[GRAPHIC]
FINANCIAL REVIEW
Selected Financial Data 27
Management's Discussion 28-39
Consolidated Financial Statements 40-43
Notes to Consolidated Financial Statements 44-62
Report of Independent Auditors 63
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SELECTED FINANCIAL DATA
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Selected Consolidated Financial Data(1)
(in millions, except per share data)
As of or for the Year Ended December 31 1999 1998 1997 1996 1995
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Income Statement Data
Investment income $ 810.3 $ 820.9 $ 853.1 $ 796.4 $ 761.8
Interest credited to policyholders (526.6) (562.2) (594.1) (572.7) (555.8)
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Investment spread 283.7 258.7 259.0 223.7 206.0
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Net realized investment gains (losses) (42.2) 2.4 25.9 8.0 (4.0)
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Fee income:
Investment advisory and administrative fees 268.5 237.7 217.9 196.4 155.8
Distribution and service fees 60.4 52.7 49.2 44.9 28.9
Transfer agency fees 51.7 49.0 47.7 43.9 30.8
Surrender charges and net commissions 36.5 33.7 36.1 34.7 23.4
Separate account fees 33.5 20.6 17.1 16.0 13.2
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Total fee income 450.6 393.7 368.0 335.9 252.1
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Expenses:
Operating expenses (360.4) (328.2) (309.7) (277.9) (225.1)
Amortization of deferred policy acquisition costs (97.4) (77.4) (86.4) (70.4) (68.0)
Amortization of deferred distribution costs (40.3) (40.1) (34.2) (33.9) (18.8)
Amortization of intangible assets (20.3) (15.3) (13.5) (15.4) (12.2)
Interest expense, net (19.3) (14.9) (17.0) (19.7) (16.2)
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Total expenses (537.7) (475.9) (460.8) (417.3) (340.3)
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Pretax income 154.4 178.9 192.1 150.3 113.8
Income tax expense (55.1) (54.4) (62.6) (49.6) (39.9)
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Income before extraordinary item 99.3 124.5 129.5 100.7 73.9
Extraordinary loss on extinguishment
of debt, net of tax -- (9.7) -- -- --
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Net income $ 99.3 $ 114.8 $ 129.5 $ 100.7 $ 73.9
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Per Share Data(2)
Net income per share - basic $ 2.11 $ 2.51 $ 2.94 $ 2.36 $ 1.85
Net income per share - assuming dilution 2.07 2.42 2.77 2.24 1.76
Dividends on common stock(3) 0.40 0.40 0.40 0.40 0.30
Dividends on convertible preferred stock 2.88 2.88 2.88 2.88 2.21
Book value 24.99 27.41 26.82 24.42 23.03
Other Operating Data
Net operating income(4) $ 126.7 $ 122.6 $ 112.4 $ 94.8 $ 76.5
Extraordinary loss on extinguishment
of debt, net of tax -- (9.7) -- -- --
Net realized investment gains (losses),
net of taxes (27.4) 1.9 17.1 5.9 (2.6)
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Net income $ 99.3 $ 114.8 $ 129.5 $ 100.7 $ 73.9
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Balance Sheet Data
Total investments $12,195.1 $12,598.3 $12,343.5 $11,537.9 $10,144.7
Intangible assets 282.0 292.8 199.0 205.4 192.3
Total assets 18,372.5 16,519.1 15,851.6 14,427.7 12,749.4
Notes payable to affiliates -- -- 229.0 229.0 229.0
Notes payable 552.0 486.4 26.5 52.5 61.0
Series A redeemable convertible preferred stock 16.0 15.3 14.6 13.8 13.0
Stockholders' equity 1,185.9 1,271.3 1,198.9 1,051.4 956.4
Shares of common stock outstanding(2) 47.5 46.4 44.7 43.1 41.5
1 Includes data for acquired entities from and after the applicable
acquisition date (the most significant being Colonial, which was acquired on
March 24, 1995). The data presented should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto and other financial
information included herein and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
2 Share and per share amounts have been adjusted for a three-for-two common
stock split effected in the form of a 50 percent stock dividend distributed
on December 10, 1997.
3 The amount for 1995 does not include a non-cash dividend of $30.0 million to
an affiliate of Liberty Mutual.
4 Net operating income is defined as net income, excluding extraordinary items
and net realized investment gains and losses, net of related income taxes.
27
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MANAGEMENT'S DISCUSSION
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Net Income was $99.3 million or $2.07 per share in 1999 compared to $114.8
million or $2.42 per share in 1998 and $129.5 million or $2.77 per share in
1997. The decrease in 1999 compared to 1998 resulted primarily from net realized
investment losses in 1999 compared to net realized investment gains in 1998.
Operating expenses, amortization expense and interest expense, net also
increased, largely offset by higher fee and investment spread income. Although
pretax income decreased in 1999 compared to 1998, income tax expense increased
as the effective tax rate was significantly higher in 1999 compared to 1998. In
addition, net income for 1998 included an extraordinary loss on extinguishment
of debt, net of tax, of $9.7 million. The decrease in 1998 compared to 1997
resulted primarily from lower net realized investment gains and higher operating
expenses. Partially offsetting these items were increased fee income and
decreased amortization expense, interest expense, net and income tax expense.
Pretax Income was $154.4 million in 1999 compared to $178.9 million in 1998
and $192.1 million in 1997. The lower pretax income in 1999 compared to 1998
resulted primarily from net realized investment losses in 1999 compared to net
realized investment gains in 1998. Operating expenses, amortization expense and
interest expense, net also increased, largely offset by higher fee and
investment spread income. The lower pretax income in 1998 compared to 1997
resulted primarily from lower net realized investment gains and higher operating
expenses. Partially offsetting these items were increased fee income and
decreased amortization expense and interest expense, net.
Investment Spread is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $283.7 million in 1999 compared to $258.7 million in 1998
and $259.0 million in 1997. The amount by which the average yield on investments
exceeds the average interest credited rate on policyholder balances is the
investment spread percentage. The investment spread percentage in 1999 was 2.01%
compared to 1.83% for 1998 and 1.96% for 1997.
Investment income was $810.3 million in 1999 compared to $820.9 million in
1998 and $853.1 million in 1997. The decrease of $10.6 million in 1999 compared
to 1998 primarily relates to a $15.0 million decrease as a result of a lower
average investment yield, partially offset by a $4.4 million increase resulting
from a higher level of average invested assets. The 1999 investment income was
net of $77.2 million of S&P 500 Index call option amortization expense related
to the Company's equity-indexed annuities compared to $70.8 million in 1998. The
average investment yield was 6.29% in 1999 compared to 6.41% in 1998. The
decrease of $32.2 million in 1998 compared to 1997 primarily relates to a $66.0
million decrease as a result of a lower average investment yield, partially
offset by a $33.8 million increase resulting from a higher level of average
invested assets. The 1997 investment income was net of $47.6 million of S&P 500
Index call option amortization expense. The average investment yield was 6.95%
in 1997.
Interest credited to policyholders totaled $526.6 million in 1999 compared
to $562.2 million in 1998 and $594.1 million in 1997. The decrease of $35.6
million in 1999 compared to 1998 primarily relates to a $36.9 million decrease
resulting from a lower average interest credited rate. Policyholder balances
averaged $12.3 billion (including $10.1 billion of fixed products, consisting of
fixed annuities and a closed block of single premium whole life insurance, and
$2.2 billion of equity-indexed annuities) in 1999 compared to $12.3 billion
(including $10.5 billion of fixed products and $1.8 billion of equity-indexed
annuities) in 1998. The average interest credited rate was 4.28% (5.00% on fixed
products, consisting of fixed annuities and a closed block of single premium
whole life insurance, and 0.85% on
28 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
equity-indexed annuities) in 1999 compared to 4.58% (5.23% on fixed products and
0.85% on equity-indexed annuities) in 1998. Keyport's equity-indexed annuities
credit interest to the policyholder at a "participation rate" equal to a portion
(ranging for existing policies from 25% to 100%) of the change in value of the
S&P 500 Index. Keyport's equity-indexed annuities also provide a full guarantee
of principal if held to term, plus interest at 0.85% annually. For each of the
periods presented, the interest credited to equity-indexed policyholders related
to the participation rate was offset by investment income recognized on the S&P
500 Index call options and futures, resulting in a 0.85% net credited rate. The
decrease of $31.9 million in 1998 compared to 1997 primarily relates to a $48.6
million decrease resulting from a lower average interest credited rate,
partially offset by a $16.7 million increase as a result of a higher level of
average policyholder balances. Policyholder balances in 1997 averaged $11.9
billion (including $10.8 billion of fixed products and $1.1 billion of
equity-indexed annuities). The average interest credited rate in 1997 was 4.99%
(5.45% on fixed products and 0.85% on equity-indexed annuities).
Average investments in the Company's general account (computed without
giving effect to Statement of Financial Accounting Standards No. 115), including
cash and cash equivalents in the Company's annuity operations, were $12.9
billion in 1999 compared to $12.8 billion in 1998 and $12.3 billion in 1997. The
increase of $0.1 billion in 1999 compared to 1998 was primarily due to the
reinvestment of portfolio earnings, partially offset by net redemptions and
transfers to separate accounts. The increase of $0.5 billion in 1998 compared to
1997 was primarily due to the reinvestment of portfolio earnings.
Net Realized Investment Gains (Losses) were $(42.2) million in 1999
compared to $2.4 million in 1998 and $25.9 million in 1997. The net realized
investment losses in 1999 and net realized investment gains in 1998 included
losses of $18.3 million and $28.3 million, respectively, for certain fixed
maturity investments where the decline in value was determined to be other than
temporary.
Investment Advisory and Administrative Fees are based on the market value
of assets managed for mutual funds, private capital management and institutional
investors. Investment advisory and administrative fees were $268.5 million in
1999 compared to $237.7 million in 1998 and $217.9 million in 1997. These
increases primarily reflect a higher level of average fee-based assets under
management.
Average fee-based assets under management were $48.4 billion in 1999
compared to $41.9 billion in 1998 and $37.2 billion in 1997. The increase during
1999 compared to 1998 resulted from market appreciation and net sales for the
year ended December 31, 1999 and the full year impact of 1998 acquisitions. The
increase during 1998 compared to 1997 resulted from acquisitions, market
appreciation and net sales for the year ended December 31, 1998. Investment
advisory and administrative fees were 0.55% of average fee-based assets under
management in 1999, 0.57% in 1998 and 0.59% in 1997.
The amount of fee-based assets under management are affected by product
sales and redemptions, acquisitions, and changes in the market values of such
assets under management. Fee-based assets under management and changes in such
assets are set forth in the tables below (in billions).
29
Fee-Based Assets Under Management
As of December 31
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Mutual Funds: 1999 1998 1997
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Intermediary-distributed $18.3 $17.9 $16.1
Direct-marketed 6.7 6.8 7.2
Closed-end 2.7 2.4 2.2
Variable annuity 2.1 1.5 1.3
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29.8 28.6 26.8
Private Capital Management 9.1 7.9 6.6
Institutional 12.5 11.4 5.3
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Total fee-based assets under management* $51.4 $47.9 $38.7
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* As of December 31, 1999, 1998 and 1997, Keyport's insurance assets of $13.7
billion, $13.1 billion and $12.8 billion, respectively, bring total assets
under management to $65.1 billion, $61.0 billion and $51.5 billion,
respectively.
Changes in Fee-Based Assets Under Management
Year Ended December 31
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1999 1998 1997
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Fee-based assets under management - beginning $47.9 $38.7 $35.9
Sales and reinvestments 11.9 8.5 6.6
Redemptions and withdrawals (10.6) (6.8) (6.6)
Acquisitions -- 5.4 --
Market appreciation 2.2 2.1 2.8
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Fee-based assets under management - ending $51.4 $47.9 $38.7
===============================================================================
Distribution and Service Fees are based on the market value of the
Company's intermediary-distributed mutual funds. Distribution fees of 0.75% are
generally earned on the average assets attributable to such funds sold with
12b-1 distribution fees and contingent deferred sales charges and service fees
of 0.25% (net of amounts passed on to selling brokers) are generally earned on
the total of such average mutual fund assets. These fees totaled $60.4 million
in 1999 compared to $52.7 million in 1998 and $49.2 million in 1997. These
increases in 1999 and 1998 were primarily attributable to the higher asset
levels of mutual funds with 12b-1 distribution fees and contingent deferred
sales charges. As a percentage of intermediary-distributed average mutual fund
assets, distribution and service fees were approximately 0.35% in 1999, 0.32% in
1998 and 0.31% in 1997.
Transfer Agency Fees are based on the market value of the assets managed in
the Company's intermediary-distributed, direct-marketed and variable annuity
mutual funds. Such fees were $51.7 million on average assets of $26.1 billion in
1999, $49.0 million on average assets of $24.9 billion in 1998 and $47.7 million
on average assets of $24.1 billion in 1997. As a percentage of total average
assets under management, transfer agency fees were approximately 0.20% in each
of 1999, 1998 and 1997.
Surrender Charges and Net Commissions are revenues earned on: a) the early
withdrawal of annuity policyholder balances and redemptions of the
intermediary-distributed mutual funds which were sold with 12b-1 distribution
fees and contingent deferred sales charges; b) the distribution of the Company's
intermediary-distributed mutual funds (net of the substantial portion of
commissions that is passed on to the selling brokers); and c) the sales of
non-proprietary
30 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
products in the Company's bank marketing businesses (net of commissions that are
paid to the Company's client banks and brokers). Total surrender charges and net
commissions were $36.5 million in 1999 compared to $33.7 million in 1998 and
$36.1 million in 1997.
Surrender charges on fixed and variable annuity withdrawals generally are
assessed at declining rates applied to policyholder withdrawals during the first
five to seven years of the contract; contingent deferred sales charges on mutual
fund redemptions are assessed at declining rates on amounts redeemed generally
during the first six years. Such charges totaled $24.5 million, $21.9 million
and $21.4 million in 1999, 1998 and 1997, respectively. Total annuity
withdrawals represented 14.7%, 13.2% and 11.6% of the total average annuity
policyholder and separate account balances in 1999, 1998 and 1997, respectively.
Net commissions were $12.0 million in 1999, $11.8 million in 1998 and $14.7
million in 1997.
Separate Account Fees include mortality and expense charges earned on
variable annuity and variable life policyholder balances. In addition, for
certain separate institutional accounts, the difference between investment
income and interest credited on these institutional accounts is included in
separate account fees. These fees, which are primarily based on the market
values of the assets in separate accounts supporting the contracts, were $33.5
million in 1999 compared to $20.6 million in 1998 and $17.1 million in 1997.
Such fees represented 1.32%, 1.44% and 1.54% of average variable annuity,
variable life and institutional separate account balances in 1999, 1998 and
1997, respectively.
Operating Expenses primarily represent compensation, marketing and other
general and administrative expenses. These expenses were $360.4 million in 1999
compared to $328.2 million in 1998 and $309.7 million in 1997. These increases
were primarily due to the acquisitions of Crabbe Huson and Progress in the
second half of 1998 and to increases in compensation and marketing expenses.
Operating expenses expressed as a percent of average total assets under
management were 0.59%, 0.60% and 0.63% in 1999, 1998 and 1997, respectively.
Amortization of Deferred Policy Acquisition Costs relates to the costs of
acquiring new business which vary with, and are primarily related to, the
production of new annuity business. Such costs include commissions, costs of
policy issuance and underwriting and selling expenses. Amortization was $97.4
million in 1999 compared to $77.4 million in 1998 and $86.4 million in 1997. The
increase in amortization in 1999 compared to 1998 was primarily related to the
increase in investment spread from the growth of business in force associated
with fixed and indexed products and the increased sales of variable annuity
products in 1999. The decrease in amortization in 1998 compared to 1997 was
primarily related to revisions in investment spread assumptions, partially
offset by increased amortization from the growth of business in force associated
with increased sales of variable annuity products during 1998. Amortization
expense represented 30.7%, 27.7% and 31.3% of investment spread and separate
account fees in 1999, 1998 and 1997, respectively.
Amortization of Deferred Distribution Costs relates to the distribution of
mutual fund shares sold with 12b-1 distribution fees and contingent deferred
sales charges. Amortization was $40.3 million in 1999 compared to $40.1 million
in 1998 and $34.2 million in 1997.
Amortization of Intangible Assets relates to goodwill and certain
identifiable intangible assets arising from business combinations accounted for
as purchases. Amortization was $20.3 million in 1999 compared to $15.3 million
in 1998 and $13.5 million in 1997. These increases in amortization in 1999 and
1998 were primarily attributable to acquisitions during 1998.
Interest Expense, Net was $19.3 million in 1999 compared to $14.9 million
in 1998 and $17.0 million in 1997. Interest expense primarily consists of
interest on notes payable and interest on the Liberty Funds Group revolving
credit facility which is utilized to finance sales commissions paid in
connection with the distribution of mutual fund shares
31
sold with 12b-1 distribution fees and contingent deferred sales charges.
Interest expense was net of interest income of $17.3 million, $8.4 million and
$4.6 million in 1999, 1998 and 1997, respectively.
Income Tax Expense was $55.1 million or 35.7% of pretax income in 1999
compared to $54.4 million or 30.4% of pretax income in 1998 and $62.6 million or
32.6% of pretax income in 1997. The significantly lower effective tax rates on
pretax income in 1998 and 1997 were primarily attributable to reductions in the
deferred tax asset valuation allowance on federal net operating loss
carryforwards.
Financial Condition
Stockholders' Equity as of December 31, 1999 was $1.19 billion compared to
$1.27 billion as of December 31, 1998. Net income in 1999 was $99.3 million and
cash dividends on the Company's preferred and common stock totaled $6.3 million.
Common stock totaling $7.3 million was issued in connection with the exercise of
stock options and awards of nonvested stock. A decrease in accumulated other
comprehensive income which consists of net unrealized investment losses, net of
adjustments to deferred policy acquisition costs and income taxes, during the
period decreased stockholders' equity by $185.3 million.
Book Value Per Share amounted to $24.99 at December 31, 1999 compared to
$27.41 at December 31, 1998. Excluding net unrealized gains (losses) on
investments (computed pursuant to Statement of Financial Accounting Standards
No. 115), book value per share amounted to $28.32 at December 31, 1999 and
$26.82 at December 31, 1998. As of December 31, 1999, there were 47.5 million
common shares outstanding compared to 46.4 million common shares outstanding as
of December 31, 1998.
Investments not including cash and cash equivalents, totaled $12.2 billion
at December 31, 1999 compared to $12.6 billion at December 31, 1998.
The Company manages the majority of its invested assets internally. The
Company's general investment policy is to hold fixed maturity securities for
long-term investment and, accordingly, the Company does not have a trading
portfolio. To provide for maximum portfolio flexibility and appropriate tax
planning, the Company classifies its entire portfolio of fixed maturity
securities as "available for sale" and accordingly carries such investments at
fair value. The Company's total investments at December 31, 1999 and 1998
reflected net unrealized (losses) gains of $(318.6) million and $105.3 million,
respectively.
Approximately $11.1 billion or 81.0% of the Company's general account
investments at December 31, 1999 were rated by Standard & Poor's Corporation,
Moody's Investors Service or under comparable statutory rating guidelines
established by the National Association of Insurance Commissioners ("NAIC"). At
December 31, 1999, the carrying value of investments in below investment grade
securities totaled $1.2 billion or 8.9% of general account investments,
including cash and cash equivalents in the Company's annuity operations, and
certain separate account investments of $13.7 billion. Below investment grade
securities generally provide higher yields and involve greater risks than
investment grade securities because their issuers typically are more highly
leveraged and more vulnerable to adverse economic conditions than investment
grade issuers. In addition, the trading market for these securities may be more
limited than for investment grade securities.
The Company routinely reviews its portfolio of investment securities. The
Company identifies monthly any investments that require additional monitoring,
and carefully reviews the carrying value of such investments at least quarterly
to determine whether specific investments should be placed on a nonaccrual basis
and to determine declines in value that may be other than temporary. In making
these reviews, the Company principally considers the adequacy of collateral (if
any), compliance with contractual covenants, the borrower's recent financial
performance, news reports, and other
32 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
externally generated information concerning the borrower's affairs. In the case
of publicly traded fixed maturity securities, management also considers market
value quotations if available. As of December 31, 1999 and 1998, the carrying
value of fixed maturity securities that were non-income producing was $22.6
million and $30.0 million, respectively, which constituted 0.2% of investments
in each year.
Quantitative and Qualitative Disclosures About Market Risk
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
Market risk is the risk that the Company will incur losses due to adverse
changes in market rates and prices. The Company's primary market risk exposures
are to changes in interest rates and to changes in equity prices.
The active management of market risk is integral to the Company's
operations. The Company may use the following approaches to manage its exposure
to market risk within defined tolerance ranges: rebalance its existing asset and
liability portfolios, change the character of future investment purchases, or
use derivative instruments to modify the market risk characteristics of existing
assets and liabilities or assets expected to be purchased.
CORPORATE OVERSIGHT
The Company generates substantial investable funds from its annuity
operations. The Company believes that its fixed and indexed policyholder
balances should be backed by investments, principally comprised of fixed
maturities, which generate predictable rates of return. The Company does not
have a specific target rate of return. Instead, its rates of return vary over
time depending on the current interest rates, the slope of the yield curve and
the excess at which fixed maturities are priced over the yield curve. The
Company's portfolio strategy is designed to achieve acceptable risk-adjusted
returns by effectively managing portfolio liquidity and credit quality.
The Company administers and oversees the investment risk management
processes primarily through its Investment Committee and its Board of Directors.
The Investment Committee and Board of Directors provide executive oversight of
investment activities. The Investment Committee is a committee consisting of the
Chief Executive Officer and other members of senior management of the Company.
The Investment Committee meets monthly to provide detailed oversight of
investment risk, including market risk.
The Company has investment guidelines that define the overall framework for
managing market and other investment risks, including the accountability and
control over these activities. In addition, the Company has specific investment
policies that delineate the investment limits and strategies that are
appropriate given the Company's liquidity, product and regulatory requirements.
The Company monitors and manages its exposure to market risk through asset
allocation limits, duration limits, and stress tests. Asset allocation limits
place restrictions on the aggregate fair value which may be invested within an
asset class. Duration limits on the aggregate investment portfolio, and, as
appropriate, on individual components of the portfolio, place restrictions on
the amount of interest rate risk that may be taken. Stress tests measure
downside risk to fair value and earnings over longer time intervals and for
adverse market scenarios.
The day-to-day management of market risk within defined tolerance ranges
occurs as portfolio managers buy and sell within their respective markets based
upon the acceptable boundaries established by asset allocation, duration and
other limits, including but not limited to credit and liquidity.
INTEREST RATE RISK
Interest rate risk is the risk that the Company will incur economic losses
due to adverse changes in interest rates. This risk arises from the Company's
primary activities, as the Company invests substantial funds in
interest-sensitive
33
assets and also has interest-sensitive liabilities. The Company's
asset/liability management emphasizes a conservative approach, which is oriented
toward reducing downside risk in adverse markets, as opposed to maximizing
spread in favorable markets.
The Company manages the interest rate risk inherent in its assets relative
to the interest rate risk inherent in its liabilities. One of the measures the
Company uses to quantify this exposure is effective duration. Effective duration
is a common measure for the price sensitivity of assets and liabilities to
changes in interest rates. It measures the approximate percentage change in the
market value of assets and liabilities when interest rates change by 100 basis
points. This measure includes the impact of estimated changes in portfolio cash
flows from features such as prepayments and bond calls. The effective duration
of assets and related liabilities are produced using standard financial
valuation techniques. At December 31, 1999 and 1998, the estimated difference
between the Company's asset and liability duration was approximately 1.85 and
1.24, respectively. This positive duration gap indicates that the fair value of
the Company's assets is somewhat more sensitive to interest rate movements than
the fair value of its liabilities.
The Company seeks to invest premiums and deposits to create future cash
flows that will fund future benefits, claims, and expenses, and earn stable
margins across a wide variety of interest rate and economic scenarios. In order
to achieve this objective and limit its exposure to interest rate risk, the
Company adheres to a philosophy of managing the effective duration of assets and
related liabilities. The Company uses interest rate and total return swaps,
futures and caps to reduce the interest rate risk resulting from effective
duration mismatches between assets and liabilities. To the extent that actual
results differ from the assumptions utilized, the Company's effective duration
could be significantly impacted. Important assumptions include the timing of
cash flows on mortgage-related assets and liabilities subject to policyholder
surrenders. Additionally, the Company's calculation assumes that the current
relationship between short-term and long-term interest rates (the term structure
of interest rates) will remain constant over time. As a result, these
calculations may not fully capture the impact of non-parallel changes in the
term structure of interest rates and/or large changes in interest rates.
The Company's potential exposure due to a 10% increase in prevailing
interest rates from their December 31, 1999 and 1998 levels was a loss of $146.3
million and $87.0 million, respectively, in fair value of its fixed-rate assets
that were not offset by a decrease in the fair value of its fixed-rate
liabilities. The increase in potential exposure is primarily due to higher
prevailing market interest rates and the increase in the positive duration gap.
The Company expects that its exposure to loss as interest rate changes occur
will be minimized and that actual losses will be less than the estimated
potential loss due to the combination of asset/liability management strategies
and flexibility in adjusting crediting rate levels.
EQUITY PRICE RISK
Equity price risk is the risk that the Company will incur economic losses
due to adverse changes in a particular stock or stock index. At December 31,
1999 and 1998, the Company had approximately $37.9 million and $24.6 million,
respectively, in common stocks and $701.1 million and $535.1 million,
respectively, in other equity investments (primarily equity options and equity
futures).
At December 31, 1999 and 1998, the Company had $2.4 billion and $2.0
billion, respectively, in equity-indexed annuity liabilities which provide
customers with contractually guaranteed participation in price appreciation of
the Standard & Poor's 500 Composite Price Index ("S&P 500 Index"). The Company
purchases equity-indexed options and futures to hedge the risk associated with
the price appreciation component of equity-indexed annuity liabilities.
34 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
The Company manages the equity risk inherent in its assets relative to the
equity risk inherent in its liabilities by conducting detailed computer
simulations that model its S&P 500 Index derivatives and its equity-indexed
annuity liabilities under stress-test scenarios in which both the index level
and the index option implied volatility are varied through a wide range. Implied
volatility is a value derived from standard option valuation models representing
an implicit forecast of the standard deviation of the returns on the underlying
asset over the life of the option or future. The fair values of S&P 500 Index
linked securities, derivatives, and annuities are produced using standard
derivative valuation techniques. The derivatives portfolio is constructed to
maintain acceptable interest margins under a variety of possible future S&P 500
Index levels and option and futures cost environments. In order to achieve this
objective and limit its exposure to equity price risk, the Company measures and
manages these exposures using methods based on the fair value of assets and the
price appreciation component of related liabilities. The Company uses
derivatives, including futures, options and total return swaps to modify its net
exposure to fluctuations in the S&P 500 Index.
Based upon the information and assumptions the Company uses in its
stress-test scenarios at December 31, 1999, management estimates that if the S&P
500 Index decreases by 10%, the net fair value of its assets and liabilities
described above would decrease by approximately $0.2 million. Based upon the
information and assumptions the Company used in its stress-test scenarios at
December 31, 1998, management estimated that if the S&P 500 Index increased by
10%, the net fair value of its assets and liabilities described above would have
decreased by approximately $2.0 million. If option implied volatilities were to
increase by 100 basis points, management estimates that the net fair value of
its assets and liabilities would have decreased by approximately $5.2 million
and $6.0 million as of December 31, 1999 and 1998, respectively.
The simulations do not consider the effects of other changes in market
conditions that could accompany changes in the equity option and futures markets
including the effects of changes in implied dividend yields, interest rates, and
equity-indexed annuity policy surrenders.
Derivatives
As a component of its investment strategy and to reduce its exposure to interest
rate risk, the Company utilizes interest rate and total return swap agreements
and interest rate cap agreements to match assets more closely to liabilities.
Interest rate swap agreements are agreements to exchange with a counterparty
interest rate payments of differing character (e.g., fixed-rate payments
exchanged for variable-rate payments) based on an underlying principal balance
(notional principal) to hedge against interest rate changes. The Company
currently utilizes interest rate swap agreements to reduce asset duration and to
better match interest earned on longer-term fixed-rate assets with interest
credited to policyholders. A total return swap agreement is an agreement to
exchange payments based upon an underlying notional balance and changes in
variable rate and total return indices. The Company utilizes total return swap
agreements to hedge its obligations related to certain separate account
liabilities. The Company had 67 and 42 outstanding swap agreements with an
aggregate notional principal amount of $3.4 billion and $2.4 billion as of
December 31, 1999 and 1998, respectively.
Interest rate cap agreements are agreements with a counterparty which
require the payment of a premium for the right to receive payments for the
difference between the cap interest rate and a market interest rate on specified
future dates based on an underlying principal balance (notional principal) to
hedge against rising interest rates. The Company had interest rate cap
agreements with an aggregate notional amount of $50.0 million and $250.0 million
as of December 31, 1999 and 1998, respectively.
With respect to the Company's equity-indexed annuities and certain separate
account liabilities, the Company buys call options, futures and certain total
return swap agreements on the S&P 500 Index to hedge its obligations to provide
35
returns based upon this index. The Company had call options with a carrying
value of $701.1 million and $535.7 million as of December 31, 1999 and 1998,
respectively. The Company had futures with a carrying value of $(0.6) million as
of December 31, 1998. The Company had total return swap agreements with a
carrying value of $37.8 million as of December 31, 1999.
There are risks associated with some of the techniques the Company uses to
match its assets and liabilities. The primary risk associated with swap, cap and
call option agreements is counterparty non-performance. The Company believes
that the counterparties to its swap, cap and call option agreements are
financially responsible and that the counterparty risk associated with these
transactions is minimal. Futures contracts trade on organized exchanges and
therefore have minimal credit risk. In addition, swap and cap agreements have
interest rate risk and call options, futures and certain total return swap
agreements have stock market risk. These swap and cap agreements hedge
fixed-rate assets and the Company expects that any interest rate movements that
adversely affect the market value of swap and cap agreements would be offset by
changes in the market values of such fixed rate assets. However, there can be no
assurance that these hedges will be effective in offsetting the potential
adverse effects of changes in interest rates. Similarly, the call options,
futures and certain total return swap agreements hedge the Company's obligations
to provide returns on equity-indexed annuities and certain separate account
liabilities based upon the S&P 500 Index, and the Company believes that any
stock market movements that adversely affect the market value of S&P 500 Index
call options, futures and certain total return swap agreements would be
substantially offset by a reduction in policyholder and certain separate account
liabilities. However, there can be no assurance that these hedges will be
effective in offsetting the potentially adverse effects of changes in S&P 500
Index levels. The Company's profitability could be adversely affected if the
value of its swap and cap agreements increase less than (or decrease more than)
the change in the market value of its fixed rate assets and/or if the value of
its S&P 500 Index call options, futures and certain total return swap agreements
increase less than (or decrease more than) the value of the guarantees made to
equity-indexed and certain separate account policyholders.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities." This statement standardizes the
accounting for derivative instruments and the derivative portion of certain
other contracts that have similar characteristics by requiring that an entity
recognize those instruments on the balance sheet at fair value. This statement
also requires a new method of accounting for hedging transactions, prescribes
the type of items and transactions that may be hedged, and specifies detailed
criteria to be met to qualify for hedge accounting. In June 1999, the FASB
issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133." SFAS No.
137 defers the effective date of SFAS No. 133 until fiscal years beginning after
June 15, 2000. Upon adoption, the Company will be required to record a
cumulative effect adjustment to reflect this accounting change. At this time,
the Company has not completed its analysis and evaluation of the requirements
and impact of this statement.
Liquidity
The Company is a holding company whose liquidity needs include the following:
(i) operating expenses; (ii) debt service; (iii) dividends on preferred stock
and common stock; (iv) acquisitions; and (v) working capital where needed by its
operating subsidiaries. The Company's principal sources of cash are dividends
from its operating subsidiaries, and, in the case of funding for acquisitions
and certain long-term capital needs of its subsidiaries, long-term borrowings
and offerings of preferred and common stock. In connection with the Crabbe Huson
acquisition, the Company entered into a $100.0 million revolving credit facility
with a commercial bank (the "Bridge Facility"). The Bridge Facility matured on
March
36 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
30, 1999 and bore interest at a per annum rate equal to LIBOR plus
twenty-five basis points. The Company borrowed $90.0 million under the Bridge
Facility to finance the acquisition of Crabbe Huson. In November 1998, the
Company issued $450.0 million of senior debt securities. The offering
consisted of $300.0 million of 6 3/4% 10-year notes due November 15, 2008 and
$150.0 million of 7 5/8% 30-year debentures due November 15, 2028. The
proceeds were utilized to repay the $90.0 million borrowed under the Bridge
Facility, to repay notes payable to affiliates of $229.0 million and for
general corporate purposes.
The Company also has a $150.0 million revolving credit facility (the
"Facility") which is utilized to finance sales commissions paid in connection
with the distribution of mutual fund shares sold with 12b-1 distribution fees
and contingent deferred sales charges. The Facility was established in April
1999 and replaced a $60.0 million revolving credit facility which was used for
the same purpose. This five year Facility is secured by such 12b-1 distribution
fees and contingent deferred sales charges. Interest accrues on the outstanding
borrowings under the Facility at a rate determined by sales of highly rated
commercial paper backed in part by the security interest in such fees and
charges. At December 31, 1999, the interest paid on borrowings under the
Facility was at the rate of 6.13% per annum.
Current Rhode Island insurance law applicable to Keyport permits the
payment of dividends or distributions, which, together with dividends and
distributions paid during the preceding 12 months, do not exceed the lesser of
(i) 10% of Keyport's statutory surplus as of the preceding December 31 or (ii)
Keyport's statutory net gain from operations for the preceding fiscal year. Any
proposed dividend in excess of this amount is called an "extraordinary dividend"
and may not be paid until it is approved by the Commissioner of Insurance of the
State of Rhode Island. As of December 31, 1999, the amount of dividends that
Keyport could pay without such approval was $57.8 million. Keyport paid
dividends totaling $30.0 million during 1999. Future regulatory changes and
credit agreements may create additional limitations on the ability of the
Company's subsidiaries to pay dividends.
Based upon the historical cash flow of the Company, the Company's current
financial condition and the Company's expectation that there will not be a
material adverse change in the results of operations of the Company and its
subsidiaries during the next twelve months, the Company believes that cash flow
provided by operating activities over this period will provide sufficient
liquidity for the Company to meet its working capital, capital investment and
other operational cash needs, its debt service obligations, its obligations to
pay dividends on the preferred stock and its intentions to pay dividends on the
common stock. The Company may require external sources of liquidity in order to
finance material acquisitions where the purchase price is not paid in equity.
Each of the Company's business segments has its own liquidity needs and
financial resources. In the Company's annuity insurance operations, liquidity
needs and financial resources pertain to the management of the general account
assets and policyholder balances. In the Company's asset management business,
liquidity needs and financial resources pertain to the investment management and
distribution of mutual funds, private capital management and institutional
accounts. The Company expects that, based upon their historical cash flow and
current prospects, these operating subsidiaries will be able to meet their
liquidity needs from internal sources and, in the case of LFG, from its credit
facility used to finance sales of mutual fund shares sold with 12b-1
distribution fees and contingent deferred sales charges.
Keyport uses cash for the payment of annuity and life insurance benefits,
operating expenses and policy acquisition costs, and the purchase of
investments. Keyport generates cash from annuity premiums and deposits, net
investment income, and from the sales and maturities of fixed investments.
Annuity premiums, maturing investments and net investment income have
historically been sufficient to meet Keyport's cash requirements. Keyport
monitors cash and cash
37
equivalents in an effort to maintain sufficient liquidity and has strategies in
place to maintain sufficient liquidity in changing interest rate environments.
Consistent with the nature of its obligations, Keyport has invested a
substantial amount of its general account assets in readily marketable
securities. As of December 31, 1999, $10.3 billion, or 75.6%, of Keyport's
general account investments are considered readily marketable.
To the extent that unanticipated surrenders cause Keyport to sell for
liquidity purposes a material amount of securities prior to their maturity, such
surrenders could have a material adverse effect on the Company. Although no
assurances can be given, Keyport believes that liquidity to fund anticipated
withdrawals would be available through incoming cash flow and the sale of
short-term or floating-rate instruments, thereby precluding the sale of fixed
maturity investments in a potentially unfavorable market. In addition, the
Company's fixed-rate products incorporate surrender charges to encourage
persistency and to make the cost of its policyholder balances more predictable.
Approximately 76.0% of the Company's fixed annuity policyholder balances were
subject to surrender charges or restrictions as of December 31, 1999.
Year 2000
The Year 2000 issue relates to computer programs that use two digits to identify
a year in the date field and therefore may not be able to correctly process
dates after December 31, 1999. As the Company relies significantly on computer
systems and applications in its operations, it completed a remediation plan that
included repairing or replacing programs that were identified as not being Year
2000 compliant. As a result, the Company did not experience any significant Year
2000 problems with respect to computer systems, application programs, and
non-information technology systems. In addition, the Company did not experience
any significant disruptions related to interactions with third parties. The
Company is continuing to closely monitor critical systems and applications to
ensure that no unexpected Year 2000 issues develop. There can be no assurance
that there will be no such issues.
During 1999, the external cost of the Year 2000 project was approximately
$1.9 million, which was primarily related to consultants and replacement
hardware and software. Such external costs for 1998 were approximately $2.5
million. The Company has not segregated payroll or other internal costs
specifically devoted to its efforts to address Year 2000 issues. The costs of
the Year 2000 project have been funded through operating cash flows and have
been expensed as incurred. In the opinion of management, any additional costs of
addressing the Year 2000 issue are not expected to have a material adverse
effect on the Company's financial condition or its results of operations.
Effects of Inflation
Inflation has not had a material effect on the Company's consolidated results of
operations to date. The Company manages its investment portfolio in part to
reduce its exposure to interest rate fluctuations. In general, the market value
of the Company's fixed maturity portfolio increases or decreases in inverse
relationship with fluctuations in interest rates, and the Company's net
investment income increases or decreases in direct relationship with interest
rate changes. For example, if interest rates decline, the Company's fixed
maturity investments generally will increase in market value, while net
investment income will decrease as fixed maturity investments mature or are sold
and the proceeds are reinvested at reduced rates. Inflation may result in
increased operating expenses that may not be readily recoverable in the prices
of the services charged by the Company.
Forward-Looking Statements
The Company desires to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Investors
are cautioned that all statements, trend analyses and other information
contained
38 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
in this report or in any of the Company's filings under Section 13 or 15 (d) of
the Securities Exchange Act of 1934 (the "Exchange Act"), relative to the
markets for the Company's products and trends in the Company's operations or
financial results, as well as other statements including words such as
"anticipate", "believe", "plan", "estimate", "expect", "intend" and other
similar expressions, constitute forward-looking statements under the Reform Act.
These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors, many of which are beyond the Company's control,
that may cause actual results to be materially different from those contemplated
by the forward-looking statements. Such factors include, among other things: (1)
general economic conditions and market factors, such as prevailing interest rate
levels, stock market performance and fluctuations in the market for
retirement-oriented savings products and investment management products, which
may adversely affect the ability of the Company to sell its products and
services and the market value of the Company's investments and assets under
management and, therefore, the portion of its revenues that are based on a
percentage of assets under management; (2) the Company's ability to manage
effectively its investment spread (i.e. the amount by which investment income
exceeds interest credited to annuity and life insurance policyholders) as a
result of changes in interest rates and crediting rates to policyholders, market
conditions and other factors (the Company's results of operations and financial
condition are significantly dependent on the Company's ability to manage
effectively its investment spread); (3) levels of surrenders, withdrawals and
net redemptions of the Company's retirement-oriented insurance products and
investment management products; (4) relationships with investment management
clients, including levels of assets under management; (5) the ability of the
Company to manage effectively certain risks with respect to its investment
portfolio, including risks relating to holding below investment grade securities
and the ability to dispose of illiquid and/or restricted securities at desired
times and prices, and the ability to manage and hedge against interest rate
changes through asset/liability management techniques; (6) competition in the
sale of the Company's products and services, including the Company's ability to
establish and maintain relationships with distributors of its products; (7)
changes in financial ratings of Keyport or those of its competitors; (8) the
Company's ability to attract and retain key employees, including senior
officers, portfolio managers and sales executives; (9) the impact of and
compliance by the Company with existing and future regulation, including
restrictions on the ability of certain subsidiaries to pay dividends and any
obligations of the Company under any guaranty fund assessment laws; (10) changes
in applicable tax laws which may affect the relative tax advantages and
attractiveness of some of the Company's products; (11) the result of any
litigation or legal proceedings involving the Company; (12) changes in generally
accepted accounting principles and the impact of accounting principles and
pronouncements on the Company's financial condition and results of operations;
(13) changes in the Company's senior debt ratings; and (14) the other risk
factors or uncertainties contained from time to time in any document
incorporated by reference in this report or otherwise filed by the Company under
the Exchange Act. Given these uncertainties, prospective investors are cautioned
not to place undue reliance on such forward-looking statements and no assurances
can be given that the estimates and expectations reflected in such statements
will be achieved.
39
- --------------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Consolidated Balance Sheets
($ in millions)
December 31 1999 1998
- ---------------------------------------------------------------------------------------------------
Assets
Assets:
Investments $12,195.1 $12,598.3
Cash and cash equivalents 1,232.6 984.1
Accrued investment income 162.0 161.0
Deferred policy acquisition costs 739.2 407.6
Deferred distribution costs 153.7 130.2
Intangible assets 282.0 292.8
Other assets 244.8 179.6
Separate account assets 3,363.1 1,765.5
- ---------------------------------------------------------------------------------------------------
$18,372.5 $16,519.1
===================================================================================================
Liabilities and Stockholders' Equity
Liabilities:
Policyholder balances $12,109.6 $12,504.1
Notes payable 552.0 486.4
Payable for investments purchased and loaned 754.9 240.4
Other liabilities 453.1 278.4
Separate account liabilities 3,301.0 1,723.2
- ---------------------------------------------------------------------------------------------------
Total liabilities 17,170.6 15,232.5
- ---------------------------------------------------------------------------------------------------
Series A redeemable convertible preferred stock, par value $.01;
authorized, issued and outstanding 324,759 shares in 1999 and 1998 16.0 15.3
- ---------------------------------------------------------------------------------------------------
Stockholders' Equity:
Common stock, $.01 par value, authorized 100,000,000
shares; issued and outstanding 47,462,995 shares
in 1999 and 46,384,015 shares in 1998 0.5 0.5
Additional paid-in capital 923.0 901.5
Retained earnings 425.2 346.4
Accumulated other comprehensive income (loss) (158.1) 27.2
Unearned compensation (4.7) (4.3)
- ---------------------------------------------------------------------------------------------------
Total stockholders' equity 1,185.9 1,271.3
- ---------------------------------------------------------------------------------------------------
$18,372.5 $16,519.1
===================================================================================================
See accompanying notes to consolidated financial statements.
40 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
Consolidated Income Statements
(in millions, except per share data)
Year Ended December 31 1999 1998 1997
- ---------------------------------------------------------------------------------
Investment income $ 810.3 $ 820.9 $ 853.1
Interest credited to policyholders (526.6) (562.2) (594.1)
- ---------------------------------------------------------------------------------
Investment spread 283.7 258.7 259.0
- ---------------------------------------------------------------------------------
Net realized investment gains (losses) (42.2) 2.4 25.9
- ---------------------------------------------------------------------------------
Fee income:
Investment advisory and administrative fees 268.5 237.7 217.9
Distribution and service fees 60.4 52.7 49.2
Transfer agency fees 51.7 49.0 47.7
Surrender charges and net commissions 36.5 33.7 36.1
Separate account fees 33.5 20.6 17.1
- ---------------------------------------------------------------------------------
Total fee income 450.6 393.7 368.0
- ---------------------------------------------------------------------------------
Expenses:
Operating expenses (360.4) (328.2) (309.7)
Amortization of deferred policy acquisition costs (97.4) (77.4) (86.4)
Amortization of deferred distribution costs (40.3) (40.1) (34.2)
Amortization of intangible assets (20.3) (15.3) (13.5)
Interest expense, net (19.3) (14.9) (17.0)
- ---------------------------------------------------------------------------------
Total expenses (537.7) (475.9) (460.8)
- ---------------------------------------------------------------------------------
Pretax income 154.4 178.9 192.1
Income tax expense (55.1) (54.4) (62.6)
- ---------------------------------------------------------------------------------
Income before extraordinary item 99.3 124.5 129.5
Extraordinary loss on extinguishment of debt -- (9.7) --
- ---------------------------------------------------------------------------------
Net income $ 99.3 $ 114.8 $ 129.5
=================================================================================
Net income per share - basic:
Income before extraordinary item $ 2.11 $ 2.72 $ 2.94
=================================================================================
Net income $ 2.11 $ 2.51 $ 2.94
=================================================================================
Net income per share - assuming dilution:
Income before extraordinary item $ 2.07 $ 2.63 $ 2.77
=================================================================================
Net income $ 2.07 $ 2.42 $ 2.77
=================================================================================
See accompanying notes to consolidated financial statements.
41
Consolidated Statements of Stockholders' Equity
(in millions)
Accumulated
Additional Other Total
Common Paid-In Retained Comprehensive Unearned Stockholders'
Stock Capital Earnings Income (Loss) Compensation Equity
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $ 0.3 $ 835.3 $ 141.4 $ 74.4 $ -- $ 1,051.4
---------
Comprehensive income:
Net income 129.5 129.5
Other comprehensive income, net
of taxes:
Net unrealized gains on securities 8.6 8.6
---------
Total comprehensive income 138.1
---------
3 for 2 common stock split effected in the
form of a 50 percent stock dividend 0.1 (0.1) --
Common stock issued for acquisition 2.5 2.5
Effect of stock-based compensation plans 14.8 (2.2) 12.6
Accretion to face value of preferred stock (0.8) (0.8)
Common stock dividends 13.6 (17.6) (4.0)
Preferred stock dividends (0.9) (0.9)
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 0.4 866.2 251.5 83.0 (2.2) 1,198.9
---------
Comprehensive income:
Net income 114.8 114.8
Other comprehensive income, net of taxes:
Net unrealized losses on securities (55.8) (55.8)
---------
Total comprehensive income 59.0
---------
Common stock issued for acquisition 8.9 8.9
Effect of stock-based compensation plans 0.1 13.2 (2.1) 11.2
Accretion to face value of preferred stock (0.8) (0.8)
Common stock dividends 13.2 (18.2) (5.0)
Preferred stock dividends (0.9) (0.9)
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 0.5 901.5 346.4 27.2 (4.3) 1271.3
Comprehensive loss:
Net income 99.3 99.3
Other comprehensive loss, net of taxes:
Net unrealized losses on securities (185.3) (185.3)
---------
Total comprehensive loss (86.0)
---------
Effect of stock-based compensation plans 8.1 (0.4) 7.7
Accretion to face value of preferred stock (0.8) (0.8)
Common stock dividends 13.4 (18.8) (5.4)
Preferred stock dividends (0.9) (0.9)
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 $ 0.5 $ 923.0 $ 425.2 $ (158.1) $ (4.7) $1,185.9
===============================================================================================================================
See accompanying notes to consolidated financial statements.
42 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
Consolidated Statements of Cash Flows
(in millions)
Year Ended December 31 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 99.3 $ 114.8 $ 129.5
Adjustments to reconcile net income to net cash provided by operating activities:
Extraordinary loss on extinguishment of debt, net of tax -- 9.7 --
Depreciation and amortization 77.4 81.6 74.4
Interest credited to policyholders 526.6 562.2 594.1
Net realized investment (gains) losses 42.2 (2.4) (25.9)
Net amortization on investments 79.5 75.4 29.9
Change in deferred policy acquisition costs (17.4) (24.2) 1.4
Change in current and deferred income taxes 62.9 (3.8) 71.9
Net change in other assets and liabilities (114.9) (124.6) (19.9)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 755.6 688.7 855.4
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Investments purchased available for sale (4,993.3) (6,789.0) (4,548.4)
Investments sold available for sale 4,322.7 5,406.0 2,563.5
Investments matured available for sale 823.2 1,273.5 1,531.6
Increase in policy loans, net (20.7) (24.1) (21.9)
Decrease in mortgage loans, net 43.0 5.5 6.4
Acquisitions, net of cash acquired -- (98.7) --
Other (37.3) (9.7) (73.9)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 137.6 (236.5) (542.7)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Withdrawals from policyholder accounts (2,108.9) (1,690.0) (1,320.8)
Deposits to policyholder accounts 894.4 1,225.0 950.5
Securities lending 505.0 (510.6) 495.2
Repayment of notes payable to affiliates -- (244.0) --
Change in notes payable 65.6 459.9 (26.0)
Exercise of stock options 5.5 7.4 7.6
Dividends paid (6.3) (5.9) (4.9)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (644.7) (758.2) 101.6
- -----------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 248.5 (306.0) 414.3
Cash and cash equivalents at beginning of year 984.1 1,290.1 875.8
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $1,232.6 $ 984.1 $1,290.1
===================================================================================================================================
Noncash Financing Activities: Noncash financing activities relate to dividends
paid in common stock, primarily to an affiliate of Liberty Mutual, in the amount
of $13.4 million, $13.2 million and $13.6 million in 1999, 1998 and 1997,
respectively, pursuant to the Company's dividend reinvestment plan.
See accompanying notes to consolidated financial statements.
43
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. Accounting Policies
Organization
Liberty Financial Companies, Inc. (the "Company") is an asset accumulation and
management company providing investment management products and
retirement-oriented insurance products through multiple distribution channels.
The Company is a majority owned indirect subsidiary of Liberty Mutual
Insurance Company ("Liberty Mutual").
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries, including Colonial Management Associates, Inc. ("Colonial"),
Independent Holdings, Inc. ("Independent"), Keyport Life Insurance Company
("Keyport"), Liberty Asset Management Company ("LAMCO"), Liberty Funds Group LLC
("LFG"), Newport Pacific Management, Inc. ("Newport"), Stein Roe & Farnham
Incorporated ("Stein Roe"), and, from the date of acquisition: Crabbe Huson
Group, Inc. ("Crabbe Huson") and Progress Investment Management Company
("Progress"). All significant intercompany balances and transactions have been
eliminated. Certain prior year amounts have been reclassified to conform to the
current year's presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Investments
Investments in debt and equity securities classified as available for sale are
carried at fair value, and unrealized gains and losses (net of adjustments to
deferred policy acquisition costs and income taxes) are reported as a separate
component of stockholders' equity. The cost basis of securities is adjusted for
declines in value that are determined to be other than temporary. Realized
investment gains and losses are calculated on a first-in, first-out basis, net
of adjustment for amortization of deferred policy acquisition costs.
For the mortgage-backed bond portion of the fixed maturity investment
portfolio, the Company recognizes income using a constant effective yield based
on anticipated prepayments over the estimated economic life of the security.
When actual prepayments differ significantly from anticipated prepayments, the
effective yield is recalculated to reflect actual payments to date and
anticipated future payments; and any resulting adjustment is included in
investment income.
Mortgage loans are carried at amortized cost. Policy loans are carried at
the unpaid principal balances plus accrued interest. Partnerships are generally
accounted for by using the equity method of accounting. Partnership investments
totaled $180.7 million and $126.8 million at December 31, 1999 and 1998,
respectively.
Derivatives
The Company uses interest rate swap and cap agreements to manage its interest
rate risk and call options and futures on the Standard & Poor's 500 Composite
Stock Price Index ("S&P 500 Index") to hedge its obligations to provide returns
based upon this index.
The Company utilizes interest rate swap agreements ("swap agreements") and
interest rate cap agreements ("cap agreements") to match assets more closely to
liabilities. Swap agreements are agreements to exchange with a counterparty
interest rate payments of differing character (e.g., fixed-rate payments
exchanged for variable-rate payments) based on an
44 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
underlying principal balance (notional principal) to hedge against interest rate
changes. The Company currently utilizes swap agreements to reduce asset duration
and to better match interest rates earned on longer-term fixed rate assets with
interest rates credited to policyholders. The Company also utilizes total return
swap agreements to hedge its obligations related to certain separate account
liabilities. A total return swap agreement is an agreement to exchange payments
based upon an underlying notional balance and changes in variable rate and total
return indices.
Cap agreements are agreements with a counterparty which require the payment
of a premium for the right to receive payments for the difference between the
cap interest rate and a market interest rate on specified future dates based on
an underlying principal balance (notional principal) to hedge against rising
interest rates.
Hedge accounting is applied after the Company determines that the items to
be hedged expose it to interest rate or price risk, designates the instruments
as hedges and assesses whether the instruments reduce the indicated risks
through the measurement of changes in the value of the instruments and the items
being hedged at both inception and throughout the hedge period. From time to
time, interest rate swap agreements, cap agreements, call options and futures
are terminated. If the terminated position was accounted for as a hedge,
realized gains or losses are deferred and amortized over the remaining lives of
the hedged assets or liabilities. Conversely, if the terminated position was not
accounted for as a hedge, or the assets and liabilities that were hedged no
longer exist, the position is "marked to market" and realized gains or losses
are immediately recognized in income.
The net differential to be paid or received on interest rate swap
agreements is recognized as a component of net investment income. The net
differential to be paid or received on total return swap agreements is
recognized as a component of separate account fees. Premiums paid for interest
rate cap agreements are deferred and amortized to net investment income on a
straight-line basis over the terms of the agreements. The unamortized premium is
included in other invested assets. Amounts earned on interest rate cap
agreements are recorded as an adjustment to net investment income. Interest rate
swap agreements and cap agreements hedging investments designated as available
for sale are adjusted to fair value with the resulting unrealized gains and
losses included in stockholders' equity. Total return swap agreements hedging
certain separate account liabilities are adjusted to fair value with the
resulting unrealized gains and losses included in stockholders' equity.
Premiums paid on call options are amortized to net investment income over
the terms of the contracts. The call options are included in other invested
assets and are carried at amortized cost plus intrinsic value, if any, of the
call options as of the valuation date. Changes in intrinsic value of the call
options are recorded as an adjustment to interest credited to policyholders.
Futures are carried at fair value and require daily cash settlement. Changes in
the fair value of futures that qualify as hedges are deferred and recognized as
an adjustment to the hedged asset or liability. Call options and futures that do
not qualify as hedges are carried at fair value; changes in value are
immediately recognized in income.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities." This statement standardizes the
accounting for derivative instruments and the derivative portion of certain
other contracts that have similar characteristics by requiring that an entity
recognize those instruments on the balance sheet at fair value. This statement
also requires a new method of accounting for hedging transactions, prescribes
the type of items and transactions that may be hedged, and specifies detailed
criteria to be met to qualify for hedge accounting. In June 1999, the FASB
issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133." SFAS No.
137 defers the effective date of SFAS No. 133 until fiscal years beginning after
June 15, 2000. Upon adoption, the Company will be required to record a
cumulative effect adjustment to reflect this
45
accounting change. At this time, the Company has not completed its analysis and
evaluation of the requirements and impact of this statement.
Fee Income
Fees from asset management and investment advisory services and from transfer
agent, bookkeeping, 12b-1 distribution and service fees are recognized as
revenues when services are provided. Revenues from fixed and variable annuities
and single premium whole life policies include mortality charges, surrender
charges, policy fees and contract fees and are recognized when earned under the
respective contracts. Net commission revenue is recognized on the trade date.
Deferred Policy Acquisition Costs
Policy acquisition costs are the costs of acquiring new business which vary
with, and are primarily related to, the production of new annuity business. Such
costs include commissions, costs of policy issuance and underwriting and selling
expenses. These costs are deferred and amortized in relation to the present
value of estimated gross profits from mortality, investment spread and expense
margins. Deferred policy acquisition costs are adjusted for amounts relating to
unrealized gains and losses on fixed maturity securities the Company has
designated as available for sale. This adjustment, net of tax, is included with
the change in net unrealized investment gains or losses that is credited or
charged directly to stockholders' equity. Deferred policy acquisition costs were
increased by $235.7 million at December 31, 1999 and decreased by $66.3 million
at December 31, 1998, relating to this adjustment.
Deferred Distribution Costs
Sales commissions and other direct distribution costs related to the sale of
Company-sponsored intermediary-distributed mutual funds which charge 12b-1
distribution fees and contingent deferred sales commissions are recorded as
deferred distribution costs. Amortization is provided on a straight-line basis
over periods up to six years to match the estimated period in which the
associated fees will be earned. Contingent deferred sales charges (back-end
loads) received are applied to deferred distribution costs to the extent of the
estimated unamortized portion of such costs, with the remainder recognized as
additional distribution fee income.
Intangible Assets
Intangible assets consist of goodwill and certain identifiable intangible assets
arising from business combinations accounted for as a purchase. Amortization is
provided on a straight-line basis over estimated lives of the acquired
intangibles which range from 5 to 30 years. The Company evaluates the carrying
value of goodwill and other intangible assets when events or changes in
circumstances indicate that the carrying amount of the assets might not be
recoverable. Any impairments would be recognized when the expected future cash
flows derived from such goodwill and other intangible assets are less than their
carrying value.
Separate Account Assets and Liabilities
The assets and liabilities resulting from variable annuities, variable life
policies and certain separate institutional accounts are segregated in separate
accounts. Separate account assets consist principally of investments in mutual
funds and fixed maturities and are carried at fair value. Investment income and
changes in mutual fund asset values are allocated to the policyholders, and
therefore, do not affect the operating results of the Company. The Company earns
separate account fees for providing administrative services and bearing the
mortality risk related to these contracts. The difference between investment
income and interest credited on the institutional accounts is reported as
separate account fee income. Keyport
46 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
also classified as separate account assets investments in Company-sponsored
mutual funds and other investments of $62.2 million and $42.3 million at
December 31, 1999 and 1998, respectively.
Policyholder Balances
Policyholder balances consist of deposits received plus interest credited, less
accumulated policyholder charges, assessments, and withdrawals related to
deferred annuities and single premium whole life policies. Policy benefits that
are charged to expense include benefit claims incurred in the period in excess
of related policy account balances.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options. Under APB 25,
because the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.
Income Taxes
Effective July 18, 1997, the Company and its non-life insurance subsidiaries
file a consolidated federal income tax return and the Company's life insurance
subsidiaries file separate life company returns. Prior to July 18, 1997, the
Company was included in the consolidated federal income tax return filed by
Liberty Mutual. Income taxes have been provided using the liability method in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes," and, for periods prior to July 18, 1997, were calculated as
if the Company filed its own consolidated income tax return.
Earnings Per Share
Basic earnings per share is calculated using income available to common
shareholders divided by the weighted average of common shares outstanding during
the year. Diluted earnings per share is similar to basic earnings per share
except that the weighted average of common shares outstanding is increased to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued.
Cash Equivalents
Short-term investments having an original maturity of three months or less are
classified as cash equivalents.
2. ACQUISITIONS
On August 31, 1998, the Company acquired certain assets and assumed certain
liabilities of Progress Investment Management Company, a registered investment
adviser to institutional accounts with approximately $2.1 billion in assets
under management as of that date. On September 30, 1998, the Company acquired
certain assets and assumed certain liabilities of The Crabbe Huson Group, Inc.,
a registered investment adviser with approximately $3.3 billion in assets under
management as of that date. The combined purchase price for these transactions
totaled approximately $104.0 million, $95.1 million in cash and $8.9 million in
the Company's common stock. In addition, the Company has agreed to pay
additional cash and common stock over four years, contingent upon the attainment
of certain earnings objectives. In 1999, the Company paid $4.0 million of such
contingent payments. An additional $67.5 million can be paid as contingent
payments if earnings objectives are attained. These transactions were accounted
for as purchases and resulted in the recording of goodwill and other intangible
assets of approximately $105.6 million.
47
3. INVESTMENTS
Investments, which largely pertain to the Company's annuity insurance
operations, were comprised of the following (in millions):
December 31 1999 1998
- --------------------------------------------------------------------------------
Fixed maturities $10,516.1 $11,277.2
Equity securities 37.9 24.6
Policy loans 599.5 578.9
Other invested assets 1,041.6 717.6
- --------------------------------------------------------------------------------
$12,195.1 $12,598.3
================================================================================
As of December 31, 1999, the Company did not have a material concentration
of financial instruments in a single investee, industry or geographic location
and no investment in any person or its affiliates (other than bonds issued by
agencies of the United States government) exceeded ten percent of stockholders'
equity.
As of December 31, 1999, $1.2 billion of fixed maturities were below
investment grade. These securities represented 8.9% of general account
investments, including cash and cash equivalents in the Company's annuity
operations, and certain separate account assets.
Fixed Maturities
The amortized cost, gross unrealized gains and losses and fair value of fixed
maturity securities are as follows (in millions):
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 1999 Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------
U.S. Treasury securities $ 70.0 $ 4.2 $ (5.0) $ 69.2
Mortgage backed securities of U.S. government
corporations and agencies 1,166.5 15.6 (29.5) 1,152.6
Debt securities issued by foreign governments 169.4 17.8 (9.0) 178.2
Corporate securities 5,274.4 96.9 (283.3) 5,088.0
Other mortgage backed securities 2,325.7 21.8 (94.8) 2,252.7
Asset backed securities 1,794.8 5.9 (67.9) 1,732.8
Senior secured loans 45.6 -- (3.0) 42.6
- -----------------------------------------------------------------------------------------------
Total fixed maturities $10,846.4 $162.2 $(492.5) $10,516.1
===============================================================================================
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 1998 Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------
U.S. Treasury securities $ 90.8 $ 3.1 $ (0.2) $ 93.7
Mortgage backed securities of U.S. government
corporations and agencies 940.1 28.4 (2.9) 965.6
Debt securities issued by foreign governments 251.1 9.4 (16.2) 244.3
Corporate securities 5,396.3 185.1 (156.3) 5,425.1
Other mortgage backed securities 2,286.6 65.1 (19.5) 2,332.2
Asset backed securities 1,942.0 25.9 (16.5) 1,951.4
Senior secured loans 267.8 1.2 (4.1) 264.9
- -----------------------------------------------------------------------------------------------
Total fixed maturities $11,174.7 $318.2 $(215.7) $11,277.2
===============================================================================================
48 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
At December 31, 1999 and 1998, gross unrealized gains on equity securities,
interest rate cap agreements, investments in separate accounts and other
invested assets aggregated $32.4 million and $7.8 million, and gross unrealized
losses aggregated $11.1 million and $3.6 million, respectively.
Deferred tax liabilities for the Company's unrealized investment gains and
losses included in stockholders' equity, net of adjustments to deferred policy
acquisition costs, were $84.8 million and $14.1 million at December 31, 1999 and
1998, respectively.
The change in net unrealized gains (losses) on securities included in other
comprehensive income in 1999, 1998 and 1997 include: gross unrealized gains
(losses) on securities of $(470.2) million, $(182.1) million and $73.7 million,
respectively; reclassification adjustments for realized (gains) losses in net
income of $53.5 million, $3.6 million and $(31.3) million, respectively; and
adjustments to deferred policy acquisition costs of $302.2 million, $92.5
million and $(29.1) million, respectively. The above amounts are shown before
income tax expense (benefit) of $70.7 million, $(30.2) million and $4.7 million,
respectively. The 1999 income tax expense of $70.7 million includes a valuation
allowance of $109.9 million related to the Company's unrealized capital losses
on available for sale securities.
Contractual Maturities
The amortized cost and estimated fair value of fixed maturities by contractual
maturity as of December 31, 1999 are as follows (in millions):
Amortized Fair
December 31, 1999 Cost Value
- --------------------------------------------------------------------------------
Due in one year or less $ 164.9 $ 162.6
Due after one year through five years 1,836.7 1,823.2
Due after five years through ten years 2,164.2 2,094.6
Due after ten years 1,393.6 1,297.6
- --------------------------------------------------------------------------------
5,559.4 5,378.0
Mortgage and asset backed securities 5,287.0 5,138.1
- --------------------------------------------------------------------------------
$10,846.4 $10,516.1
================================================================================
Actual maturities may differ from those shown above because borrowers may have
the right to call or prepay obligations.
Net Investment Income
Net investment income is summarized as follows (in millions):
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------------
Fixed maturities $ 814.7 $ 810.5 $ 811.7
Equity securities 1.5 4.4 5.4
Policy loans 36.3 33.2 32.2
Other invested assets 28.4 18.2 27.8
Cash and cash equivalents 20.8 38.3 34.5
- -------------------------------------------------------------------------------
Gross investment income 901.7 904.6 911.6
Investment expenses (14.2) (11.6) (9.2)
Amortization of call options and interest rate caps (77.2) (72.1) (49.3)
- -------------------------------------------------------------------------------
Net investment income $ 810.3 $ 820.9 $ 853.1
===============================================================================
49
As of December 31, 1999 and 1998, the carrying value of fixed maturity
investments that were non-income producing was $22.6 million and $30.0 million,
respectively.
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) primarily relate to the Company's fixed
maturity investments. Gross realized gains were $48.1 million, $88.5 million and
$51.6 million for 1999, 1998 and 1997, respectively. Gross realized losses were
$102.3 million, $90.4 million and $19.2 million for 1999, 1998 and 1997,
respectively. Gross realized losses in 1999 and gross realized gains in 1998
included $18.3 million and $28.3 million, respectively, for certain fixed
maturity investments where the decline in value was determined to be other than
temporary. Net realized investment gains (losses) are net of adjustments to the
amortization of deferred policy acquisition costs.
4. DERIVATIVES
Outstanding derivatives are as follows (in millions):
Assets (Liabilities)
--------------------------------------
1999 1998
--------------------------------------
Notional Amounts
------------------ Carrying Fair Carrying Fair
December 31 1999 1998 Value Value Value Value
- ------------------------------------------------------------------------------------------------
Interest rate swap agreements $2,917.3 $2,369.0 $ 41.4 $ 41.4 $(71.2) $(71.2)
Total return swap agreements 500.0 -- 37.8 36.3 -- --
Interest rate cap agreements 50.0 250.0 -- -- -- --
S&P 500 Index call options -- -- 701.1 803.1 535.7 607.0
S&P 500 Index futures -- -- -- -- (0.6) (0.6)
================================================================================================
The interest rate and total return swap agreements expire in 2000 through 2029.
The interest rate cap agreement expires in 2000. The S&P 500 call options and
futures maturities range from 2000 to 2006.
The Company currently utilizes interest rate swap agreements to reduce
asset duration and to better match interest rates earned on longer-term fixed
rate assets with interest credited to policyholders. The Company utilizes total
return swap agreements to hedge its obligations related to certain separate
account liabilities. Cap agreements are used to hedge against rising interest
rates. With respect to the Company's equity-indexed annuities and certain
separate account liabilities, the Company buys call options, futures and certain
total return swap agreements on the S&P 500 Index to hedge its obligations to
provide returns based upon this index. At December 31, 1999 and 1998, the
Company had approximately $128.7 million and $156.4 million, respectively, of
unamortized premium in call option contracts.
Fair values for swap and cap agreements are based on current settlement
values. The current settlement values are based on quoted market prices and
brokerage quotes, which utilize pricing models or formulas using current
assumptions. Fair values for call options and futures are based upon quoted
market prices.
There are risks associated with some of the techniques the Company uses to
match its assets and liabilities. The primary risk associated with swap, cap and
call option agreements is the risk associated with counterparty nonperformance.
The Company believes that the counterparties to its swap, cap and call option
agreements are financially responsible and that the counterparty risk associated
with these transactions is minimal. Futures trade on organized exchanges and,
therefore, have minimal credit risk.
50 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
5. NOTES PAYABLE
Notes payable include the following (in millions):
December 31 1999 1998
- --------------------------------------------------------------------------------------------------------
6 3/4% notes due 2008, net of unamortized discount of $2.2 million and $2.3 million in
1999 and 1998, respectively, effective rate 6.86% $ 297.8 $ 297.7
7 5/8% debentures due 2028, net of unamortized discount of $0.8 million in 1999 and
1998, effective rate 7.67% 149.2 149.2
Revolving credit facility 105.0 39.5
- --------------------------------------------------------------------------------------------------------
$ 552.0 $ 486.4
========================================================================================================
In connection with the Crabbe Huson acquisition, the Company entered into a
$100.0 million revolving credit facility with a commercial bank (the "Bridge
Facility"). The Bridge Facility matured on March 30, 1999 and bore interest at a
per annum rate equal to LIBOR plus twenty-five basis points. The Company
borrowed $90.0 million under the Bridge Facility to finance the acquisition of
Crabbe Huson. In November 1998, the Company issued $450.0 million of senior debt
securities. The offering consisted of $300.0 million of 6 3/4% 10-year notes due
November 15, 2008 and $150.0 million of 7 5/8% 30-year debentures due November
15, 2028. The proceeds were utilized to repay the $90.0 million borrowed under
the Bridge Facility and to discharge the Company's existing $229.0 million notes
payable to affiliates. The early extinguishment of the notes payable to
affiliates resulted in an extraordinary charge of $9.7 million, net of a tax
benefit of $5.3 million. The indenture under which the senior notes and
debentures were issued contains covenants which prohibit the Company from
granting a lien on or disposing of the stock of any subsidiary which accounts
for more than 10% of the consolidated revenues or assets of the Company.
The Company also has a $150.0 million revolving credit facility (the
"Facility") which is utilized to finance sales commissions paid in connection
with the distribution of mutual fund shares sold with 12b-1 distribution fees
and contingent deferred sales charges. The Facility was established in April
1999 and replaced a $60.0 million revolving credit facility which was used for
the same purpose. This five year Facility is secured by such 12b-1 distribution
fees and contingent deferred sales charges. Interest accrues on the outstanding
borrowings under the Facility at a rate determined by sales of highly rated
commercial paper backed in part by the security interest in such fees and
charges. At December 31, 1999, the interest paid on borrowings under the
Facility was at the rate of 6.13% per annum.
Interest paid was $36.6 million, $25.5 million and $21.7 million in 1999,
1998 and 1997, respectively.
6. INCOME TAXES
Income tax expense is summarized as follows (in millions):
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------------
Current $ (9.9) $ 10.1 $ (42.0)
Deferred 65.0 44.3 104.6
- -------------------------------------------------------------------------------
$ 55.1 $ 54.4 $ 62.6
===============================================================================
51
A reconciliation of income tax expense with expected federal income tax expense
computed at the applicable federal income tax rate of 35% is as follows (in
millions):
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------------
Expected income tax expense $ 54.3 $ 62.6 $ 67.3
Increase (decrease) in income taxes resulting from:
Nontaxable investment income (2.2) (2.1) (1.4)
Reduction in deferred tax asset valuation allowance (2.3) (10.6) (10.0)
Amortization of goodwill and other intangible assets 4.2 3.8 3.1
State taxes, net of federal tax benefit 0.4 0.7 1.2
Other, net 0.7 -- 2.4
- -------------------------------------------------------------------------------
Income tax expense $ 55.1 $ 54.4 $ 62.6
===============================================================================
The components of deferred federal income taxes are as follows (in
millions):
December 31 1999 1998
- -------------------------------------------------------------------------------
Deferred tax assets:
Policyholder balances $ 85.2 $ 107.4
Guaranty fund expense 2.1 2.1
Deferred compensation and other benefit plans 18.8 16.2
Net operating loss carryforwards 24.1 25.3
Distribution fees 25.9 18.4
Net unrealized capital losses 111.2 --
Other 7.9 7.4
- -------------------------------------------------------------------------------
Total deferred tax assets 275.2 176.8
Less: valuation allowance (109.9) (2.3)
- -------------------------------------------------------------------------------
Net deferred tax assets 165.3 174.5
- -------------------------------------------------------------------------------
Deferred tax liabilities:
Deferred policy acquisition costs (231.3) (115.8)
Excess of book over tax basis of investments (120.0) (141.0)
Deferred revenue (33.7) (24.0)
Separate account assets (5.8) (0.5)
Amortization of deferred distribution costs (49.0) (35.8)
Other (9.6) (8.6)
- -------------------------------------------------------------------------------
Total deferred tax liabilities (449.4) (325.7)
- -------------------------------------------------------------------------------
Net deferred tax liability $(284.1) $(151.2)
===============================================================================
As of December 31, 1999, the Company had Federal net operating loss
carryforwards related to certain of the Company's non-insurance operations of
$65.3 million. Of this amount, $10.1 million, which expires through 2003, is
limited to use against future profits in a component of the Company's
non-insurance operations. The remaining Federal non-insurance loss carryforwards
of $55.2 million expire through 2019. As of December 31, 1999, the Company also
had $3.2 million of purchased Federal net operating loss carryforwards, which
expire through 2006, relating to an acquisition in its insurance operations.
Utilization of these loss carryforwards is limited to use against future profits
in a
52 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
component of the Company's insurance operations. The Company believes that it is
more likely than not that it will realize the benefit of the deferred tax asset
related to its Federal net operating loss carryforwards. Additionally, as of
December 31, 1999, the Company had state net operating loss carryforwards
related to certain of the Company's non-insurance operations of $5.5 million.
Utilization of these loss carryforwards, which expire through 2008, is limited
to use against future profits of a component of the Company's non-insurance
operations. As a result of certain events occurring in 1999, the Company now
believes that it is more likely than not that it will realize the tax benefit of
the deferred tax asset related to these state net operating loss carryforwards.
As of December 31, 1999, the Company had $313.8 million of unrealized
capital losses related to its insurance operations in its available for sale
portfolio. Under the tax law, utilization of these capital losses, when
realized, is limited to use against future capital gains. The Company believes
that it is not more likely than not that it will realize the benefit of the
deferred tax asset related to these losses and has established a valuation
allowance against the full amount of the tax benefit ($109.9 million) in
stockholders' equity.
Income taxes paid (refunded) were $(6.2) million, $27.6 million and ($4.2)
million in 1999, 1998 and 1997, respectively.
7. REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Series A Redeemable Convertible Preferred Stock, which has a $50 face value,
has an annual cumulative cash dividend rate of $2.875 per share and is
convertible into shares of Company common stock at a rate of 1.58385 for each
share of such preferred stock. The preferred stock is redeemable at the option
of the Company anytime after March 24, 2000 at a declining premium over face
value through March 24, 2005, when the Company must redeem the preferred stock.
The preferred stock may also be put to the Company by the holders of such
preferred stock after March 24, 2000, for a period of sixty days, at face value
plus cumulative unpaid dividends. Each share of preferred stock is entitled to
that number of votes equal to the number of common shares into which it is
convertible. The difference between the face value of the preferred stock and
its fair value at the time of its issuance is added to the carrying value of the
preferred stock ratably over a five year period by a direct charge to retained
earnings.
8. RETIREMENT PLANS
The Company maintains a noncontributory defined benefit pension plan (the
"Plan") covering its employees (except employees of LFG and Stein Roe, who
participate in separate profit sharing plans, and except employees of Crabbe
Huson, Independent, and Progress). It is the Company's practice to fund amounts
for the Plan sufficient to meet the minimum requirements of the Employee
Retirement Income Security Act of 1974. Additional amounts are contributed from
time to time when deemed appropriate by the Company. Under the Plan, all
employees are vested after five years of service. Benefits are based on years of
service, the employee's average pay for the highest five consecutive years
during the last ten years of employment and the employee's estimated social
security retirement benefit. The Company also has an unfunded nonqualified
Supplemental Pension Plan (collectively with the Plan, the "Plans") to replace
benefits lost due to limits imposed on Plan benefits under the Internal Revenue
Code. Plan assets consist of investments in certain Company-sponsored mutual
funds.
53
The following table sets forth the Plans' funded status (in millions) as of
December 31, 1999 and 1998.
December 31 1999 1998
- -----------------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation at beginning of year $ 32.8 $ 27.1
Service cost 2.1 1.8
Interest cost 2.4 2.1
Actuarial (gain) loss (4.9) 2.4
Benefits paid (0.9) (0.6)
- -----------------------------------------------------------------------------------
Benefit obligation at end of year $ 31.5 $ 32.8
===================================================================================
Change in plan assets
Fair value of plan assets at beginning of year $ 16.1 $ 14.7
Actual return on plan assets 2.7 1.1
Employer contribution 1.3 0.9
Benefits paid (0.9) (0.6)
- -----------------------------------------------------------------------------------
Fair value of plan assets at end of year $ 19.2 $ 16.1
===================================================================================
Projected benefit obligation in excess of the plans' assets $ 12.3 $ 16.7
Unrecognized net actuarial gain (loss) 2.1 (4.4)
Prior service cost not yet recognized in net periodic pension cost (1.4) (1.8)
- -----------------------------------------------------------------------------------
Accrued pension cost $ 13.0 $ 10.5
===================================================================================
Pension cost includes the following components (in millions):
Year Ended December 31 1999 1998 1997
- ------------------------------------------------------------------------------
Service cost benefits earned during the period $ 2.1 $ 1.8 $ 1.6
Interest cost on projected benefit obligation 2.4 2.1 1.8
Expected return on plan assets (1.4) (1.2) (1.7)
Net amortization and deferred amounts 0.7 0.4 1.2
- ------------------------------------------------------------------------------
Total net periodic pension cost $ 3.8 $ 3.1 $ 2.9
==============================================================================
The assumptions used to develop the actuarial present value of the projected
benefit obligation, and the expected long-term rate of return on plan assets are
as follows:
Year Ended December 31 1999 1998 1997
- --------------------------------------------------------------------------------
Discount rate 7.75% 6.75% 7.25%
Rate of increase in compensation level 4.50% 4.75% 5.00%
Expected long-term rate of return on assets 9.00% 9.00% 8.50%
The Company provides various other funded and unfunded defined contribution
plans, which include savings and investment plans and supplemental savings
plans. Expenses related to these defined contribution plans totaled $9.3
million, $9.5 million and $8.5 million in 1999, 1998 and 1997, respectively.
54 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
9. STOCKHOLDERS' EQUITY
The Company has two stock-based compensation plans, the 1990 Stock Option Plan
(the "1990 Plan") and the 1995 Stock Incentive Plan (the "1995 Plan"). The 1990
Plan provided for grants of incentive and nonqualified stock options, which were
issued from 1990 through 1994. The 1995 Plan provides for grants of incentive
and nonqualified stock options, stock appreciation rights, nonvested stock,
unrestricted stock and performance shares, as well as cash and other awards. To
date, only stock options and nonvested stock have been granted under the 1995
Plan. For any year, the Company may issue awards under the 1995 Plan providing
for the issuance of not more than two percent of the total number of shares
outstanding as of December 31 of the preceding year, subject to certain
adjustments and to certain carryovers for expired and forfeited awards. This
amount does not include 124,500 nonqualified options at prices ranging from
$5.92 to $21.00 that were assumed by the Company in connection with the LFG
acquisition.
All options granted under the 1990 Plan were granted at a price not less
than the fair market value of the Company's Common Stock (determined by the
valuation provisions of the 1990 Plan). All options granted under the 1995 Plan
have been granted at the market price of the Company's Common Stock on the grant
date. All granted options provide for vesting in four equal annual installments,
beginning one year after the date of grant, and expire 10 years after the grant
date.
In April 1997, the Company began to award nonvested stock under the 1995
Plan. The nonvested shares issued to employees vest generally after the end of
six years. Such vesting date may accelerate if the Company achieves certain
performance targets. Upon termination of employment, any nonvested shares would
generally be forfeited. The Company recorded $1.4 million, $1.0 million and $0.4
million in compensation expense related to nonvested stock in 1999, 1998 and
1997 respectively.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. As provided for
under SFAS 123, the fair value for these options was estimated using a
Black-Scholes option pricing model with the following assumptions: risk free
interest rate: 6.46% for 1999, 4.68% for 1998 and 5.73% for 1997; dividend
yield: 1.64% for 1999, 1.22% for 1998 and 1.25% for 1997; expected volatility of
the market price of the Company's Common Stock: 26.0% for 1999, 23.2% for 1998
and 19.1% for 1997; and the weighted average life of the options: 6 years for
all three periods.
For pro forma disclosure purposes, the estimated fair value of the options
is amortized to expense over the options' vesting period. Pro forma information
follows (in millions, except for earnings per share information):
55
Year Ended December 31 1999 1998 1997
- --------------------------------------------------------------------------------
Income before extraordinary item $96.0 $120.6 $127.1
Extraordinary loss on extinguishment of debt, net of tax -- (9.7) --
- --------------------------------------------------------------------------------
Net income $96.0 $110.9 $127.1
================================================================================
Net income per share - basic:
Income before extraordinary item $2.04 $ 2.64 $ 2.88
Extraordinary loss on extinguishment of debt, net of tax -- (0.21) --
- --------------------------------------------------------------------------------
Net income $2.04 $ 2.43 $ 2.88
================================================================================
Net income per share - assuming dilution:
Income before extraordinary item $2.00 $ 2.55 $ 2.73
Extraordinary loss on extinguishment of debt, net of tax -- (0.21) --
- --------------------------------------------------------------------------------
Net income $2.00 $ 2.34 $ 2.73
================================================================================
Because SFAS 123 is applicable only to options granted subsequent to December
31, 1994, its pro forma effect was not fully reflected until 1998.
A summary of the stock option activity, and related information for the years
ended December 31 follows (in thousands, except price data):
1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Exercise Average Exercise Average Exercise
Options Price Options Price Options Price
- ---------------------------------------------------------------------------------------------------------------
Outstanding - beginning of year 3,729 $21.72 4,038 $16.31 4,484 $12.49
Granted 788 24.52 627 36.92 699 28.67
Exercised (459) 12.65 (936) 8.58 (1,027) 7.56
Forfeited (332) 27.34 -- -- (118) 20.74
- ---------------------------------------------------------------------------------------------------------------
Outstanding - end of year 3,726 $22.93 3,729 $21.72 4,038 $16.31
===============================================================================================================
Exercisable - end of year 2,132 $19.09 2,051 $15.72 2,346 $11.11
===============================================================================================================
Weighted-average fair value of
options granted during year $ 8.12 $10.62 $ 8.15
===============================================================================================================
Exercise prices for options outstanding as of December 31, 1999 ranged from
$5.92 to $38.94. The weighted-average remaining contractual life of these
options is 6.73 years.
56 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
10. NET INCOME PER SHARE
The following table sets forth the computation of net income per share -- basic
and net income per share -- assuming dilution:
Year Ended December 31 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------
Numerator (in millions)
Income before extraordinary item $ 99.3 $ 124.5 $ 129.5
Less: preferred stock dividends (0.9) (0.9) (0.9)
- ----------------------------------------------------------------------------------------------------------------
Numerator for income per share - basic - income before
extraordinary item available to common stockholders 98.4 123.6 128.6
Extraordinary loss on extinguishment of debt, net of tax -- (9.7) --
- ----------------------------------------------------------------------------------------------------------------
Numerator for net income per share - basic - net income
available to common stockholders $ 98.4 $ 113.9 $ 128.6
================================================================================================================
Income available to common stockholders $ 98.4 $ 123.6 $ 128.6
Plus: income impact of assumed conversions
Preferred stock dividends 0.9 0.9 0.9
- ----------------------------------------------------------------------------------------------------------------
Numerator for income per share - assuming dilution - income before
extraordinary item available to common stockholders
after assumed conversions 99.3 124.5 129.5
Extraordinary loss on extinguishment of debt, net of tax -- (9.7) --
- ----------------------------------------------------------------------------------------------------------------
Numerator for net income per share - assuming dilution - net income
available to common stockholders after assumed conversions $ 99.3 $ 114.8 $ 129.5
================================================================================================================
Denominator
Denominator for basic - weighted average shares 46,719,223 45,330,561 43,808,904
- ----------------------------------------------------------------------------------------------------------------
Effect of dilutive securities:
Employee stock options 679,210 1,521,333 2,403,729
Convertible preferred stock 514,370 515,657 518,081
- ----------------------------------------------------------------------------------------------------------------
Dilutive potential common shares 1,193,580 2,036,990 2,921,810
- ----------------------------------------------------------------------------------------------------------------
Denominator for assuming dilution 47,912,803 47,367,551 46,730,714
- ----------------------------------------------------------------------------------------------------------------
Net income per share - basic:
Income before extraordinary item $ 2.11 $ 2.72 $ 2.94
Extraordinary loss on extinguishment of debt, net of tax -- (0.21) --
- ----------------------------------------------------------------------------------------------------------------
Net income $ 2.11 $ 2.51 $ 2.94
================================================================================================================
Net income per share - assuming dilution:
Income before extraordinary item $ 2.07 $ 2.63 $ 2.77
Extraordinary loss on extinguishment of debt, net of tax -- (0.21) --
- ----------------------------------------------------------------------------------------------------------------
Net income $ 2.07 $ 2.42 $ 2.77
================================================================================================================
57
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in determining
fair values of financial instruments:
Fixed maturities and equity securities: Fair values for fixed maturity
securities are based on quoted market prices, where available. For fixed
maturities not actively traded, the fair values are determined using values from
independent pricing services, or, in the case of private placements, are
determined by discounting expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the securities. The
fair values for equity securities are based on quoted market prices.
Policy loans: The carrying value of policy loans approximates fair value.
Other invested assets: The fair values for other invested assets are generally
based on quoted market prices.
Cash and cash equivalents: The carrying value of cash and cash equivalents
approximates fair value.
Policyholder balances: Deferred annuity contracts are assigned fair value equal
to current net surrender value. Annuitized contracts are valued based on the
present value of the future cash flows at current pricing rates.
Notes payable: The fair value of the Company's notes payable is estimated based
on quoted market prices.
The fair values and carrying values of the Company's financial instruments
are as follows (in millions):
1999 1998
---------------------------------------------
Carrying Fair Carrying Fair
December 31 Value Value Value Value
- --------------------------------------------------------------------------------
Assets:
Fixed maturity securities $10,516.1 $10,516.1 $11,277.2 $11,277.2
Equity securities 37.9 37.9 24.6 24.6
Policy loans 599.5 599.5 578.9 578.9
Other invested assets 1,041.6 1,145.1 717.6 787.0
Cash and cash equivalents 1,232.6 1,232.6 984.1 984.1
Liabilities:
Policyholder balances 10,015.1 9,306.8 10,392.2 9,617.1
Notes payable 552.0 531.7 486.4 511.7
58 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
12. SEGMENT INFORMATION
The Company has two reportable segments: annuity and asset management. Annuity
operations relate principally to the issuance of fixed, indexed and variable
annuity products and a closed block of investment-oriented life insurance
products. Asset management includes mutual funds, private capital management and
institutional asset management. The Company evaluates performance based on
earnings before income taxes, not including net realized gains and losses. The
Company's reportable segments offer different products and are each managed
separately. Information by reported segment for 1999, 1998 and 1997 is shown
below (in millions):
Year Ended December 31 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------
Statement of Operations Data
Revenues (excluding net realized investment gains and losses):
Annuity:
Unaffiliated $ 877.0 $ 870.1 $ 897.7
Intersegment (14.0) (10.5) (9.3)
- ----------------------------------------------------------------------------------------------------------
Total annuity 863.0 859.6 888.4
- ----------------------------------------------------------------------------------------------------------
Asset management:
Unaffiliated 383.9 344.5 323.4
Intersegment 14.0 10.5 9.3
- ----------------------------------------------------------------------------------------------------------
Total asset management 397.9 355.0 332.7
- ----------------------------------------------------------------------------------------------------------
Total revenues (excluding net realized investment gains and losses) $1,260.9 $1,214.6 $1,221.1
==========================================================================================================
Income before income taxes and extraordinary item:
Annuity:
Income before amortization of intangible assets $ 179.0 $ 155.2 $ 143.1
Amortization of intangible assets (1.2) (1.3) (1.1)
- ----------------------------------------------------------------------------------------------------------
Subtotal annuity 177.8 153.9 142.0
- ----------------------------------------------------------------------------------------------------------
Asset management:
Income before amortization of intangible assets 85.8 77.0 79.9
Amortization of intangible assets (18.9) (13.8) (12.1)
- ----------------------------------------------------------------------------------------------------------
Subtotal asset management 66.9 63.2 67.8
- ----------------------------------------------------------------------------------------------------------
Other:
Loss before amortization of intangible assets (47.9) (40.4) (43.3)
Amortization of intangible assets (0.2) (0.2) (0.3)
- ----------------------------------------------------------------------------------------------------------
Subtotal other (48.1) (40.6) (43.6)
- ----------------------------------------------------------------------------------------------------------
Income before net realized investment gains (losses), income taxes and
extraordinary item 196.6 176.5 166.2
Net realized investment gains (losses) (42.2) 2.4 25.9
- ----------------------------------------------------------------------------------------------------------
Total income before income taxes and extraordinary item $ 154.4 $ 178.9 $ 192.1
==========================================================================================================
59
December 31 1999 1998
- --------------------------------------------------------------------------------
Balance Sheet Data
Identifiable Assets:
Annuity $17,460.6 $15,742.9
Asset management 643.4 575.3
Other 268.5 200.9
- --------------------------------------------------------------------------------
Total consolidated assets $18,372.5 $16,519.1
================================================================================
All revenues are attributed to the United States. All long-lived assets are
located in the United States.
13. QUARTERLY FINANCIAL DATA, IN MILLIONS, EXCEPT PER SHARE AMOUNTS (UNAUDITED)
Quarter Ended 1999 March 31 June 30 September 30 December 31
- ------------------------------------------------------------------------------------------------------------
Investment income $ 206.2 $ 197.1 $ 197.9 $ 209.1
Interest credited to policyholders (134.8) (129.4) (131.3) (131.1)
- ------------------------------------------------------------------------------------------------------------
Investment spread 71.4 67.7 66.6 78.0
Net realized investment losses (3.1) (11.6) (12.7) (14.8)
Fee income 108.8 113.0 114.9 113.9
Pretax income 44.0 36.0 37.1 37.3
Net income 27.4 23.3 24.6 24.0
Net income per share - basic 0.59 0.49 0.52 0.51
Net income per share - assuming dilution 0.58 0.49 0.51 0.50
Quarter Ended 1998 March 31 June 30 September 30 December 31
- ------------------------------------------------------------------------------------------------------------
Investment income $ 207.4 $ 202.3 $ 202.7 $ 208.5
Interest credited to policyholders (142.1) (140.2) (143.3) (136.6)
- ------------------------------------------------------------------------------------------------------------
Investment spread 65.3 62.1 59.4 71.9
Net realized investment gains (losses) 2.2 (2.4) 4.2 (1.6)
Fee income 94.7 100.0 97.1 101.9
Pretax income 45.4 43.5 49.4 40.6
Income before extraordinary item 31.5 29.7 33.5 29.8
Extraordinary loss on extinguishment of debt, net of tax -- -- -- (9.7)
Net income 31.5 29.7 33.5 20.1
Net income per share - basic:
Income before extraordinary item $ 0.70 $ 0.65 $ 0.73 $ 0.64
Extraordinary loss on extinguishment of debt, net of tax -- -- -- (0.21)
- ------------------------------------------------------------------------------------------------------------
Net income per share - basic $ 0.70 $ 0.65 $ 0.73 $ 0.43
============================================================================================================
Net income per share - assuming dilution:
Income before extraordinary item $ 0.67 $ 0.63 $ 0.71 $ 0.63
Extraordinary loss on extinguishment of debt, net of tax -- -- -- (0.21)
- ------------------------------------------------------------------------------------------------------------
Net income per share - assuming dilution $ 0.67 $ 0.63 $ 0.71 $ 0.42
============================================================================================================
60 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
14. STATUTORY INFORMATION
Keyport is domiciled in Rhode Island and prepares its statutory financial
statements in accordance with accounting principles and practices prescribed or
permitted by the State of Rhode Island Insurance Department. Statutory surplus
and statutory net income differ from shareholder's equity and net income
reported in accordance with GAAP primarily because policy acquisition costs are
expensed when incurred, policy liabilities are based on different assumptions,
and income tax expense reflects only taxes paid or currently payable. Keyport's
statutory surplus and net income are as follows (in millions):
Year Ended December 31 1999 1998 1997
- --------------------------------------------------------------------------------
Statutory surplus $ 877.8 $ 790.9 $ 702.6
Statutory net income 116.3 98.9 107.1
15. TRANSACTIONS WITH AFFILIATED COMPANIES
Liberty Mutual from time to time provides management, legal, audit and financial
services to the Company. Reimbursements to Liberty Mutual for these services
totaled $0.6 million, $0.6 million and $0.7 million in 1999, 1998 and 1997,
respectively. These reimbursements are based on direct and indirect costs
incurred by Liberty Mutual and are allocated to the Company primarily based upon
the amount of time spent by Liberty Mutual's employees on the Company's behalf.
The Company believes that this allocation methodology is reasonable.
Regulatory authorities permit dividend payments from Keyport to the Company
up to the lesser of (i) 10% of statutory surplus as of the preceding December 31
or (ii) the net gain from operations for the preceding fiscal year. As of
December 31, 1999, Keyport could pay dividends of up to $57.8 million without
the approval of the Commissioner of Insurance of the State of Rhode Island.
Keyport paid dividends of $30.0 million during 1999.
16. COMMITMENTS AND CONTINGENCIES
Leases: The Company leases data processing equipment, furniture and certain
office facilities from others under operating leases expiring in various years
through 2009. Rental expense amounted to $19.7 million, $16.5 million and $15.0
million for the years ended December 31, 1999, 1998 and 1997, respectively. For
each of the next five years, and in the aggregate, as of December 31, 1999, the
following are the minimum future rental payments under noncancelable operating
leases having remaining terms in excess of one year (in millions):
Year Payments
- --------------------------------------------------------------------------------
2000 $19.9
2001 19.3
2002 18.8
2003 18.3
2004 17.5
Thereafter 42.2
61
Legal Matters: The Company is involved at various times in litigation
common to its business. In the opinion of management, the resolution of any such
litigation is not expected to have a material adverse effect on the Company's
financial condition, results of operations or cash flows.
Regulatory Matters: Under existing guaranty fund laws in all states,
insurers licensed to do business in those states can be assessed for certain
obligations of insolvent insurance companies to policyholders and claimants. The
actual amount of such assessments will depend upon the final outcome of
rehabilitation proceedings and will be paid over several years. In 1999, 1998
and 1997, Keyport was assessed $0.1 million, $3.2 million and $5.9 million,
respectively. During 1999, Keyport did not record any provisions for guaranty
fund association expenses and recorded $1.2 million and $1.0 million for the
years ended December 31, 1998 and 1997, respectively. At December 31, 1999 and
1998, the reserve for such assessments was $5.9 million and $6.0 million,
respectively.
62 LIBERTY FINANCIAL COMPANIES, INC. 1999 Annual Report
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
- --------------------------------------------------------------------------------
[LOGO:ERNST & YOUNG LLP]
Shareholders and Board of Directors
Liberty Financial Companies, Inc.
We have audited the accompanying consolidated balance sheets of Liberty
Financial Companies, Inc. as of December 31, 1999 and 1998, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and the significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Liberty
Financial Companies, Inc. at December 31, 1999 and 1998, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
Boston, Massachusetts
January 27, 2000
63