The Company occupies facilities in Portland, Maine, which are comprised of eight owned facilities totaling 968,000 square feet of office space and 250 acres of land, a portion of which has been developed for employee parking. In addition, approximately 127,000 square feet of office space is leased and occupied in three buildings with rents totaling $1.5 million per year.
The Company occupies facilities totaling 341,000 square feet in Worcester, Massachusetts, with approximately 5.6 acres of surrounding property used primarily for parking. In addition, the Company leases 15,000 square feet in Springfield, Massachusetts, and 13,000 square feet in Auburn, Massachusetts.
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 discussed herein give effect to the merger as if it had been completed at the beginning of the earliest period presented. See Notes 1 and 2 of the "Notes to Consolidated Financial Statements" for further discussion.
Separately, the Company and Max Re Ltd. entered into an agreement whereby Max Re Ltd. 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 which were incurred prior to January 1, 1996. The agreement was effective January 1, 2000.
During 2000, tax legislation was enacted in the United Kingdom that allowed additional group tax relief among companies with common ownership. The Company expects to realize foreign tax benefits as a result of this legislation.
Prior to the June 30, 1999 merger, Unum's process and assumptions used to calculate the discount rate for claim reserves of certain disability businesses differed from that used by Provident. While Unum's and Provident's methods for calculating the discount rate for disability claim reserves were both in accordance with generally accepted accounting principles, management believed that the combined entity should have consistent discount rate accounting policies and methods for applying these policies for similar products. The previous Unum methodology used the same investment strategy for assets backing both liabilities and surplus. Provident's methodology, which allows for different investment strategies for assets backing surplus than those backing product liabilities, was determined by management to be the more appropriate approach for the combined entity. Accordingly, at June 30, 1999, the Company adopted Provident's method of calculating the discount rate for claim reserves. The impact on 1999 earnings related to the change in method of calculating the discount rate for claim reserves was $240.7 million before tax and $156.5 million after tax. The charge was reflected in the Employee Benefits, Individual, and Other segments as an increase in benefits to policyholders of $191.7 million, $38.9 million, and $10.1 million, respectively.
See "Other Segment Operating Results" and Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of these charges and the Company's reinsurance operations.
Employee Benefits new annualized sales, on a submitted date basis, decreased 9.4 percent to $862.7 million in 2000 from $952.5 million in 1999 and $981.1 million in 1998. On an effective date basis, sales decreased 32.1 percent to $744.9 million in 2000 from $1,097.7 million in 1999 and $926.3 million in 1998. Although total year over year comparisons show a decrease, submitted sales during the last half of 2000 increased $93.3 million over sales submitted during the last half of 1999. Sales that combine long-term disability, short-term disability, and group life products also increased from prior year, showing continued strong integrated sales and collaboration in the field. During 2000, 32 percent of all new sales were with long-term disability, short-term disability, and group life combined coverage, compared to 26 percent in 1999.
Revenue from the managed disability line of business, which includes GENEX Services, Inc. and Options and Choices, Inc., totaled $126.1 million in 2000 compared to $107.8 million in 1999 and $96.2 million in 1998.
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 compared unfavorably to 1999, but showed slight improvement throughout 2000. The paid claim incidence for long-term disability compares favorably to 1999 due to lower claim acceptance rates, and claim resolution experience continued to improve during 2000. The 2000 submitted claim incidence rate for long-term disability was higher than the rate for 1999.
The benefit ratio for short-term disability decreased marginally 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.
Additionally, the increase in the amortization of deferred policy acquisition costs had a negative impact on 2000 income. This increase resulted from $25.8 million of additional amortization necessitated by the higher level of group long-term and short-term disability terminations experienced during 2000 relative to that which was expected at the time the business was written. However, the disability business retained is relatively more profitable than the business that terminated. The additional amortization during 1999 was $4.2 million.
As previously discussed under "Results of Operations," during 2000 the Company entered into a 100 percent indemnity coinsurance agreement to cede the future claim payments on one of its insurance subsidiaries' long duration group long-term disability claims which were incurred prior to January 1, 1996. The agreement was effective January 1, 2000.
Group disability revenue increased to $3,029.0 million in 1999 compared to $2,632.1 million in 1998. Premium income growth was driven primarily by prior period sales. As previously discussed, the rate of growth in new sales declined during 1999. New annualized sales, on a submitted date basis, for group long-term disability were $385.2 million in 1999 compared to $441.7 million in 1998. New annualized sales for group short-term disability were $172.0 million in 1999 as compared to $176.2 million in 1998. On an effective date basis, new annualized sales for long-term disability and short-term disability were $466.9 million and $203.1 million in 1999 and $426.4 million and $159.7 million in 1998.
Group disability reported a loss of $225.7 million for 1999, as compared with $334.4 million of income for 1998. The loss was the result of the $191.7 million second quarter 1999 charge and the $359.2 million third quarter 1999 charge as previously discussed. Excluding the effect of these two charges, this line reported an 83.5 percent benefit ratio for 1999. The benefit ratio for 1998 was 79.4 percent, excluding the effect of the fourth quarter of 1998 claims disruption charge discussed in the following paragraphs. The incidence rates for new claims submitted for long-term disability increased during 1999 over the level experienced in 1998, but new claim incidence rates in the third and fourth quarters of 1999 improved relative to levels experienced in the first half of 1999 and the last half of 1998. Small case business continues to perform well, and large case and mid-size business showed improvement in 1999. The incidence rates for new claims submitted for short-term disability improved during 1999 as compared to 1998.
Group life and long-term care both reported an increase in revenue for 2000 compared to 1999 due to increases in premium income and net investment income. Offsetting the revenue increase was an increase in the benefit ratio when compared to 1999. Group life reported an unfavorable benefit ratio in 2000 compared to the prior year due to an increase in the average paid claim size and waiver incidence, partially offset by favorable paid mortality incidence.
The 2000 benefit ratio for accidental death and dismemberment compares unfavorably with 1999. The increase in the average paid claim size contributed to the unfavorable comparison. Submitted incidence for accidental death and dismemberment has improved relative to 1999.
The reinsurance transaction with Reassure America, discussed under Item 1 contained herein, reduced 2000 group life and accidental death and dismemberment premium income and benefits approximately $15.4 million and $11.7 million, respectively.
The reinsurance transaction with Manulife Reinsurance Limited and SCOR Reinsurance Company, under which an insurance subsidiary of the Company cedes through a net quota share reinsurance agreement 50 percent of the group life volume above the aggregate retention limit, does not meet the conditions for reinsurance accounting and is therefore accounted for as a deposit. As such, there is no effect on reported premium income or benefits. The only impact on the income statement is the risk charge paid to the reinsurers.
See Note 13 of the "Notes to Consolidated Financial Statements" for further discussion of the 2000 reinsurance transactions.
Group long-term care reported a higher benefit ratio for 2000 compared to 1999. The long-term care net claim resolution rate for 2000 is below the average rate for 1999, primarily due to a decrease in claim recoveries. The 2000 incidence rates for both submitted and paid claims improved over the prior year.
Group life, accidental death and dismemberment, and long-term care reported income of $239.5 million in 1999 compared to $197.5 million in 1998. The increase resulted from the growth in premium income, which was driven by strong prior period sales, and a lower operating expense ratio. The results also benefited from higher net investment income and a higher volume of business. There was a slight increase in the benefit ratio, from 72.7 percent in 1998 to 73.3 percent in 1999, primarily due to an increase in the average claim size in the group life line of business.
The Individual segment includes results from the individual disability and individual long-term care lines of business. Individual life, which was previously included in the Individual segment, is no longer actively marketed and is now reported in the Other segment. Historical by segment results have been reclassified. See "Other Segment Operating Results" for further discussion of the individual life line of business.
Income in the individual disability income line of business increased to $256.7 million in 1999 from $190.0 million in 1998. Excluding the 1999 discount rate change of $38.9 million, this line reported an increase in the benefit ratio in 1999 compared to 1998. The 1999 claim resolution rate compared unfavorably with 1998, but showed improvement throughout 1999. New claims for 1999 were fairly level with 1998. This line benefited from higher net investment income and a favorable operating expense ratio for 1999 as compared to 1998.
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. New annualized sales were $47.7 million in 2000, $40.0 million in 1999, and $23.5 million in 1998. 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 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 unfavorable compared to 1999. The primary drivers were unfavorable results in the life product line and an increase in the incurred and paid loss ratios for the cancer product line.
Income in the Voluntary Benefits segment in 1999 was $137.0 million versus $131.1 million in 1998. The increase in income for 1999 was primarily due to the increase in premium income in all of the product lines and an increase in investment income, partially offset by a slightly higher benefit ratio in the life, accident and sickness, and disability product lines.
Total revenue and income for individual life and corporate-owned life insurance was $236.1 million and $49.6 million, respectively, in 2000 compared to $435.0 million in revenue and $65.6 million in income for 1999.
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
The Corporate segment reported losses of $49.5 million in 2000, $484.6 million in 1999, and $125.5 million in 1998. Interest and debt expense was $181.8 million in 2000, $137.8 million in 1999, and $112.0 million in 1998 due to increased corporate borrowings. The amortization of goodwill was $22.3 million in 2000, $82.6 million in 1999, and $28.0 million in 1998. The Company recorded write-downs of goodwill of $57.7 million during 1999 related to its reinsurance operations. See previous discussion under "Other Segment Operating Results" and Note 13 of the "Notes to Consolidated Financial Statements."
Results for 2000 were positively impacted by the gain of $116.1 million on the pension plan transaction, partially offset by consolidation and benefit accruals of $9.4 million. See previous discussion contained herein in "Results of Operations" and Note 10 of the "Notes to Consolidated Financial Statements."
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 durations with related expected liability durations and to maximize investment returns, subject to constraints of quality, liquidity, diversification, and regulatory considerations. See Note 4 of the "Notes to Consolidated Financial Statements" for further discussion of the Company's investments.
The following table provides the distribution of invested assets for the years indicated. Policy loans are reported on a gross basis in the consolidated statements of financial condition and in the table below. As of December 31, 2000, $2.2 billion of policy loans were ceded, and the investment income thereon is no longer included in income.
The Company's exposure to below-investment-grade fixed maturity securities at December 31, 2000, was $1,760.8 million, representing 7.2 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 $2,147.4 million at December 31, 1999, representing 8.1 percent of invested assets.
The mortgage loan portfolio is well diversified geographically and among property types. The incidence of new problem mortgage loans and foreclosure activity has remained low in 2000 and 1999, reflecting improvements in overall economic activity and improving real estate markets in the geographic areas where the Company has mortgage loans. Management expects the level of delinquencies and problem loans to remain low in the future. No new mortgage loans were added to the Company's investment portfolio during 2000 other than one purchase money mortgage for $14.8 million associated with the sale of real estate.
The Company believes the cash flows from its operations will be sufficient to meet its operating and financial cash flow requirements, excluding the strain placed on capital as a result of the charges recorded in connection with the merger. As a result of the effect on capital during 1999 of the merger related charges, the Company raised approximately $500 million through the debt markets during the fourth quarter of 1999 by securing $200 million of one-year bank debt and by issuing commercial paper.
The Company is dependent upon payments from its subsidiaries to pay dividends to its stockholders and to pay its expenses. These payments by the Company's insurance and non-insurance subsidiaries may take the form of interest payments on amounts loaned to such subsidiaries by the Company, operating and investment management fees, and/or dividends. At December 31, 2000, the Company had outstanding from its insurance subsidiaries a $150.0 million surplus debenture due in 2006 with a weighted average interest rate during 2000 of 8.20 percent and a $100.0 million surplus debenture due in 2027 with a weighted average interest rate during 2000 of 8.25 percent. Semi-annual interest payments are conditional upon the approval by the insurance department of the state of domicile.
. in 2001, $359.9 million will be available for the payment of dividends to the Company from its domestic insurance subsidiaries, and approximately $20.9 million will be available for the payment of dividends from Unum Limited.
The ability of the Company to continue to receive dividends from its insurance subsidiaries without regulatory approval will be dependent upon the level of earnings of its insurance subsidiaries as calculated under law. In addition to regulatory restrictions, the amount of dividends that will be paid by insurance subsidiaries will depend on additional factors, such as risk-based capital ratios, funding growth objectives at an affiliate level, and maintaining appropriate capital adequacy ratios to support the ratings desired by the Company. Regulatory restrictions do not limit the amount of dividends available for distribution to the Company from its non-insurance subsidiaries.
At December 31, 2000, the Company had short-term and long-term debt totaling $402.2 million and $1,615.5 million, respectively. At December 31, 2000, approximately $551.0 million was available for additional financing under the Company's revolving credit facilities. Contingent upon market conditions and corporate needs, management may refinance short-term notes payable for longer-term securities.
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, funding will be used to refinance short-term debt on a long-term basis and to fund other corporate needs.
In the fourth quarter of 1998, the Company rescinded its stock repurchase program as a result of the pending merger. During 1998, the Company acquired approximately 1.4 million shares of its common stock in the open market at an aggregate cost of $72.7 million.
Standard & Poor's Corporation (S&P), Moody's Investors Service (Moody's), Fitch, Inc. (Fitch), formerly Fitch/Duff & Phelps, 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.
We have audited the accompanying consolidated statements of financial condition of UnumProvident Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. 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. We did not audit the financial statements and schedules of the former Unum Corporation which statements reflect total revenues constituting 54% of the related consolidated totals for the year ended December 31, 1998. Those statements and schedules were audited by other auditors whose report has been furnished to us, and our opinion, in so far as it relates to data included for the former Unum Corporation, is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
Chattanooga, Tennessee February 12, 2001, except for Notes 13 and 15, for which the date is February 27, 2001
Mortgage Loans are generally carried at amortized cost less an allowance for probable losses.
Real Estate classified as investment real estate is carried at cost less accumulated depreciation. Real estate acquired through foreclosure is valued at fair value at the date of foreclosure. 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 to real estate held for sale when it no longer meets the Company's investment criteria. Real estate held for sale is valued net of a valuation allowance that reduces the carrying value to the lower of cost less accumulated depreciation or fair value less estimated cost to sell. Accumulated depreciation on real estate was $31.0 million and $42.8 million as of December 31, 2000 and 1999, respectively.
Fixed maturity securities include bonds and redeemable preferred stocks. Equity securities include common stocks and nonredeemable preferred stocks. Fixed maturity and equity securities not bought and held for the purpose of selling in the near term but for which the Company does not have the positive intent and ability to hold to maturity are classified as available-for-sale. Fixed maturity securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity. The Company determines the appropriate classification of fixed maturity securities at the time of purchase.
The Company regularly monitors the effectiveness of its hedging programs. In the event a hedge becomes ineffective, it is marked-to-market, resulting in a charge or credit to net investment income or policyholder benefits.
The fair values of futures and forwards which hedge available-for-sale securities are reported in the consolidated statements of financial condition as a component of fixed maturity securities. The fair values of open futures and forwards which hedge liabilities are reported in the consolidated statements of financial condition as a component of other liabilities. Gains or losses realized on the termination of futures and forwards contracts are accounted for in the same manner as interest rate swap agreements.
Deferred policy acquisition costs related to traditional policies are amortized over the premium paying period of the related policies in proportion to the ratio of the present value of annual expected premium income to the present value of total expected premium income. Adjustments are made each year to recognize actual persistency experience as compared to assumed experience.
Loss recognition is performed when, in the judgment of management, adverse deviations from original assumptions have occurred and may be likely to continue such that recoverability of deferred policy acquisition costs on a line of business is questionable. Insurance contracts are grouped on a basis consistent with the Company's manner of acquiring, servicing, and measuring profitability of the contracts. If loss recognition testing indicates that deferred policy acquisition costs are not recoverable, the deficiency is charged to expense. Once a loss recognition adjustment is required, loss recognition testing is generally performed on an annual basis using then current assumptions until the line of business becomes immaterial or results improve significantly. The assumptions used in loss recognition testing represent management's best estimates of future experience.
Value of Business Acquired: Value of business acquired represents the present value of future profits recorded in connection with the acquisition of a block of insurance policies. The asset is amortized based upon expected future premium income for traditional insurance policies and estimated future gross profits for interest-sensitive insurance policies, with the accrual of interest added to the unamortized balance at interest rates principally ranging from 5.55 percent to 8.13 percent. The accumulated amortization for value of business acquired was $168.7 million and $133.2 million as of December 31, 2000 and 1999, respectively. The Company periodically reviews the carrying amount of value of business acquired using the same methods used to evaluate deferred policy acquisition costs.
Property and Equipment: Property and equipment is depreciated on the straight- line method over its estimated useful life. The accumulated depreciation for property and equipment was $350.1 million and $376.1 million as of December 31, 2000 and 1999, respectively.
The Company follows the periodic method of accounting for its Lloyd's of London (Lloyd's) business in which premiums are recognized as revenue over the policy term, and claims, including an estimate of claims incurred but not reported, are recognized as they occur. Premiums for the Lloyd's business are based on participation in the individual syndicate underwriting years that generate premiums over a three year period of time. The Company uses its historical experience and information obtained from its managing agents to estimate revenues, losses, expenses, and the related assets and liabilities. See Note 13.
Interest assumptions for active life reserves are generally graded downward over a period of years. Reserves for future policy and contract benefits on interest- sensitive products are principally policyholder account values determined on the retrospective deposit method.
Financial Accounting Standards Board Interpretation No. 44 (Interpretation 44), Accounting for Certain Transactions Involving Stock Compensation
Effective July 1, 2000, the Company adopted the provisions of Interpretation 44 which clarify the application of Opinion 25. The adoption of the Interpretation had no effect on the Company's financial position or results of operations.
Foreign currency exposures hedge. In a hedge of foreign currency exposures in a net investment in a foreign operation, to the extent the hedge is effective, the change in the fair value of the derivative is treated as a translation gain or loss and recognized in accumulated other comprehensive income offsetting other translation gains and losses arising in consolidation. Any ineffective portion must be recognized in operating earnings at the same time the change in fair value of the derivative is recognized on the statement of financial condition.
The expenses related to the merger reduced 1999 earnings $184.7 million before tax and $139.6 million after tax. The expense related to the early retirement offer reduced earnings $125.9 million before tax and $81.8 million after tax.
Claim termination rates $ 372.6 Incurred but not reported factors 101.4 Discount rates (114.8) ------- Net change $ 359.2 =======
The assumptions concerning claim termination rates relate to changes in the estimated average length of time a claim is open (duration) and the ultimate cost of settling claims. Recent trends indicate the duration of a disability claim is increasing. Claim termination rates are based on industry experience adjusted for Company historical and anticipated experience, which considers emerging trends and Company actions that would have a material effect on claim termination rates.
The carrying amounts and fair values of the Company's financial instruments are as follows:
Fair values for insurance contracts other than investment contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.
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 (losses) on these securities were $23.6 million and $(25.9) million, respectively, at December 31, 2000 and 1999.
Adjustments to reserves for future policy and contract benefits that would have been necessary if the unrealized investment gains and losses related to the available-for-sale securities had been realized as of December 31, 2000 and 1999, were $36.0 million and $(123.1) million, respectively.
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 $17.7 million and $18.1 million, respectively, at December 31, 2000 and 1999. Included in the impaired loans at December 31, 2000 were loans of $6.5 million which had a related allowance for losses of $2.4 million and loans of $11.2 million which had no related allowance for losses. Included in the impaired loans at December 31, 1999 were loans of $6.6 million which had a related allowance for losses of $2.4 million and loans of $11.5 million which had no related allowance for losses.
To help limit the credit exposure of the derivatives, the Company has entered into master netting agreements with its counterparties whereby contracts in a gain position can be offset against contracts in a loss position. The Company also typically enters into bilateral, cross-collateralization agreements with its counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a loss position to submit acceptable collateral with the other counterparty in the event the net loss position meets or exceeds an agreed upon amount. The Company's current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position, was $73.8 million at December 31, 2000.
Additions and terminations reported above for futures and options include roll activity, which is the closing out of an old contract and initiation of a new one when a contract is about to mature but the need for it still exists.
The following table summarizes the timing of anticipated settlements of interest rate swaps outstanding at December 31, 2000, whereby the Company receives a fixed rate and pays a variable rate. The weighted average interest rates assume current market conditions.
The Company has executed a series of cash flow hedges in the group disability, individual disability, and group single premium annuities portfolios using interest rate swaps, forwards, futures, and options. The purpose of these hedges is to lock in the reinvestment rates on future cash flows and protect the Company from the potential adverse impact of declining interest rates on the associated policy reserves. The Company uses futures contracts to partially offset hedges on fixed maturity securities purchased prior to the termination date of interest rate swaps and forwards. The Company also uses futures contracts to replace terminated forwards and interest rate swaps in order to maintain hedges until the fixed maturity securities are purchased. The notional amount outstanding for these cash flow hedges was $1,075.0 million, $1,482.9 million, and $1,285.0 million at December 31, 2000, 1999, and 1998, respectively. The deferred gain on these contracts was $82.3 million, $94.0 million, and $63.7 million, at December 31, 2000, 1999, and 1998, respectively.
In 2000, 1999, and 1998, the Company amortized into net investment income $3.5 million, $3.1 million, and $1.9 million, respectively, of the deferred gains from this program. Realized investment gains from this program during 2000 were $6.3 million. Realized investment gains and losses from this program during 1999 and 1998 were immaterial.
Future contracts to hedge anticipated cash flows have also been utilized for other product portfolios. At December 31, 2000, the Company had no open contracts for other product portfolios.
In 1998 and 1997, the Company sold indexed annuity products whereby a portion of the crediting rate on the annuity was based on the performance of the S&P 500 stock index. In order to hedge this fluctuating credit rate, the Company purchased options with the S&P 500 stock index as the underlying item. These options will be settled with a net cash payment to the Company at the expiration date if the S&P 500 index moves above the option contract's strike price; otherwise, no cash payment will take place at expiration. At December 31, 2000 and 1999, the outstanding notional amount of these options was $7.3 million for both years, and the fair values and carrying amounts were $4.3 million and $5.9 million, respectively.
At December 31, 2000, the Company had no open contracts under this program.
The estimated net amortization of value of business acquired for each of the next five years is $45.6 million in 2001, $44.2 million in 2002, $42.8 million in 2003, $41.2 million in 2004, and $39.8 million in 2005. Acquisition and disposition activity relates to certain reinsurance transactions. See Note 13.
It is the Company's policy to estimate the ultimate cost of settling claims in each reporting period based upon the information available to management at the time. Actual claim resolution results are monitored and compared to those anticipated in claim reserve assumptions. Claim resolution rate assumptions are based upon industry standards adjusted as appropriate to reflect actual Company experience as well as Company actions which would have a material impact on claim resolutions. Company actions for which plans have been established and committed to by management are factors which would modify past experience in establishing claim reserves. Adjustments to the reserve assumptions will be made if expectations change. Given that insurance products contain inherent risks and uncertainties, the ultimate liability may be more or less than such estimates indicate.
Immediately following the announcement of the merger and continuing into December of 1998, senior management of the Company worked to develop the strategic direction of the Company's claims organization. As part of the strategic direction, senior management committed claims management personnel to be involved in developing the detailed integration plans and implementing the plans during 1999. Knowing that those involved in the claims operations integration activities would not be available full time to perform their normal claims management functions, management deemed it necessary to anticipate this effect on the claim reserves at December 31, 1998. Prior to the merger, during the first six months of 1999 approximately 90 claims managers and benefit specialists spent nearly 40 percent of their time developing the detailed integration plans. Effective with the merger, virtually all claims personnel were involved in the process of implementing the new work processes and required training. Implementation and related systems conversions continued into the second quarter of 2000. However, due to actions taken by management to mitigate effects on resolution rates, the effect on new claim resolution rates was not material after the end of 1999.
Actions by management to mitigate the effect on resolution rates included aggressive hiring of new claims staff, restrictions on early retirement elections, selective use of personnel for integration planning, and significant communications with staff members.
For most of the Company's subsidiaries, tax years through 1995 are closed to further assessment by the Internal Revenue Service (IRS). During 2000, the IRS continued its examination of subsequent years. Management believes any future adjustments that may result from IRS examinations of tax returns will not have a material impact on the financial position, liquidity, or results of operations of the Company.
During 1999, the Company reached a settlement with the IRS relating to its federal income tax liability for the 1986 through 1992 tax years. Results for the year ended December 31, 1999 increased $36.8 million due to settlements of these prior year tax issues.
The Company's subsidiaries had net operating loss carryforwards of approximately $641.7 million, alternative minimum tax credit carryforwards of approximately $11.7 million, and capital loss carryforwards of $1.9 million as of December 31, 2000. The majority of the net operating loss carryforwards will begin to expire, if not utilized, in 2015; the alternative minimum tax credits do not expire; the capital loss carryforwards begin expiring in 2005.
In April 2000, the Company issued $200.0 million of variable rate notes in a privately negotiated transaction. The notes are due in April 2001 and were used to refinance other short-term debt and had a weighted average interest rate of 7.33 percent during 2000.
In August 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. The shelf registration became effective in September 2000, but as of December 31, 2000, no securities had been issued.
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 2000, 1999, and 1998 was $22.2 million, $22.2 million, and $11.1 million, respectively.
During the fourth quarter of 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, the annual rate of increase in the per capita cost of covered health care benefits assumed for 2001 was 7.5 percent. The rate range was assumed to change gradually to a rate of 5.5 percent for 2004 and remain at that level thereafter.
The following table provides the components of the net periodic benefit cost (credit) and early retirement cost for the plans described above.
During February 1998, the Company redeemed its 8.10% cumulative preferred stock outstanding of $156.2 million.
The Company applies Opinion 25 and related interpretations in accounting for the stock option plans and ESPP. Accordingly, no compensation cost has been recognized for these plans. Compensation cost for the Company's stock option plans and ESPP under the fair value approach was estimated as of the grant date using Black-Scholes option pricing models.
Volatility 23.8% to 26.4% Risk-free Rate of Return 4.2% to 5.3% Dividend Payout Rate 1.0% Time of Exercise 4 to 8 years Weighted Average Fair Value of Options Granted During the Year $12.88
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, 2000, relates to over 140 reinsurance relationships. Of the five major relationships which account for approximately 75 percent of the reinsurance receivable amount at December 31, 2000, 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 $618.1 million, $576.7 million, and $489.0 million during 2000, 1999, and 1998, respectively.
Effective January 1, 2000, an insurance subsidiary of the Company reinsured the inforce individual disability income block of business of the New York Life Insurance Company through a 100 percent indemnity modified coinsurance agreement. The Company paid a ceding commission of $88.0 million which is being amortized as earnings emerge from the business assumed.
Net GAAP Reserves $ 713.2 Experience Layer 385.0 ---------- Attachment Point 1,098.2 Centre Re's Defined Risk Layer 145.4 ---------- Defined Risk Limit $1,243.6 =========
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 Standard 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 gains or losses from sales of assets are reflected as realized investment gains and losses in the Company's consolidated statements of operations.
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. The Company 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. During the first quarter of 2001, the Company entered into an agreement in principle to limit its liabilities pertaining to the Lloyd's syndicate participations.
The table below summarizes the charges recognized by the Company during 2000 and 1999 related to the reinsurance operations (in millions).
In 1999 the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities to American United Life Insurance Company (AUL) and also reinsured the Company's risk participation in these facilities with AUL (see below). Certain risks related to prior operations were not assumed by AUL. The terms of the sale required the Company to continue to participate in certain of the reinsurance facilities in year 2000, thereby assuming underwriting risks. A before-tax loss of $12.9 million, including the write-off of $6.0 million of goodwill related to this portion of the operations, was recognized during 1999.
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.
As previously stated, during the first quarter of 2001, the Company entered into an agreement in principle to limit its liabilities pertaining to the Lloyd's syndicate participations.
In connection with the development of the cost of exiting the reinsurance operations, during 1999 the Company updated its review of reserves related to non-Lloyd's reinsurance operations as well as future costs associated with managing the run-off of the retained reinsurance pools liabilities. Based upon this review, the Company increased reserves related to its participation in certain managed and non-managed reinsurance facilities by $21.9 million in 1999.
When an event or change in circumstance occurs that indicates the recoverability of an asset should be assessed for impairment, a recoverability test is performed to determine if impairment has 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. After factoring in the first quarter 1999 results and the revised forecasts current at that time, future undiscounted cash flows were insufficient to recover the entire goodwill amount, indicating that the goodwill was impaired. Goodwill recoverability testing of these operations performed prior to March 31, 1999 had indicated that the goodwill was not impaired.
Following the write-downs of $27.0 million and $2.0 million, the Company's remaining unamortized goodwill related to its reinsurance operations was $53.7 million. Of the $31.0 million unamortized balance attributable to the A&H and LTC business being sold, $6.0 million was determined to be unrecoverable and was written off and included in the $12.9 million loss on the sale reported above. The balance of $25.0 million was recovered through the sales proceeds when the sale closed. The remaining unamortized balance of $22.7 million was determined to be unrecoverable based on revised earnings forecasts for the reinsurance operations and was written off during the third quarter of 1999. The total write-down of goodwill was $51.7 million during 1999, exclusive of the $6.0 million included in the loss on the sale.
On April 10, 2000, the defendants filed a motion to dismiss the complaints. On January 8, 2001, the district court affirmed a Recommended Decision by the Magistrate Judge, entered November 8, 2000, that granted in part, and denied in part, the motion. The district court granted the motion to dismiss plaintiff's claims (i) under Section 10(b) of the Securities Exchange Act of 1934, (ii) under Section 14(a) of the Securities Exchange Act of 1934 on behalf of the former shareholders of Unum Corporation, and (iii) under Section 12(a) of the Securities Act of 1933 on behalf of purchasers of UnumProvident stock after the merger. The district court also dismissed plaintiff's claims relating to disclosures regarding the costs associated with Unum's exit from its reinsurance business, but otherwise denied defendants' motion to dismiss plaintiff's claims under Sections 11 and 12(a) (2) of the Securities Act of 1933 and the claim under Section 14(a) of the Securities Exchange Act of 1934.
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 Note 13 for further discussion regarding reinsurance pool participation.
Various other lawsuits against the Company have arisen in the normal course of its business. Contingent liabilities that might arise from such other litigation are not deemed likely to materially affect the financial position or results of operations of the Company.
At December 31, 2000, the Company's insurance subsidiaries had on deposit with regulatory authorities securities with a book value of $1,407.6 million held for the protection of policyholders.
During the third quarter of 1999, the Company incurred net charges of $592.2 million before tax ($436.2 million after tax) related to reserve increases, reinsurance operation activities, and merger costs, partially offset by interest income on a federal income tax refund. During the second quarter of 1999, the Company incurred net charges of $508.8 million before tax ($350.3 million after tax) related to reserve increases and merger and early retirement