SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 1-13654
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LIBERTY FINANCIAL COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
Massachusetts 04-3260640
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
600 Atlantic Avenue, Boston, Massachusetts 02210-2214
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(Address of principal executive offices) (Zip Code)
(617) 722-6000
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
There were 48,904,744 shares of the registrant's Common Stock, $.01 par
value, and 213,242 shares of the registrant's Series A Convertible Preferred
Stock, $.01 par value, outstanding as of April 30, 2001.
Exhibit Index - Page 26 Page 1 of 27
LIBERTY FINANCIAL COMPANIES, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED MARCH 31, 2001
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2001 and December 31,
2000 3
Consolidated Statements of Operations for the Three Months Ended
March 31, 2001 and 2000 4
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2001 and 2000 5
Consolidated Statement of Stockholders' Equity for the Three Months Ended
March 31, 2001 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
Exhibit Index 26
2
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
MARCH 31 DECEMBER 31
2001 2000
--------- -----------
UNAUDITED
ASSETS
Assets:
Investments $12,270.8 $12,232.4
Cash and cash equivalents 1,877.9 1,891.0
Accrued investment income 153.2 163.5
Deferred policy acquisition costs 566.2 547.9
Deferred distribution costs 172.6 169.4
Intangible assets 524.2 533.0
Other assets 432.1 401.0
Separate account assets 3,901.4 4,212.5
--------- ---------
$19,898.4 $20,150.7
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policyholder balances $12,022.5 $11,968.5
Notes payable to affiliates 200.0 200.0
Notes payable 572.2 563.2
Payable for investments purchased and loaned 1,388.3 1,364.5
Other liabilities 393.7 429.3
Separate account liabilities 3,880.5 4,166.8
--------- ---------
Total liabilities 18,457.2 18,692.3
--------- ---------
Series A redeemable convertible preferred stock, par value $.01;
authorized, issued and outstanding 213,242 shares in 2001 and
2000 10.7 10.7
--------- ---------
Stockholders' Equity:
Common stock, par value $.01; authorized 100,000,000 shares,
issued and outstanding 48,904,744 shares in 2001 and
48,784,459 shares in 2000 0.5 0.5
Additional paid-in capital 952.5 949.1
Retained earnings 477.9 532.4
Accumulated other comprehensive income (loss) 2.9 (30.6)
Unearned compensation (3.3) (3.7)
--------- ---------
Total stockholders' equity 1,430.5 1,447.7
--------- ---------
$19,898.4 $20,150.7
========= =========
See accompanying notes to consolidated financial statements.
3
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE DATA)
UNAUDITED
THREE MONTHS ENDED
MARCH 31
---------------------
2001 2000
---- ----
Investment income, including distributions from private
equity limited partnerships of $8.9 million and
$1.7 million in 2001 and 2000, respectively $ 236.3 $ 205.9
Interest credited to policyholders (148.5) (127.3)
------- -------
INVESTMENT SPREAD 87.8 78.6
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NET DERIVATIVE LOSS (3.8) --
------- -------
NET REALIZED INVESTMENT LOSSES (19.7) (3.9)
------- -------
NET CHANGE IN UNREALIZED AND UNDISTRIBUTED GAINS IN PRIVATE
EQUITY LIMITED PARTNERSHIPS 2.7 15.0
------- -------
Fee income:
Investment advisory and administrative fees 75.1 71.9
Distribution and service fees 15.3 15.4
Transfer agency fees 12.6 12.7
Surrender charges and net commissions 8.8 10.7
Separate account fees 12.8 10.7
------- -------
TOTAL FEE INCOME 124.6 121.4
------- -------
Expenses:
Operating expenses (105.4) (102.3)
Restructuring charges (1.4) --
Special compensation plan (20.4) --
Amortization of deferred policy acquisition costs (32.7) (27.1)
Amortization of deferred distribution costs (12.0) (10.2)
Amortization of intangible assets (8.7) (5.1)
Interest expense, net (10.2) (4.0)
------- -------
TOTAL EXPENSES (190.8) (148.7)
------- -------
PRETAX INCOME 0.8 62.4
Income tax benefit (expense) 4.0 (23.0)
------- -------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 4.8 39.4
Cumulative effect of accounting change, net of tax (54.3) --
------- -------
NET INCOME (LOSS) $(49.5) $ 39.4
====== =======
Net income (loss) per share - basic:
Income before cumulative effect of accounting change $ 0.10 $ 0.83
====== =======
Net income (loss) $(1.02) $ 0.83
====== =======
Net income (loss) per share - assuming dilution:
Income before cumulative effect of accounting change $ 0.10 $ 0.82
====== =======
Net income (loss) $(0.98) $ 0.82
====== =======
See accompanying notes to consolidated financial statements.
4
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
UNAUDITED
THREE MONTHS ENDED
MARCH 31
---------------------------
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (49.5) $ 39.4
Adjustments to reconcile net income to net cash provided by
operating activities:
Cumulative effect of accounting change, net of tax 54.3 --
Depreciation and amortization 24.0 20.3
Interest credited to policyholders 148.5 127.3
Net realized investment losses 19.7 3.9
Net change in unrealized and undistributed gains in private
equity limited partnerships (2.7) (15.0)
Net (accretion) amortization on investments (4.4) 22.6
Change in deferred policy acquisition costs (17.3) (9.0)
Net change in other assets and liabilities (63.8) 13.2
--------- --------
Net cash provided by operating activities 108.8 202.7
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased available for sale (1,150.6) (628.9)
Investments sold available for sale 1,294.3 663.6
Investments matured available for sale 5.3 36.5
Change in policy loans, net (2.3) (7.9)
Change in mortgage loans, net 0.5 0.7
Other (2.1) (2.9)
--------- --------
Net cash provided by investing activities 145.1 61.1
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Withdrawals from policyholder accounts (642.1) (516.4)
Deposits to policyholder accounts 388.9 310.9
Securities lending (20.6) 302.9
Change in notes payable 9.0 10.0
Exercise of stock options 2.8 1.3
Dividends paid (5.0) (1.6)
--------- --------
Net cash (used in) provided by financing activities (267.0) 107.1
--------- --------
(Decrease) increase in cash and cash equivalents (13.1) 370.9
Cash and cash equivalents at beginning of period 1,891.0 1,232.6
--------- --------
Cash and cash equivalents at end of period $ 1,877.9 $1,603.5
========= ========
See accompanying notes to consolidated financial statements.
5
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN MILLIONS)
UNAUDITED
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON STOCK PAID-IN RETAINED COMPREHENSIVE UNEARNED STOCKHOLDERS'
CAPITAL EARNINGS INCOME (LOSS) COMPENSATION EQUITY
------------ ------------ --------------- ------------------- ----------------- -------------------
BALANCE,
DECEMBER 31, 2000 $0.5 $949.1 $532.4 $(30.6) $(3.7) $1,447.7
Effect of stock-based
compensation plans 3.4 0.4 3.8
Common stock
dividends (4.8) (4.8)
Preferred stock
dividends (0.2) (0.2)
Net loss (49.5) (49.5)
Other comprehensive
income, net of tax 33.5 33.5
------------- ------------ --------------- ------------------- ----------------- -------------------
BALANCE,
MARCH 31, 2001 $0.5 $952.5 $477.9 $2.9 $(3.3) $1,430.5
============= ============ =============== =================== ================= ===================
See accompanying notes to consolidated financial statements.
6
LIBERTY FINANCIAL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
UNAUDITED
1. GENERAL
The accompanying unaudited consolidated financial statements include
all adjustments, consisting of normal recurring accruals, that management
considers necessary for a fair presentation of the Company's financial
position and results of operations as of and for the interim periods
presented. Certain footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles in the United States have been condensed or omitted pursuant to
the rules and regulations of the Securities and Exchange Commission.
Therefore, these consolidated financial statements should be read in
conjunction with the audited consolidated financial statements contained in
the Company's Form 10-K (as amended) for the year ended December 31, 2000.
The results of operations for the three months ended March 31, 2001 are not
necessarily indicative of the results to be expected for the full year.
Certain previously reported amounts have been reclassified to conform with
the current period presentation.
2. SUBSEQUENT EVENTS
On May 3, 2001, the Company announced that it had reached a definitive
agreement to sell its annuity and bank marketing businesses to Sun Life
Financial. Through this transaction, Sun Life Financial will acquire
Keyport Life Insurance Company and Independent Financial Marketing Group.
Sun Life Financial will pay approximately $1.7 billion in cash for the two
businesses.
The transaction is subject to customary conditions to closing,
including receipt of approvals by various state insurance regulators in the
U.S., certain other regulatory authorities in the U.S. and Canada and
Liberty Financial's shareholders. In connection with the execution of the
definitive purchase agreement, Liberty Mutual Insurance Company, the
Company's controlling stockholder, entered into an agreement to vote in
favor of the Sun Life Financial transaction.
The acquisition is expected to close in the second half of 2001. Based
on current estimates, the Company expects that it will record an after-tax
gain of approximately $150 million and will have proceeds, net of
transaction costs and taxes, of approximately $1.47 billion from the
closing of the Sun Life Financial transaction.
On May 3, 2001, the Company also announced that it was continuing to
explore strategic alternatives for its remaining asset management business
and has instructed Credit Suisse First Boston to continue to seek a buyer
for that business.
3. CHANGE IN ACCOUNTING PRINCIPLE
The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities", and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities - an amendment of SFAS No. 133"
on January 1, 2001. The Statement requires the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through operations. If the
derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset by the change in fair
value of the hedged assets, liabilities or firm commitments through
operations or recognized in other comprehensive income until the hedged
item is recognized in operations. The ineffective portion of a
derivative's change in fair value will be immediately recognized in
operations.
The cumulative effect, reported after tax and net of related effects on
deferred policy acquisition costs, upon adoption of the Statement at
January 1, 2001 decreased net income and stockholders' equity by $54.3
million. The adoption of the Statement may increase volatility in future
reported income due, among other reasons, to the requirements of defining
an effective hedging relationship under the Statement as opposed to certain
hedges the Company believes are effective economic hedges. The Company
anticipates that it will continue to utilize its current risk management
philosophy, which includes the use of derivative instruments.
7
4. ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES
All derivatives are recognized on the balance sheet at fair value. On
the date the derivative contract is entered into, the Company designates
the derivative as either (1) a hedge of the fair value of a recognized
asset ("fair value hedge") or (2) utilizes the derivative as an economic
hedge ("non-designated derivative"). Changes in the fair value of a
derivative that is highly effective and is designated and qualifies as a
fair value hedge, along with the loss or gain on the hedged asset
attributable to the hedged risk, are recorded in current period operations
as a component of net derivative loss. Changes in the fair value of
non-designated derivatives are reported in current period operations as a
component of net derivative loss.
The Company issues equity-indexed annuity contracts that contain a
derivative instrument that is "embedded" in the contract. Upon issuing the
contract, the embedded derivative is separated from the host contract
(annuity contract), is carried at fair value and is considered a
non-designated derivative. The Company purchases call options and futures
on the S&P 500 Index to economically hedge its obligation under the annuity
contract to provide returns based upon this index. The call options and
futures are non-designated derivatives. In addition, the Company utilizes
non-designated total return swap agreements to hedge its obligations
related to certain separate account liabilities.
As a component of its investment strategy and to reduce its exposure to
interest rate risk, the Company utilizes interest rate swap agreements.
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 interest rate swap agreements are designated and qualify
as fair value hedges. The ineffective portion of the fair value hedges, net
of related effects on deferred policy acquisition costs, resulted in a loss
of $0.7 million for the quarter ended March 31, 2001.
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedging transactions. This process
includes linking all fair value hedges to specific assets on the balance
sheet. The Company also formally assesses, both at the hedge's inception
and on an ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values.
When it is determined that a derivative is not highly effective as a hedge
or that it has ceased to be a highly effective hedge, the Company
discontinues hedge accounting prospectively.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair value hedge, the
derivative will continue to be carried on the balance sheet at its fair
value and changes in fair value will be reported in operations. The
subsequent fair value changes in the hedged asset will no longer be
reported in current period operations.
5. SEGMENT INFORMATION
The Company is an asset accumulation and management company with two
reportable segments: retirement-oriented insurance (principally annuities)
and asset management. The annuity insurance business is conducted at
Keyport Life Insurance Company ("Keyport"). Keyport generates investment
spread income from the investment portfolio which supports policyholder
balances associated with its fixed and indexed annuity business and its
closed block of single premium whole life insurance. The annuity insurance
business also derives fee income from the administration of fixed, indexed
and variable annuity contracts. The asset management business is conducted
at Liberty Funds Group, an investment advisor (through its subsidiary
Colonial Management Associates), distributor and transfer agent to mutual
funds, Stein Roe & Farnham Incorporated, a diversified investment advisor,
Newport Pacific Management, Inc., an investment advisor to mutual funds and
institutional accounts specializing in Asian
8
equity markets, Crabbe Huson Group, Inc., an investment advisor to mutual
funds and institutional accounts, Progress Investment Management Company,
an investment advisor to institutional accounts, Liberty Asset Management
Company, an investment advisor to mutual funds, and Liberty Wanger Asset
Management, an investment advisor to mutual funds and institutional
accounts. The asset management business derives fee income from investment
products and services.
The Company's reportable segments offer different products and are
each managed separately. Information by reportable segment is shown below
(in millions):
THREE MONTHS ENDED
MARCH 31
---------- ----------
2001 2000
---------- ----------
Statement of Operations Data
REVENUES (EXCLUDING NET REALIZED INVESTMENT LOSSES AND NET CHANGE IN
UNREALIZED AND UNDISTRIBUTED GAINS IN PRIVATE EQUITY LIMITED PARTNERSHIPS):
Annuity:
Unaffiliated $258.1 $226.3
Intersegment (4.5) (3.8)
------ ------
Total annuity 253.6 222.5
------ ------
Asset management:
Unaffiliated 102.8 101.0
Intersegment 4.5 3.8
------ ------
Total asset management 107.3 104.8
------ ------
Total revenues (excluding net realized investment losses and net change
in unrealized and undistributed gains in private equity
limited partnerships) $360.9 $327.3
====== ======
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE:
Annuity:
Income before amortization of intangible assets $ 48.1 $49.4
Amortization of intangible assets (0.3) (0.3)
------ ------
Subtotal annuity 47.8 49.1
------ ------
Asset management:
Income before amortization of intangible assets 15.9 17.8
Amortization of intangible assets (8.3) (4.8)
------ ------
Subtotal asset management 7.6 13.0
------ ------
Other:
Loss before amortization of intangible assets (15.7) (10.8)
Amortization of intangible assets (0.1) --
------ ------
Subtotal other (15.8) (10.8)
------ ------
Income before non-operating items, cumulative effect of accounting
change and income taxes 39.6 51.3
Net realized investment losses (19.7) (3.9)
Net change in unrealized and undistributed gains in private equity
limited partnerships 2.7 15.0
Restructuring charges (1.4) --
Special compensation plan (20.4) --
------ ------
Pretax income $ 0.8 $ 62.4
====== ======
9
6. INVESTMENTS
Investments were comprised of the following (in millions):
MARCH 31 DECEMBER 31
2001 2000
--------- -----------
Fixed maturities $10,885.0 $10,668.3
Equity securities 75.8 76.4
Policy loans 623.2 620.8
Other invested assets 686.8 866.9
--------- ---------
Total $12,270.8 $12,232.4
========= =========
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.
10
7. NET INCOME PER SHARE
The following table sets forth the computation of net income per
share-basic and net income per share-assuming dilution:
THREE MONTHS ENDED
MARCH 31
----------------------------
2001 2000
------------ ------------
Numerator (in millions)
Income before cumulative effect of accounting change $ 4.8 $ 39.4
Less: preferred stock dividends (0.2) (0.2)
----------- -----------
Numerator for net income per share - basic - income before cumulative
effect of accounting change available to common stockholders 4.6 39.2
Cumulative effect of accounting change, net of tax (54.3) --
----------- -----------
Numerator for net income (loss) per share - basic - net income (loss)
available to common stockholders $ (49.7) $ 39.2
=========== ===========
Income before cumulative effect of accounting change available to common
stockholders $ 4.6 $ 39.2
Plus: income impact of assumed conversions
Preferred stock dividends 0.2 0.2
----------- -----------
Numerator for income per share - assuming dilution - income before
cumulative effect of accounting change available to common
stockholders after assumed
conversions 4.8 39.4
Cumulative effect of accounting change, net of tax (54.3) --
----------- -----------
Numerator for net income (loss) per share - assuming dilution - income
(loss) available to common stockholders after assumed conversions $ (49.5) $ 39.4
=========== ===========
Denominator
Denominator for net income per share - basic - weighted-average shares 48,573,227 47,363,267
Effect of dilutive securities:
Employee stock options 1,443,851 393,549
Convertible preferred stock 337,743 514,370
----------- -----------
Dilutive potential common shares 1,781,594 907,919
----------- -----------
Denominator for net income per share - assuming dilution 50,354,821 48,271,186
=========== ===========
Net income (loss) per share - basic:
Income before cumulative effect of accounting change $ 0.10 $ 0.83
Cumulative effect of accounting change, net of tax (1.12) --
----------- -----------
Net income (loss) $ (1.02) $ 0.83
=========== ===========
Net income (loss) per share - assuming dilution:
Income before cumulative effect of accounting change $ 0.10 $ 0.82
Cumulative effect of accounting change, net of tax (1.08) --
----------- -----------
Net income (loss) $ (0.98) $ 0.82
=========== ===========
11
8. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) was comprised of the following (in
millions):
THREE MONTHS ENDED
MARCH 31
------------------------
2001 2000
---------- ----------
Net income (loss) $(49.5) $39.4
Other comprehensive income (loss), net of taxes:
Net unrealized gains (losses) on securities 33.5 (4.5)
------ -----
Comprehensive income (loss) $(16.0) $34.9
====== =====
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
On November 1, 2000, the Company announced that it had retained the
investment banking firm of Credit Suisse First Boston Corporation to review its
strategic alternatives, including a possible sale of the Company. On May 3,
2001, the Company announced that it had reached a definitive agreement to sell
its annuity and bank marketing businesses to Sun Life Financial. Through this
transaction, Sun Life Financial will acquire Keyport Life Insurance Company and
Independent Financial Marketing Group. Sun Life Financial will pay approximately
$1.7 billion in cash for the two businesses.
The transaction is subject to customary conditions to closing, including
receipt of approvals by various state insurance regulators in the U.S., certain
other regulatory authorities in the U.S. and Canada and Liberty Financial's
shareholders. In connection with the execution of the definitive purchase
agreement, Liberty Mutual Insurance Company, the Company's controlling
stockholder, entered into an agreement to vote in favor of the Sun Life
Financial transaction.
The acquisition is expected to close in the second half of 2001. Based on
current estimates, the Company expects that it will record an after-tax gain of
approximately $150 million and will have proceeds, net of transaction costs and
taxes, of approximately $1.47 billion from the closing of the Sun Life Financial
transaction.
On May 3, 2001, the Company also announced that it was continuing to
explore strategic alternatives for its remaining asset management business and
has instructed Credit Suisse First Boston to continue to seek a buyer for that
business.
RESULTS OF OPERATIONS
NET INCOME (LOSS) was $(49.5) million or $(0.98) per share for the quarter
ended March 31, 2001 compared to $39.4 million or $0.82 per share for the
quarter ended March 31, 2000. This decrease resulted largely from the cumulative
effect of an accounting change, which related to the adoption of Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities." Income before cumulative effect of accounting change
decreased reflecting special compensation plan and restructuring expenses and
the net derivative loss. In addition, there were increased net realized
investment losses, amortization expense, interest expense and operating expenses
and decreased net change in unrealized and undistributed gains in private equity
limited partnerships. Partially offsetting these items were a tax benefit in
2001 compared to tax expense in 2000 and higher investment spread and fee
income.
PRETAX INCOME was $0.8 million for the quarter ended March 31, 2001
compared to $62.4 million for the quarter ended March 31, 2000. Pretax income
decreased reflecting special compensation plan and restructuring expenses and
the net derivative loss. In addition, there were increased net realized
investment losses, amortization expense, interest expense and operating expenses
and decreased net change in unrealized and undistributed gains in private equity
limited partnerships. Partially offsetting these items were higher investment
spread and fee income.
CHANGE IN ACCOUNTING PRINCIPLE
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 133, "Accounting for Derivative Instruments and Hedging Activities", and
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an amendment of SFAS No. 133" on January 1, 2001. The
Statement requires the Company to recognize all derivatives on the balance
sheet at fair value. Derivatives that are not hedges must be adjusted to fair
value through operations. If the derivative is a hedge, depending on the
nature of the hedge, changes in the fair value of derivatives will either be
offset by the change in fair value of the hedged assets, liabilities or firm
commitments through operations or recognized in other comprehensive income
until the hedged item is recognized in operations. The ineffective portion of
a derivative's change in fair value will be immediately recognized in
operations.
13
The cumulative effect, reported after tax and net of related effects on
deferred policy acquisition costs, upon adoption of the Statement at January 1,
2001 decreased net income and stockholders' equity by $54.3 million. The
adoption of the Statement may increase volatility in future reported income due,
among other reasons, to the requirements of defining an effective hedging
relationship under the Statement as opposed to certain hedges the Company
believes are effective economic hedges. The Company anticipates that it will
continue to utilize its current risk management philosophy, which includes the
use of derivative instruments.
NET DERIVATIVE LOSS of $3.8 million for the quarter ended March 31, 2001,
represents fair value changes of non-designated derivatives and the ineffective
portion of fair value hedges, net of related effects on deferred policy
acquisition costs.
All derivatives are recognized on the balance sheet at fair value. On the
date the derivative contract is entered into, the Company designates the
derivative as either (1) a hedge of the fair value of a recognized asset ("fair
value hedge") or (2) utilizes the derivative as an economic hedge
("non-designated derivative"). Changes in the fair value of a derivative that is
highly effective and is designated and qualifies as a fair value hedge, along
with the loss or gain on the hedged asset attributable to the hedged risk, are
recorded in current period operations as a component of net derivative loss.
Changes in the fair value of non-designated derivatives are reported in current
period operations as a component of net derivative loss.
The Company issues equity-indexed annuity contracts that contain a
derivative instrument that is "embedded" in the contract. Upon issuing the
contract, the embedded derivative is separated from the host contract (annuity
contract), is carried at fair value and is considered a non-designated
derivative. The Company purchases call options and futures on the S&P 500 Index
to economically hedge its obligation under the annuity contract to provide
returns based upon this index. The call options and futures are non-designated
derivatives. In addition, the Company utilizes non-designated total return swap
agreements to hedge its obligations related to certain separate account
liabilities. The net derivative gain (loss) related to changes in the fair value
of the "embedded" derivatives and call options and futures, net of related
effects on deferred policy acquisition costs, for the three month period ended
March 31, 2001 was a gain of $30.6 million and a loss of $(33.7) million,
respectively.
As a component of its investment strategy and to reduce its exposure to
interest rate risk, the Company utilizes interest rate swap agreements. 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 interest rate swap
agreements are designated and qualify as fair value hedges. The ineffective
portion of the fair value hedges, net of related effects on deferred policy
acquisition costs, resulted in a loss of $0.7 million for the quarter ended
March 31, 2001.
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedging transactions. This process includes
linking all fair value hedges to specific assets on the balance sheet. The
Company also formally assesses, both at the hedge's inception and on an ongoing
basis, whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values. When it is determined that a
derivative is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, the Company discontinues hedge accounting prospectively.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair value hedge, the derivative
will continue to be carried on the balance sheet at its fair value and changes
in value will be reported in operations. The subsequent fair value changes in
the hedged asset will no longer be reported in current period operations.
INVESTMENT SPREAD is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $87.8 million for the quarter ended March 31, 2001
compared to $78.6 million for the quarter ended March 31, 2000. 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 for the quarter ended March 31, 2001 was 2.52%
compared to 2.26% for the quarter ended March 31, 2000.
14
Investment income was $236.3 million for the quarter ended March 31,
2001 compared to $205.9 million for the quarter ended March 31, 2000. The
increase of $30.4 million in 2001 compared to 2000 includes a $30.9 million
increase as a result of a higher average investment yield and a $0.5 million
decrease resulting from a slightly lower level of average invested assets.
The average investment yield was 7.46% for the quarter ended March 31, 2001
compared to 6.49% for the quarter ended March 31, 2000. The adoption of SFAS
133 requires that call options be carried at fair value and are
non-designated derivatives. The changes of the fair value of the call options
are reported as a component of net derivative income (loss) in 2001. In the
prior year, the premium paid for a call option was amortized over its
contract term and the call option amortization was included as a component of
investment income. Investment income for the quarter ended March 31, 2000 was
net of $21.1 million of S&P 500 Index call option amortization expense
related to the Company's equity-indexed annuities. If SFAS 133 was not
adopted, call option amortization expense and the average investment yield
would have been $24.8 million and 6.68%, respectively, for the quarter ended
March 31, 2001.
Interest credited to policyholders totaled $148.5 million for the quarter
ended March 31, 2001 compared to $127.3 million for the quarter ended March 31,
2000. The increase of $21.2 million in 2001 compared to 2000 primarily relates
to a $21.5 million increase as a result of a higher average interest credited
rate, partially offset by a $0.3 million decrease as a result of a slightly
lower level of average policyholder balances. Policyholder balances averaged
$12.0 billion (including $9.9 billion of fixed products, consisting of fixed
annuities and a closed block of single premium whole life insurance, and $2.1
billion of equity-indexed annuities) for the quarter ended March 31, 2001
compared to $12.0 billion (including $9.7 billion of fixed products and $2.3
billion of equity-indexed annuities) for the quarter ended March 31, 2000. The
average interest credited rate was 4.94% (5.23% on fixed products and 3.56% on
equity-indexed annuities) for the quarter ended March 31, 2001 compared to 4.23%
(5.01% on fixed and 0.85% on equity-indexed annuities) for the quarter ended
March 31, 2000. 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.
Under SFAS 133, the index annuities are deemed to contain an embedded
derivative (the change in value attributable to the change in the S&P 500 index)
and a host contract. The host contracts' interest rate is derived at the
inception of the contract and an effective interest rate is utilized that will
result in a liability equal to the guaranteed minimum account value at the end
of the term. The embedded derivative is considered a non-designated derivative
and the changes in fair value are reported as a component of derivative income
(loss). In 2000, the interest credited to equity-indexed policyholders related
to the participation rate is reflected net of income recognized on the S&P 500
Index call options and futures resulting in a 0.85% net credited rate. If SFAS
133 was not adopted, interest credited and the average interest credited rate
would have been $140.7 million and 4.68% for the quarter ended March 31, 2001,
respectively.
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 $12.7
billion for the quarters ended March 31, 2001 and 2000.
NET REALIZED INVESTMENT LOSSES were $19.7 million for the quarter ended
March 31, 2001 compared to $3.9 million for the quarter ended March 31, 2000.
The net realized investment losses in 2001 and 2000 included losses of $21.8
million and $3.3 million, respectively, for certain investments where the
decline in value was determined to be other than temporary.
NET CHANGE IN UNREALIZED AND UNDISTRIBUTED GAINS IN PRIVATE EQUITY LIMITED
PARTNERSHIPS is accounted for on the equity method and represents primarily
increases in the fair value of the underlying investments of the private equity
limited partnerships for which the Company has ownership interests in excess of
3%. This change in unrealized and undistributed gains is recorded net of the
related amortization of deferred policy acquisition costs of $4.9 million and
$27.8 million for the three months ended March 31, 2001 and 2000, respectively,
and net of amounts realized, which are recognized in investment income, of $8.9
million and $1.7 million for the three months ended March 31, 2001 and 2000,
15
respectively. The financial information for these investments is obtained
directly from the private equity limited partnerships on a periodic basis. There
can be no assurance that any unrealized and undistributed gains will ultimately
be realized or that the Company will not incur losses in the future on such
investments.
INVESTMENT ADVISORY AND ADMINISTRATIVE FEES are based on the market value
of assets managed for mutual funds and institutional investors. Investment
advisory and administrative fees were $75.1 million for the quarter ended March
31, 2001 compared to $71.9 million for the quarter ended March 31, 2000. The
increase during 2001 compared to 2000 primarily reflects a higher level of fees
earned on average fee-based assets under management resulting from a change in
product mix.
Average fee-based assets under management were $51.3 billion for the
quarter ended March 31, 2001 compared to $51.7 billion for the quarter ended
March 31, 2000. The decrease during 2001 compared to 2000 resulted from negative
market action for the twelve months ended March 31, 2001 and from the sale,
completed on December 29, 2000, of the Company's Private Capital Management
division of Stein Roe & Farnham, Incorporated, largely offset by the
acquisition, completed on September 29, 2000, of Wanger Asset Management, L.P.
and net sales for the twelve months ended March 31, 2001. Investment advisory
and administrative fees were 0.59% and 0.56% of average fee-based assets under
management for the quarters ended March 31, 2001 and 2000, respectively.
The amount of fee-based assets under management is affected by product
sales and redemptions 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).
FEE-BASED ASSETS UNDER MANAGEMENT
AS OF MARCH 31
------------------------
2001 2000
-------- -------
Mutual Funds:
Intermediary-distributed $17.1 $18.0
Direct-marketed 11.8 6.9
Closed-end 2.5 2.9
Variable annuity 2.5 2.1
----- -----
33.9 29.9
Private Capital Management -- 9.6
Institutional 15.0 13.6
----- -----
Total Fee-Based Assets Under Management* $48.9 $53.1
===== =====
- --------------
* As of March 31, 2001 and 2000, Keyport's insurance assets of $14.8 billion
and $14.0 billion, respectively, bring total assets under management to
$63.7 billion and $67.1 billion, respectively.
16
CHANGES IN FEE-BASED ASSETS UNDER MANAGEMENT
THREE MONTHS ENDED
MARCH 31
-------------------------
2001 2000
-------- --------
Fee-based assets under management - beginning $51.8 $51.4
Sales and reinvestments:
Mutual funds 2.6 1.6
Private Capital Management -- 0.4
Institutional 0.4 0.9
----- -----
3.0 2.9
----- -----
Redemptions and withdrawals:
Mutual funds (2.4) (2.2)
Private Capital Management -- (0.2)
Institutional (0.4) (0.4)
----- -----
(2.8) (2.8)
----- -----
Market appreciation (depreciation) (3.1) 1.6
----- -----
Fee-based assets under management - ending $48.9 $53.1
===== =====
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 $15.3 million
for the quarter ended March 31, 2001 compared to $15.4 million for the quarter
ended March 31, 2000. As a percentage of intermediary-distributed average mutual
fund assets, distribution and service fees were approximately 0.34% and 0.35%
for the quarters ended March 31, 2001 and 2000, respectively.
TRANSFER AGENCY FEES for the Company's intermediary-distributed mutual
funds are based on a three-tier structure, which includes an account fee, a
transaction fee, and a fee based on the market value of the assets managed.
Transfer agency fees for the Company's direct-marketed mutual funds are based on
the market value of the assets in the funds, and variable annuity mutual funds
are charged a flat fee. Such fees were $12.6 million on average assets of $33.9
billion for the quarter ended March 31, 2001 and $12.7 million on average assets
of $26.8 billion for the quarter ended March 31, 2000. As a percentage of total
average assets under management, transfer agency fees were approximately 0.15%
for the quarter ended March 31, 2001 compared to 0.19% for the quarter ended
March 31, 2000.
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 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 $8.8 million for the quarter ended
March 31, 2001 compared to $10.7 million for the quarter ended March 31, 2000.
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 $5.7 million for the quarter
ended March 31, 2001 and $7.4 million for the quarter ended March 31, 2000.
Total annuity withdrawals represented 17.5% and 14.9% of the total average
annuity policyholder and separate account balances for the quarters ended March
31, 2001 and 2000, respectively. Net commissions were $3.1 million for the
quarter ended March 31, 2001 and $3.3 million for the quarter ended March 31,
2000.
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
17
based on the market values of the assets in separate accounts supporting the
contracts, were $12.8 million for the quarter ended March 31, 2001 compared to
$10.7 million for the quarter ended March 31, 2000. The increase in separate
account fees was due to the increase in separate account assets for the twelve
months ended March 31, 2001. Such fees represented 1.25% and 1.27% of average
variable annuity, variable life and institutional separate account balances for
the quarters ended March 31, 2001 and 2000, respectively.
OPERATING EXPENSES primarily represent compensation, marketing, and other
general and administrative expenses. These expenses were $105.4 million for the
quarter ended March 31, 2001 compared to $102.3 million for the quarter ended
March 31, 2000. Operating expenses expressed as a percent of average total
assets under management were 0.64% and 0.63% for the quarters ended March 31,
2001 and 2000, respectively.
RESTRUCTURING CHARGES in the first quarter of 2001 of $1.4 million consist
of severance and other expenses. The restructuring charges primarily relate to
three initiatives, which commenced during 2000, streamlining the Company's
mutual fund product offerings, centralizing corporate functions and outsourcing
certain mutual fund operations.
SPECIAL COMPENSATION PLAN expense of $20.4 million for the quarter ended
March 31, 2001 relates to the Company's announcement on November 1, 2000 that it
has retained the investment banking firm of Credit Suisse First Boston
Corporation to review its strategic initiatives, including a possible sale of
the Company. To help retain its employees during the strategic review, the
Company implemented a special compensation plan that provides cash retention
bonuses to substantially all employees. The retention bonuses are generally
based on employees' base salary and/or target incentive compensation amounts,
except for sales personnel where retention bonuses are based on sales. The
estimated maximum cost of the retention bonuses, assuming all covered employees
remain with the Company, is approximately $165.0 million with fifty percent
payable on November 1, 2001 and the remainder payable on May 1, 2002. In the
event of a change of control of the Company that occurs prior to November 1,
2001, the payments would be accelerated and the retention bonus amount would be
reduced, subject to a minimum. Under the special compensation plan, the sale of
either the annuity and bank marketing businesses or the asset management
business will be deemed a change of control of such businesses only. The
estimated minimum retention bonus is approximately $91.0 million and would be
recognized if a change of control occurs prior to May 14, 2001. The amount of
the retention bonus increases from the minimum on May 14, 2001 to the maximum on
October 31, 2001. In calculating the expense of $20.4 million for the quarter
ended March 31, 2001, an annualized turnover rate of 15% was assumed.
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 $32.7
million for the quarter ended March 31, 2001 compared to $27.1 million for the
quarter ended March 31, 2000. The increase during 2001 compared to 2000 was due
to the increased spread realized on the in-force business associated with fixed
and equity-indexed products. Amortization expense represented 32.5% and 30.3% of
investment spread and separate account fees for the quarters ended March 31,
2001 and 2000, 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 $12.0 million for the quarter ended March 31,
2001 compared to $10.2 million for the quarter ended March 31, 2000. The
increase in 2001 compared to 2000 was due to increased sales of
intermediary-distributed mutual funds, which were sold with 12b-1 distribution
fees and contingent deferred sales charges.
AMORTIZATION OF INTANGIBLE ASSETS relates to goodwill and certain
identifiable intangible assets arising from business combinations accounted for
as purchases. Amortization was $8.7 million for the quarter ended March 31, 2001
compared to $5.1 million for the quarter ended March 31, 2000. The increase in
amortization in 2001 is primarily attributable to the purchase of Wanger Asset
Management, L.P. in September of 2000. The Company has experienced higher than
anticipated redemptions of assets under management at an acquired company, which
at March 31, 2001 had goodwill and other intangible assets of $77.7 million.
Although the Company has determined that there is no impairment of goodwill and
other intangible assets at this time, if the higher level of redemptions were to
continue and sales were not to increase, the Company's estimate of related
future cash flows may change, resulting in the need to record an impairment
loss.
18
INTEREST EXPENSE, NET was $10.2 million for the quarter ended March 31,
2001 compared to $4.0 million for the quarter ended March 31, 2000. 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 sold
with 12b-1 distribution fees and contingent deferred sales charges. Interest
expense was net of interest income of $5.0 million and $5.8 million for the
quarters ended March 31, 2001 and 2000, respectively.
INCOME TAX BENEFIT (EXPENSE) was $4.0 million for the quarter ended March
31, 2001 compared to $(23.0) million, or 36.9% of pretax income for the quarter
ended March 31, 2000. The tax benefit for the first quarter of 2001 primarily
reflects a reduction to the valuation allowance established for unrealized
capital losses in the "available for sale" investment portfolio.
FINANCIAL CONDITION
STOCKHOLDERS' EQUITY as of March 31, 2001 was $1.43 billion compared to
$1.45 billion as of December 31, 2000. The net loss for the first three months
of 2001 was $49.5 million and cash dividends on the Company's preferred and
common stock totaled $5.0 million. Common stock totaling $2.8 million was issued
in connection with the exercise of stock options. Other comprehensive income,
which consists of net unrealized investment gains net of adjustments to deferred
policy acquisition costs and income taxes, during the period increased
stockholders' equity by $33.5 million.
BOOK VALUE PER SHARE amounted to $29.25 at March 31, 2001 compared to
$29.68 at December 31, 2000. Excluding net unrealized gains and losses on
investments (computed pursuant to Statement of Financial Accounting Standards
No. 115), book value per share amounted to $29.19 at March 31, 2001 and $30.30
at December 31, 2000. As of March 31, 2001, there were 48.9 million common
shares outstanding compared to 48.8 million shares as of December 31, 2000.
INVESTMENTS not including cash and cash equivalents, totaled $12.3 billion
at March 31, 2001 as compared to $12.2 billion at December 31, 2000.
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 March 31, 2001 and December 31,
2000 reflected net unrealized gains (losses) of $108.0 million and ($62.0)
million, respectively.
Approximately $12.1 billion, or 78.6%, of the Company's general account and
certain separate account investments at March 31, 2001 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 March 31, 2001, the carrying value of investments in
below investment grade securities totaled $1.3 billion or 8.6% of general
account investments, including cash and cash equivalents in the Company's
annuity operations, and certain separate account investments of $15.4 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 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 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 March 31, 2001 and December 31, 2000, the carrying value of fixed maturity
securities that were non-income producing was $52.3 million and $24.4 million,
respectively.
19
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. 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 86 and 69 outstanding swap agreements with an
aggregate notional principal amount of $3.2 billion and $3.8 billion as of
March 31, 2001 and December 31, 2000, 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 no outstanding interest
rate cap agreements as of March 31, 2001 and December 31, 2000.
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. The Company had call
options with a carrying value of $134.7 million and $337.7 million as of
March 31, 2001 and December 31, 2000, respectively. The Company had total
return swap agreements with a carrying value of $12.7 million and $23.9
million as of March 31, 2001 and December 31, 2000, respectively.
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.
20
LIQUIDITY
The Company is a holding company whose liquidity needs include the
following: (i) operating expenses; (ii) debt service; (iii) dividends on
preferred 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
Wanger acquisition, the Company issued $200.0 million of debt to Liberty Mutual
Insurance Company and its affiliates. Such debt is payable upon any change of
control 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. 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 March 31, 2001, the interest rate on borrowings under the Facility
was 5.21% 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 March 31, 2001, the amount of dividends that
Keyport could pay during 2001 without such approval was $38.4 million. 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 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 Liberty Funds Group LLC, also 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 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 March 31, 2001, $12.4 billion, or 80.4%, 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 investments, thereby precluding the sale of fixed
maturity
21
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 March 31, 2001.
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 not based on historical fact, trend
analyses and other information contained 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 Company's plans, 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 made based on current expectations and assumptions and 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 expressed or implied 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) that the net change in unrealized and undistributed gains in private equity
limited partnerships will not be realized or that future losses on such
investment will not occur; (4) levels of surrenders, withdrawals and net
redemptions of the Company's retirement-oriented insurance products and
investment management products; (5) the Company's ability to establish and
maintain relationships with investment management clients, including levels of
assets under management; (6) 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; (7) 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; (8) changes in
financial ratings of Keyport or those of its competitors; (9) the Company's
ability to attract and retain key employees, including senior officers,
portfolio managers and sales executives; (10) 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; (11) changes in applicable tax
laws which may affect the relative tax advantages and attractiveness of some of
the Company's products; (12) the result of any litigation or legal proceedings
involving the Company; (13) changes in generally accepted accounting principles
and the impact of accounting principles and pronouncements on the Company's
financial condition and results of operations; (14) changes in the Company's
senior debt ratings; (15) changes in operating expense levels; (16) acquisition
risks, including risks that the acquisition and integration of Wanger Asset
Management, L.P. will not be as successful as anticipated; (17) sales risks,
including the risk that the proposed sale of the Company's annuity segment to
Sun Life Financial will not be consummated; (18) risks that the Company will not
achieve favorable effective tax rates; (19) risks
22
that the Company's restructuring efforts and retention efforts will not be
successful; (20) risks that the Company's continued exploration of strategic
alternatives with respect to the asset management business will not succeed or
result in a transaction on attractive terms or at all; (21) expected benefits
from the combination of the Company's annuity segment with Sun Life Financial
failing to materialize; (22) risks that the actual after-tax gain and net
proceeds on the sale of Keyport and Independent Financial Marketing Group
("IFMG") may be different than estimates due to, among other things, changes in
the estimated stockholders' equity of Keyport and IFMG including the effects of
Statement of Financial Accounting Standards No. 115 - net unrealized investment
gains and losses, changes in estimated income taxes on the sale, transaction
costs and other factors; (23) increased volatility of reported income associated
with the adoption of SFAS Nos. 133 and 138; and (24) 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.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes during the first three months of 2001
in the Company's market risks or in the methods which the Company uses to manage
such risks, which are described in the Company's Form 10-K (as amended) for the
year ended December 31, 2000.
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
12 Statement re Computation of Ratios
(b) REPORTS ON FORM 8-K
On May 4, 2001, the Company filed a report on Form 8-K under Item 5 of
such form. A copy of the definitive agreement to sell the Company's annuity
and bank marketing businesses to Sun Life Financial was filed as Exhibit
99.1 to the Form 8-K.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LIBERTY FINANCIAL COMPANIES, INC.
/s/ J. Andy Hilbert
---------------------------------
J. Andy Hilbert
(Duly Authorized Officer and
Chief Financial Officer)
Date: May 14, 2001
25
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE
12 Statement re Computation of Ratios 27
26