primarily the result of a focus on strengthening risk management programs and improved new claims experience. Management believes that the level of future earnings for UNUM Limited will be a function of various factors, including but not limited to, the effectiveness of these continuing risk management actions over
In general, UNUM Limited's earnings expressed in British pound sterling are affected by fluctuations in the exchange rates used in the translation of earnings into U.S. dollars. The weighted average exchange rate was approximately $1.56, $1.58 and $1.53 for the years ended December 31, 1996, 1995 and 1994, respectively. At December 31, 1996, the spot rate was approximately $1.71.
As a result of the merger of Commercial Life into UNUM America, which was effective December 31, 1996, UNUM now reports the operations of the Association Group disability business with the individual disability business. Current and prior period information for individual disability has been restated to reflect this change.
Pretax operating income for the disability reinsurance operations was adversely affected by unfavorable claims experience and decreased premium, for the year ended December 31, 1996, as compared with the same period in 1995. Management continues to focus on improving risk management programs and strengthening underwriting standards to address this claims experience.
The Special Risk Insurance segment includes group life products sold by UNUM America and First UNUM, special risk accident insurance previously sold by Commercial Life, which has been merged with UNUM America, and other special risk insurance products. The segment also includes non-disability reinsurance operations, which represent UNUM's participation in various reinsurance pools, and the reinsurance underwriting management operations of Duncanson & Holt, Inc.
For the year ended December 31, 1996, as compared with 1995, the Special Risk Insurance segment reported an increase in pretax operating income. The increase 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. Due to the nature of the risks underwritten and the relative size of the blocks of businesses, several of the Special Risk Insurance segment's products can exhibit claims variability.
and continued renewal efforts contributed to the group life premium growth of 14.2%. Claim block acquisitions generated one-time premiums for group life and reinsurance operations of $3.6 million and $16.3 million, respectively, for 1996, and $1.3 million and $38.3 million, respectively, for 1995.
The Colonial Products segment includes Colonial Life & Accident Insurance Company ("Colonial") and affiliates. Colonial offers payroll-deducted, voluntary employee benefits to employees at their worksites. Accident and sickness, cancer and life insurance products are marketed by Colonial primarily through independent sales representatives.
Colonial's benefit ratio improved again in 1996 to 48.5%, as compared with 49.7% in 1995 and 50.4% in 1994, primarily driven by the effect of the universal life reinsurance agreement, continued favorable claims experience, and improved incidence rates in the life, and accident and sickness product lines.
Investment income increased during 1996, primarily because of increased cash flows resulting from a product mix shift and a change in asset mix to higher yielding securities. Investment income increased during 1995, primarily because of increased cash flows and additional income realized from the reinvestment of the proceeds from the second quarter 1995 sale of Colonial's equity portfolio into investment grade fixed income assets.
During 1996, Colonial experienced slower growth in sales and premium as compared with 1995, reflecting the effects of weaker sales growth during the third and fourth quarters of the year. Management is focusing on increasing sales and premium at Colonial by enhancing collaborative sales across the UNUM enterprise, introducing several new products and developing alternative distribution channels.
- -------- nm = not meaningful or in excess of 100%
The Retirement Products segment includes tax sheltered annuities ("TSA") in UNUM America and First UNUM, guaranteed investment contracts ("GICs"), deposit administration accounts ("DAs"), 401(k) plans, individual life and group medical insurance, all of which are no longer actively marketed by UNUM.
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 purchase price (ceding commission) paid upon closing was approximately $71 million, and the transaction generated statutory capital of approximately $160 million. The contracts have initially been reinsured on an indemnity basis. Upon consent of the TSA contractholders and/or participants, the contracts will be considered reinsured on an assumption basis, legally releasing UNUM America and First UNUM from future contractual obligation to the respective contractholders and/or participants. The sale resulted in a deferred pretax gain of $80.8 million, which will be recognized in income as a special item in proportion to contractholder and/or participant consents for assumption reinsurance, the majority of which management believes will occur during 1997. Through March 1, 1997, consent for assumption reinsurance has been provided by TSA contractholders and/or participants owning approximately 60% of assets under management.
For the year ended December 31, 1996, the Retirement Products segment reported decreased pretax operating income as compared with the same period in 1995. The decrease was primarily due to reduced earnings from the runoff of GICs, DAs and 401(k) plans during the year and lower interest spread margins on tax sheltered annuities through October 1, 1996, the effective date of the TSA sale. For 1995, the decrease in pretax operating income was primarily attributable to lower interest spread margins on tax sheltered annuities, as compared with the unusually favorable levels experienced during 1994.
During 1996, investment income declined reflecting the transfer of $2,690 million of assets to Lincoln on October 1, 1996, to effect the sale of the TSA business, and the shifting of assets to lower yielding, highly liquid, instruments during the year in anticipation of the transfer. During 1995, investment income decreased primarily due to investments in lower yielding tax-exempt securities and a reduced average investment yield caused by the low interest rate environment. In addition, the reduced asset base under management for GICs, DAs and 401(k) plans has resulted in lower investment income and reduced amounts of interest credited during 1996 and 1995. Management expects continued decreases in the amounts of investment income and interest credited as the related GICs, DAs and 401(k) contracts mature or terminate.
Corporate includes transactions that are generally non-insurance related. The increased pretax operating loss in Corporate for the year ended December 31, 1996, as compared with 1995, was primarily the result of increased international development costs and interest expense on corporate borrowings, partially offset by increased investment income.
The increased pretax operating loss in 1995, compared with 1994, was primarily attributable to increased interest expense, partially offset by reduced operating expenses. Effective January 1, 1995, the operations of UNUM Japan are reported in the Disability Insurance segment. Costs related to UNUM's investment in Japan prior to January 1, 1995, were reported as operating expenses in Corporate.
UNUM's investments are reported in the consolidated financial statements at net realizable value or net of applicable allowances for probable losses. Allowances for real estate held for sale and mortgages are established based on a review of specific assets as well as the overall portfolio, considering the carrying value of the underlying assets. If a decline in fair value is considered to be other than temporary or if a long-lived asset is deemed permanently impaired, the investment is reduced to estimated net realizable value and the reduction is recorded as a realized investment loss. UNUM discontinues the accrual of investment income on invested assets when it is determined that collectability is doubtful. Management monitors the risk associated with the invested asset portfolio and regularly reviews and adjusts the allowance for probable losses.
At December 31, 1996, and 1995, the fixed maturity portfolio included $102.0 million and $139.4 million, respectively, of below investment grade bonds (below "BAA") recorded at fair value. These bonds had an associated amortized cost of $101.7 million and $133.8 million, respectively. Virtually all of the below investment grade bonds were purchased at investment grade, but were subsequently downgraded. Management does not expect any risks or uncertainties associated with below investment grade bonds to have a significant affect on UNUM's consolidated financial position or results of operations. The amount of fixed maturities delinquent 60 days or more was zero at December 31, 1996, and 1995.
At December 31, 1996, and 1995, UNUM's mortgage loans were $1,132.1 million and $1,163.4 million, respectively. UNUM invests new funds in commercial properties in targeted geographical areas that meet UNUM's underwriting standards. Management 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. Management establishes allowances for mortgage loans based on a review of individual loans and the overall loan portfolio, considering the value of the underlying collateral.
Management believes that its mortgage loan portfolio is well diversified geographically and among property types, as summarized in Item 1 F. Investments. UNUM's incidence of new problem mortgage loans and foreclosure activity has remained very low in 1996, reflecting improvements in overall economic activity and improving real estate markets in the geographic areas where UNUM has mortgage loans. Management expects a modest level of delinquencies and problem loans in the future. The percentage of mortgage loans delinquent 60 days or more on a contract delinquency basis was 0.5% and 0.2% at December 31, 1996, and 1995, respectively.
Effective January 1, 1995, UNUM adopted FAS 114, "Accounting by Creditors for Impairment of a Loan," and FAS 118, "Accounting by Creditors for Impairment of a Loan-- Income Recognition and Disclosures," which defined the principles to measure and record a loan when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The adoption of FAS 114 and FAS 118 did not have a material affect on UNUM's results of operations or financial position.
At December 31, 1996, investment real estate amounted to $248.1 million, compared with $222.2 million at December 31, 1995. UNUM purchases investment real estate in selected markets when certain investment criteria are met. Investment real estate is intended to be held long-term and is carried at cost less accumulated depreciation. If investment real estate is determined to be permanently impaired, the carrying amount of the asset is reduced to fair value. Occasionally, investment real estate is reclassified and revalued as real estate held for sale when it no longer meets UNUM's investment criteria.
At December 31, 1996, and 1995, real estate held for sale amounted to $9.4 million and $35.5 million, respectively. Real estate acquired through foreclosure is valued at fair value at the date of foreclosure and may be classified as investment real estate, if it meets UNUM's investment criteria. Real estate held for sale is included in other assets in the Consolidated Balance Sheets and is valued net of a valuation allowance which 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.
UNUM's businesses produce positive cash flows that are invested primarily in intermediate, fixed maturity investments intended to reflect the anticipated cash obligations of insurance benefit payments and insurance contract maturities and to optimize investment returns at appropriate risk levels. Unexpected cash requirements and liquidity needs can be met through UNUM's investment portfolio of fixed maturities classified as available for sale, equity securities, cash and short-term investments.
From time to time, dividend payments, which may be subject to approval by insurance regulatory authorities, are made from UNUM's affiliates and insurance subsidiaries to UNUM Corporation. These dividends, along with other funds, are used to service the needs of UNUM Corporation including: debt service, common stock dividends, stock repurchase, administrative costs and corporate development. Net statutory operating income, which excludes realized investment gains net of tax, is one of the major determinants of an insurance company's dividend capacity to its parent in the following fiscal year. Statutory accounting rules and practices, which differ in certain respects
In 1996, UNUM's United States insurance subsidiaries reported net statutory operating income of approximately $167 million, compared with approximately $143 million in 1995. The amount available under current law for payment of dividends during 1997 to UNUM Corporation from all U.S. domiciled insurance subsidiaries without state insurance regulatory approval is approximately $153 million, as compared with approximately $135 million for 1996. UNUM Corporation also has the ability to draw a dividend from its United Kingdom-based affiliate, UNUM Limited, subject to certain U.S. tax consequences.
In connection with the closing of the TSA sale on October 1, 1996, as described in the Retirement Products segment, UNUM America paid an extraordinary dividend of $123 million to UNUM Corporation during the fourth quarter of 1996. As a result of the reinsurance of the individual disability business, discussed in the Disability Insurance segment, UNUM America and First UNUM intend to pay extraordinary dividends to UNUM Corporation during 1997, subject to regulatory approval and certain capital considerations.
Cash flow requirements are also supported by a committed revolving credit facility totaling $500 million. On October 29, 1996, a new committed revolving credit facility became effective, expiring on October 1, 2001, which replaced a previously existing facility of the same amount. UNUM's commercial paper program is supported by the revolving credit facility and is available for general liquidity needs, capital expansion, acquisitions and stock repurchase. The committed revolving credit facility contains certain covenants that, among other provisions, require maintenance of certain levels of stockholders' equity and limits on debt levels.
At December 31, 1996, UNUM had short-term and long-term debt totaling $117.7 million and $409.2 million, respectively. At December 31, 1996, approximately $439 million was available for additional financing under the existing revolving credit facility and $500 million of investment grade debt instruments was available for issuance under the shelf registration. Contingent upon market conditions and corporate needs, management may refinance short-term notes payable for longer term securities.
Effective October 23, 1996, UNUM's Board of Directors approved an expansion of the Company's stock repurchase program to 6.0 million shares by authorizing an additional 3.7 million shares. At December 31, 1996, approximately 4.5 million shares of common stock remained authorized for repurchase. During 1996, UNUM acquired approximately 1.9 million shares of its common stock in the open market at an aggregate cost of $119.1 million. UNUM did not acquire any shares in the open market in 1995. During 1994, UNUM repurchased 3.9 million shares in the open market at an aggregate cost of $183.3 million.
UNUM was committed at December 31, 1996, to purchase fixed maturities and other invested assets in the amount of $104.3 million. Independent of the cash flows of UNUM Corporation, management anticipates that the operating cash flows of the subsidiaries of UNUM Corporation will be sufficient to meet benefit obligations, planned investment commitments and operational needs of those companies.
The table below reflects the debt ratings for UNUM Corporation and the claims paying ability and financial strength ratings for UNUM's United States domiciled insurance company subsidiaries at March 7, 1997:
At March 7, 1997, the unsold portion of the shelf registration related to preferred stock carried a rating of "(P)"a1" " (Upper-Medium Quality) from Moody's.
At December 31, 1996, the ACL ratios for UNUM America, First UNUM, and Colonial were 406%, 467%, and 389%, respectively. This compares with ACL ratios at December 31, 1995, of 382%, 382%, and 436%, respectively. For 1996, UNUM America's ACL ratio reflects the merger of Commercial Life into UNUM America as of December 31, 1996. At December 31, 1995, Commercial Life had an ACL ratio of 329% that is not included in the UNUM America 1995 ACL ratio.
Effective January 1, 1996, UNUM adopted Financial Accounting Standard ("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.
Effective January 1, 1996, UNUM adopted FAS 123, "Accounting for Stock-Based Compensation." FAS 123 established financial accounting and reporting standards for stock-based employee compensation plans. The statement defines a new method of accounting for employee stock compensation plans using a fair value based method, under which compensation cost is measured and recognized in results of operations. Alternatively, FAS 123 allows an entity to retain the accounting for employee stock compensation plans defined under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." UNUM retained the accounting defined under APB No. 25, and as required, will disclose in a footnote the pro forma effects of stock- based compensation using the fair value based method defined under FAS 123. Refer to Note 9 in
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of UNUM Corporation and subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
except for Note 5 for which the date is March 1, 1997,
and Note 18 for which the date is March 14, 1997
In conjunction with the sale of UNUM's tax sheltered annuity business, as discussed in Note 5, fixed maturities available for sale of $588.6 million and short-term investments of $1,825.9 million were transferred to the buyer on October 1, 1996. Upon transfer, there was a corresponding increase in UNUM's deposit assets.
Certain 1995 and 1994 amounts have been reclassified in 1996 for comparative purposes.
Real estate held for sale is included in other assets in the Consolidated Balance Sheets and is valued net of a valuation allowance which 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.
Group insurance premiums are recognized as income over the period to which the premiums relate. Individual disability premiums are recognized as income when due. Benefits and expenses are associated with earned premiums to result in recognition of profits over the life of the contracts. This association is accomplished by recording a provision for future policy benefits and unpaid claims and claim expenses, and by amortizing deferred policy acquisition costs.
For retirement and universal life products, premium and other policy fee revenue consist of charges for the cost of insurance, policy administration and surrenders assessed during the period. Charges related to services to be performed in the future are deferred until earned. The amounts received in excess of premium and fees are recorded as deposits and included in other policyholder funds in the Consolidated Balance Sheets. Benefits and expenses include benefit claims in excess of related account balances, interest credited at various rates, and amortization of deferred policy acquisition costs.
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 to actual experience and are 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, 1996, and 1995, principally ranged from:
The effects of changes in reserve estimates and assumptions were more significant in 1995 and 1994, primarily as a result of increased reserves from lower discount rates for certain disability products following the sale of the common stock portfolio in 1995, and adjustments to strengthen certain disability reserves in 1995 and 1994.
Beginning in 1995, as explained in Note 2, unpaid claims are adjusted to reflect changes that would have been necessary if the unrealized gains and losses related to fixed maturities classified as available for sale had been realized. Where applicable, UNUM has reflected those adjustments in the liability balances with corresponding credits or charges, net of related deferred taxes, reported as a component of unrealized gains on available for sale securities in stockholders' equity.
During 1995, UNUM increased reserves for unpaid claims related to the Association Group disability business by $15.0 million to reflect management's expectations of slower than expected claim recoveries. This change in accounting estimate, which was reflected in the Disability Insurance segment, decreased net income by $9.8 million, or $0.14 per share.
Liabilities for restructuring activities are recorded when management, prior to the balance sheet date, commits to execute an exit plan that will result in the incurral of costs that have no future economic benefit, or approves a plan of termination and communicates sufficient detail of the plan to employees. Liabilities for restructuring activities are included in other liabilities in the Consolidated Balance Sheets.
Certain assets from tax sheltered annuity ("TSA") contracts and UNUM's defined benefit plans are in separate accounts that are pooled investment funds of securities. Investment income and realized gains and losses on these accounts accrue directly to the contractholders. Assets, carried at market value, and liabilities of the separate accounts are shown separately in the Consolidated Balance Sheets. The assets of the separate accounts are legally segregated and are not subject to claims that arise out of any other business of UNUM.
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 sole benefit of all of Union Mutual's individual participating life and annuity policies and contracts.
The assets of the PFA are to 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 2.3% and 2.5% of consolidated assets and 2.7% and 2.8% of consolidated liabilities at December 31, 1996, and 1995, respectively.
The weighted average number of shares outstanding used to calculate earnings per share was approximately 72,969,000, 72,677,000 and 74,158,000 in 1996, 1995 and 1994, respectively. The assumed exercise of outstanding stock options does not result in a material dilution of earnings per share.
In March 1997, the FASB issued FAS No. 128, "Earnings Per Share," which is intended to simplify the computation and presentation of earnings per share ("EPS"). FAS 128 supersedes Accounting Principles Board ("APB") Opinion No. 15, "Earnings Per Share." FAS 128 will eliminate the concept of "primary" EPS and require dual presentation of "basic" and "diluted" EPS. Diluted EPS under FAS 128 is similar to "fully diluted" EPS as defined by APB 15. UNUM is required to adopt FAS 128 effective December 31, 1997. As stated in Note 1, under the caption "Earnings Per Share," the assumed exercise of UNUM's outstanding stock options does not result in a material dilution of earnings per share.
The following tables summarize the components of investment income, net realized investment gains, and changes in unrealized investment gains on available for sale securities:
The amortized cost and fair value of fixed maturities available for sale at December 31, 1996, 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.
During 1995, UNUM sold fixed maturities of two issuers classified as held to maturity with an amortized cost of $4.0 million due to evidence of significant deterioration of the issuers' creditworthiness, as evidenced by bankruptcy filings. These sales resulted in a net realized loss of $1.2 million in 1995. During 1994, UNUM sold fixed maturities of five issuers classified as held to maturity with an amortized cost of $49.8 million due to evidence of significant deterioration of the issuers' creditworthiness. These sales resulted in a net realized loss of $3.0 million in 1994.
NOTE 2. INVESTMENTS (Continued) refinanced with terms more favorable to the borrower. Interest lost on restructured loans was not material for the years ended December 31, 1996, 1995 or 1994.
Real estate with a depreciated cost of $7.7 million and no bonds or mortages were non-income producing for the twelve months ended December 31, 1996. Interest lost on these investments was not material in 1996, 1995 or 1994.
UNUM was committed at December 31, 1996, to purchase fixed maturities and other invested assets in the amount of $104.3 million.
The sale resulted in a deferred pretax gain of $80.8 million, which will be recognized in income in proportion to contractholder and/or participant consents for assumption reinsurance, the majority of which management believes will occur during 1997. The purchase price (ceding commission) paid upon closing was approximately $71 million, and the transaction generated statutory capital of approximately $160 million. As of March 1, 1997, consent for assumption reinsurance has been provided by TSA contractholders and/or participants owning approximately 60% of assets under management.
The agreement is a finite reinsurance arrangement that transfers liabilities to Centre Re based on the level of statutory reserves. At December 31, 1996, active life reserves of $427 million and reserves established for claims in 1996 of $137 million were ceded to Centre Re. Under the agreement, Centre Re has an obligation to fund a defined risk layer, while UNUM will retain the earnings risk related to potential adverse claims experience up to a certain threshold. This threshold amount represents the existence of an experience layer with a value of $195 million at December 31, 1996. UNUM has recorded the value of the experience layer on its Consolidated Balance Sheet as a deposit asset. UNUM funded its obligation under the agreement by transferring assets totaling approximately $403 million into a trust account in late December 1996. The assets transferred were equal to the experience layer plus reserves, determined under generally accepted accounting principles, net of related deferred acquisition costs. Future net cash flows of the block will be transferred to/from the trust account and, together with changes in reserve levels, will determine the value of UNUM's deposit asset. Changes in the deposit asset will flow through UNUM's results of operations. The agreement generated slightly more than $200 million of statutory capital.
The effect of reinsurance on premiums earned and written for the years ended December 31, 1996, 1995 and 1994 was as follows:
For the years ended December 31, 1996, 1995 and 1994, recoveries recognized under reinsurance agreements reduced benefits to policyholders by $90.8 million, $58.9 million and $53.3 million, respectively.
NOTE 7. BUSINESS RESTRUCTURING AND OTHER CHARGES (Continued) UNUM America, and consisted of $2.8 million of severance costs for 120 employees and $4.4 million of lease exit costs. The charges in 1995 and 1994 relate 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 $3.4 million curtailment gain, related to workforce reductions in UNUM Corporation's noncontributory defined benefit pension plan. As of December 31, 1996, the liability carried in the Consolidated Balance Sheet for all three charges was $5.3 million.
In connection with the merger of Commercial Life into UNUM America, the sale of the tax-sheltered annuity business (see Note 5), 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, or $0.36 per share for 1996.
Effective January 1, 1997, UNUM replaced its existing pension plans with a new noncontributory defined benefit pension plan ("Lifecycle Plan") covering substantially all domestic employees, including employees of Colonial Companies and D&H. Under the Lifecycle Plan, a new benefit formula is used, resulting in benefits being earned more consistently over an employee's career, and is based on the employee's age at retirement, years of service, and earnings during the highest five of the last ten years of employment. Beginning in 1997, plan assets were transferred from UNUM's separate accounts into a trust for the exclusive benefit of plan participants.
The calculation of the December 31, 1996, benefit obligations shown below is based on the Lifecycle Plan, reflecting the impacts of adding Colonial Companies and D&H employees to the plan, merging Colonial Companies' previous defined benefit plan, and changes in certain actuarial assumptions related to the new benefit formula.
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 $10.3 million, $10.0 million and $8.2 million for the years ended December 31, 1996, 1995 and 1994, respectively. At December 31, 1996, and 1995 the liability associated with these plans was $80.9 million and $72.4 million, respectively.
At December 31, 1996, 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, UNUM's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
The 1987 Executive Stock Option Plan ("Option Plan") provided for granting to officers and key employees options to purchase UNUM Corporation common stock over ten years. Options were granted at the discretion of the Compensation Committee of the Board of Directors ("the Committee") and had vesting schedules of one to four years. The number of shares subject to options under the Option Plan could not exceed 2.5 million. Grants are no longer made under this plan.
The 1996 Long-Term Stock Incentive Plan ("1996 Incentive Plan") provides for granting of options to officers, non-employee directors of UNUM Corporation, and key employees, to purchase UNUM Corporation common stock over ten years. The 1996 Incentive Plan also provides for granting to key officers restricted stock awards whose vesting is contingent upon achieving prescribed financial performance objectives or upon the grantee remaining in UNUM's employ for a specified period of time. Options and restricted stock may be granted annually at the discretion of the Committee. The number of shares subject to issuance cannot exceed 3.5 million. At December 31, 1996, 3,495,000 shares were available for grant under the 1996 Incentive Plan.
The weighted-average exercise price of options outstanding at December 31, 1996, 1995 and 1994, was $45.85, $41.81 and $40.32 per share, respectively.
Between 1991 and 1994, certain officers were granted limited stock appreciation rights ("LSARs") in conjunction with their options for those years. If a change in control of UNUM Corporation, as defined in the plans, should occur, the option holder can exercise the LSAR. An LSAR is meant to compensate an officer if the associated options lose value due to a change in control by allowing the officer to receive payment for the difference between the option exercise price and the highest price paid per share in connection with the change in control. As an underlying stock option is exercised, the LSARs are automatically canceled. At December 31, 1996, 1995 and 1994, there were 398,300 LSARs, 480,825 LSARs and 590,275 LSARs outstanding, 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 1996, 1995 and 1994, expense for these plans was $41.7 million, $19.9 million and $7.5 million, respectively.
UNUM subsidiaries had operating loss carryforwards totaling $3.6 million as of December 31, 1996. The operating loss carryforward will expire, if not utilized, in 1999 through 2002.
Aggregate maturities of notes payable are as follows: 1997-$117.7 million; 1998-$68.0 million; 1999-$21.5 million; 2000-$60.0 million; thereafter-$259.7 million.
Effective October 23, 1996, UNUM's Board of Directors approved an expansion of the Company's stock repurchase program to 6.0 million shares by authorizing an additional 3.7 million shares. At December 31, 1996, approximately 4.5 million shares of common stock remained authorized for stock repurchase. During 1996, UNUM acquired approximately 1.9 million shares of its common stock in the open market at an aggregate cost of $119.1 million. UNUM did not acquire any shares in the open market in 1995. During 1994, UNUM repurchased 3.9 million shares in the open market at an aggregate cost of $183.3 million.
UNUM Corporation also has the ability to draw a dividend from its United Kingdom based affiliate, UNUM Limited, subject to certain U.S. tax consequences.
In the normal course of its business operations, UNUM is involved in litigation from time to time with claimants, beneficiaries and others, and a number of lawsuits were pending at December 31, 1996. In some instances, these proceedings include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from this litigation is not expected to have a material adverse effect on the consolidated financial position or the consolidated operating results of UNUM.
The following table summarizes the carrying amounts and fair values of UNUM's financial instruments at December 31, 1996, and 1995:
Individual Annuities and Supplementary Contracts not Involving Life Contingencies: Fair values approximate the carrying amounts reported in other policyholder funds in the Consolidated Balance Sheets.
UNUM's markets for its insurance products are the United States, its principal market, Canada, the United Kingdom and the Pacific Rim. 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 doctors, attorneys, accountants and engineers.
To more clearly reflect UNUM's management of its businesses and to more appropriately group its product portfolios, UNUM began reporting its operations, effective January 1, 1995, principally in four business segments: Disability Insurance, Special Risk Insurance, Colonial Products and Retirement Products. For comparative purposes, 1994 information was previously restated to reflect reporting in these segments.
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, Association Group 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 Companies, Inc. and subsidiaries, which offer payroll-deducted, voluntary employee benefits including accident and sickness, cancer and life insurance products to employees at their worksites. The Retirement Products segment includes tax sheltered annuities, guaranteed investment contracts, deposit administration accounts, 401(k) plans, individual life and group medical products, all of which are no longer actively marketed by UNUM. Corporate includes transactions that are generally non-insurance related.
On March 14, 1997, the Board of Directors also announced its intent to increase the next regularly scheduled cash dividend, payable in May, to 28.5 cents from 27.5 cents per common share on a pre-split basis.