UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-21874
London Pacific Group Limited
(Exact name of registrant as specified in its charter)
----------------------
Jersey, Channel Islands Not applicable
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
Minden House, 6 Minden Place
St. Helier, Jersey JE2 4WQ
Channel Islands
(Address of principal executive offices)
(Zip Code)
011 44 (1534) 607700
(Registrant's telephone number, including area code)
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 [ ]
As of May 17, 2002, the registrant had outstanding 64,439,073 Ordinary
Shares, par value $0.05 per share.
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements: Page
Condensed Consolidated Balance Sheets as of March 31, 2002 and
December 31, 2001............................................................................ 3
Condensed Consolidated Statements of Income for the three months
ended March 31, 2002 and 2001................................................................ 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2002 and 2001................................................................ 5
Consolidated Statements of Changes in Shareholders' Equity for the three months
ended March 31, 2002 and 2001................................................................ 6
Consolidated Statements of Comprehensive Income for the three months
ended March 31, 2002 and 2001................................................................ 7
Notes to Interim Consolidated Financial Statements............................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ....................................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...................................... 23
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ................................................................ 24
Signature ................................................................................................. 25
2
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
March 31, December 31,
2002 2001
--------------- ---------------
ASSETS
Investments, principally of life insurance subsidiaries:
Fixed maturities:
Available-for-sale, at fair value (amortized cost: $1,623,328 and $1,595,080
as of March 31, 2002 and December 31, 2001, respectively).................... $ 1,587,474 $ 1,562,790
Held-to-maturity, at amortized cost (fair value: $90,747 and $100,936
as of March 31, 2002 and December 31, 2001, respectively).................... 89,095 98,619
Equity securities:
Trading, at fair value (cost: $87,289 and $86,036 as of March 31, 2002
and December 31, 2001, respectively)......................................... 70,636 81,787
Available-for-sale, at fair value (cost: $202,651 and $185,539 as of
March 31, 2002 and December 31, 2001, respectively).......................... 197,651 181,927
Policy loans..................................................................... 10,488 10,529
--------------- ---------------
Total investments.................................................................. 1,955,344 1,935,652
Cash and cash equivalents.......................................................... 74,652 82,417
Accrued investment income.......................................................... 34,142 33,373
Deferred policy acquisition costs.................................................. 175,387 168,826
Assets held in separate accounts................................................... 225,511 227,675
Reinsurance assets................................................................. 42,243 42,025
Other assets....................................................................... 54,406 46,360
--------------- ---------------
Total assets....................................................................... $ 2,561,685 $ 2,536,328
--------------- ---------------
--------------- ---------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Life insurance policy liabilities.................................................. $ 2,089,737 $ 2,031,852
Liabilities related to separate accounts........................................... 226,298 226,015
Notes payable...................................................................... 36,874 36,874
Accounts payable, accruals and other liabilities................................... 19,597 19,934
--------------- ---------------
Total liabilities.................................................................. 2,372,506 2,314,675
--------------- ---------------
Commitments and contingencies
Shareholders' equity:
Ordinary shares, $0.05 par value per share: 86,400,000 shares authorized;
64,439,073 shares issued and outstanding as of March 31, 2002 and
December 31, 2001................................................................ 3,222 3,222
Additional paid-in capital......................................................... 68,364 68,346
Retained earnings.................................................................. 193,285 223,590
Employee benefit trusts, at cost (13,684,881 and 13,698,181 shares as of
March 31, 2002 and December 31, 2001, respectively).............................. (63,571) (63,599)
Accumulated other comprehensive income (loss)...................................... (12,121) (9,906)
--------------- ---------------
Total shareholders' equity......................................................... 189,179 221,653
--------------- ---------------
Total liabilities and shareholders' equity......................................... $ 2,561,685 $ 2,536,328
--------------- ---------------
--------------- ---------------
<FN>
See accompanying Notes to Interim Consolidated Financial Statements.
</FN>
3
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share and ADS amounts)
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
Revenues:
Investment income.................................................................. $ 34,369 $ 34,988
Insurance policy charges........................................................... 967 1,381
Financial advisory services, asset management and other fee income................. 6,278 6,604
Net realized investment gains (losses)............................................. (22,640) 31,101
Change in net unrealized investment gains and losses on trading securities......... (12,404) (218,645)
--------------- ---------------
6,570 (144,571)
Expenses:
Interest credited on insurance policyholder accounts............................... 29,901 27,450
Amortization of deferred policy acquisition costs.................................. 4,175 5,682
Operating expenses................................................................. 11,927 13,180
Goodwill amortization.............................................................. - 57
Interest expense................................................................... 289 678
--------------- ---------------
46,292 47,047
--------------- ---------------
Income (loss) before income tax expense............................................ (39,722) (191,618)
Income tax expense (benefit)....................................................... (9,417) (11,392)
--------------- ---------------
Net income (loss).................................................................. $ (30,305) $ (180,226)
--------------- ---------------
--------------- ---------------
Basic earnings (loss) per share and ADS............................................ $ (0.60) $ (3.50)
Diluted earnings (loss) per share and ADS.......................................... $ (0.60) $ (3.50)
<FN>
See accompanying Notes to Interim Consolidated Financial Statements.
</FN>
4
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
Net cash provided by operating activities.......................................... $ 28,438 $ 63,234
Cash flows from investing activities:
Purchases of held-to-maturity fixed maturity securities............................ (231) (2,157)
Purchases of available-for-sale fixed maturity securities.......................... (105,536) (225,960)
Purchases of available-for-sale equity securities.................................. (20,254) (51,100)
Proceeds from redemption of held-to-maturity fixed maturity securities............. 9,865 7,003
Proceeds from sale of available-for-sale fixed maturity securities................. 49,033 75,635
Proceeds from sale of available-for-sale equity securities......................... 29 -
Capital expenditures............................................................... (490) (251)
Other cash flows from (used in) investing activities............................... 41 (115)
--------------- ---------------
Net cash provided by (used in) investing activities................................ (67,543) (196,945)
--------------- ---------------
Cash flows from financing activities:
Insurance policyholder contract deposits........................................... 75,072 143,650
Insurance policyholder benefits paid............................................... (43,710) (48,129)
Issuance of Ordinary Shares........................................................ - 16
Purchases of Ordinary Shares by the employee benefit trusts........................ - (4,669)
Proceeds from disposal of shares by the employee benefit trusts.................... 43 327
--------------- ---------------
Net cash provided by financing activities.......................................... 31,405 91,195
--------------- ---------------
Net increase (decrease) in cash and cash equivalents............................... (7,700) (42,516)
Cash and cash equivalents at beginning of period................................... 82,417 114,285
Foreign currency translation adjustment............................................ (65) (116)
--------------- ---------------
Cash and cash equivalents at end of period......................................... $ 74,652 $ 71,653
--------------- ---------------
--------------- ---------------
<FN>
See accompanying Notes to Interim Consolidated Financial Statements.
</FN>
5
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands)
Accumulated
Other
Ordinary Additional Employee Compre- Total
Shares at Paid-in Retained Benefit hensive Shareholders'
Par Value Capital Earnings Trusts Income (Loss) Equity
------------ ------------- ------------- ------------- ------------ -------------
Balance as of January 1, 2001...... $ 3,222 $ 67,591 $ 580,176 $ (58,003) $ (25,244) $ 567,742
Net income (loss).................. - - (180,226) - - (180,226)
Change in net unrealized gains
and losses on available-for-sale
securities....................... - - - - 12,202 12,202
Foreign currency translation
adjustment....................... - - - - (8) (8)
Exercise of employee share
options, including income
tax effect....................... - 84 - 295 - 379
Grant of employee share options
below fair market value.......... - 530 - - - 530
Net realized gains on disposal
of shares held by the employee
benefit trusts................... - 32 - - - 32
Issuance of Ordinary Shares........ - 1 - - - 1
Purchase of shares by the
employee benefit trusts.......... - - - (4,669) - (4,669)
------------ ------------- ------------- ------------- ------------ -------------
Balance as of March 31, 2001....... $ 3,222 $ 68,238 $ 399,950 $ (62,377) $ (13,050) $ 395,983
------------ ------------- ------------- ------------- ------------ -------------
------------ ------------- ------------- ------------- ------------ -------------
Accumulated
Other
Ordinary Additional Employee Compre- Total
Shares at Paid-in Retained Benefit hensive Shareholders'
Par Value Capital Earnings Trusts Income (Loss) Equity
------------ ------------- ------------- ------------- ------------ -------------
Balance as of January 1, 2002...... $ 3,222 $ 68,346 $ 223,590 $ (63,599) $ (9,906) $ 221,653
Net income (loss).................. - - (30,305) - - (30,305)
Change in net unrealized gains
and losses on available-for-sale
securities....................... - - - - (2,409) (2,409)
Foreign currency translation
adjustment....................... - - - - 194 194
Exercise of employee share
options, including income
tax effect....................... - 3 - 28 - 31
Net realized gains on disposal
of shares held by the employee
benefit trusts................... - 15 - - - 15
------------ ------------- ------------- ------------- ------------ -------------
Balance as of March 31, 2002....... $ 3,222 $ 68,364 $ 193,285 $ (63,571) $ (12,121) $ 189,179
------------ ------------- ------------- ------------- ------------ -------------
------------ ------------- ------------- ------------- ------------ -------------
<FN>
See accompanying Notes to Interim Consolidated Financial Statements.
</FN>
6
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
Net income (loss).................................................................. $ (30,305) $ (180,226)
Other comprehensive income (loss), net of deferred income taxes:
Foreign currency translation adjustments, net of income taxes of $0................ 194 (8)
Change in net unrealized gains and losses:
Change in net unrealized gains and losses on available-for-sale securities....... (6,107) 35,894
Deferred policy acquisition cost amortization adjustments........................ 2,745 (17,325)
Deferred income taxes............................................................ 953 (6,367)
--------------- ---------------
Other comprehensive income (loss).................................................. (2,215) 12,194
--------------- ---------------
Comprehensive income (loss)........................................................ $ (32,520) $ (168,032)
--------------- ---------------
--------------- ---------------
<FN>
See accompanying Notes to Interim Consolidated Financial Statements.
</FN>
7
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
Item 1. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1. Basis of Presentation and Principles of Consolidation
The accompanying interim consolidated financial statements are unaudited
and have been prepared by London Pacific Group Limited (the "Company") in
conformity with United States generally accepted accounting principles ("U.S.
GAAP"). These consolidated financial statements include the accounts of the
Company, its subsidiaries, the Employee Share Option Trust and the Agent Loyalty
Opportunity Trust (collectively, the "Group"). All intercompany transactions
have been eliminated in consolidation. Certain information and note disclosures
normally included in the Group's annual consolidated financial statements have
been condensed or omitted. The interim consolidated financial statements, in the
opinion of management, reflect all adjustments (consisting only of normal
recurring accruals) which are necessary for a fair statement of the results for
the interim periods presented.
While the Group believes that the disclosures presented are adequate to
make the information not misleading, these interim consolidated financial
statements should be read in conjunction with the audited financial statements
and related notes for the year ended December 31, 2001, which are contained in
the Company's Annual Report on Form 10-K, filed with the U.S. Securities and
Exchange Commission on April 1, 2002. The year-end condensed balance sheet data
was derived from audited financial statements but does not include all
disclosures required by U.S. GAAP.
The results for the three month period ended March 31, 2002, are not
necessarily indicative of the results to be expected for the full fiscal year.
Note 2. Comprehensive Income
Comprehensive income consists of net income (loss); changes in unrealized
gains and losses on available-for-sale securities, net of income taxes and
deferred policy acquisition cost amortization adjustments; and foreign currency
translation gains or losses arising on the translation of the Group's non-U.S.
dollar based subsidiaries.
Note 3. Earnings Per Share and ADS
The Group calculates earnings per share in accordance with Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share." This
statement requires the presentation of basic and diluted earnings per share.
Basic earnings per share is calculated by dividing net income or loss by the
weighted average number of Ordinary Shares outstanding during the applicable
period, excluding shares held by the Employee Share Option Trust and the Agent
Loyalty Opportunity Trust which are regarded as treasury stock for the purposes
of this calculation. The Group has issued employee share options, which are
considered potential common stock under SFAS 128. Diluted earnings per share is
calculated by dividing net income by the weighted average number of Ordinary
Shares outstanding during the applicable period as adjusted for these
potentially dilutive options which are determined based on the "Treasury Stock
Method." As the Group recorded a net loss for both of the three month periods
ended March 31, 2002 and 2001, the calculations of diluted earnings per share
for these periods do not include these potentially dilutive options as they are
anti-dilutive and would result in a reduction of net loss per share. If the
Group had reported net income for both of the three month periods March 31, 2002
and 2001, there would have been an additional 478,921 and 6,076,286 shares,
respectively, included in the calculations of diluted earnings per share.
8
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
Item 1. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
A reconciliation of the numerators and denominators for the basic and
diluted earnings per share calculations is as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands, except share,
per share and ADS amounts)
Net income (loss).................................................................. $ (30,305) $ (180,226)
Basic earnings per share and ADS:
Weighted average number of Ordinary Shares outstanding,
excluding shares held by the employee benefit trusts............................. 50,754,192 51,557,999
--------------- ---------------
Basic earnings (loss) per share and ADS............................................ $ (0.60) $ (3.50)
--------------- ---------------
--------------- ---------------
Diluted earnings per share and ADS:
Weighted average number of Ordinary Shares outstanding,
excluding shares held by the employee benefit trusts............................. 50,754,192 51,557,999
--------------- ---------------
Diluted earnings (loss) per share and ADS.......................................... $ (0.60) $ (3.50)
--------------- ---------------
--------------- ---------------
Note 4. Investments
Equity Securities
Equity securities are comprised of available-for-sale and trading
securities. An analysis of equity securities is as follows:
March 31, 2002 December 31, 2001
------------------------------------------------- -------------------------------------------------
Gross Gross Estimated Gross Gross Estimated
Unrealized Unrealized Fair Unrealized Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(In thousands)
Private corporate equity
securities.............. $ 200,875 $ 4,043 $ (8,376) $ 196,542 $ 183,621 $ 4,043 $ (6,876) $ 180,788
Other equity securities... 1,776 - (667) 1,109 1,918 - (779) 1,139
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total available-for-sale
equity securities....... 202,651 4,043 (9,043) 197,651 185,539 4,043 (7,655) 181,927
Trading securities........ 87,289 12,076 (28,729) 70,636 86,036 17,755 (22,004) 81,787
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total equity securities... $ 289,940 $ 16,119 $ (37,772) $ 268,287 $ 271,575 $ 21,798 $ (29,659) $ 263,714
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Trading securities are carried at fair value with changes in net unrealized
gains and losses of $(12,404,000) and $(218,645,000) included in earnings for
the three month periods ended March 31, 2002 and 2001, respectively.
9
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
Item 1. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
Investment Concentration and Risk
As of March 31, 2002, fixed maturity securities included investments in
Daimler Chrysler Holdings of $23,810,000 and in Ford Motor Credit of
$22,419,000, and equity securities included an investment in Catena Networks of
$21,500,000. These three corporate issuers each represented more than ten
percent of shareholders' equity.
Realized Gains and Losses
Information about gross realized gains and losses on securities
transactions is as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands)
Gross realized gains (losses) on securities transactions:
Fixed maturities, available-for-sale:
Gross gains................................................................ $ 1,309 $ 3,600
Gross losses............................................................... (23,025) (356)
Fixed maturities, held-to-maturity:
Gross losses............................................................... - (12)
Equity securities, trading:
Gross gains................................................................ 3,841 43,665
Gross losses............................................................... - (1,646)
Equity securities, available-for-sale:
Gross gains................................................................ 601 400
Gross losses............................................................... (5,366) (14,550)
--------------- ---------------
Net realized investment gains (losses) on securities transactions.................. $ (22,640) $ 31,101
--------------- ---------------
--------------- ---------------
During the three month period ended March 31, 2002, management determined
that five public corporate debt securities held by the Group and classified as
available-for-sale were other-than-temporarily impaired and consequently $20.1
million of realized losses were reflected in the consolidated income statement
for the difference between amortized cost and the fair value of these
securities. In addition, three private investments classified as
available-for-sale were considered by management to be other-than-temporarily
impaired and realized losses totaling $6.4 million were recorded in the
consolidated income statement.
Note 5. Recently Issued Accounting Pronouncements
On January 1, 2002, the Group adopted Statement of Financial Accounting
Standard No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which
superseded APB Opinion No. 17, "Intangible Assets." SFAS 142 eliminates the
requirement to amortize goodwill and indefinite-lived intangible assets,
addresses the amortization of intangible assets with a defined life, and
addresses the impairment testing and recognition for goodwill and intangible
assets. The adoption of SFAS 142 did not have a material effect on the Group's
consolidated results of operations or financial position. For the three month
period ended March 31, 2002, goodwill amortization was zero compared to $57,000
for the same period in 2001.
10
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
Item 1. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
On January 1, 2002, the Group adopted Statement of Financial Accounting
Standard No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS 144 addresses financial accounting and reporting for
the impairment or disposal of long-lived assets and supersedes, with exceptions,
Statement of Financial Accounting Standard No. 121, "Accounting for the
Impairment of Long-Lived Assets to Be Disposed Of." The adoption of SFAS 144 did
not have an effect on the Group's consolidated results of operations or
financial position for the three month period ended March 31, 2002.
Note 6. Business Segment and Geographical Information
The Group's reportable operating segments are classified according to its
principal businesses, which are the following: life insurance and annuities,
financial advisory services, asset management and venture capital management.
During the three month periods ended March 31, 2002 and 2001, there were
included in the asset management and venture capital management segments,
portfolio management fees from the life insurance and annuities segment of
$3,056,000 and $2,724,000, respectively. These management fees have been
approved by the insurance regulatory body in the life insurance company's U.S.
state of domicile. Realized investment losses in the amount of $31,368,000 were
recorded by the venture capital management segment, related to intersegmental
investment sales to the life insurance and annuities segment. These realized
investment losses were eliminated on consolidation by a corresponding increase
in unrealized investment gains for the same amount.
Summary revenue and investment gain (loss) information by geographic
segment, based on the domicile of the Group company generating those revenues,
is as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands)
Jersey............................................................................. $ (3,375) $ (99,459)
Guernsey........................................................................... (3,433) (55,560)
United States...................................................................... 13,378 10,448
--------------- ---------------
Consolidated revenues and net investment gains (losses)............................ $ 6,570 $ (144,571)
--------------- ---------------
--------------- ---------------
11
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
Item 1. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Continued)
Revenues and income before taxes for the Group's reportable operating
segments, based on management's internal reporting structure, were as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands)
Revenues:
Life insurance and annuities (1), (2), (3)......................................... $ 3,173 $ (97,390)
Financial advisory services........................................................ 4,433 5,065
Asset management (2)............................................................... 1,647 1,785
Venture capital management (3)..................................................... (2,903) (54,479)
--------------- ---------------
6,350 (145,019)
Reconciliation of segment amounts to consolidated amounts:
Interest income.................................................................... 220 448
--------------- ---------------
Consolidated revenues and net investment gains (losses)............................ $ 6,570 $ (144,571)
--------------- ---------------
--------------- ---------------
Income before income taxes:
Life insurance and annuities (1), (2), (3), (4).................................... $ (33,363) $ (133,023)
Financial advisory services........................................................ (948) (1,455)
Asset management (2)............................................................... 359 287
Venture capital management (3)..................................................... (3,981) (55,317)
--------------- ---------------
(37,933) (189,508)
Reconciliation of segment amounts to consolidated amounts:
Intersegmental interest (4)........................................................ 93 -
Interest income.................................................................... 220 448
Corporate expenses................................................................. (1,813) (1,823)
Goodwill amortization.............................................................. - (57)
Interest expense................................................................... (289) (678)
--------------- ---------------
Consolidated income (loss) before income taxes..................................... $ (39,722) $ (191,618)
--------------- ---------------
--------------- ---------------
<FN>
(1) Netted against the revenues (investment income) of the life insurance and
annuities segment are management fees paid to the asset management and venture
capital management segments of $3,056,000 and $2,724,000 in the first quarters
of 2002 and 2001, respectively.
(2) Included in the revenues of the asset management segment are management fees
from the life insurance and annuities segment of $483,000 and $529,000 in the
first quarters of 2002 and 2001, respectively.
(3) Included in the revenues of the venture capital management segment are
management fees from the life insurance and annuities segment of $2,573,000 and
$2,195,000 in the first quarters of 2002 and 2001, respectively.
(4) Included in the life insurance and annuities segment is intersegmental
interest expense of $93,000 in the first quarter of 2002 which is eliminated in
the consolidated financial statements.
</FN>
12
The only material change in segmental assets during the first quarter of
2002 was in the venture capital management segment, where assets decreased by
$26,025,000 from $46,253,000 to $20,228,000, primarily caused by the transfer of
certain trading securities from the venture capital management segment to the
life insurance and annuities segment, with a corresponding increase in the
corporate and other segment.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the unaudited interim
consolidated financial statements, and the notes thereto, presented elsewhere in
this report. The interim consolidated financial statements are prepared in
accordance with generally accepted accounting principles in the United States.
This item should also be read in conjunction with the "Forward-Looking
Statements and Factors That May Affect Future Results" which are set forth below
and in the Company's other filings with the U.S. Securities and Exchange
Commission ("SEC").
Forward-Looking Statements and Factors That May Affect Future Results
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other sections of this report contain forward-looking
statements within the meaning of Section 21E of the Exchange Act. Such
forward-looking statements are based on current expectations, estimates,
forecasts and projections about the industries in which the Group operates,
management's current beliefs and assumptions made by management. Words such as
"expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates,"
"goals," variations of such words and similar expressions are intended to
identify such forward-looking statements. These statements are not guarantees of
future performance and involve certain risks, uncertainties and assumptions that
are difficult to predict. Future outcomes and results may differ materially from
what is expressed or forecast in such forward-looking statements. The Group
undertakes no obligation to update any forward-looking statements, whether as a
result of new information, future developments or otherwise.
Factors that could cause or contribute to deviations from the
forward-looking statements include those discussed in this section, elsewhere in
this report and in the Company's other filings with the SEC. The factors
include, but are not limited to, (i) the risks described in Item 3 "Quantitative
and Qualitative Disclosures About Market Risk," (ii) variations in demand for
the Group's products and services, (iii) the success of new products and
services provided by the Group, (iv) the credit ratings of the Group's insurance
subsidiaries, (v) significant changes in net cash flows in or out of the Group's
businesses, (vi) fluctuations in the performance of debt and equity markets
worldwide, (vii) the enactment of adverse state, federal or foreign regulation
or changes in government policy or regulation (including accounting standards)
affecting the Group's operations, (viii) regulatory response to any company
action plans required due to the risk-based capital position falling to the
company action level, (ix) the effect of economic conditions and interest rates
in the U.S., the U.K. or internationally, (x) the ability of the Group's
subsidiaries to compete in their respective businesses, and (xi) the ability of
the Group to attract and retain key personnel.
13
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
Life Insurance and Annuities
Certain information regarding the life insurance and annuities segment's
results of operations is as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands)
Revenues:
Investment income.................................................................. $ 31,093 $ 31,817
Insurance policy charges........................................................... 967 1,381
Net realized investment gains (losses), including related amortization (1), (2).... (22,644) 66,744
Change in net unrealized investment gains and losses on trading securities,
including related amortization (1), (2).......................................... (9,676) (199,734)
Other fee income................................................................... 681 282
--------------- ---------------
Total revenues and investment gains (losses), including related
amortization (1)................................................................. 421 (99,510)
Expenses:
Interest credited on insurance policyholder accounts............................... 29,901 27,450
Amortization of deferred policy acquisition costs related to operations (1)........ 1,423 3,562
Mortality expenses (gains)......................................................... (354) 50
General and administrative expenses................................................ 2,721 2,451
Intersegmental interest expense.................................................... 93 -
--------------- ---------------
Total expenses related to operations (1)........................................... 33,784 33,513
--------------- ---------------
Income (loss) before income taxes.................................................. $ (33,363) $ (133,023)
--------------- ---------------
--------------- ---------------
<FN>
(1) As a result of net realized investment gains on available-for-sale
securities and the change in net unrealized investment gains on trading
securities which back the life insurance and annuities segment's investment-type
products, amortization of deferred policy acquisition costs was increased by
$2,752,000 and $2,120,000 in the first quarters of 2002 and 2001, respectively.
For purposes of the above business segment presentation, this additional
amortization is not shown in operating expenses in accordance with the Group's
accounting policy used to prepare the consolidated income statements, but is
netted against net realized investment gains (losses) ($123,000 and $2,120,000
in the first quarters of 2002 and 2001, respectively) and the change in net
unrealized investment gains and losses ($2,629,000 and $0 in the first quarters
of 2002 and 2001, respectively).
(2) Realized investment gains in the amount of $37,763,000 were recorded in the
first quarter of 2001 by the life insurance and annuities segment, related to
intersegmental investment sales to the venture capital management segment. These
realized investment gains were offset by a corresponding decrease in unrealized
investment gains on trading securities for the same amount. These have been
eliminated in the Group's consolidated financial statements.
</FN>
First quarter of 2002 compared to first quarter of 2001
In the first quarter of 2002, the life insurance and annuities segment,
which consists of London Pacific Life & Annuity Company ("LPLA") and London
Pacific Assurance Limited ("LPAL"), contributed a loss before income taxes of
$33.4 million to the Group's overall loss before income taxes, compared to a
loss before income taxes of $133.0 million in the first quarter of 2001. Net
realized investment losses in the first quarter of 2002, including related
amortization of deferred policy acquisition costs ("DPAC"), were $22.6 million,
compared to net realized investment gains of $66.7 million in the first quarter
of 2001. The loss from the change in net unrealized investment gains and losses,
including related DPAC amortization, was $9.7 million in the first quarter of
2002, compared to a loss of $199.7 million in the first quarter of 2001. The
spread between
14
investment income and interest credited to policyholder accounts decreased by
$3.2 million; amortization of DPAC, excluding amortization related to investment
gains and losses, decreased by $2.1 million; and general and administrative
expenses increased by $0.3 million, each as compared to the first quarter of
2001. Policy charges for the first quarter of 2002 decreased by $0.4 million and
other fee income increased by $0.4 million, each as compared to the first
quarter of 2001.
In accordance with U.S. GAAP, premiums collected on annuity and universal
life contracts are not reported as revenues, but rather as deposits to insurance
liabilities. Revenues for these products are recognized over time in the form of
investment income and surrender or other charges. LPLA offers both fixed
annuities which typically have an interest rate guaranteed from one to seven
years, after which LPLA has the discretionary ability to change the crediting
rate to any rate not below a guaranteed rate, and variable annuities which allow
the contract holders the ability to direct premiums into specific investment
portfolios with rates of return being based on the performance of the portfolio.
LPAL began selling guaranteed bond contracts, which are similar to LPLA's fixed
annuity products, in the Jersey, Channel Islands market in the first quarter of
2000 and in the U.K. market during the second quarter of 2000.
Premiums received for all life, annuity and guaranteed bond products were
$80.1 million for the first quarter of 2002, a decrease of 47.9% over the
premiums received in the first quarter of 2001. LPAL generated $3.6 million of
the total premiums received during the first quarter of 2002, a decrease of
$24.2 million of the total premium volume received during the first quarter of
2001. LPAL's premium volume continued to decline as a result of lowering
interest crediting rates during the last quarter of 2001. LPLA generated
premiums of $76.5 million in the first quarter of 2002, a 39.2% decrease over
the premiums received in the first quarter of 2001. The $49.3 million decrease
in LPLA's premiums reflected the impact of a declining U.S. interest rate
environment. As a result of lower reinvestment rates, LPLA reduced annuity
crediting rates during 2001, which reduced the competitiveness of its annuity
product line. During the first quarter of 2002, LPLA's premiums largely
represented traditional annuities, which typically guarantee crediting rates for
one year, but have surrender charge periods ranging from seven to ten years.
Sales of traditional annuities in the first quarter of 2002 increased to $63.2
million, compared to $61.9 million in the first quarter of 2001. LPLA has been
able to attract new distribution sources for its traditional annuities due in
part to its strong track record in the industry. The declining U.S. interest
rate environment had the most significant impact on LPLA's multi-year guaranteed
rate annuities, sales of which in the first quarter of 2002 decreased to $7.7
million, compared to $57.7 million in the first quarter of 2001. If interest
rates remain at their current level or decline further, sales of annuity and
guaranteed bond products may continue to decline.
Interest and dividend income on investments was $31.1 million in the first
quarter of 2002 as compared with $31.8 million in the first quarter of 2001.
This $0.7 million decrease was primarily due to lower reinvestment rates and
acquisitions of capital appreciation (zero yield) securities. The carrying value
of the private equity portfolio as of March 31, 2002 was $196.5 million,
compared with $180.7 million as of December 31, 2001.
Net investment losses, including related DPAC amortization, were $32.3
million in the first quarter of 2002, compared to net investment losses of
$133.0 million in the first quarter of 2001. Net investment losses in the first
quarter of 2002 were comprised of net realized investment losses of $22.5
million, a $7.0 million loss from the change in net unrealized gains and losses
on the listed equity securities held in the trading portfolio, and related DPAC
amortization of $2.8 million. The trading portfolio increased from $36.5 million
as of December 31, 2001 to $51.4 million as of March 31, 2002. Additions to the
trading portfolio during the first quarter of 2002 of $22.0 million resulted
from the transfer of certain listed equity securities from the venture capital
management segment. LPAL sold certain trading positions during the first quarter
of 2002, which resulted in net realized gains of $3.8 million based on an
aggregate original cost of zero. These disposals represented shares previously
held in escrow of companies that had completed initial public offerings of their
securities. These realized gains were offset by net realized losses of $26.3
million, including other-than-temporary impairment write-downs on five publicly
traded corporate debt securities and three private placement securities.
15
If the Group's investment portfolio continues to decline due to further
market or other declines in the remainder of 2002, additional
other-than-temporary investment impairments are possible which could have a
material adverse impact on LPLA's and LPAL's ability to write new business at
the same level as in 2001 and in the first quarter of 2002. LPLA is currently
analyzing ways to reduce the volatility of its regulatory capital base, due to
its equity holdings, through a number of strategic initiatives. One option could
include the sale of a percentage of its private equity securities in exchange
for an equity-linked note. Another option is a reinsurance transaction involving
a block of LPLA's annuity policies. LPAL is significantly smaller than LPLA, and
any necessary capital infusion would be on a much smaller scale.
Total invested assets (defined as total assets excluding DPAC, other assets
and income tax related accounts) remained unchanged at $2.2 billion as of March
31, 2002, compared to December 31, 2001. On total average invested assets for
the first quarter of 2002, the average annualized net return, including both
realized and unrealized investment gains and losses, was 0.28%, as compared with
- -18.37% for the first quarter of 2001.
Policy surrender and mortality charge income decreased by $0.4 million in
the first quarter of 2002 to $1.0 million, compared with $1.4 million in the
first quarter of 2001. Full policy surrenders totaled $17.7 million in the first
quarter of 2002, a $9.5 million decrease over the first quarter of 2001.
Internal policy conversions accounted for $4.8 million of the full surrenders in
the first quarter of 2002, compared to $9.9 million in the first quarter of
2001. The decrease in policy surrenders reflects one of the effects of the
declining U.S. interest rate environment, which has reduced yields on competing
products. Although the current U.S. interest rate environment favors higher
policy persistency, annuity surrenders may increase in future periods,
particularly if interest rates increase, as the portion of the business that can
be withdrawn by policyholders without incurring a surrender charge penalty
grows. Higher surrenders could slow down the growth of the asset base of the
life insurance and annuities segment.
Interest credited on policyholder accounts increased by $2.4 million in the
first quarter of 2002 to $29.9 million, compared with $27.5 million in the first
quarter of 2001. The increase was primarily due to new business growth, offset
by favorable renewal rates on certain blocks of business. The average rate
credited to policyholders was 5.48% during the first quarter of 2002, compared
with 5.90% during the first quarter of 2001.
Amortization of DPAC, excluding amortization related to investment gains
and losses, was $1.4 million in the first quarter of 2002, a decrease of $2.1
million over the first quarter of 2001. This decrease was primarily due to the
lower level of policy surrenders, partially offset by new business growth.
Realized and unrealized investment gains and losses were included in the gross
profits used to calculate the amortization of DPAC. This inclusion of investment
gains and losses resulted in additional amortization of $2.8 million in the
first quarter of 2002, compared to $2.1 million in the first quarter of 2001.
General and administrative expenses were $2.7 million in the first quarter
of 2002, compared with $2.4 million in the first quarter of 2001. This $0.3
million increase was primarily due to higher professional fees largely related
to the strategic initiatives at LPLA discussed above, partially offset by lower
marketing and business development costs and lower insurance guaranty fund
assessments. The expense ratio in the first quarter of 2002, which is defined as
general and administrative expenses divided by the average book value of total
cash and investments, was 0.45%, compared with 0.40% in the first quarter of
2001.
16
Financial Advisory Services
Certain information regarding the financial advisory services segment's
results of operations is as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands)
Gross financial advisory services fees............................................. $ 4,433 $ 5,065
Payments due to independent advisors............................................... (2,864) (3,596)
--------------- ---------------
1,569 1,469
Operating expenses................................................................. 2,517 2,924
--------------- ---------------
Income (loss) before income taxes.................................................. $ (948) $ (1,455)
--------------- ---------------
--------------- ---------------
First quarter of 2002 compared to first quarter of 2001
The pre-tax loss from the financial advisory services segment decreased by
$0.5 million to $0.9 million in the first quarter of 2002 compared to the first
quarter of 2001, primarily due to a decrease in operating expenses, as well as
an increase in net revenues resulting from new institutional client contracts.
Net revenues increased from $1.5 million in the first quarter of 2001 to
$1.6 million in the first quarter of 2002. Net asset management and consulting
fees increased from the prior period as a result of a shift toward higher margin
managed and consulting accounts, while net revenues from brokerage and
commission product sales decreased due to a change in focus toward fee based
(rather than commission based) services and the difficult market conditions
prevailing throughout 2001 and during the first quarter of 2002.
Assets under management, consulting or administration increased from $1.4
billion as of March 31, 2001 to $2.5 billion as of March 31, 2002. The addition
of assets from new institutional clients more than offset the decline in managed
assets resulting from the negative market conditions.
Operating expenses decreased by $0.4 million to $2.5 million in the first
quarter of 2002 compared to the first quarter of 2001, primarily due to lower
staff costs resulting from the stabilization of staffing levels in support of
the institutional and Internet based initiatives discussed below.
In late 1999, the Group decided to make the London Pacific Advisors
business the foundation for an Internet based initiative that could then be
migrated to other vertical markets in which the Group has expertise. This
initiative aims to deliver a full complement of consulting and back office
services to institutions and financial advisors through the Internet. An
overview of the project is available at www.lpadvisors.com.
The total investment in the Internet based project through March 31, 2002
was $3.4 million, including $150,000 in the first quarter of 2002. Of this
total, $2.7 million has been capitalized as software development costs and is
being amortized (as a component of operating expenses) over five years;
amortization of these costs began in May 2001 and the amount amortized during
the first quarter of 2002 was $130,000.
The Internet based initiative has opened the door for marketing of
financial advisory services to institutions and large groups of advisors. To
date, service contracts have been signed with ten major institutions, and
additional contracts are currently under negotiation. The revenue impact of
these contracts increased during the second half of 2001 and the first quarter
of 2002 as newly contracted business came on line. Net asset management and
consulting fees are expected to steadily increase during the remainder of 2002
as new business from institutional clients comes onto the myOfficeOnline (SM)
platform.
17
Asset Management
Certain information regarding the asset management segment's results of
operations is as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands)
Revenues........................................................................... $ 1,647 $ 1,785
Operating expenses................................................................. 1,288 1,498
--------------- ---------------
Income before income taxes......................................................... $ 359 $ 287
--------------- ---------------
--------------- ---------------
First quarter of 2002 compared to first quarter of 2001
Berkeley Capital Management ("BCM"), the Group's U.S. asset manager,
generates most of this segment's revenues and expenses. BCM's revenues declined
in the first quarter of 2002 by $0.1 million to $1.4 million. Expenses decreased
in the first quarter of 2002 by $0.2 million to $1.3 million. The lower revenues
were more than offset by the lower expenses which increased BCM's contribution
to segment income by $0.1 million in the first quarter of 2002 compared to the
first quarter of 2001.
The decline in revenues was due to a lower fee structure paid by one of
BCM's largest clients which became effective January 1, 2002, and to a decline
in institutional assets under management in BCM's Growth Equity style. BCM
implemented a cost reduction program during the second quarter of 2001, which
caused operating expenses to decline and its operating margins to increase
during the first quarter of 2002, compared with the first quarter of 2001.
Total wrap fee account assets under management were $1.1 billion as of
March 31, 2002, compared to $997 million as of December 31, 2001 and $906
million as of March 31, 2001. The additional wrap assets under management for
the first quarter of 2002 resulted from a 2% net increase in the number of wrap
accounts during the quarter and also from a positive return during the period
for BCM's predominant Income Equity investment style. Wrap account assets under
management in BCM's Growth Equity style decreased during the quarter due to
market value declines and a decline in the number of accounts managed. The
increase in total wrap fee assets under management as of March 31, 2002 compared
to March 31, 2001 was primarily due to a 15% net increase in the number of
accounts over the period.
BCM seeks to add an additional wrap account product during 2002 with the
objective of further boosting BCM's assets under management and profitability in
future years.
Included in the revenues of the asset management segment for the first
quarter of 2002 were portfolio management fees from the life insurance and
annuities segment of $0.5 million, which remained level from the first quarter
of 2001. Intersegmental fees of $0.2 million are included in the revenues of BCM
for the first quarter of 2002.
18
Venture Capital Management
Certain information regarding the venture capital management segment's
results of operations is as follows:
Three Months Ended
March 31,
-----------------------------------
2002 2001
--------------- ---------------
(In thousands)
Revenues:
Management fees.................................................................... $ 2,573 $ 2,195
Net realized investment gains (losses) (1)......................................... (31,487) 37,269
Change in net unrealized investment gains and losses on trading securities (1)..... 26,011 (93,943)
--------------- ---------------
Total revenues and net investment gains (losses)................................... (2,903) (54,479)
Operating expenses................................................................. 1,078 838
--------------- ---------------
Income (loss) before income taxes.................................................. $ (3,981) $ (55,317)
--------------- ---------------
--------------- ---------------
<FN>
(1) Realized investment gains and losses in the amount of $(31,368,000) and
$37,269,000 were recorded in the first quarters of 2002 and 2001, respectively,
by the venture capital management segment, related to intersegmental investment
sales to the life insurance and annuities segment. These realized investment
gains and losses were offset by corresponding increases and decreases in
unrealized investment gains and losses on trading securities for the same
amounts. These gains and losses have been eliminated in the Group's consolidated
financial statements.
</FN>
First quarter of 2002 compared to first quarter of 2001
The loss before income taxes from the venture capital management segment
decreased from $55.3 million in the first quarter of 2001 to $4.0 million in the
first quarter of 2002. The loss in both periods was primarily attributable to
the change in net unrealized gains and losses on the listed equity securities
held in the trading portfolio, excluding the intersegmental gains and losses as
noted above. These positions in listed equity securities were the result of
private equity transactions in technology companies.
The change in net unrealized gains and losses in the listed equity trading
portfolio during the first quarter of 2002 was a gain of $26.0 million, which
was more than offset by realized losses of $31.4 million from disposals of
certain listed equity securities to the life insurance and annuities segment,
based on their aggregate cost of $53.4 million. The trading portfolio decreased
from $45.3 million as of December 31, 2001 to $19.2 million as of March 31,
2002. Additions to the trading portfolio during the first quarter of 2002 of
$1.3 million resulted from the purchase of certain listed equity securities.
Significant fluctuations in net unrealized gains and losses in the listed
equity trading portfolio are likely in future periods, reflecting equity market
volatility, especially in the technology sector.
Included in the revenues of the venture capital management segment for the
first quarter of 2002 are portfolio management fees from the life insurance and
annuities segment of $2.6 million, compared to $2.2 million for the first
quarter of 2001. The $0.4 million increase in fees reflects the larger portfolio
of private investments held by LPLA during the first quarter of 2002 which were
monitored by Berkeley International Capital Corporation ("BICC"). BICC sources
and monitors private investments for LPLA, for which LPLA pays BICC management
fees. Total financings completed by BICC during the first quarter of 2002 were
$19.9 million, compared to $51.1 million during the first quarter of 2001. There
were no financings made in new companies during the first quarter of 2002, but
follow-on investments were added in selected portfolio companies where, in some
cases, larger ownership stakes could be taken in promising companies at
attractive prices. This decreased level of activity in venture capital
placements reflected a general trend in the industry as a whole during the first
quarter of 2002, as many venture capitalists adopted a wait and see policy in
view of the difficulties experienced by the market and the technology sector in
particular.
19
Operating expenses in the first quarter of 2002 were $1.1 million, compared
to $0.8 million in the first quarter of 2001. This $0.3 million increase was
primarily attributable to an expense credit in the first quarter of 2001 due to
the reversal of unrealized appreciation on certain underlying listed investments
in the Group's deferred compensation plan, which did not recur during the first
quarter of 2002.
Corporate and Other
First quarter of 2002 compared to first quarter of 2001
Corporate expenses remained level at $1.8 million in the first quarter of
2002, as compared to the first quarter of 2001. However, in the first quarter of
2001, there was compensation expense of $0.5 million relating to the grant of
employee share options at an exercise price below fair market value on the date
of the grant, which was not repeated in 2002. This was offset by an increase of
$0.5 million in expenses in the first quarter of 2002 primarily due to higher
professional fees and shareholder reporting costs.
Interest income earned by the Group (excluding the life insurance and
annuities segment) decreased by $0.2 million to $0.2 million in the first
quarter of 2002 as compared with the first quarter of 2001, primarily due to the
decrease in interest rates earned on cash and cash equivalents held by the
Group. Interest expense incurred by the Group (excluding the life insurance and
annuities segment) also decreased by $0.4 million to $0.3 million in the first
quarter of 2002 as compared with the first quarter of 2001, primarily due to the
lower interest rate environment. A discussion of the Group's sources and uses of
cash is discussed in "Liquidity and Capital Resources" below.
Consolidated Income (Loss) Before Income Taxes
First quarter of 2002 compared to first quarter of 2001
The consolidated loss before income taxes decreased from $191.6 million in
the first quarter of 2001 to $39.7 million in the first quarter of 2002,
primarily due to lower net realized and unrealized investment losses.
Consolidated income before income taxes for the remainder of 2002 and
future years may be volatile due to the Group's holdings of listed equity
securities primarily in the technology sector, which are marked to market with
changes in their market value recognized in the income statement for each
period. Other-than-temporary impairments of the Group's private equity
securities primarily in the technology sector could also affect consolidated
income before income taxes in future periods. For more information on the
possible effects of volatility in the prices of equity securities, see Item 3
"Quantitative and Qualitative Disclosures About Market Risk" below.
Income Taxes
The Group is subject to taxation on its income in all countries in which it
operates based upon the taxable income arising in each country. However,
realized gains on certain investments are exempt from Jersey and Guernsey
taxation. The Group is subject to income tax in Jersey at a rate of 20%. In the
United States, the Group is subject to both federal and California taxes at
34-35% and 8.84%, respectively.
First quarter of 2002 compared to first quarter of 2001
The effective tax credit rate, as a percentage of the loss before income
taxes for the first quarter of 2002, was 24%. This effective tax credit rate
reflects the losses of $11.2 million contributed by the Jersey and Guernsey
operations during the first quarter of 2002, which primarily consisted of
realized investment losses for which no tax benefits will be realized. The
effective tax credit rate, as a percentage of the loss before income taxes for
the first quarter of 2001, was 6%. This low effective tax credit rate was
primarily attributable to losses of $159.1 million contributed by the Jersey and
Guernsey operations during the first quarter of 2001, which primarily consisted
of investment losses for which no tax benefits were realized.
20
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents of the Group decreased during the first quarter
of 2002 by $7.7 million to $74.7 million. This decrease resulted from a $67.5
million use of cash in investing activities, partially offset by $28.4 million
and $31.4 million provided by operating and financing activities, respectively.
The majority of cash used in investing activities relates to investment
transactions within the life insurance and annuities segment. As of March 31,
2002, cash and cash equivalents of the Group, excluding the life insurance and
annuities segment, amounted to $52.2 million, a decrease of $6.1 million from
December 31, 2001. The Group, excluding the life insurance and annuities
segment, also held $19.2 million of listed equity securities which could be sold
within a short period of time as of March 31, 2002, compared to $24.4 million as
of December 31, 2001.
As of March 31, 2002, the Group held $39.7 million in private corporate
debt securities and $196.5 million in private corporate equity securities,
compared to $42.0 million and $180.8 million, respectively, as of December 31,
2001. These securities were held almost exclusively in the investment portfolios
of the Group's insurance subsidiaries (LPLA and LPAL). Liquid markets exist for
$10.1 million of these private securities. No public price information is
available for the remainder of these securities. Debt securities that are
classified as held-to-maturity are valued at amortized cost, unless these
securities become other-than-temporarily impaired, and all other debt and equity
securities are classified as available-for-sale and valued at estimated fair
value based on appropriate valuation methodologies. For a discussion of the
Group's accounting policies with respect to the determination of fair values of
investments and other-than-temporary impairments, see the section entitled
"Critical Accounting Policies" in Item 7 of the Company's Form 10-K, filed with
the SEC on April 1, 2002. Debt securities largely represent loans to an array of
companies that are diversified by industry, geography and financial structure.
The private equity securities are primarily convertible preferred stock holdings
in technology companies. Financial information on the issuers of these debt and
equity securities is received and reviewed periodically by Group management. In
addition, Group management maintains contact with the management of these
issuers through ongoing dialogue to examine the issuers' future plans and
prospects.
The Group's investment portfolio includes 15 private equity investments in
technology companies with an aggregate fair value of $165.1 million as of March
31, 2002. The $17.1 million increase in the portfolio from December 31, 2001
resulted from $18.0 million in follow-on financings, $0.6 million of fixed
maturity securities which were exchanged for equity securities, and a decline in
value, which Group management believes will be temporary, on one security of
$1.5 million.
During the first quarter of 2002, certain other private corporate debt and
equity investments were considered by management to be other-than-temporarily
impaired and realized losses totaling $6.4 million were recorded in the
consolidated income statement for the differences between cost and the estimated
fair value of these securities. As of March 31, 2002, the remaining carrying
value of these private investments totaled $8.5 million.
During the first quarter of 2002, certain public corporate debt securities
classified as available-for-sale were considered by management to be
other-than-temporarily impaired and realized losses totaling $20.1 million were
recorded in the consolidated income statement for the difference between
amortized cost and the fair value of these securities. As of March 31, 2002, the
fair value of these securities totaled $19.8 million.
Shareholders' equity decreased during the first quarter of 2002 by $32.5
million from $221.7 million to $189.2 million, which included LPLA's equity of
$97.8 million, primarily due to a net loss for the quarter of $30.3 million. As
of March 31, 2002, $63.6 million of the Company's Ordinary Shares, at cost, held
by the employee benefit trusts were netted against shareholders' equity. If
employee share options are exercised, shareholders' equity will be increased by
the cost of the shares transferred to the employees and the proceeds received
will increase the amount of cash available to the Group.
As of March 31, 2002, the Group had utilized $12.7 million of its $50.0
million bank facility in the form of letters of credit and guarantees in
connection with certain portfolio companies, and had drawn down
21
$36.9 million in loans. These loans were used for general corporate purposes and
are scheduled for repayment in May 2003. As of March 31, 2002, the Group,
excluding the life insurance and annuities segment, had $71.4 million of cash
and liquid securities, which it considers adequate to service its bank facility
and operating requirements, excluding those of the life insurance and annuities
segment, during the twelve month period ending March 31, 2003. The Group's
consolidated results for the quarter ended March 31, 2002 resulted in a breach
of the net worth and operating profit/interest charge financial covenants under
its bank facility. The Group is seeking a waiver from the bank regarding these
covenant breaches, as well as an extension of the bank facility beyond the May
2003 expiration date. The bank granted a similar waiver in connection with the
2001 year-end results and has granted similar extensions under the facility in
the past. While the Company believes it will be able to obtain the proposed
waiver and extension from the bank, no assurances can be given that (i) the
waiver and/or extension will be obtained, (ii) the bank will not place any
special conditions on the waiver and/or extension or require a fee or other
consideration in connection with granting the waiver and/or extension or (iii)
the bank will refrain from exercising its rights under the bank facility. If the
Company is unsuccessful in negotiating a waiver and extension with the bank on
terms acceptable to the Company, the Company could experience liquidity issues
in the next 12 months.
As of March 31, 2002, the Group had no material commitments outstanding for
capital expenditures or additional funding of private equity portfolio
companies.
THE GROUP'S PRIMARY INSURANCE SUBSIDIARY, LONDON PACIFIC LIFE & ANNUITY
COMPANY, IS FACING A RISK-BASED CAPITAL ISSUE, AND IF IT IS UNABLE TO RESOLVE
THE ISSUE MAY BECOME SUBJECT TO FURTHER ACTION BY ITS PRIMARY STATE REGULATOR.
The National Association of Insurance Commissioners ("NAIC") has
established, and the states in which LPLA operates including North Carolina, its
domiciliary state, have adopted, risk-based capital ("RBC") standards that life
insurers must meet. Regulatory compliance is determined by a ratio of the
insurer's regulatory adjusted capital and surplus to its authorized control
level RBC, as defined by the NAIC. Insurers below specific trigger points or
ratios are classified within certain levels, each of which requires specific
corrective actions. These levels, in increasing order of regulatory priority and
involvement, are company action level, regulatory action level, authorized
control level and mandatory control level.
The corrective actions required by an insurer are based upon the specific
level the insurer has triggered. Insurers at the company action level are
required to file a comprehensive financial plan, which includes forecasts of
future operating results and capital and surplus, with the state of domicile
that identifies the conditions that contribute to the company action level event
and the proposed corrective actions the insurer intends to take to eliminate the
company action level event. An insurer at the regulatory action level is
required to submit a risk-based capital plan and is subject to a regulatory
examination or analysis of its assets, liabilities and operations, including a
review of the risk-based capital plan. An insurer at the authorized control
level is required to adopt corrective actions ordered by the Insurance
Commissioner and may be placed under regulatory control if the Insurance
Commissioner deems regulatory control is in the best interest of the
policyholders and creditors of the insurer and of the public. At the mandatory
control level, the Insurance Commissioner is required to take actions necessary
to cause the insurer to be placed under regulatory control. Regulatory control
may result in rehabilitation or ultimately liquidation.
During the quarter ended March 31, 2002, LPLA experienced further declines
in the value of its investment portfolio which resulted in other-than-temporary
impairments. The March 31, 2002 Statutory Quarterly Statement LPLA intends to
file with the North Carolina Department of Insurance will reflect a $48.2
million reduction in statutory capital and surplus from the level of statutory
capital and surplus LPLA reported in its 2001 Statutory Annual Statement
primarily due to these other-than-temporary impairments. The reduction in
statutory capital and surplus will result in LPLA's RBC position falling to the
company action level as of March 31, 2002. LPLA will be working with the North
Carolina Department of Insurance on a series of corrective measures designed to
raise LPLA's RBC position above the company action level.
A corrective measure LPLA is actively exploring is exchanging a significant
portion of LPLA's private equity investments for an equity-linked note. Such a
transaction could result in a significant improvement in LPLA's risk-based
capital position as a result of the likely reduction in the asset risk charge
associated with the
22
equity-linked note. Another measure could include a reinsurance transaction of a
block of LPLA's annuity products. By reinsuring this business LPLA would
increase its RBC position. Other corrective measures the Group is considering
could include the sale of an interest in LPLA to outside investors. Such a
transaction could result in new capital and surplus being infused into LPLA.
If the outcome of the corrective measures being developed by LPLA is not
successful, if the corrective measures are not subsequently achieved, or if the
results of subsequent operations or other events cause further reductions in
surplus, LPLA may not be able to continue operations in the usual manner, and
could be subject to further regulatory action as described above.
Private corporate debt and equity investments held by LPLA at March 31,
2002 totaled $220.0 million. The determination of fair values for private
corporate debt and equity securities and the evaluations for other-
than-temporary impairments require the application of significant judgement. It
is possible that the impairment factors evaluated by management and fair values
could change in subsequent periods. Further declines in the value of LPLA's
private equity portfolio will have a significant impact on LPLA's statutory
capital level.
Further declines in the value of LPLA's listed equity portfolio will also
have a significant impact on LPLA's statutory capital level.
At March 31, 2002, LPLA identified seven securities which have an aggregate
unrealized loss of $18.3 million that could become other-than-temporary
impairments in future reporting periods. Additional declines in LPLA's statutory
capital and surplus could result in LPLA's RBC position falling to the
regulatory action level. The company currently believes that the RBC position
will not fall below the regulatory action level.
On May 16, 2002 A.M. Best completed a review of LPLA's financial strength
rating. As a result of this review A.M. Best have put the company under negative
event watch. The company currently believes that if it achieves its plans to
restore sufficient capital it will not experience a change in its financial
strength rating. If the company experienced a significant change in its
financial strength rating it could have a material adverse impact on future
operations.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The nature of the Group's businesses exposes the Group to market risk.
Market risk is the risk of loss that may occur when changes in interest rates
and public equity prices adversely affect the value of invested assets.
Interest Rate Risk
The Group's life insurance and annuities segment is subject to risk from
interest rate fluctuations when there is a difference between the amount of
interest earning assets and the amount of interest bearing liabilities that are
prepaid, mature or are repriced in specific periods. LPLA and LPAL attempt to
minimize their exposure to interest rate fluctuations by managing the
characteristics of their assets and liabilities so that the effects of changes
are reasonably likely to be offset. LPLA's and LPAL's principal asset/liability
management goals are to achieve sufficient cash flows from invested assets to
fund contractual obligations, while maximizing investment returns. LPLA and LPAL
have not used derivative financial instruments to achieve their asset/liability
management goals. Exposure to interest rate risk is estimated by performing
sensitivity tests based on duration analysis of LPLA's investment and product
portfolios.
Duration is an option adjusted measure of the percentage change in the
market value of the assets or liabilities in response to a given change in
interest rates. For LPLA's universal life products and for all of LPAL's
products, given that policyholder liabilities are only $47.8 million and $133.5
million, respectively, interest rate risk is considered to be minimal. To
demonstrate the sensitivity of LPLA's assets and liabilities, tests performed on
LPLA's assets and liabilities indicated that, as of March 31, 2002, if market
interest rates had suddenly increased by 100 basis points, the fair value of the
investment portfolio that is subject to interest rate risk, which was
approximately $2.0 billion, would have decreased by $82.2 million, compared with
a
23
decrease of $59.1 million for the calculated market value of liabilities, which
was approximately $1.9 billion. Conversely, a sudden decrease of 100 basis
points would have increased the investment portfolio's fair value by $85.5
million, compared with an increase in the calculated market value of liabilities
of $75.9 million. These results depend upon certain key assumptions regarding
the behavior of interest sensitive cash flows. Although LPLA has attempted to
ensure that the assumptions used are based on the best available data, cash
flows cannot be forecasted with certainty and can deviate materially from the
assumed results.
Equity Price Risk
The Group, including LPLA and LPAL, is exposed to equity price risk on the
listed equity securities held entirely in its trading portfolio. Changes in the
level or volatility of equity prices affect the value of the listed equity
securities. These changes in turn directly affect the Group's net income because
the Group's holdings of listed equity securities are marked to market, with
changes in their market value recognized in the income statement for the period
in which the changes occur. These listed equity securities are primarily in
companies in the high technology industry sector, many of which are small
capitalization stocks.
If the fair value of the Group's listed equity portfolio as of March 31,
2002 and 2001, which totaled $70.6 million and $117.8 million, respectively, had
abruptly increased or decreased by 50%, the fair value of the listed equity
portfolio would have increased or decreased by $35.3 million and $58.9 million,
respectively.
The Group's listed equity securities largely represent investments that
were originally made as private equity investments that either completed an
initial public offering or were acquired by a larger publicly traded company.
The performance of these listed equity securities can be highly volatile, but
the Group attempts to manage its risk in various ways. The performance of the
listed equity securities are monitored daily. In addition, the Group seeks to
sell investments after a period of time, particularly in the case of large
public company securities.
As of March 31, 2002, the Group held $196.5 million in private corporate
equity securities primarily in technology companies for which liquid markets do
not exist. Private equity prices do not fluctuate directly with public equity
markets, but significant market movements may trigger a review for
other-than-temporary adjustment of the carrying values of these Group's private
equity securities. For example, see the discussion on page 22 and 23 under
"Liquidity and Capital Resources" for a description of such reductions in the
carrying value of certain of the Group's private equity securities during the
first quarter of 2002, and of such reductions that may need to be considered for
future reporting periods. The risks inherent in these private equity investments
relate primarily to the viability of the investee companies. These risks are
managed in various ways. Extensive due diligence procedures are performed prior
to making an investment, and regular reviews of the progress of the investee
companies are carried out. In addition, the investments are diversified in a
number of technology companies to avoid excessive concentration in any one
company.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
None.
(b) REPORTS ON FORM 8-K:
No reports on Form 8-K were filed by the Company during the first
quarter of 2002.
24
SIGNATURE
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.
LONDON PACIFIC GROUP LIMITED
(Registrant)
Date: May 17, 2002 By: /s/ Ian K. Whitehead
Ian K. Whitehead
Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized
Officer of the Registrant)
25