SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549
FORM 10-Q
Commission file number 1-11834
UnumProvident Corporation (Exact name of registrant as specified in its charter)
1 FOUNTAIN SQUARECHATTANOOGA, TENNESSEE 37402(Address of principal executive offices)
423.755.1011(Registrant’s telephone number, including area code)
Not Applicable(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
TABLE OF CONTENTS
PART I
PART II
Cautionary Statement Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the Act) provides a “safe-harbor” for forward-looking statements which are identified as such and are accompanied by the identification of important factors which could cause actual results to differ materially from the forward-looking statements. UnumProvident Corporation (the Company) claims the protection afforded by the safe harbor in the Act. Certain information contained in this discussion, or in any other written or oral statements made by the Company, is or may be considered as forward-looking. Examples of disclosures that contain such information include, among others, sales estimates, income projections, and reserves and related assumptions. Forward-looking statements are those not based on historical information, but rather relate to future operations, strategies, financial results, or other developments. These statements may be made directly in this document or may be made part of this document by reference to other documents filed with the Securities and Exchange Commission by the Company, which is known as “incorporation by reference.” You can find many of these statements by looking for words such as “may,” “should,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “projects,” “goals,” “objectives,” or similar expressions in this document or in documents incorporated herein.
These forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Factors that may cause actual results to differ materially from those contemplated by the forward-looking statements include, among others, the following possibilities:
For further discussion of risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in Part I of the Company’s Form 10-K for the fiscal year ended December 31, 2001.
All subsequent written and oral forward-looking statements attributable to the Company or any person acting on its behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. The Company does not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
UnumProvident Corporation and Subsidiaries
See notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - Continued
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2002
Note 1 - Basis of Presentation
The accompanying condensed consolidated financial statements of UnumProvident Corporation and subsidiaries (the Company) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month and nine month periods ended September 30, 2002, are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2001.
Note 2 - Changes in Accounting Principles and Accounting Pronouncements Outstanding
Effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations. SFAS 141 addresses financial accounting and reporting for business combinations and requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. The adoption of SFAS 141 had no material impact to the Company’s financial position or results of operations.
Effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. In accordance with SFAS 142, the Company is no longer amortizing goodwill but will subject the asset to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives.
Transition to the provisions of SFAS 142 required the Company to complete, within the year of adoption, transitional impairment tests of goodwill existing at January 1, 2002, measured as of that date using a fair value approach. The Company had previously, prior to the adoption of SFAS 142, used undiscounted cash flows to determine if goodwill was recoverable. Goodwill impairment is deemed to occur if the net book value of a reporting unit exceeds its estimated fair value. The Company’s reporting units are generally operating segments, as defined in Note 5, or one level below the operating segment if that reporting unit constitutes a business.
The Company completed the required transitional impairment tests and determined that the goodwill related to the acquisition of the assets of EmployeeLife.com, now doing business as BenefitAmerica and included in the Other segment, should be reduced $11.0 million. The charge, net of a $3.9 million tax benefit, was $7.1 million ($0.03 per common share, basic and assuming dilution) and is reported as a cumulative effect of accounting principle change in the condensed consolidated statements of income.
The Company reclassified its January 1, 2002 goodwill asset balance of $663.7 million from the corporate segment to the segments expected to benefit from the originating business combinations. The reclassification increased the Employee Benefits segment and Individual segment assets by $78.2 million and $585.5 million, respectively.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Note 2 - Changes in Accounting Principles and Accounting Pronouncements Outstanding - Continued
Had the amortization of goodwill been excluded from the three and nine month periods ended September 30, 2001, income before federal income taxes would have been $198.5 million and $645.5 million, respectively, and net income would have been $132.2 million ($0.54 per common share assuming dilution) and $470.4 million ($1.93 per common share assuming dilution), respectively.
Effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 supercedes Statement of Financial Accounting Standards No. 121 (SFAS 121), Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 (Opinion 30), Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Two accounting models existed for long-lived assets to be disposed of under SFAS 121 and Opinion 30. SFAS 144 represents a single accounting model for long-lived assets to be disposed of by sale. The adoption of SFAS 144 did not have a material impact on the Company’s financial position or results of operations.
In the second quarter of 2002, the Financial Accounting Standards Board (FASB) released Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections (SFAS 145). The Company will adopt SFAS 145 effective January 1, 2003 as required. Adoption of SFAS 145 is not expected to have a material impact on the Company’s financial position or results of operations.
In the third quarter of 2002, the FASB released Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146). This pronouncement requires companies to recognize a liability for the costs associated with exit or disposal activities at the time the liability is incurred rather than at the commitment date, using fair value as the initial measurement basis for the liability. The Company will adopt the provisions of SFAS 146 effective January 1, 2003 as required. Adoption of SFAS 146 is not expected to have a material impact on the Company’s financial position or results of operations.
Note 3 - Stockholders’ Equity and Earnings Per Common Share
The Company has 25,000,000 shares of preferred stock authorized with a par value of $0.10 per share. No preferred stock has been issued to date.
During the second quarter of 2002, the Company’s board of directors authorized a common stock repurchase program of up to $100.0 million over the next year at prices not to exceed market value. The stock purchases will be used in connection with the Company’s benefit and compensation plans and for other corporate purposes and can be made through the open market or privately negotiated transactions. Under this program, the Company acquired approximately 1.8 million shares of its common stock in the open market through the third quarter of 2002 at an aggregate cost of approximately $45.0 million. It is not anticipated that further repurchases will be made under the program.
Note 3 - Stockholders’ Equity and Earnings Per Common Share - Continued
Net income per common share is determined as follows:
In computing earnings per share assuming dilution, only potential common shares that are dilutive (those that reduce earnings per share) are included. Potential common shares are not used when computing earnings per share assuming dilution if the result would be antidilutive, such as when options are out-of-the-money. Options out-of-the-money approximated 15.6 million and 14.9 million shares for the three and nine month periods ended September 30, 2002, respectively, and 8.3 million and 9.2 million shares for the three and nine month periods ended September 30, 2001, respectively.
Note 4 - Comprehensive Income
The components of accumulated other comprehensive income, net of deferred tax, are as follows:
Note 4 - Comprehensive Income - Continued
The components of comprehensive income and the related deferred tax are as follows:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – Continued
Note 5 - Segment Information
Selected data by segment is as follows:
Note 6 – Commitments and Contingent Liabilities
In 1997 two alleged class action lawsuits were filed in Superior Court in Worcester, Massachusetts (Superior Court) against UnumProvident Corporation (UnumProvident) and several of its subsidiaries, The Paul Revere Corporation (Paul Revere), The Paul Revere Life Insurance Company, The Paul Revere Variable Annuity Insurance Company, The Paul Revere Protective Life Insurance Company, and Provident Life and Accident Insurance Company. One purported to represent independent brokers who sold certain individual disability income policies with benefit riders that were issued by subsidiaries of Paul Revere. The trial for the independent broker class action commenced in March 2001. In April 2001, the jury returned a complete defense verdict. The court subsequently entered judgment on that verdict. The plaintiffs have not given an indication as to whether or not they will appeal the jury verdict. The plaintiffs have a pending motion seeking a new trial. Notwithstanding the jury verdict, the judge was obligated to rule separately on the claim that UnumProvident and its affiliates violated the Massachusetts Consumer Protection Act (Act). The bench trial for the alleged violation commenced in October 2001 and concluded in November 2001 with closing briefs submitted to the judge in December 2001 and closing arguments heard in January 2002. The judge ruled that Paul Revere violated the Act and awarded double damages plus attorney fees. Issues remain as to how these amounts are to be determined. The Company feels strongly that the judge’s ruling is contrary to both the law and the facts of the case and plans to appeal after the judgment is made final.
The career agent class action purports to represent all career agents of subsidiaries of Paul Revere whose employment relationships ended on June 30, 1997 and were offered contracts to sell insurance policies as independent producers. At the hearing to determine class certification heard in December 1999 in Superior Court, class certification was denied for the career agents. Summary judgment motions were heard in November 2000 and all motions from plaintiffs and defendants were denied pertaining to the two class representatives whose cases survived. The career agent plaintiffs have re-filed their complaint seeking a class action status by limiting the issues to those in the certified broker class action. The court has not ruled on the re-filing.
In addition, the same plaintiffs’ attorney who had initially filed the class action lawsuits has filed 50 individual lawsuits on behalf of current and former Paul Revere sales managers (including the career class action representatives) alleging various breach of contract claims. UnumProvident and affiliates filed a motion in federal court to compel arbitration for 17 of the plaintiffs who are licensed by the National Association of Securities Dealers (NASD) and have executed the Uniform Application for Registration or Transfer in the Securities Industry (Form U-4). The federal court denied 15 of those motions and granted two. In June 2001, the first arbitration was heard before a NASD panel and the arbitration panel awarded the plaintiffs $190,000 in compensatory damages with no award for punitive damages, attorney’s fees, or interest. The second arbitration was cancelled because all of the claims of the 43 out of 47 general managers (including the arbitration) were settled in July of 2002. Partial claims for five general managers remain along with the two career class representatives. UnumProvident and affiliates believe that they have strong defenses and plan to vigorously defend their position in the remaining cases. Management does not currently expect these suits to materially affect the financial position or results of operations of the Company.
In certain reinsurance pools associated with the Company’s reinsurance businesses there are disputes among the pool members and reinsurance participants concerning the scope of their obligations and liabilities within the complex pool arrangements, including pools for which subsidiaries of the Company acted either as pool managers or underwriting agents, as pool members or as reinsurers. The Company or the Company’s subsidiaries either have been or may in the future be brought into disputes, arbitration proceedings, or litigation with other pool members or reinsurers of the pools in the process of resolving the various claims. See the reinsurance pools and management section contained in the segment results discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained herein in Item 2.
Note 6 – Commitments and Contingent Liabilities - Continued
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.
Note 7 - Other Items
In June 2002, the Company completed two long-term debt offerings, issuing $250.0 million of 7.375% senior debentures due June 15, 2032, and $150.0 million of 7.250% public income notes due June 15, 2032. The public income notes are redeemable at the Company’s option, in whole or in part, on or after June 25, 2007. The proceeds were used to refinance existing commercial paper borrowings.
On November 1, 2002, the Company filed with the Securities and Exchange Commission a shelf registration on Form S-3. The shelf registration statement will allow the Company to issue various types of securities, including common stock, preferred stock, debt securities, depository shares, and warrants, from time to time, up to an aggregate of $1.5 billion. The shelf registration will enable the Company to raise funds from the offering of any individual security covered by the shelf registration as well as any combination thereof, subject to market conditions and the Company’s capital needs.
Independent Auditors’ Review Report
Board of Directors and ShareholdersUnumProvident Corporation
We have reviewed the accompanying condensed consolidated statement of financial condition of UnumProvident Corporation and subsidiaries as of September 30, 2002, and the related condensed consolidated statements of income for the three and nine month periods ended September 30, 2002 and 2001, and the condensed consolidated statements of stockholders’ equity, and cash flows for the nine month periods ended September 30, 2002 and 2001. These financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated statement of financial condition of UnumProvident Corporation as of December 31, 2001, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated February 6, 2002, except for Note 15, for which the date is March 21, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of December 31, 2001, is fairly stated, in all material respects, in relation to the consolidated statement of financial condition from which it has been derived.
Chattanooga, TennesseeNovember 6, 2002
Introduction
UnumProvident Corporation (the Company) is the parent holding company for a group of insurance and non-insurance companies that collectively operate throughout North America and in the United Kingdom, Japan, and, to a limited extent, elsewhere around the world. The Company’s principal operating subsidiaries are Unum Life Insurance Company of America, Provident Life and Accident Insurance Company, The Paul Revere Life Insurance Company, and Colonial Life & Accident Insurance Company. The Company, through its subsidiaries, is the largest provider of group and individual disability insurance in North America and the United Kingdom. It also provides a complementary portfolio of other insurance products, including long-term care insurance, life insurance, employer- and employee-paid group benefits, and related services.
The Company is organized around its customers, with reporting segments that reflect its major market segments: Employee Benefits, Individual, and Voluntary Benefits. The Other segment includes products that the Company no longer actively markets. The Corporate segment includes investment income on corporate assets not specifically allocated to a line of business, corporate interest expense, and certain corporate expenses not allocated to a line of business.
The trends in new annualized sales in the Employee Benefits, Individual, and Voluntary Benefits segments are indicators of the Company’s potential for growth in its respective markets and the level of market acceptance of price changes and new products. The Company emphasizes integrated selling that combines employee benefit coverages, individual products, and voluntary workplace products. The Company has closely linked its various incentive compensation programs to the achievement of its goals for new sales and persistency.
The following should be read in conjunction with the condensed consolidated financial statements and notes thereto in Part I, Item 1 contained herein and with the discussion, analysis, and consolidated financial statements and notes thereto in Part I, Item I and Part II, Items 6, 7, 7A, and 8 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
Critical Accounting Policies
Reserves for Policy and Contract Benefits
The two primary categories of liabilities for policy and contract benefits are policy reserves for claims not yet incurred and claim reserves for claims that have been incurred and have future benefits to be paid. Policy reserves equal the present value of the difference between future policy benefits and expenses and future premiums, allowing a margin for profit. These reserves are applicable for the majority of the Company’s business, which is traditional non-interest sensitive in nature. The claim payments are estimated using assumptions established when the policy was issued. Ordinarily, generally accepted accounting principles require that these assumptions not be subsequently modified unless the policy reserves are determined to be inadequate. Throughout the life of the policy, the reserve is based on the original assumptions used for the policy’s issue year.
A claim reserve is established when a claim is incurred or is estimated to have been incurred but not yet reported to the Company. Policy reserves for a particular policy continue to be maintained after a claim reserve has been established for as long as the policy remains in force. Claim reserves generally equal the Company’s estimate, at the current reporting period, of the present value of the liability for future benefits to be paid on a claim. A claim reserve for a specific claim is based on assumptions derived from the Company’s actual historical experience as to claim duration as well as the specific circumstances of the claimant such as benefits available under the policy, the covered benefit period and the age and occupation of the claimant. Consideration is given to historical trends in the Company’s experience and to expected deviations from historical experience that result from changes in benefits available, changes in the Company’s risk management policies and procedures, and other economic, environmental, or societal factors. Reserves for claims that are estimated to have already been incurred but that have not yet been reported to the Company are based on factors such as historical claim reporting patterns, the average cost of claims, and the expected volumes of incurred claims.
Claim reserves, unlike policy reserves, are subject to revision as current claim experience and projections of future factors impacting claim experience change. In a reporting period, actual experience may deviate from the long-term assumptions used to determine the claim reserves. The Company reviews annually, or more frequently as appropriate, emerging experience to ensure that its claim reserves provide the Company’s current estimate of adequate and reasonable provision for future benefits. This review includes the determination of a range of reasonable estimates within which the reserve must fall.
Deferred Policy Acquisition Costs
The Company defers certain costs incurred in acquiring new business and amortizes (expenses) these costs over the life of the related policies. The Company uses its own historical experience and expectation of the future performance of its business in determining the expected life of the policies. Approximately 95 percent of the Company’s deferred policy acquisition costs relate to traditional non interest-sensitive products, for which the costs are amortized in proportion to the estimated premium income to be received over the life of the policies. The estimated premium income in the early years of the amortization period is higher than in the later years due to anticipated policy lapses, which results in a greater proportion of the costs being amortized in the early years of the life of the policy. Amortization of deferred costs on traditional products is adjusted annually to reflect the actual policy lapse experience as compared to the anticipated experience . The Company will experience accelerated amortization if policies terminate earlier than projected.
Deferred costs related to group and individual disability products are amortized over a twenty-year period. Approximately 60 percent and 85 percent of the original deferred costs related to group disability products are expected to be amortized by years ten and fifteen, respectively. For individual disability policies, approximately 50 percent and 70 percent of the original deferred costs are expected to be amortized by years ten and fifteen, respectively. Deferred costs for group life products are amortized over a fifteen-year period, with approximately 20 percent of the cost expected to remain at year ten.
Valuation of Fixed Maturity Securities
In determining when a decline in fair value below amortized cost of a fixed maturity security is other than temporary, the Company evaluates the following factors:
The Company’s review procedures include biweekly meetings of the Company’s senior investment personnel to review reports on investments with changes in market value of five percent or more, investments with changes in rating either by external rating agencies or internal analysts, investments segmented by issuer, industry, and foreign exposure levels, and any other relevant financial information to help identify the Company’s exposure to possible credit losses. When a decline in value is determined to be other than temporary, the Company recognizes an impairment loss in the current period results to the extent of the decline in value and includes this loss in realized investment gains and losses.
The Company has no held-to-maturity fixed maturity securities. All fixed maturity securities are classified as available-for-sale and are reported at fair value. Fair values are based on quoted market prices, where available. For fixed maturity securities that are thinly traded, fair values are estimated using values obtained from independent pricing sources.
Private placement fixed maturity securities with a carrying value of approximately $3.9 billion, or 14.7 percent of total fixed maturity securities at September 30, 2002, do not have readily determinable market prices. For these securities, the Company uses internally prepared valuations combining matrix pricing with vendor purchased software programs, including valuations based on estimates of future profitability, to estimate the fair value. All such investments are classified as available for sale. The Company’s ability to liquidate its positions in some of these securities could be impacted to a significant degree by the lack of an actively traded market, and the Company may not be able to dispose of these investments in a timely manner. Although the Company believes its estimates reasonably reflect the fair value of those securities, the key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral (if any), and other factors involve significant assumptions and may not reflect those of an active market. The Company believes that generally these private placement securities carry a credit quality comparable to companies rated Baa by major credit rating organizations.
As of September 30, 2002, the key assumptions used to estimate the fair value of private placement fixed maturity securities included the following:
Historically, the Company’s realized gains or losses on dispositions of its private placement fixed maturity securities have not varied significantly from amounts estimated under the valuation methodology described above.
Changes in the fair value of fixed maturity securities, other than declines that are determined to be other than temporary, are reported as a component of other comprehensive income in stockholders’ equity. If it is subsequently determined that any of these securities are other than temporarily impaired, the impairment loss is reported as a realized investment loss. The recognition of the impairment loss does not affect total stockholders’ equity to the extent that the decline in value had been previously reflected in other comprehensive income.
There are a number of significant risks inherent in the process of monitoring the Company’s fixed maturity securities for impairments and determining when and if an impairment is other than temporary. These risks and uncertainties include the following possibilities:
Reinsurance Receivable
Reinsurance is a contractual agreement whereby the Company’s reinsurance partners assume a defined portion of the risk for future benefits payable under reinsurance contracts. The reinsurance receivable reported as an asset in the Company’s consolidated statements of financial condition includes amounts due from the Company’s reinsurers on current claims and estimates of amounts that will be due on future claims. Policy reserves and claim reserves reported in the Company’s consolidated statements of financial condition are not reduced for reinsurance. The reinsurance receivable is generally equal to the policy reserves and claim reserves related to the risk being reinsured. The Company reduces the reinsurance receivable if recovery is not likely due to the financial position of the reinsurer or if there is disagreement between the Company and the reinsurer regarding the liability of the reinsurer.
Consolidated Operating Results
(in millions of dollars)
Effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. Under SFAS 142, goodwill is no longer amortized but is subject to annual impairment tests. Other intangible assets continue to be amortized over their useful lives.
Transition to the provisions of SFAS 142 required the Company to complete, within the year of adoption, transitional impairment tests of goodwill existing at January 1, 2002, measured as of that date using a fair value approach. The Company had previously, prior to the adoption of SFAS 142, used undiscounted cash flows to determine if goodwill was recoverable. The Company completed the required tests during the second quarter of 2002 and determined the carrying value of its goodwill should be reduced $11.0 million. The charge, net of a $3.9 million tax benefit, was $7.1 million and is reported as a cumulative effect of accounting principle change in the condensed consolidated statements of income. See Note 2 of the “Notes to Condensed Consolidated Financial Statements” contained herein for further discussion.
During the first quarter of 2002, the Company acquired whereiwork, a provider of online solutions for insurance enrollment, communications, administration, and analysis, at a price of $2.8 million. This acquisition should strengthen and broaden the Company’s Internet-based benefits services currently offered to brokers and employers.
During the first quarter of 2001, the Company recognized a tax benefit of approximately $35.2 million related to its investment in the foreign reinsurance operations. Additionally, as a result of tax legislation enacted in the United Kingdom during 2000 that allows additional group tax relief among companies with common ownership, the Company began recognizing foreign tax benefits during 2001.
Continued declines in the performance of equity investment markets combined with steadily increasing pension liabilities have reduced the Company’s pension plan’s funding level. In December 2002, in accordance with the provisions of Statement of Financial Accounting Standards No. 87 (SFAS 87), Employers’ Accounting for Pensions, the Company may be required to record a non-cash charge to accumulated other comprehensive income in stockholders’ equity. Based on a projected range of possible investment values and discount rates as of September 30, 2002, the Company has estimated a charge to stockholders’ equity in the range of $29.0 million to $177.0 million, net of deferred federal income tax. The Company may elect to make a cash contribution in December 2002 to its qualified U.S. pension plan, in an amount estimated to be $70.0 million or less, to fully fund the plan’s accumulated benefit obligation. In this event, the Company has projected a charge to stockholders’ equity in the range of $29.0 million to $38.0 million, net of deferred federal income tax.
The Company expects that its net periodic benefit cost which is calculated in accordance with SFAS 87, may substantially increase in 2003 due to the recent decline in the stock market and the general decline in overall corporate bond yields that are used to establish the discount rate for projecting the benefit obligation. Based on investment projections as of September 30, 2002 and using the current discount rate, the Company has estimated a net periodic benefit cost for 2003 in the range of $47.0 million to $64.0 million compared to an estimated $2.1 million net periodic benefit cost for 2002.
The actual net periodic benefit cost and pension plan funding levels may differ materially from these estimates based on the investment results during the fourth quarter of 2002 as well as changes in the discount rate. If the Company records a non-cash charge to stockholders’ equity within the currently estimated range of $29.0 million to $177.0 million, it will continue to be in compliance with the covenants of its senior revolving credit facilities.
In the following discussion of operating results by segment, “revenue” includes premium income, net investment income, and other income. “Income” excludes net realized investment gains and losses, federal income tax, and the cumulative effect of accounting principle change.
Employee Benefits Segment Operating Results
The Employee Benefits segment includes group long-term and short-term disability insurance, group life insurance, accidental death and dismemberment coverages, group long-term care, and the results of managed disability.
The Company focuses on integrated selling that combines long-term disability, short-term disability, and group life products. During the first nine months of 2002, 28 percent of all new sales included long-term disability, short-term disability, and group life combined coverage. This compares to 28 percent and 32 percent for the full year 2001 and 2000, respectively.
Sales for Employee Benefits, on both a submitted and effective date basis, are reported in the following chart. Administrative services only (ASO) premium equivalents are now reported separately for short-term disability as the Company begins to emphasize more ASO and self-insured business in the large case short-term disability market. Certain other prior year amounts have been reclassified to conform to current year reporting.
Sales on a submitted date basis for group long-term disability increased $9.1 million in the third quarter of 2002 compared to the prior year, with $6.3 million of the increase attributable to the Company’s United Kingdom operations. Sales in the U.S. operations declined in the small and mid-size case markets but increased 91.2 percent in the large case market. Fully insured sales for short-term disability were down 43.8 percent in the third quarter of 2002 compared to the prior year third quarter, due to a decline in sales in all case size markets, offset partially by an 18.7 percent increase in ASO sales. Group life third quarter 2002 sales, relative to the prior year third quarter, decreased in the small and mid-size case markets but increased in the large case market due to the Company’s strategic decision to focus on selling large case group life as combined coverage with long-term and short-term disability rather than as a stand-alone product. Year-to-date group life sales also decreased from the prior year due to the Company’s focus on integrated sales of life and disability and less on stand-alone life. In addition, two large group life cases totaling approximately $41.7 million were sold in the second quarter of 2001. The Company expects that group life sales for the fourth quarter of 2002 will likewise decline relative to the fourth quarter of 2001 due to the magnitude of large case group life policies sold during the prior year period.
Sales related to employee benefits can fluctuate significantly due to large case size and timing of sales submissions. In order to give the appropriate focus to the Company’s primary business markets, the Company has national practice groups that focus on large employers, executive benefits, and voluntary benefits. These national practice groups partner with the Company’s sales force and representatives from claims, customer service, and underwriting to present coverage solutions to potential customers and to manage existing customer accounts. The Company expects that this organizational focus on customers will continue to favorably impact sales growth, but management intends to maintain pricing discipline to balance sales growth and profitability, which may slow the rate of long-term sales growth.
The Company monitors persistency and reflects adverse changes in persistency in the current period’s amortization of deferred policy acquisition costs. One way in which the Company monitors persistency is at the overall block of business level (i.e., group long-term disability, group short-term disability, group life, and accidental death and dismemberment). Persistency, at the overall block of business level, is the year-to-date rate at which existing business for all issue years in the block of business at the beginning of the period remains inforce at the end of the period. In determining whether additional amortization of deferred policy acquisition costs is required due to adverse persistency, the Company measures persistency by issue year (i.e., the rate at which existing business for that specific issue year at the beginning of the period remains inforce at the end of the period). The rate of persistency for an overall block of business may improve while individual issue years within the overall block of business may deteriorate and require accelerated amortization of deferred policy acquisition costs.
Persistency during the first nine months of 2002 for group long-term disability on average improved from that experienced in the comparable period of 2001, but the persistency for group life and accidental death and dismemberment was lower than the prior year first nine months. Persistency for short-term disability, after adjusting for cases transferring from fully insured to ASO, was level with the prior year first nine months. Persistency for group long-term and short-term disability, as well as group life and accidental death and dismemberment, was lower for certain issue years when compared to the persistency expected at the time the business was written. This resulted in additional amortization of $8.7 million for the third quarter of 2002, a slight increase over the $8.5 million third quarter of 2001 persistency adjustment. The adjustment for the first nine months was $22.2 million for 2002, an improvement over the $28.8 million persistency adjustment reported for 2001. It is expected that persistency for the foreseeable future may continue to be lower than historical levels, particularly in certain issue years.
The Company’s renewal programs have generally been successful at retaining business that is relatively more profitable than business that terminated. It is expected that the additional premium and related profits associated with renewal activity will continue to emerge. The Company intends to maintain a disciplined approach in the re-pricing of renewal business, while balancing the need to maximize persistency and retain producer relationships. This disciplined approach may lead to lower profit margins on affected renewal cases than originally planned.
Revenue from the managed disability line of business, which includes the Company’s wholly-owned subsidiaries GENEX Services, Inc. and Options and Choices, Inc., totaled $43.4 million in the third quarter of 2002 compared to $38.5 million in the third quarter of 2001. On a year-to-date basis, revenue was $130.6 million in 2002 and $112.6 million in 2001.
Group Disability
Group disability reported revenue of $906.7 million for the third quarter of 2002 compared to $844.0 million for the third quarter of 2001. For the first nine months, revenue was $2,687.3 million in 2002 compared to $2,497.0 million in 2001. Revenue improved due to increases in both premium income and net investment income. The growth in premium income compared to the prior year is due to new sales growth in 2001 as well as 2002 and favorable renewal activity on the existing block of business, offset partially by terminations. Premium income is relatively flat with the second quarter of 2002. Included in other income are ASO fees of $8.6 million and $24.9 million for the three and nine month periods ended September 30, 2002 and $6.8 million and $18.7 million for the three and nine month comparable prior year periods.
Income for group disability was $85.4 million for the third quarter of 2002 compared to $79.1 million for the third quarter of 2001. Group disability reported income of $257.4 million for the nine months of 2002 compared to $256.1 million for the same period of 2001. Group disability 2001 third quarter and nine month results included $7.3 million for losses related to September 11, 2001.
A critical part of the Company’s strategy for group disability involves executing its renewal program and managing persistency, both of which management expects will have a positive impact on future premium growth and profitability. The Company has implemented pricing changes in the group disability line wherein prices may increase or decrease by market segment, as appropriate, to respond to current claim experience and other factors and assumptions, although pricing changes typically lag by several quarters the changes in actual claim experience. Persistency during the first nine months of 2002 on the overall block of group disability improved over 2001, with long-term disability persistency at 85.5 percent compared to 84.8 percent in the first nine months of 2001 and 84.9 percent for the full year. Short-term disability persistency for the first nine months of 2002 was 81.0 percent versus 82.3 percent in the first nine months of 2001 and 82.1 percent for the year 2001. Excluding the effects of cases that transferred from fully insured to ASO, short-term disability persistency was 82.3 percent for the first nine months of 2002. Although the overall blocks of group long-term and short-term business experienced favorable persistency in the first nine months of 2002 compared to the previous year first nine months, certain issue year business did not persist at the levels expected when the business was issued.
The third quarter 2002 benefit ratio for group disability was lower than the third quarter of 2001 but slightly higher than the second quarter of 2002. The operating expense ratio increased relative to the third quarter of 2001 but was consistent with the second quarter of 2002. Third quarter 2002 results include $7.7 million of additional amortization necessitated by the higher level of group long-term and short-term disability terminations experienced relative to that which was expected when the policies were issued, particularly on more recently issued business with higher remaining deferred acquisition cost balances, compared to $7.3 million of additional amortization recorded in the third quarter of 2001. For the nine months, the additional amortization was $13.0 million and $19.3
million for 2002 and 2001. Although the overall block of group disability business experienced favorable persistency in the first nine months of 2002 compared to the previous year first nine months, certain issue year business did not persist at the levels expected when the business was issued.
Group long-term disability reported a slight decrease in the benefit ratio for third quarter versus third quarter 2001 and a slight increase from the second quarter of 2002, but the ratios were essentially unchanged for all three time periods. Both submitted and paid claim incidence for group long-term disability increased from the second quarter of 2002 as well as the third quarter of 2001. Industry segments contributing to the increased submitted incidence in the third quarter relative to the second include wholesale/retail, transportation, and utilities. Claim recovery rates for group long-term disability in the third quarter of 2002 were consistent with the second quarter of 2002 and lower than full year 2001 but continued to be above historical levels. Payments to settle claims in litigation increased in the third quarter of 2002 compared to the third quarter of 2001 as did the number of new lawsuits filed.
For short-term disability, the benefit ratio was lower than the third quarter of 2001 but increased over the second quarter of 2002. Paid claim incidence was down from the second quarter of 2002, but marginally higher than the third quarter of 2001. The average weekly indemnity and premium per life continued to increase as expected, but the growth in premium per life was greater than the growth in the average weekly indemnity compared to the growth level relationships experienced in the third quarter of 2001. The average claim duration for closed short-term disability claims was above the second quarter of 2002 but down from the third quarter of 2001.
As discussed under “Cautionary Statement Regarding Forward-Looking Statements,” certain risks and uncertainties are inherent in the Company’s business. Components of claims experience, including, but not limited to, incidence levels and claims duration, may be worse than expected. Management monitors claims experience in group disability and responds to changes by periodically adjusting prices, refining underwriting guidelines, changing product features, and strengthening risk management policies and procedures. The Company expects to price new business and re-price existing business, at contract renewal dates, in an attempt to mitigate the effect of these and other factors, including interest rates, on new claim liabilities. Given the competitive market conditions for the Company’s disability products, it is uncertain whether pricing actions can entirely mitigate the effect.
The Company, similar to all financial institutions, has some exposure if a severe and prolonged recession occurs, but management believes that the Company is well positioned if a weaker economy were to occur. Many of the Company’s products can be re-priced, which would allow the Company to reflect in its pricing any fundamental change which might occur in the risk associated with a particular industry or company within an industry. The Company has a well-diversified book of insurance exposure, with no disproportionate concentrations of risk in any one industry. Because of improvements made in the claims organization in recent years, the Company believes it can respond to increased levels of submitted claims which might result from a further slowing economy.
Group Life, Accidental Death and Dismemberment, and Long-term Care
Group life, accidental death and dismemberment, and long-term care reported revenue of $489.3 million, a 6.6 percent increase over the third quarter of 2001, due to increases in premium income and net investment income. Income was $59.2 million in the third quarter of 2002 compared to $44.1 million in the third quarter of 2001. For the first nine months, these three lines of business reported revenue of $1,451.6 million compared to $1,325.6 million for the comparable period of 2001 and income of $161.8 million compared to $116.2 in 2001. Third quarter and nine month 2001 results included a net increase in benefits of $6.7 million related to September 11, 2001.
Premium growth in 2002 relative to 2001 was attributable to favorable renewal results, strong sales results in 2001, and stable persistency. Persistency for group life, while improved from 2000 levels, was less favorable during the first nine months of 2002 than in 2001, with persistency of 83.7 percent compared to 84.6 percent for the first nine months of 2001 and for the full year 2001. For accidental death and dismemberment, persistency was 82.9 percent and 83.1 percent for the first nine months of 2002 and 2001, respectively, and 83.0 percent for the full year 2001. The amortization of deferred policy acquisition costs for the third quarter and nine months of 2002 includes $1.0 million and $9.2 million of additional amortization due to the higher level of terminations for group life products experienced during 2002 than expected at the time the policies were written. The third quarter and first nine months of 2001 included $1.2 million and $9.5 million, respectively, of additional amortization, with the unfavorable variance of actual to expected terminations occurring primarily in the group life product line.
Group life reported an increase in income compared to the prior year comparable quarter and the second quarter of 2002. The improvement was attributable to a lower benefit ratio and an improved operating expense ratio. Submitted and paid claim incidence both decreased compared to the second quarter of 2002 but are slightly higher than the third quarter of 2001. The average paid claim size increased from the second quarter of 2002 as well as the third quarter of last year and is high relative to historical levels. Waiver incidence increased over the third quarter of 2001 but is lower than the last three quarters. Waiver recovery rates continued to increase as well. Group life third quarter and nine month 2001 results included a net increase in benefits of $3.0 million related to September 11, 2001.
The Company is implementing several actions in the group life line of business, including tighter underwriting guidelines and pricing changes, and is developing case specific remedial plans for under performing business. The Company believes these actions will improve profitability in group life, but it is uncertain whether these actions will restore the profitability that this line of business has historically reported. As a result of these actions, it is expected that the sales growth rate in this business may continue to slow from that experienced in recent years.
Accidental death and dismemberment reported results for the third quarter of 2002 that were significantly below the amounts reported for the prior year third quarter and the second quarter of 2002. The third quarter 2002 benefit ratio for accidental death and dismemberment increased over both the second quarter of 2002 and third quarter of 2001. The increase in the benefit ratio was the result of higher incidence and an increase in the average paid claim size. The Company is discontinuing the sales of certain accidental death and dismemberment products but expects there may be continued volatility in this line of business. Third quarter and nine month 2001 results for accidental death and dismemberment included a net increase in benefits of $3.7 million related to September 11, 2001.
Income for group long-term care increased over the third quarter of 2001 and the second quarter of 2002. The improvement resulted primarily from increases in premium income and a decrease in the benefit ratio. Submitted claim incidence was down slightly from the second quarter of 2002 but continued to be elevated over 2001 levels. The new claim rate exhibited a similar pattern.
Individual Segment Operating Results
The Individual segment includes results from the individual disability and individual long-term care lines of business.
Individual Disability
New annualized sales in the individual disability line of business were $36.4 million in the third quarter of 2002, up slightly when compared to $35.3 million in the third quarter of 2001. On a year-to-date basis, new annualized sales were $103.1 million in 2002 and $103.0 million in 2001. Management expects that sales in the individual disability line should benefit from the focus on integrated disability sales in group and individual, as well as other sales initiatives discussed under “Employee Benefits Segment Operating Results.” Sales of multi-life business continues to increase, with approximately 73 percent of year-to-date sales related to multi-life cases, compared to 65 percent for the first nine months of 2001. The persistency of existing individual disability business continues to be stable.
Revenue was $685.6 million for the third quarter of 2002 compared to $651.4 million in the same period of 2001. Premium income increased 2.6 percent over the prior year third quarter, and net investment income increased 6.8 percent. Income in the individual disability line of business was $68.8 million in the third quarter of 2002 compared to $56.7 million in the third quarter of 2001. The benefit ratio for the third quarter of 2002 increased relative to the prior year third quarter but decreased from the second quarter of 2002. The interest adjusted loss ratio was 69.4 percent and 65.4 percent for the third quarter of 2002 and 2001, respectively. Submitted claim incidence was lower than the second quarter of 2002 and the third quarter of 2001, with decreases in many of the Company’s large market segments. Paid claim incidence also decreased from each of the prior four quarters. The claim recovery rate increased for the third quarter of 2002 relative to the second quarter of the year but remains below full year 2001. Payments to settle claims in litigation increased in the third quarter of 2002 compared to the third quarter of 2001 while the number of new lawsuits filed decreased. Individual disability results benefited from an improvement in the operating expense ratio relative to the third quarter of 2001, somewhat offset by a slight increase in the commission ratio.
For the first nine months, revenue was $2,008.5 million in 2002 and $1,969.2 million in 2001. Income was $203.3 million in 2002 compared to $213.8 million in 2001. The interest adjusted loss ratio increased to 66.5 percent for the first nine months of 2002 compared to 63.0 percent for the comparable prior year period and 63.6 percent for full year 2001. Included in the third quarter and nine month results for 2001 was an increase in net benefits of $10.0 million related to September 11, 2001.
The overall individual disability results continue to be negatively impacted by the business issued during the mid-1990s and prior years. The interest adjusted loss ratio for recently issued business is significantly below the ratio for the older block, even in the more poorly performing market segments and product lines. The business issued in the mid-1990s and prior experienced a significantly higher increase in the interest adjusted loss ratio during the first nine months of 2002 relative to 2001 than did the newer block of business. The higher interest adjusted loss ratio on the older business is driven by higher incidence and lower claim recoveries relative to more recently issued business. For the recently issued business, the majority of market segments experienced decreases in the interest adjusted loss ratios during the third quarter of 2002 compared to the second quarter of 2002 due to lower submitted incidence, but the ratios are higher than 2001. Most of the market segments in the recently issued business are still performing within expectations. The improvement in recently issued business reflects the substantial product, distribution, and underwriting changes made during that time period. The “Old” individual disability block generally consists of those policies in force prior to the Company’s substantial changes in product offerings, pricing, distribution, and underwriting. As discussed in the 2001 Annual Report on Form 10-K, the Company is reviewing internal and external alternatives, including reinsurance, for improving the overall results in its individual disability line of business, particularly as related to business issued prior to the mid-1990s.
Individual Long-term Care
Revenue for individual long-term care was $69.7 million, a 28.1 percent increase over the third quarter of 2001. Premium income increased $13.2 million for the third quarter of 2002 compared to the same period of 2001, primarily due to new sales growth. New annualized sales for long-term care were $16.6 million for the third quarter of 2002, compared to $13.1 million for the prior year third quarter. For nine months, sales were $44.4 million in 2002 and $38.6 million in 2001. Net investment income continues to increase due to the growth in invested assets supporting this line of business.
Income in the individual long-term care line of business decreased to $1.9 million for the third quarter of 2002 compared to $4.6 million for the same period of 2001 due to an increase in the benefit ratio. The benefit ratio increase was driven primarily by the increase in active life reserves resulting from higher policy persistency and lower claim resolutions. The new claim rate, weighted by reserve dollar, decreased from the second quarter of 2002 but was above the third quarter of 2001. The increase in the new claim rate over the prior year third quarter was driven by an increase in the average reserve size of new claims. Submitted incidence, by policy count rather than reserve dollar, decreased from the second quarter of 2002 as well as the prior year third quarter. The claim recovery rate decreased from the second quarter of 2002 and from the prior year third quarter. The commission and operating expense ratios both improved relative to the third quarter of 2001 and the second quarter of 2002.
For the first nine months, revenue and income in the individual long-term care line of business was $196.5 million and $2.8 million in 2002 compared to $152.2 million and $9.6 million in 2001.
Voluntary Benefits Segment Operating Results
(in million of dollars)
N.M. = not a meaningful percentage
The Voluntary Benefits segment includes the results of products sold to employees through payroll deduction at the workplace. These products include life insurance and health products, primarily disability, accident and sickness, and cancer.
Revenue in the Voluntary Benefits segment increased to $251.2 million in the third quarter of 2002 from $231.5 million in the third quarter of 2001 due to an increase in premium income in the disability and life product lines. For the first nine months, revenue was $730.2 million and $691.2 million for 2002 and 2001, respectively. The increase in 2002 was attributable to sales growth and favorable persistency. New annualized sales for the third quarter and nine months of 2002 were $74.2 million and $234.0 million, compared to $66.4 million and $198.8 million for the comparable prior year periods. Management continues its efforts to increase sales through the sales initiatives discussed under “Employee Benefits Segment Operating Results.”
Income for the third quarter of 2002 was $41.7 million compared to $37.4 million in the third quarter of 2001. For the first nine months, income was $120.8 million and $118.1 million in 2002 and 2001. The overall third quarter 2002 benefit ratio for this segment increased from the second quarter of 2002 and was marginally higher than the third quarter of 2001. The life and disability product lines both reported an increase in the benefit ratio compared to the second quarter of 2002 and the prior year third quarter. Life paid claims, as well as the average claim size, were both up in the third quarter of 2002 compared to the third quarter of 2001. The individual short-term disability product reported an increase in claim incidence and average indemnity relative to the second quarter of 2002 and third quarter of 2001. The average claim duration also increased over the prior year third quarter and the second quarter of 2002.
During 2001, the Company reinsured on a 100 percent indemnity coinsurance basis certain cancer policies written by the Company’s subsidiary, Colonial Life & Accident Insurance Company. The transaction closed during the fourth quarter with an effective date of November 1, 2001. The Company ceded approximately $113.6 million of reserves to the reinsurer. The $12.3 million before-tax gain on this transaction was deferred and is being amortized into income based upon expected future premium income on the policies ceded. The Company will continue to market its other cancer products. Premium income for the cancer product line declined when compared to the prior year, as expected, due to this transaction. The benefit ratio also decreased relative to the prior year.
Other Segment Operating Results
The Other operating segment includes results from products no longer actively marketed, including individual life and corporate-owned life insurance, reinsurance pools and management operations, group pension, health insurance, and individual annuities. It is expected that revenue and income in this segment will decline over time as these business lines wind down. Management expects to reinvest the capital supporting these lines of business in the future growth of the Employee Benefits, Individual, and Voluntary Benefits segments. The closed blocks of business have been segregated for reporting and monitoring purposes.
Reinsurance Pools and Management
The Company’s reinsurance operations include the reinsurance management operations of Duncanson & Holt, Inc. (D&H) and the risk assumption, which includes reinsurance pool participation; direct reinsurance which includes accident and health (A&H), long-term care (LTC), and long-term disability coverages; and Lloyd’s of London (Lloyd’s) syndicate participations. During 1999, the Company concluded that these operations were not solidly aligned with the Company’s strength in the disability insurance market and decided to exit these operations through a combination of a sale, reinsurance, and/or placing certain components in run-off. In 1999, the Company sold the reinsurance management operations of its A&H and LTC reinsurance facilities and reinsured the Company’s risk participation in these facilities. The Company also decided to discontinue its London accident reinsurance pool participation beginning in year 2000. With respect to Lloyd’s, the Company implemented a strategy which limited participation in year 2000 underwriting risks, ceased participation in Lloyd’s underwriting risks after year 2000, and managed the run-off of its risk participation in open years of account of Lloyd’s reinsurance syndicates.
During 2001, the Company entered into an agreement to limit its liabilities pertaining to the Lloyd’s syndicate participations. Separately, the Company also reinsured 100 percent of the group disability reinsurance reserves and all future business underwritten and managed by Duncanson and Holt Services, Inc., a subsidiary of D&H. The transaction, in which reserves of approximately $323.8 million were ceded to the reinsurer, had an effective date of January 1, 2001. In a separate but related transaction, the Company also sold the reinsurance management operations of Duncanson and Holt Services, Inc. and divested the remaining assets of that facility during 2001.The reinsurance pools and management operations reported a loss of $0.7 million in the third quarter of 2002 compared to a $1.3 million loss for the comparable period of 2001. For the first nine months, results were a loss of $1.3 million for 2002 and income of $1.9 million for 2001. Premium income was $8.2 million compared to $24.0 million in the third quarter of 2001. On a year-to-date basis, premium income was $17.7 million in 2002 and $75.6 million in 2001. The premium income decline will continue as the Company exits from this business.
Other
Individual life and corporate-owned life, group pension, individual annuities, and other lines of business had revenue of $50.9 million and $61.2 million in the third quarter of 2002 and 2001, respectively, and $152.4 million and $184.2 million year-to-date for 2002 and 2001, respectively. Income was $12.9 million for the third quarter of 2002 and $14.9 million for the comparable period of 2001. For the first nine months, income was $38.4 million and $38.9 million in 2002 and 2001. Decreases in revenue and income are expected as these lines of business wind down.
Corporate Segment Operating Results
Revenue in the Corporate segment was $6.0 million in the third quarter of 2002 and $11.1 million in the third quarter of 2001. This segment reported a loss of $34.6 million in the third quarter compared to a loss of $36.4 million in the third quarter of 2001. Interest and debt expense was $42.9 million and $41.1 million in the third quarter of 2002 and 2001, respectively. During 2001, the amortization of goodwill was $5.3 million and $15.9 million in the third quarter and first nine months. Interest and debt expense is expected to increase relative to the prior year and first six months due to the issuance of two long-term debt offerings during the second quarter of 2002. See “Liquidity and Capital Resources” for further information on the debt offerings.
For the first nine months revenue was $29.4 million and $32.4 million in 2002 and 2001, respectively. Interest and debt expense was $120.0 million in 2002 compared to $128.1 million in 2001. The corporate segment reported a loss of $103.6 million and $123.3 million for the first nine months of 2002 and 2001, respectively. The improvement was due primarily to the reduction in interest and debt expense as well as the cessation of goodwill amortization.
Investments
Investment activities are an integral part of the Company’s business, and profitability is significantly affected by investment results. Invested assets are segmented into portfolios, which support the various product lines. Generally, the investment strategy for the portfolios is to match the effective asset cash flows and durations with related expected liability cash flows and durations and to maximize investment returns, subject to constraints of quality, liquidity, diversification, and regulatory considerations.
Excluding the net investment income reported in the Other segment, which continues its expected decline as these product lines are sold, reinsured, or wind down, third quarter 2002 net investment income increased 6.5 percent over the previous year third quarter and 5.3 percent year-to-date. The overall yield in the portfolio was 7.86 percent as of September 30, 2002, compared to 8.02 percent and 8.06 percent at the end of 2001 and 2000, respectively. The Company expects that the portfolio yield will continue to gradually decline, due to yields on new purchase activity, until the level of market rates increases. The Company is actively marketing selected properties in its real estate and mortgage loan portfolios for replacement with longer duration securities.
The Company reported a before-tax net realized investment loss of $70.3 million in the third quarter, $85.8 million in the second quarter, and $118.3 million in the first quarter of 2002. The third quarter loss was the net of gains of $13.6 million and losses of $83.9 million, including write-downs of $71.8 million on fixed maturity securities. Year-to-date, the Company’s before-tax net realized investment loss was $274.4 million, comprised of gross gains of $184.4 million and gross losses of $458.8 million, of which $402.2 million related to write-downs on fixed maturity securities. These write-downs were recognized as a result of management’s determination that the value of certain fixed maturity securities had other than temporarily declined during the applicable quarter of 2002, as well as the result of further declines in the values of fixed maturity securities that had initially been written down in a prior quarter. The value of the securities was determined to have other than temporarily declined or to have further declined from the initial impairment based on the factors discussed herein in “Critical Accounting Policies.” Due to the current negative credit market environment and the associated economic uncertainty, the Company anticipates additional investment losses will occur during the remainder of 2002 and possibly extend into 2003.
Approximately 72 percent of the year-to-date 2002 write-downs occurred in the communications industry. The following list includes write-downs representing five percent or greater of the total year-to-date write-downs, the circumstances that contributed to the write-downs, and how those circumstances might cause impairments in other material investments held by the Company.
The following table provides the distribution of invested assets for the periods indicated. Ceded policy loans of $2.5 billion and $2.3 billion as of September 30, 2002 and December 31, 2001, which are reported on a gross basis in the statements of financial condition contained herein in Item 1, are excluded from the table below. The investment income on these ceded policy loans is not included in income.
Distribution of Invested Assets
Fixed Maturity Securities
Fixed maturity securities at September 30, 2002 included $26.1 billion, or 99.0 percent, bonds and $256.3 million, or 1.0 percent, redeemable preferred stocks. The following table shows the composition by internal industry classification of the fixed maturity bond portfolio and the associated unrealized gains and losses.
Fixed Maturity Bonds – By Industry ClassificationAs of September 30, 2002
As of September 30, 2002 there were $2,705.4 million gross unrealized gains and $1,256.7 million gross unrealized losses in the fixed maturity bond portfolio, of which $965.7 million or 76.8 percent of those unrealized losses were concentrated in basic industry, communications, energy, financial institutions, and utilities. The Company’s analysis of risk factors relative to these industries is as follows:
Basic Industries: This sector is comprised of several cyclical, commodity-based industries, including sub-sectors of mining, chemicals, metals, and forest products. The down cycle in the economy has reduced demand for many of these commodities, and the combination of low prices, low capacity utilization, and, in some cases, high raw material prices continue to pressure many of the companies in these sub-sectors. When the economy improves, these cyclical businesses should recover, and the bonds issued by these companies should recover as well. The Company has held these sub-sectors through several economic cycles and has the ability and intent to hold these investments until they recover in value or reach maturity. The portfolio should also benefit from the Company’s credit selection process which seeks to avoid the riskier credits in these sub-sectors.
Communications: The communications sector experienced rapid growth and debt financed expansion following the Telecommunications Act of 1996, which encouraged new entrants and competition. By early 2001, supply greatly exceeded demand, and industry conditions deteriorated rapidly. The result has been numerous bankruptcies, some of which were in large world-class companies. These bankruptcies will result in lower cost structures, which will place additional pressure on the remaining companies. The Company’s strategy has been to focus on the top-tier companies and those with diversified product offerings. The Company expects conditions to remain difficult but show improvement as the economy recovers.
Energy: The Company’s energy exposure is primarily in integrated energy, independent oil and gas, refining, energy services, and select project finance investments. This industry is cyclical and driven by the supply and demand for oil and gas. In general, companies in this sector have held value fairly well as the lower volumes produced, due to a slower economy, were mostly offset by higher oil prices. Refiner’s margins have been weak due to the higher crude prices and lower prices on refined products. The weakest sub-sectors have been those investments in emerging markets. Although most of these investments have dollar-based products, political and regional economic developments add additional risk.
Financial Institutions: This sector entered the recent economic slowdown with record capital levels and strong profitability. Bank balance sheets appear capable, in general, of withstanding the increased loan write-offs typically seen in past recessions. In addition to the telecommunications industry, which has been problematic for several quarters, banks are now experiencing more loan write-offs from the energy and utility industries. Finance companies, both consumer and commercial, can be expected to also experience an increase in non-performing receivables. The degree of the economic slowdown will be a key determinant of the amount of credit degradation in the financial services sector.
Utilities: This sector, which includes regulated electric utilities, gas transmission and distribution companies, and independent power projects, has been operating in a difficult environment since 2000. The California power crisis in 2000 and 2001 impacted both electric and gas providers outside of California as issues regarding energy trading and a flawed deregulatory model provoked national scrutiny. Enron’s bankruptcy filing in late 2001 exacerbated the issues and resulted in numerous negative rating agency actions as the agencies developed a stricter model for analyzing industry participants. This in turn has contributed to decreased financial liquidity for many of the national utilities and resulted in numerous proposed asset sales as companies attempt to restructure their balance sheets. The Company believes that this sector will stabilize over the intermediate term (one to two years) as the industry works its way through the issues and then improve as the economy rebounds and participants realize the benefits of their current restructuring initiatives.
Of the $1,256.7 million in gross unrealized losses at September 30, 2002, $393.9 million or 31.3 percent are related to investment-grade fixed maturity bonds. Unrealized losses on investment-grade fixed maturity securities principally relate to changes in interest rates or changes in credit spreads which occurred subsequent to the acquisition of the securities. These changes are generally temporary and should not be recognized as realized investment losses unless the securities are sold. The gross unrealized loss on below-investment-grade fixed maturity bonds was $862.8 million at September 30, 2002, or 68.7 percent of the total gross unrealized loss on fixed maturity bonds. Generally, below-investment-grade fixed maturity securities are more likely to develop credit concerns. The following table shows the length of time the below-investment-grade fixed maturity bonds had been in a gross unrealized loss position as of September 30, 2002.
Unrealized Loss on Fixed Maturity BondsLength of Time in Unrealized Loss PositionAs of September 30, 2002
In determining when a decline in fair value below amortized cost of a fixed maturity security is other than temporary, the Company evaluates the related industry risk factors as well as factors specific to the security, including the significance of the decline in value, the time period during which there has been a significant decline in value, recoverability of principal and interest, the Company’s ability and intent to retain the security for a sufficient period of time for it to recover, market conditions, rating agency actions, offering prices, business prospects and trends of earnings, and any other key measures for the related security. For those fixed maturity securities with an unrealized loss and on which the Company has not recorded an impairment write-down, the Company believes that the decline in fair value below amortized cost is not other than temporary. Generally, the Company intends to hold all of its fixed maturity investments until maturity to meet its liability obligations.
The following is a distribution of the maturity dates for fixed maturity bonds in an unrealized loss position at September 30, 2002.
Fixed Maturity Bonds – By MaturityAs of September 30, 2002
As of September 30, 2002, the Company held 31 fixed maturity securities with a gross unrealized loss of $10.0 million or greater. These are as follows:
Gross Unrealized Losses $10.0 Million or GreaterAs of September 30, 2002
If information becomes available that changes the Company’s assessment as to whether the Company will receive contractual payments related to a fixed maturity security and the security is also not projected to recover in value, the related security is generally sold. During the nine months ending September 30, 2002, the Company sold fixed maturity securities with a book value of $239.5 million for proceeds of $184.3 million, for a gross realized loss of $55.2 million. Losses representing five percent or more of the total are as follows:
The Company’s investment in mortgage-backed securities was approximately $4.8 billion and $3.8 billion on an amortized cost basis at September 30, 2002 and December 31, 2001, respectively. At September 30, 2002, the mortgage-backed securities had an average life of 5.7 years and effective duration of 3.0 years. The mortgage-backed securities are valued on a monthly basis using valuations supplied by the brokerage firms that are dealers in these securities. The primary risk involved in investing in mortgage-backed securities is the uncertainty of the timing of cash flows from the underlying loans due to prepayment of principal. The Company uses models which incorporate economic variables and possible future interest rate scenarios to predict future prepayment rates. The Company has not invested in mortgage-backed derivatives, such as interest-only, principal-only or residuals, where market values can be highly volatile relative to changes in interest rates.
The Company’s exposure to below-investment-grade fixed maturity securities at September 30, 2002, was $2,538.7 million, representing 9.1 percent of the carrying value of invested assets excluding ceded policy loans, below the Company’s internal limit for this type of investment. The Company’s exposure to below-investment-grade fixed maturities totaled $2,261.7 million at December 31, 2001, representing 8.7 percent of invested assets. The comparative increase resulted from downgrades of existing securities that were previously investment grade rather than the purchase of additional below-investment-grade securities.
Below-investment-grade bonds are inherently more risky than investment-grade bonds since the risk of default by the issuer, by definition and as exhibited by bond rating, is higher. Also, the secondary market for certain below-investment-grade issues can be highly illiquid. The Company expects that additional downgrades may occur throughout 2002, with resulting realized investment losses. The Company does not anticipate any liquidity problem caused by the investments in below-investment-grade securities, nor does it expect these investments to adversely affect its ability to hold its other investments to maturity.
The Company has investments in five special purpose entities whose purposes are to support the Company’s investment objectives. These entities are for asset collateralization and contain specific investment securities that do not include the Company’s common stock or debt. These investments are described as follows:
Mortgage Loans and Real Estate
The Company’s mortgage loan portfolio was $680.4 million and $941.2 million at September 30, 2002 and December 31, 2001, respectively. The mortgage loan portfolio is well diversified geographically and among property types. The incidence of problem mortgage loans and foreclosure activity remains low, and management expects the level of delinquencies and problem loans to remain low in the future. One purchase money mortgage associated with the sale of real estate was added to the Company’s investment portfolio during the first nine months of 2002. For the years 2001 and 2000, the only additions were related to two purchase money mortgages associated with the sale of real estate. The Company sold mortgage loans with a book value of $95.1 million during the second quarter of 2002, resulting in a before-tax realized investment gain of $1.2 million.
At September 30, 2002 and December 31, 2001, impaired mortgage loans totaled $6.3 million and $13.1 million, respectively. Impaired mortgage loans are not expected to have a material impact on the Company’s liquidity, financial position, or results of operations.
Restructured mortgage loans totaled $5.5 million and $5.7 million at September 30, 2002 and December 31, 2001, respectively, and represent loans that have been refinanced with terms more favorable to the borrower. Interest lost on restructured loans was immaterial for the nine and twelve months ended September 30, 2002 and December 31, 2001.
Real estate was $37.2 million and $51.8 million at September 30, 2002 and December 31, 2001, respectively. 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 and may be classified as investment real estate if it meets the Company’s investment criteria. 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, which is valued net of a valuation allowance that reduces the carrying value to the lower of cost or fair value less estimated cost to sell, amounted to $8.2 million at September 30, 2002, and $7.6 million at December 31, 2001.
The Company uses a comprehensive rating system to evaluate the investment and credit risk of each mortgage loan and to identify specific properties for inspection and reevaluation. The Company establishes an investment valuation allowance for mortgage loans based on a review of individual loans and the overall loan portfolio, considering the value of the underlying collateral. Investment valuation allowances for real estate held for sale are established based on a review of specific assets. If a decline in value of a mortgage loan or real estate investment is considered to be other than temporary or if the asset is deemed permanently impaired, the investment is reduced to estimated net realizable value, and the reduction is recognized as a realized investment loss. Management monitors the risk associated with these invested asset portfolios and regularly reviews and adjusts the
investment valuation allowance. As a result of management’s 2001 reviews of the overall mortgage loan portfolio and based on management’s expectations that delinquencies and problem loans would remain low, the valuation allowance on mortgage loans was reduced $10.5 million during 2001. The real estate valuation allowance was reduced $5.7 million during 2001 in conjunction with the sale of the associated property. No changes were made to the allowances during the first nine months of 2002. At September 30, 2002, the balance in the valuation allowances for mortgage loans and real estate was $2.4 million and $19.9 million, respectively.
The Company’s exposure to non-current investments totaled $217.1 million at September 30, 2002 and $176.7 million at December 31, 2001, or 0.8 percent and 0.7 percent, respectively, of invested assets excluding ceded policy loans. These non-current investments are foreclosed real estate held for sale and fixed income securities and mortgage loans that became more than thirty days past due in principal and interest payments.
The Company has an investment program wherein it simultaneously enters into repurchase transactions and reverse repurchase transactions with the same party. The Company nets the related receivables and payables in the consolidated statements of financial condition as these transactions are with the same party and include a right of offset. As of September 30, 2002, the Company had $499.3 million face value of these contracts in an open position that were offset.
Historically, the Company has utilized interest rate futures contracts, current and forward interest rate swaps, interest rate forward contracts, and options on forward interest rate swaps, forward treasuries, or specific fixed income securities to manage duration and increase yield on cash flows expected from current holdings and future premium income. Positions under the Company’s hedging programs for derivative activity that were open during the first nine months of 2002 involved current and forward interest rate swaps and forward contracts on credit spreads, as well as currency swaps which are used to hedge the currency risk of certain foreign currency denominated fixed income securities. All transactions are hedging in nature and not speculative. Almost all transactions are associated with the individual and group long-term care and the individual and group disability product portfolios. All other product portfolios are periodically reviewed to determine if hedging strategies would be appropriate for risk management purposes.
During the first nine months of 2002, the Company recognized net gains of $45.4 million on the termination of cash flow hedges and reported $42.1 million in other comprehensive income and $3.3 million as a component of realized investment gains and losses. The Company amortized $8.7 million of net deferred gains into net investment income during the nine months ending September 30, 2002. The Company’s current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position, was $34.3 million at September 30, 2002. Additions and terminations, in notional amounts, to the Company’s hedging programs for the nine months ended September 30, 2002, were $743.6 million and $770.6 million, respectively. The notional amount of derivatives outstanding under the hedge programs was $1,098.1 million at September 30, 2002.
Liquidity and Capital Resources
The Company’s liquidity requirements are met primarily by cash flows provided from operations, principally in its insurance subsidiaries. Premium and investment income, as well as maturities and sales of invested assets, provide the primary sources of cash. Cash is applied to the payment of policy benefits, costs of acquiring new business (principally commissions), and operating expenses as well as purchases of new investments. The Company has established an investment strategy that management believes will provide for adequate cash flows from operations. Cash flows from operations were $1,183.9 million for the nine months ended September 30, 2002, as compared to $963.8 million for the comparable period of 2001.
The Company’s source of cash could be negatively impacted by a decrease in demand for the Company’s insurance products or an increase in the incidence of new claims or the duration of existing claims. The Company’s policy benefits are primarily in the form of claim payments, and the Company therefore has minimal exposure to the policy withdrawal risk associated with deposit products such as individual life policies or annuities. Cash flow could also be negatively impacted by a deterioration in the credit market whereby the Company’s ability to liquidate its positions in certain of its fixed maturity securities would be impacted such that the Company might not be able to dispose of these investments in a timely manner. The Company believes that cash flows from operations will be sufficient for the next twelve months.
At September 30, 2002, the Company had short-term and long-term debt totaling $35.0 million and $2,132.7 million, respectively. The debt to total capital ratio was 29.3 percent at September 30, 2002 compared to 30.3 percent at September 30, 2001 and 29.8 percent at December 31, 2001. The debt to total capital ratio, when calculated allowing 50 percent equity credit for the Company’s company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely junior subordinated debt securities of the Company, was 27.5 percent at September 30, 2002 compared to 28.4 percent at September 30, 2001 and 28.0 percent at December 31, 2001.
During 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. In the first quarter of 2001, the Company completed a long-term debt offering, issuing $575.0 million of 7.625% senior notes due March 1, 2011. In the second quarter of 2002, the Company completed two long-term offerings, issuing $250.0 million of 7.375% senior debentures due June 15, 2032 and $150.0 million of 7.250% public income notes due June 15, 2032. The public income notes are redeemable at the Company’s option, in whole or in part, on or after June 25, 2007. Proceeds from the offerings were used to refinance existing commercial paper borrowings.
During 2001 the Company redeemed its $172.5 million par value 8.8% monthly income debt securities (junior subordinated debt), which were due in 2025 but callable at par in 2000 and thereafter. The early extinguishment of debt resulted in a fourth quarter of 2001 write-off of the remaining deferred debt cost of $4.5 million associated with the issuance of the securities. The extraordinary loss, net of a $1.6 million tax benefit, was $2.9 million.
During 2000, the Company entered into $1.0 billion senior revolving credit facilities with a group of banks. The facilities are split into five-year revolver and 364-day portions. At September 30, 2002, approximately $801.3 million was available for additional financing under the Company’s revolving credit facilities. The Company received a 90-day extension on the 364-day portion of the credit facilities which was to expire on October 29, 2002. In connection with this extension, the Company elected to reduce the size of the credit facilities from $1.0 billion to $750.0 million. The Company plans to renew the 364-day portion of the credit facilities prior to January 27, 2003, the expiration date for the 90-day extension. The Company’s commercial paper program has similarly been reduced in size to $750.0 million.
The credit facilities are available for general corporate purposes, including support of the Company’s $750.0 million commercial paper program, and contain certain covenants that, among other provisions, include a minimum tangible net worth requirement, a maximum leverage ratio restriction, and a limitation on debt relative to the consolidated statutory earnings of the Company’s insurance subsidiaries. The Company has been in compliance with all covenants of the credit facilities since their inception, with the exception of the limitation on debt relative to the consolidated statutory earnings of the Company’s insurance subsidiaries, for which it received a waiver for the first and second quarters of 2002 due to non-compliance. The Company’s statutory earnings improved during the second quarter and returned to historical levels in the third quarter of 2002, but the covenant stipulates that the most recent twelve month period be used for the statutory earnings test. On August 13, 2002, in connection with the waiver received for the second quarter, the credit facilities were amended to reflect adjusted required levels of consolidated statutory earnings in the calculation of this covenant through 2002 and adjusted required levels of the ratio of senior debt to consolidated statutory earnings through 2003. The Company is currently in compliance with all covenants of the credit facilities. As previously discussed, if the Company records a pension related non-cash charge to stockholders’ equity within the currently anticipated range of $29.0 to $177.0 million, the Company will continue to be in compliance with the covenants of its senior revolving credit facilities.
During 2000, the Company issued $200.0 million of variable rate notes in a privately negotiated transaction. The notes were used to refinance other short-term debt and had a weighted average interest rate of 7.52 percent during the first quarter of 2001. The notes matured in April 2001.
During the second quarter of 2002, the Company’s board of directors authorized a common stock repurchase program of up to $100.0 million over the next year at prices not to exceed market value. The stock purchases will be used in connection with the Company’s benefit and compensation plans and for other corporate purposes and can be made through the open market or privately negotiated transactions. Under this program, the Company acquired approximately 1.8 million shares of its common stock in the open market during the second quarter at an aggregate cost of approximately $45.0 million. It is not anticipated that further repurchases will be made under the program.
Contractual debt and Company-obligated mandatorily redeemable preferred securities commitments at September 30, 2002 are as follows (in millions of dollars):
Commercial paper debt of $198.7 million was classified as long-term at September 30, 2002 because the Company has the ability through the senior revolving credit facilities to convert this obligation into long-term debt.
The Company has an agreement with an outside party wherein the Company is provided computer data processing services and related functions. The contract expires in 2010, but the Company may cancel this agreement effective August 2004 or later upon payment of applicable cancellation charges. The aggregate noncancelable contractual obligation remaining under this agreement, as amended, was $160.5 million at September 30, 2002, with no annual payment expected to exceed $58.4 million.
As previously discussed, at September 30, 2002, the Company had capital commitments of $15.2 million to fund a special purpose entity trust in which the Company has a retained interest. The Company also has capital commitments of $15.4 million to fund certain of its private placement securities. The funds are due upon satisfaction of contractual notice from the issuer. These amounts may or may not be funded during the term of the security.
Ratings
Standard & Poor’s Corporation (S&P), Moody’s Investors Service (Moody’s), Fitch, Inc. (Fitch), and A.M. Best Company (AM Best) are among the third parties that provide the Company assessments of its overall financial position. Ratings from these agencies for financial strength are available for the individual U.S. domiciled insurance company subsidiaries. Financial strength ratings are based primarily on U.S. statutory financial information for the individual U.S. domiciled insurance companies. Debt ratings for the Company are based primarily on consolidated financial information prepared using generally accepted accounting principles. Both financial strength ratings and debt ratings incorporate qualitative analyses by rating agencies on an ongoing basis. If the Company were to experience negative operating trends, it could result in a downgrade of the current ratings, which might impact the Company’s ability to sell and retain its business.
On August 23, 2002, Moody’s placed the Company’s credit ratings on review for possible downgrade, primarily as a result of concern about the level of statutory capital at the Company’s insurance subsidiaries, including their exposure to troubled credits and resulting realized investment losses.
On August 29, 2002, AM Best affirmed the commercial paper rating of the Company and the financial strength ratings of the Company’s primary insurance subsidiaries but downgraded the senior debt rating of the Company from a- to bbb+ as a result of the statutory realized investment losses incurred during the first half of 2002.
The table below reflects the current debt ratings for the Company and the financial strength ratings for the U.S. domiciled insurance company subsidiaries.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is subject to various market risk exposures including interest rate risk and foreign exchange rate risk. With respect to the Company’s exposure to market risk, see the discussion under “Investments” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained herein in Item 2 and in Part II, Item 7A of Form 10-K for the fiscal year ended December 31, 2001. During the first nine months of 2002, there was no substantive change to the Company’s market risk or the management of such risk.
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2002, an evaluation was performed under the supervision and with the participation of the Company’s management, including the chief executive officer, chief financial officer, and members of the Company’s disclosure control committee, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the chief executive officer, chief financial officer, and members of the Company’s disclosure control committee, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2002. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to September 30, 2002.
Refer to Part I, Item 1, Note 6 of the “Notes to Condensed Consolidated Financial Statements” for information on legal proceedings.
On November 11, 2002, Senator George J. Mitchell notified the Company of his intention to resign from the Company’s Board of Directors effective November 15, 2002, to enable him to devote more time to other commitments.
(a) Index to Exhibits
(b) Reports on Form 8-K
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CERTIFICATIONS
I, J. Harold Chandler, certify that:
I, Robert C. Greving, certify that: