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 September 30, 2001
-------------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------------------- -------------------
Commission file number: 1-13654
LIBERTY FINANCIAL COMPANIES, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Massachusetts 04-3260640
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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 49,131,858 shares of the registrant's Common Stock, $.01 par
value, and no shares of the registrant's Series A Convertible Preferred Stock,
$.01 par value, outstanding as of October 31, 2001.
Exhibit Index - Page 28 Page 1 of 80
LIBERTY FINANCIAL COMPANIES, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 2001
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
- ------- ----
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2001 and December 31,
2000 3
Consolidated Statements of Operations for the Three Months and Nine
Months Ended September 30, 2001 and 2000 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2001 and 2000 5
Consolidated Statement of Stockholders' Equity for the Nine Months Ended
September 30, 2001 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION
- --------
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
Exhibit Index 28
2
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
SEPTEMBER 30 DECEMBER 31
2001 2000
------------ -----------
UNAUDITED
ASSETS
Assets:
Investments $12,053.2 $12,232.4
Cash and cash equivalents 1,959.4 1,891.0
Accrued investment income 142.8 163.5
Deferred policy acquisition costs 531.0 547.9
Deferred distribution costs 175.2 169.4
Intangible assets 507.3 533.0
Other assets 402.3 401.0
Separate account assets 3,853.3 4,212.5
--------- ---------
$19,624.5 $20,150.7
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policyholder balances $12,033.3 $11,968.5
Notes payable to affiliates 200.0 200.0
Notes payable 565.3 563.2
Payable for investments purchased and loaned 1,220.9 1,364.5
Other liabilities 379.8 429.3
Separate account liabilities 3,823.4 4,166.8
--------- ---------
Total liabilities 18,222.7 18,692.3
--------- ---------
Series A redeemable convertible preferred stock, par value $.01;
authorized, issued and outstanding, no shares in 2001 and
213,242 shares in 2000 -- 10.7
--------- ---------
Stockholders' Equity:
Common stock, par value $.01; authorized 100,000,000 shares,
issued and outstanding, 48,975,583 shares in 2001 and
48,784,459 shares in 2000 0.5 0.5
Additional paid-in capital 954.2 949.1
Retained earnings 413.9 532.4
Accumulated other comprehensive income (loss) 35.7 (30.6)
Unearned compensation (2.5) (3.7)
--------- ---------
Total stockholders' equity 1,401.8 1,447.7
--------- ---------
$19,624.5 $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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------- ------------------
2001 2000 2001 2000
------- ------- ------- -------
Investment income, including distributions from private
equity limited partnerships of $0 and $26.9 million
for the three months and nine months ended
September 30, 2001, respectively, and $6.2 million
and $8.7 million for the three months and nine months
ended September 30, 2000, respectively $ 196.8 $ 214.1 $ 670.5 $ 636.4
Interest credited to policyholders (148.0) (135.8) (449.9) (396.3)
------- ------- ------- -------
INVESTMENT SPREAD 48.8 78.3 220.6 240.1
------- ------- ------- -------
NET DERIVATIVE LOSSES (5.7) -- (1.5) --
------- ------- ------- -------
NET REALIZED INVESTMENT LOSSES (25.3) (20.8) (58.4) (37.6)
------- ------- ------- -------
NET CHANGE IN UNREALIZED AND UNDISTRIBUTED (LOSSES) GAINS IN
PRIVATE EQUITY LIMITED PARTNERSHIPS (2.5) 5.9 (17.1) 28.4
------- ------- ------- -------
Fee income:
Investment advisory and administrative fees 71.1 71.2 219.4 214.4
Distribution and service fees 12.3 15.6 41.9 46.1
Transfer agency fees 12.0 12.3 36.3 37.2
Surrender charges and net commissions 8.3 10.1 25.1 30.1
Separate account fees 12.4 11.8 39.6 33.6
------- ------- ------- -------
TOTAL FEE INCOME 116.1 121.0 362.3 361.4
------- ------- ------- -------
Expenses:
Operating expenses (99.5) (98.1) (303.5) (300.0)
Restructuring 0.2 (11.3) 0.5 (11.3)
Strategic review expenses (51.0) -- (91.2) --
Amortization of deferred policy acquisition costs (24.2) (26.9) (87.8) (83.8)
Amortization of deferred distribution costs (12.9) (10.9) (37.4) (31.5)
Amortization of intangible assets (8.4) (5.1) (25.6) (15.3)
Interest expense, net (11.0) (4.8) (30.5) (13.0)
------- ------- ------- -------
TOTAL EXPENSES (206.8) (157.1) (575.5) (454.9)
------- ------- ------- -------
PRETAX INCOME (LOSS) (75.4) 27.3 (69.6) 137.4
Income tax (expense) benefit 26.3 (5.2) 27.0 (46.9)
------- ------- ------- -------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES (49.1) 22.1 (42.6) 90.5
Cumulative effect of accounting changes, net of tax -- -- (60.8) --
------- ------- ------- -------
NET INCOME (LOSS) $ (49.1) $ 22.1 $(103.4) $ 90.5
======= ======= ======= =======
Net income (loss) per share - basic:
Income (loss) before cumulative effect of accounting
changes $ (1.02) $ 0.46 $ (0.89) $ 1.89
======= ======= ======= =======
Net income (loss) $ (1.02) $ 0.46 $ (2.14) $ 1.89
======= ======= ======= =======
Net income (loss) per share - assuming dilution:
Income (loss) before cumulative effect of accounting
changes $ (0.99) $ 0.45 $(0.85) $ 1.86
======= ======= ======= =======
Net income (loss) $ (0.99) $ 0.45 $(2.06) $ 1.86
======= ======= ======= =======
See accompanying notes to consolidated financial statements.
4
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
UNAUDITED
NINE MONTHS ENDED
SEPTEMBER 30
----------------------------
2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (103.4) $ 90.5
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Cumulative effect of accounting changes, net of tax 60.8 --
Non-cash derivative activity 95.2 --
Depreciation and amortization 73.2 59.1
Interest credited to policyholders 449.9 396.3
Net realized investment losses 58.4 37.6
Net change in unrealized and undistributed losses (gains) in
private equity limited partnerships 17.1 (28.4)
Net (accretion) amortization on investments (11.9) 58.5
Change in deferred policy acquisition costs (55.3) (0.9)
Net change in other assets and liabilities (158.9) (81.1)
--------- ---------
Net cash provided by operating activities 425.1 531.6
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased available for sale (1,961.0) (4,757.9)
Investments sold available for sale 2,048.3 4,756.1
Investments matured available for sale 86.6 110.8
Change in policy loans, net (12.4) (16.9)
Change in mortgage loans, net 1.9 2.1
Acquisition, net of cash acquired -- (274.2)
Other (4.8) 44.4
--------- ---------
Net cash provided by (used in) investing activities 158.6 (135.6)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Withdrawals from policyholder accounts (1,957.6) (1,545.7)
Deposits to policyholder accounts 1,568.3 1,177.3
Securities lending (106.7) 558.5
Change in notes payable 2.2 229.1
Exercise of stock options 4.5 2.2
Dividends paid (15.1) (4.7)
Redemption of preferred stock (10.9) (5.5)
--------- ---------
Net cash (used in) provided by financing activities (515.3) 411.2
--------- ---------
Increase in cash and cash equivalents 68.4 807.2
Cash and cash equivalents at beginning of period 1,891.0 1,232.6
--------- ---------
Cash and cash equivalents at end of period $ 1,959.4 $ 2,039.8
========= =========
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 PAID-IN RETAINED COMPREHENSIVE UNEARNED STOCKHOLDERS'
STOCK 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 5.1 1.2 6.3
Common stock
dividends (14.7) (14.7)
Preferred stock
dividends (0.4) (0.4)
Net income (loss) (103.4) (103.4)
Other comprehensive
income, net of tax 66.3 66.3
---- ------ ------- ------ ----- --------
BALANCE,
SEPTEMBER 30, 2001 $0.5 $954.2 $ 413.9 $ 35.7 $(2.5) $1,401.8
==== ====== ======= ====== ===== ========
See accompanying notes to consolidated financial statements.
6
LIBERTY FINANCIAL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 and nine months ended
September 30, 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 - DISPOSITIONS AND MERGER
On October 31, 2001, the Company sold its annuity and bank marketing
business to Sun Life Assurance Company of Canada, a Canadian insurance
corporation ("Sun Life"). As part of this sale, Sun Life acquired
Keyport Life Insurance Company and Independent Financial Marketing Group.
Sun Life paid approximately $1.7 billion in cash resulting in an estimated
$116 million after-tax gain. The Company received proceeds, net of
estimated transaction costs and taxes, of approximately $1.454 billion.
A copy of the Sun Life Stock Purchase Agreement was included as an exhibit
to a Form 8-K filed on May 4, 2001.
On November 1, 2001, the Company sold its asset management business to
Fleet National Bank ("Fleet"). In connection with this sale, Fleet
acquired all of the Company's asset management operations, including:
Colonial Management Associates, Crabbe Huson Group, Inc., Liberty Asset
Management Company, Liberty Funds Distributor, Liberty Funds Services,
Newport Pacific Management, Inc., Progress Investment Management, Inc.,
Stein Roe & Farnham Incorporated and Liberty Wanger Asset Management.
Fleet paid approximately $900 million in cash and assumed approximately
$110 million in revolving debt incurred by a subsidiary of the Company to
finance sales commissions resulting in an estimated $52 million after-tax
gain. The Company received proceeds, net of estimated transaction costs
and taxes, of approximately $686 million. A copy of the Fleet Stock
Purchase Agreement was included as an exhibit to a Form 8-K filed on
June 6, 2001.
The following unaudited pro forma summary presents information as if
the sales of the annuity and bank marketing business to Sun Life and the
asset management business to Fleet had occurred as of January 1, 2000. The
pro forma information does not necessarily reflect the actual results that
would have occurred.
NINE MONTHS ENDED
SEPTEMBER 30
------------------
IN MILLIONS, EXCEPT PER SHARE DATA 2001 2000
------ ------
Net income (loss) $(50.0) $2.8
====== =====
Net income (loss) per share - assuming dilution $(1.00) $0.06
====== =====
On June 4, 2001, the Company announced that it had entered into a
merger agreement with Liberty Mutual Insurance Company ("Liberty Mutual").
Under the agreement, the Company will become a wholly owned subsidiary of
Liberty Mutual and the Company's public stockholders will receive a cash
amount currently estimated to be $33.44 per share. Such amount is subject
to adjustment in certain circumstances and may be materially different
than $33.44. The closing under the merger transaction is subject to
certain conditions. A copy of the Merger Agreement was included as an
exhibit to a Form 8-K filed on June 6, 2001.
7
On October 15, 2001, the Company commenced a cash tender offer to
purchase all of its outstanding 6.75% notes due November 15, 2008 and its
7.625% debentures due November 15, 2028, collectively referred to as (the
"securities"). To date, the Company has received tenders on approximately
95% of the securities. Payment, anticipated to occur on November 13,
2001, on the securities will be made from the net proceeds received in
the Sun Life and Fleet transactions. In addition, debt of $200 million
issued to Liberty Mutual and its affiliates was liquidated on
November 1, 2001.
3. CHANGES IN ACCOUNTING PRINCIPLES
The cumulative effect of accounting changes, net of tax for the nine
months ended September 30, 2001 of $60.8 million includes a loss of $54.3
million relating to the adoption of 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"
(collectively hereafter referred to as the "Statement") in the quarter
ended March 31, 2001 and a loss of $6.5 million relating to the adoption of
Emerging Issues Task Force ("EITF") Issue No. 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial
Interests in Securitized Financial Assets" in the quarter ended June 30,
2001.
The Company adopted the Statement 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.
The Company adopted EITF Issue No. 99-20 on April 1, 2001. EITF Issue
No. 99-20 governs the method of recognizing interest income and impairment
on asset-backed investment securities. EITF Issue No. 99-20 requires the
Company to update the estimate of cash flows over the life of certain
retained beneficial interests in securitization transactions and purchased
beneficial interests in securitized financial assets. Pursuant to EITF
Issue No. 99-20, based on current information and events, if the Company
estimates that the fair value of its beneficial interests is not greater
than or equal to its carrying value and if there has been a decrease in the
estimated cash flows since the last revised estimate, considering both
timing and amount, then an other-than-temporary impairment should be
recognized. The cumulative effect, reported after tax and net of related
effects on deferred policy acquisition costs, upon adoption of EITF Issue
No. 99-20 on April 1, 2001 decreased net income by $6.5 million with a
related increase to accumulated other comprehensive income of $1.8 million.
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 losses. Changes in the fair value of
non-designated derivatives are reported in current period operations as a
component of net derivative losses.
8
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 losses
of $4.5 million and $2.6 million for the three and nine months ended
September 30, 2001, respectively.
The Company utilizes treasury rate lock agreements to reduce its
exposure to interest rate risk related to certain of its notes payable.
Treasury rate lock agreements are agreements to exchange with a
counterparty payments based on an underlying principal balance (notional
principal) to hedge against interest rate changes. The treasury rate lock
agreements are designated and qualify as fair value hedges. The ineffective
portion of the fair value hedges resulted in gains of $0.8 million and $0.3
million for the three and nine months ended September 30, 2001,
respectively.
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
Prior to the sale of its two segments to Sun Life and Fleet (see
Note 2), the Company was 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 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.
9
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------- --------------------
2001 2000 2001 2000
------ ------- -------- ------
Statement of Operations Data
REVENUES (EXCLUDING NET REALIZED INVESTMENT LOSSES AND
NET CHANGE IN UNREALIZED AND UNDISTRIBUTED (LOSSES)
GAINS IN PRIVATE EQUITY LIMITED PARTNERSHIPS):
Annuity:
Unaffiliated $212.6 $236.8 $ 735.9 $700.6
Intersegment (4.6) (4.1) (13.8) (12.2)
------ ------ -------- ------
Total annuity 208.0 232.7 722.1 688.4
------ ------ -------- ------
Asset management:
Unaffiliated 94.6 98.3 295.4 297.2
Intersegment 4.6 4.1 13.8 12.2
------ ------ -------- ------
Total asset management 99.2 102.4 309.2 309.4
------ ------ -------- ------
Total revenues (excluding net realized investment
losses and net change in unrealized and
undistributed (losses) gains in private equity
limited partnerships) $307.2 $335.1 $1,031.3 $997.8
====== ====== ======== ======
Statement of Operations Data
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGES:
Annuity:
Income before amortization of intangible assets $ 15.7 $ 50.8 $ 125.9 $149.4
Amortization of intangible assets (0.3) (0.3) (0.9) (0.9)
------ ------ -------- ------
Subtotal annuity 15.4 50.5 125.0 148.5
------ ------ -------- ------
Asset management:
Income before amortization of intangible assets 12.3 21.6 43.2 57.6
Amortization of intangible assets (8.0) (4.8) (24.4) (14.4)
------ ------ -------- ------
Subtotal asset management 4.3 16.8 18.8 43.2
------ ------ -------- ------
Other:
Loss before amortization of intangible assets (16.4) (13.8) (46.9) (33.8)
Amortization of intangible assets (0.1) -- (0.3) --
------ ------ -------- ------
Subtotal other (16.5) (13.8) (47.2) (33.8)
------ ------ -------- ------
Income before non-operating items, cumulative effect
of accounting changes and income taxes 3.2 53.5 96.6 157.9
Net realized investment losses (25.3) (20.8) (58.4) (37.6)
Net change in unrealized and undistributed (losses)
gains in private equity limited partnerships (2.5) 5.9 (17.1) 28.4
Restructuring 0.2 (11.3) 0.5 (11.3)
Strategic review expenses (51.0) -- (91.2) --
------ ------ -------- ------
Pretax income (loss) $(75.4) $ 27.3 $ (69.6) $137.4
====== ====== ======== ======
10
6. INVESTMENTS
Investments were comprised of the following (in millions):
SEPTEMBER 30 DECEMBER 31
2001 2000
------------ -----------
Fixed maturities $10,829.1 $10,668.3
Equity securities 57.7 76.4
Policy loans 633.2 620.8
Other invested assets 533.2 866.9
--------- ---------
Total $12,053.2 $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.
11
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------ --------------------------
2001 2000 2001 2000
---------- ----------- ----------- -----------
Numerator (in millions)
Income (loss) before cumulative effect of accounting
changes $ (49.1) $ $22.1 $ (42.6) $ 90.5
Less: preferred stock dividends (0.4) (0.2) (0.7) (0.6)
---------- ----------- ----------- -----------
Numerator for income (loss) per share-basic-income
(loss) before cumulative effect of accounting changes
available to common stockholders (49.5) 21.9 (43.3) 89.9
Cumulative effect of accounting changes, net of tax -- -- (60.8) --
---------- ----------- ----------- -----------
Numerator for net income (loss) per share-basic-net
income (loss) available to common stockholders $ (49.5) $ 21.9 $ (104.1) $ 89.9
========== =========== =========== ===========
Income (loss) before cumulative effect of accounting
changes available to common stockholders $ (49.5) $ 21.9 $ (43.3) $ 89.9
Plus: income impact of assumed conversions
Preferred stock dividends 0.4 0.2 0.7 0.6
---------- ----------- ----------- -----------
Numerator for income (loss) per share-assuming
dilution-income (loss) before cumulative effect
of accounting changes available to common
stockholders after assumed conversions (49.1) 22.1 (42.6) 90.5
Cumulative effect of accounting changes, net of tax -- -- (60.8) --
------------ ------------ ------------ ------------
Numerator for net income (loss) per share-assuming
dilution-net income (loss) available to common
stockholders after assumed conversions $ (49.1) $ 22.1 $ (103.4) $ 90.5
========== =========== =========== ===========
Denominator
Denominator for net income (loss) per share-basic-
weighted-average shares 48,717,648 47,927,182 48,653,911 47,680,808
Effect of dilutive securities:
Employee stock options 885,981 588,352 1,159,648 407,683
Convertible preferred stock 194,570 339,547 289,496 440,543
---------- ----------- ----------- -----------
Dilutive potential common shares 1,080,551 927,899 1,449,144 848,226
---------- ----------- ----------- -----------
Denominator for net income (loss) per share-assuming
dilution 49,798,199 48,855,081 50,103,055 48,529,034
========== =========== =========== ===========
Net income (loss) per share-basic:
Income (loss) before cumulative effect of accounting
changes $ (1.02) $ 0.46 $ (0.89) $ 1.89
Cumulative effect of accounting changes, net of tax -- -- (1.25) --
---------- ----------- ----------- -----------
Net income (loss) $ (1.02) $ 0.46 $ (2.14) $ 1.89
========== =========== =========== ===========
Net income (loss) per share - assuming dilution:
Income (loss) before cumulative effect of accounting
changes $ (0.99) $ 0.45 $ (0.85) $ 1.86
Cumulative effect of accounting changes, net of tax -- -- (1.21) --
---------- ----------- ----------- -----------
Net income (loss) $ (0.99) $ 0.45 $ (2.06) $ 1.86
========== =========== =========== ===========
12
8. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) was comprised of the following (in millions):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------- -----------------------
2001 2000 2001 2000
------- ------ -------- ------
Net income (loss) $(49.1) $ 22.1 $(103.4) $ 90.5
Other comprehensive income, net of taxes:
Net unrealized gains on securities 31.6 84.3 66.3 46.0
------ ------ ------- ------
Comprehensive income (loss) $(17.5) $106.4 $ (37.1) $136.5
====== ====== ======= ======
9. REDEMPTION OF PREFERRED STOCK
The Company redeemed all outstanding shares of the Company's Series A
Redeemable Convertible Preferred Stock (the "Preferred Stock") on August 23,
2001 (the "Redemption Date"). The redemption price was $51.54688 per share and
included all dividends unpaid and accruing up to the Redemption Date. Any
holders who did not want to participate in this redemption converted their
Preferred Stock into shares of the Company's Common Stock (the "Common Stock")
and received a number of shares of Common Stock determined by multiplying
1.58385 times the number of shares of Preferred Stock converted, with a cash
payment in lieu of any fractional shares of Common Stock. As a result of this
transaction, the Company paid $10.9 million and issued 1,656 shares of Common
Stock.
10. SEPTEMBER 11, 2001
The Company has approximately $440.6 million of fixed maturities invested
in entities associated with the airline, hotel, and hospitality businesses.
The national tragedy of September 11, 2001 has had an adverse impact on these
industries. The Company has not recorded any other-than-temporary declines
due to the decrease in market value of these investments subsequent to the
September 11 terrorist attacks.
The Company also has a swap agreement in which the Company participates in
a reinsurance pool of catastrophic insurance. The Company's maximum exposure
under this agreement is $13.6 million per calendar year. The Company's estimated
pro-rata share of losses associated with the September 11 terrorist attacks is
$11.8 million, which has been recorded as a reduction to net investment income.
11. RECENT ACCOUNTING PRONOUNCEMENT
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets."
SFAS No. 142 addresses financial accounting and reporting for goodwill and other
intangible assets subsequent to their acquisition and distinguishes between
intangible assets that have a finite useful life and intangible assets that have
an indefinite useful life. If no legal, regulatory, contractual, competitive,
economic, or other factors limit the useful life of an intangible asset, the
useful life of the asset shall be considered to be indefinite. Intangible assets
that have a finite useful life are amortized in accordance with the requirements
of SFAS No. 142. Intangible assets that have an indefinite useful life are not
amortized until their useful life is determined to be no longer indefinite. An
intangible asset that is not subject to amortization shall be tested for
impairment annually, or more frequently if events or changes in circumstances
indicate that the asset might be impaired.
All of the provisions of SFAS No. 142 are to be applied in fiscal years
beginning after December 15, 2001 to all goodwill and other intangible assets
recognized in an entity's statement of financial position at the beginning of
that fiscal year, regardless of when those previously recognized assets were
initially recognized. The Company has not yet determined the impact of SFAS No.
142.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
On October 31, 2001, the Company sold its annuity and bank marketing
business to Sun Life Assurance Company of Canada, a Canadian insurance
corporation ("Sun Life"). As part of this sale, Sun Life acquired Keyport
Life Insurance Company and Independent Financial Marketing Group. Sun Life
paid approximately $1.7 billion in cash resulting in an estimated $116
million after-tax gain. The Company received proceeds, net of estimated
transaction costs and taxes, of approximately $1.454 billion. A copy of the
Sun Life Stock Purchase Agreement was included as an exhibit to a Form 8-K
filed on May 4, 2001.
On November 1, 2001, the Company sold its asset management business to
Fleet National Bank ("Fleet"). In connection with this sale, Fleet acquired
all of the Company's asset management operations, including: Colonial
Management Associates, Crabbe Huson Group, Inc., Liberty Asset Management
Company, Liberty Funds Distributor, Liberty Funds Services, Newport Pacific
Management, Inc., Progress Investment Management, Inc., Stein Roe & Farnham
Incorporated and Liberty Wanger Asset Management. Fleet paid approximately
$900 million in cash and assumed approximately $110 million in revolving debt
incurred by a subsidiary of the Company to finance sales commissions
resulting in an estimated $52 million after-tax gain. The Company received
proceeds, net of estimated transaction costs and taxes, of approximately $686
million. A copy of the Fleet Stock Purchase Agreement was included as an
exhibit to a Form 8-K filed on June 6, 2001.
On June 4, 2001, the Company announced that it had entered into a merger
agreement with Liberty Mutual Insurance Company ("Liberty Mutual"). Under the
agreement, the Company will become a wholly owned subsidiary of Liberty
Mutual and the Company's public stockholders will receive a cash amount
currently estimated to be $33.44 per share. Such amount is subject to
adjustment in certain circumstances and may be materially different than
$33.44. The closing under the merger transaction is subject to certain
conditions. A copy of the Merger Agreement was included as an exhibit to a
Form 8-K filed on June 6, 2001.
CHANGES IN ACCOUNTING PRINCIPLES
The cumulative effect of accounting changes, net of tax for the nine months
ended September 30, 2001 of $(60.8) million includes a loss of $(54.3) million
relating to the adoption of 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," (collectively hereafter referred to
as the "Statement") in the quarter ended March 31, 2001 and a loss of $(6.5)
million relating to the adoption of Emerging Issues Task Force ("EITF") Issue
No. 99-20, "Recognition of Interest Income and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets," in the quarter
ended June 30, 2001.
The Company adopted the Statement 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.
The Company adopted EITF Issue No. 99-20 on April 1, 2001. EITF Issue No.
99-20 governs the method of recognizing interest income and impairment on
asset-backed investment securities. EITF Issue No. 99-20 requires the Company to
update the estimate of cash flows over the life of certain retained beneficial
interests in securitization transactions and purchased beneficial interests in
securitized financial assets. Pursuant to EITF Issue No. 99-20, based on current
information and events, if the Company estimates that the fair value of its
beneficial interests is not greater than or equal to its carrying value and if
there has been a decrease in the estimated cash flows since the last revised
14
estimate, considering both timing and amount, then an other-than-temporary
impairment should be recognized. The cumulative effect, reported after tax and
net of related effects on deferred policy acquisition costs, upon adoption of
EITF Issue No. 99-20 on April 1, 2001 decreased net income by $6.5 million with
a related increase to accumulated other comprehensive income of $1.8 million.
SEPTEMBER 11, 2001
The Company has approximately $440.6 million of fixed maturities
invested in entities associated with the airline, hotel, and hospitality
businesses. The national tragedy of September 11, 2001 has had an adverse
impact on these industries. The Company has not recorded any
other-than-temporary declines due to the decrease in market value of these
investments subsequent to the September 11 terrorist attacks.
The Company also has a swap agreement in which the Company participates in
a reinsurance pool of catastrophic insurance. The Company's maximum exposure
under this agreement is $13.6 million per calendar year. The Company's estimated
pro-rata share of losses associated with the September 11 terrorist attacks is
$11.8 million, which has been recorded as a reduction to net investment income.
RESULTS OF OPERATIONS
NET INCOME (LOSS) was $(49.1) million or $(0.99) per share for the quarter
ended September 30, 2001 compared to $22.1 million or $0.45 per share for the
quarter ended September 30, 2000. This decrease resulted largely from strategic
review expenses, lower investment spread, the net change in unrealized and
undistributed (losses) gains in private equity limited partnerships, interest
expense, net, net derivative losses and lower fee income. Partially offsetting
these items was the income tax benefit in 2001 compared to income tax expense in
2000, a small restructuring credit in 2001 compared to restructuring expense in
2000 and lower net realized investment losses. For the first nine months of
2001, net income (loss) was $(103.4) million or $(2.06) per share compared to
$90.5 million or $1.86 per share for the first nine months of 2000. This
decrease resulted largely from strategic review expenses, cumulative effect of
accounting changes discussed above, the net change in unrealized and
undistributed (losses) gains in private equity limited partnerships, higher
amortization expense, lower investment spread, higher interest expense, net and
higher net realized investment losses. Partially offsetting these items were a
tax benefit in 2001 compared to tax expense in 2000 and a small restructuring
credit in 2001 compared to restructuring expense in 2000.
PRETAX INCOME (LOSS) was $(75.4) million for the quarter ended September
30, 2001 compared to $27.3 million for the quarter ended September 30, 2000.
This decrease resulted largely from strategic review expenses, lower investment
spread, the net change in unrealized and undistributed (losses) gains in private
equity limited partnerships, interest expense, net, net derivative losses and
lower fee income. Partially offsetting these items was a small restructuring
credit in 2001 compared to restructuring expense in 2000 and lower net realized
investment losses. For the first nine months of 2001, pretax income (loss) was
$(69.6) million compared to $137.4 million for the first nine months of 2000.
This decrease resulted largely from strategic review expenses, cumulative effect
of accounting changes discussed above, the net change in unrealized and
undistributed (losses) gains in private equity limited partnerships, higher
amortization expense, lower investment spread, higher interest expense, net and
higher net realized investment losses. Partially offsetting these items was a
small restructuring credit in 2001 compared to restructuring expense in 2000.
INVESTMENT SPREAD is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $48.8 million for the quarter ended September 30, 2001
compared to $78.3 million for the quarter ended September 30, 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 September 30, 2001 was 1.41%
compared to 2.20% for the quarter ended September 30, 2000. For the first nine
months of 2001, investment spread was $220.6 million compared to $240.1 million
for the first nine months of 2000. The investment spread percentage was 2.14%
for the first nine months of 2001 compared to 2.28% for the first nine months of
2000.
Investment income was $196.8 million for the quarter ended September 30,
2001 compared to $214.1 million for the quarter ended September 30, 2000. The
decrease of $17.3 million in 2001 compared to 2000 includes a $10.7
15
million decrease as a result of a lower average investment yield and a $6.6
million decrease resulting from a lower level of average invested assets.
Included in the quarter ended September 30, 2001 is the Company's estimated
pro-rata share of loss associated with a swap agreement in which the Company
participates in a reinsurance pool of catastrophic insurance of $11.8 million,
which has been recorded as a reduction to net investment income. The average
investment yield was 6.36% for the quarter ended September 30, 2001 compared to
6.69% for the quarter ended September 30, 2000. For the first nine months of
2001, investment income was $670.5 million compared to $636.4 million for the
first nine months of 2000. The increase of $34.1 million in 2001 compared to
2000 includes a $44.9 million increase as a result of a higher average
investment yield and a $10.8 million decrease resulting from a lower level of
average invested assets. The average investment yield was 7.14% for the first
nine months of 2001 compared to 6.67% for the first nine months of 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 losses 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 three and nine months ended September 30, 2000 was net
of $19.7 million and $64.3 million, respectively, 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 $19.3 million and 5.69% and $67.4 million and 6.40% for
the three and nine months ended September 30, 2001, respectively.
Interest credited to policyholders totaled $148.0 million for the quarter
ended September 30, 2001 compared to $135.8 million for the quarter ended
September 30, 2000. The increase of $12.2 million in 2001 compared to 2000
primarily relates to a $13.8 million increase as a result of a higher average
interest credited rate, partially offset by a $1.6 million decrease as a result
of a slightly lower level of average policyholder balances. Policyholder
balances averaged $12.0 billion (including $10.3 billion of fixed products,
consisting of fixed annuities and a closed block of single premium whole life
insurance, and $1.7 billion of equity-indexed annuities) for the quarter ended
September 30, 2001 compared to $12.1 billion (including $9.8 billion of fixed
products and $2.3 billion of equity-indexed annuities) for the quarter ended
September 30, 2000. The average interest credited rate was 4.95% (5.07% on fixed
products and 4.31% on equity-indexed annuities) for the quarter ended September
30, 2001 compared to 4.49% (5.30% on fixed products and 0.85% on equity-indexed
annuities) for the quarter ended September 30, 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 120%) 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 the first nine months of 2001, interest credited to policyholders totaled
$449.9 million compared to $396.3 million for the first nine months of 2000. The
increase of $53.6 million in 2001 compared to 2000 primarily relates to a $55.7
million increase as a result of a higher average interest credited rate,
partially offset by a $2.1 million decrease resulting from a slightly lower
level of average policyholder balances. Policyholder balances averaged $12.0
billion (including $10.1 billion of fixed products and $1.9 billion of
equity-indexed annuities) for the first nine months of 2001 compared to $12.1
billion (including $9.7 billion of fixed products and $2.4 billion of
equity-indexed annuities) for the first nine months of 2000. The average
interest credited rate was 5.00% (5.20% on fixed products and 3.93% on
equity-indexed annuities) for the first nine months of 2001 compared to 4.39%
(5.18% on fixed products and 0.85% on equity-indexed annuities) for the first
nine months of 2000.
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 a non-designated derivative and the
changes in fair value are reported as a component of derivative losses. 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 $143.7 million and 4.79% and $428.8 million and 4.76% for the three and
nine months ended September 30, 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 $12.4
billion for the quarter ended September 30, 2001 compared to $12.8 billion for
the quarter ended September 30, 2000.
16
For the first nine months of 2001, such average investments were $12.5 billion
compared to $12.7 billion for the first nine months of 2000.
NET DERIVATIVE LOSSES of $(5.7) million and $(1.5) million for the three
months and nine months ended September 30, 2001, respectively, represent 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 losses.
Changes in the fair value of non-designated derivatives are reported in current
period operations as a component of net derivative losses.
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 related to changes in the fair value of the
"embedded" derivatives, net of related effects on deferred policy acquisition
costs was $15.5 million and $46.4 million for the three and nine months ended
September 30, 2001, respectively. The net derivative loss related to changes in
the fair value of call options and futures, net of related effects on deferred
policy acquisition costs was $(17.5) million and $(45.6) million for the three
and nine months ended September 30, 2001, 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 $(4.5) million and $(2.6) million for
the three and nine months ended September 30, 2001, respectively.
The Company utilizes treasury rate lock agreements to reduce its exposure
to interest rate risk related to certain of its notes payable. Treasury rate
lock agreements are agreements to exchange with a counterparty payments based on
an underlying principal balance (notional principal) to hedge against interest
rate changes. The treasury rate lock agreements are designated and qualify as
fair value hedges. The ineffective portion of the fair value hedges resulted in
gains of $0.8 million and $0.3 million for the three and nine months ended
September 30, 2001, respectively.
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.
17
NET REALIZED INVESTMENT LOSSES were $25.3 million for the quarter ended
September 30, 2001 compared to $20.8 million for the quarter ended September 30,
2000. The net realized investment losses for the three months ended September
30, 2001 and 2000 included losses of $19.3 million and $5.7 million,
respectively, for certain investments where the decline in value was determined
to be other-than-temporary. For the first nine months of 2001 and 2000, net
realized investment losses were $58.4 million and $37.6 million, respectively.
The net realized investment losses for the nine months ended September 30, 2001
and 2000 included losses of $62.2 million and $8.7 million, respectively, for
certain investments where the decline in value was determined to be
other-than-temporary.
NET CHANGE IN UNREALIZED AND UNDISTRIBUTED (LOSSES) GAINS IN PRIVATE EQUITY
LIMITED PARTNERSHIPS is accounted for on the equity method and represents
primarily (decreases) 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%. The net change of $(2.5) million and $5.9 million in
unrealized and undistributed (losses) gains is recorded net of the related
amortization of deferred policy acquisition costs of $(4.6) million and $11.0
million for the three months ended September 30, 2001 and 2000, respectively,
and net of amounts realized, which are recognized in investment income, of $1.6
million and $6.2 million for the three months ended September 30, 2001 and 2000,
respectively. For the nine months ended September 30, 2001 and 2000, the change
of $(17.1) million and $28.4 million in unrealized and undistributed (losses)
gains is recorded net of the related amortization of deferred policy acquisition
costs of $(31.7) million and $52.6 million, and net of amounts realized, which
are recognized in investment income, of $31.4 million and $8.7 million,
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 $71.1 million for the quarter ended
September 30, 2001 compared to $71.2 million for the quarter ended September 30,
2000. For the first nine months of 2001, investment advisory and administrative
fees were $219.4 million compared to $214.4 million for the first nine months of
2000.
Average fee-based assets under management were $49.7 billion for the
quarter ended September 30, 2001 compared to $53.3 billion for the quarter ended
September 30, 2000. For the first nine months of 2001, average fee-based assets
under management were $50.6 billion compared to $52.3 billion for the first nine
months of 2000. The decrease during 2001 compared to 2000 included negative
market action for the twelve months ended September 30, 2001 and the sale,
completed on December 29, 2000, of the Company's Private Capital Management
division of Stein Roe & Farnham, Incorporated, partially offset by net sales for
the twelve months ended September 30, 2001. Investment advisory and
administrative fees were 0.57% and 0.53% of average fee-based assets under
management for the quarters ended September 30, 2001 and 2000, respectively. For
the first nine months of 2001 and 2000, such percentages were 0.58% and 0.55%,
respectively.
18
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 SEPTEMBER 30
-----------------------
2001 2000
----- -----
Mutual Funds:
Intermediary-distributed $16.3 $17.9
Direct-marketed 10.5 14.3
Closed-end 2.3 2.8
Variable annuity 2.5 2.9
----- -----
31.6 37.9
Private Capital Management -- 9.6
Institutional 14.9 15.5
----- -----
Total Fee-Based Assets Under Management* $46.5 $63.0
===== =====
- --------------
* As of September 30, 2001 and 2000, Keyport's insurance assets of $14.7
billion and $14.4 billion, respectively, bring total assets under
management to $61.2 billion and $77.4 billion, respectively.
CHANGES IN FEE-BASED ASSETS UNDER MANAGEMENT
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------- ---------------------
2001 2000 2001 2000
----- ----- ----- -----
Fee-based assets under management - beginning $51.3 $52.5 $51.8 $51.4
Sales and reinvestments:
Mutual funds 1.9 1.6 7.0 4.8
Private Capital Management -- 0.4 -- 1.3
Institutional 1.0 0.7 2.4 2.9
----- ----- ----- -----
2.9 2.7 9.4 9.0
----- ----- ----- -----
Redemptions and withdrawals:
Mutual funds (1.8) (1.5) (6.5) (5.3)
Private Capital Management -- (0.1) -- (0.6)
Institutional (0.5) (0.2) (1.2) (1.2)
----- ----- ----- -----
(2.3) (1.8) (7.7) (7.1)
----- ----- ----- -----
Asset acquisition -- 9.4 -- 9.4
Market appreciation (depreciation) (5.4) 0.2 (7.0) 0.3
----- ----- ----- -----
Fee-based assets under management - ending $46.5 $63.0 $46.5 $63.0
===== ===== ===== =====
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 $12.3 million
for the quarter ended September 30, 2001 compared to $15.6 million for the
quarter ended September 30, 2000. For the first nine months of 2001,
distribution and service fees were $41.9 million compared to $46.1 million for
the first nine months of 2000. As a percentage of intermediary-distributed
average mutual fund assets, distribution and service fees were approximately
0.28% for the quarter ended September 30, 2001 compared to 0.36% for the quarter
ended September 30, 2000. For the first nine months of 2001 and 2000, such
percentages were 0.31% and 0.35%, 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 $12.0 million on average assets of $32.3
billion
19
for the quarter ended September 30, 2001 and $12.3 million on average assets of
$26.6 billion for the quarter ended September 30, 2000. For the first nine
months of 2001, transfer agency fees were $36.3 million on average assets of
$33.2 billion compared to $37.2 million on average assets of $26.5 billion for
the first nine months of 2000. As a percentage of total average assets under
management, transfer agency fees were approximately 0.15% for the quarter ended
September 30, 2001 compared to 0.19% for the quarter ended September 30, 2000.
For the first nine months of 2001 and 2000, such percentages were 0.15% and
0.19%, respectively.
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 through Independent Financial Marketing Group (net of
commissions that are paid to the Company's client banks and brokers). Total
surrender charges and net commissions were $8.3 million for the quarter ended
September 30, 2001 compared to $10.1 million for the quarter ended September 30,
2000. For the first nine months of 2001, total surrender charges and net
commissions were $25.1 million compared to $30.1 million for the first nine
months of 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 nine years. Such charges totaled $5.4 million for the quarter
ended September 30, 2001 and $8.0 million for the quarter ended September 30,
2000. For the first nine months of 2001, surrender charges were $16.5 million
compared to $22.7 million for the first nine months of 2000. Total annuity
withdrawals represented 19.0% and 15.0% of the total average annuity
policyholder and separate account balances for the quarters ended September 30,
2001 and 2000, respectively. For the first nine months of 2001 and 2000, the
corresponding percentages were 19.2% and 15.6%, respectively. The higher level
of surrenders in 2001 compared to 2000 reflects increased competition for the
Company's fixed and equity-indexed annuities from other investment products and
a higher level of surrenders of the Company's equity-indexed annuities. Net
commissions were $2.9 million for the quarter ended September 30, 2001 and $2.1
million for the quarter ended September 30, 2000. For the first nine months of
2001, net commissions were $8.6 million compared to $7.4 million for the first
nine months of 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 based on the market
values of the assets in separate accounts supporting the contracts, were $12.4
million for the quarter ended September 30, 2001 compared to $11.8 million for
the quarter ended September 30, 2000. For the first nine months of 2001,
separate account fees were $39.6 million compared to $33.6 million for the first
nine months of 2000. The increase in separate account fees was due to the
increase in separate account assets in 2001. Such fees represented 1.24% and
1.23% of average variable annuity, variable life and institutional separate
account balances for the quarters ended September 30, 2001 and 2000,
respectively. For the first nine months of 2001 and 2000, such percentages were
1.30% and 1.25%, respectively.
OPERATING EXPENSES primarily represent compensation, marketing, and other
general and administrative expenses. These expenses were $99.5 million for the
quarter ended September 30, 2001 compared to $98.1 million for the quarter ended
September 30, 2000. For the first nine months of 2001, operating expenses were
$303.5 million compared to $300.0 million for the first nine months of 2000.
Operating expenses expressed as a percent of average total assets under
management were 0.62% and 0.58% for the quarters ended September 30, 2001 and
2000, respectively. For the first nine months of 2001 and 2000, such percentages
were 0.62% and 0.60%, respectively.
RESTRUCTURING income (expense) primarily relates to three initiatives,
which commenced during 2000, streamlining the Company's mutual fund product
offerings, centralizing corporate functions and outsourcing certain mutual fund
operations. Restructuring income (expense) was $0.2 million for the quarter
ended September 30, 2001 compared to $(11.3) million for the quarter ended
September 30, 2000. For the first nine months of 2001, restructuring income
(expense) was $0.5 million compared to $(11.3) million for the first nine months
of 2000. Restructuring income (expense) for the first nine months of 2001 is net
of a $1.9 million gain from the sale of the Company's internal fund accounting
system.
20
STRATEGIC REVIEW EXPENSES of $51.0 million and $91.2 million for the three
months and nine months ended September 30, 2001, respectively, relates to the
Company's announcement on November 1, 2000 that it had retained the investment
banking firm of Credit Suisse First Boston Corporation to review its strategic
initiatives, including a possible sale of the Company. Strategic review expenses
include a special compensation plan, as well as certain direct related expenses.
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 $177 million with fifty percent payable on
November 30, 2001 and the remainder payable on May 31, 2002.
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 $24.2
million for the quarter ended September 30, 2001 compared to $26.9 million for
the quarter ended September 30, 2000. For the first nine months of 2001,
amortization of deferred policy acquisition costs was $87.8 million compared to
$83.8 million for the first nine months of 2000. Amortization expense
represented 40.0% and 29.9% of investment spread and separate account fees for
the quarters ended September 30, 2001 and 2000, respectively. For the first nine
months of 2001 and 2000, the corresponding percentages were 33.7% and 30.6%,
respectively. In September 2001, an additional $5.4 million of deferred policy
acquisition cost was amortized based upon revised estimates of future gross
profits. Excluding the prospective unlocking adjustment of $5.4 million,
amortization of deferred policy acquisition cost as a percent of investment
spread and separate account fees would have been 30.7% and 31.7% for the three
and nine month periods ended September 30, 2001, 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 $12.9 million for the quarter ended September
30, 2001 compared to $10.9 million for the quarter ended September 30, 2000. For
the first nine months of 2001, amortization of deferred distribution costs was
$37.4 million compared to $31.5 million for the first nine months of 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 $8.4 million for the quarter ended September 30,
2001 compared to $5.1 million for the quarter ended September 30, 2000. For the
first nine months of 2001, amortization of intangible assets was $25.6 million
compared to $15.3 million for the first nine months of 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 September 30, 2001 had goodwill and other intangible assets of $75.1 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.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets."
SFAS No. 142 addresses financial accounting and reporting for goodwill and other
intangible assets subsequent to their acquisition and distinguishes between
intangible assets that have a finite useful life and intangible assets that have
an indefinite useful life. If no legal, regulatory, contractual, competitive,
economic, or other factors limit the useful life of an intangible asset, the
useful life of the asset shall be considered to be indefinite. Intangible assets
that have a finite useful life are amortized in accordance with the requirements
of SFAS No. 142. Intangible assets that have an indefinite useful life are not
amortized until their useful life is determined to be no longer indefinite. An
intangible asset that is not subject to amortization shall be tested for
impairment annually, or more frequently if events or changes in circumstances
indicate that the asset might be impaired.
21
All of the provisions of SFAS No. 142 are to be applied in fiscal years
beginning after December 15, 2001 to all goodwill and other intangible assets
recognized in an entity's statement of financial position at the beginning of
that fiscal year, regardless of when those previously recognized assets were
initially recognized. The Company has not yet determined the impact of SFAS No.
142.
INTEREST EXPENSE, NET was $11.0 million for the quarter ended September 30,
2001 compared to $4.8 million for the quarter ended September 30, 2000. For the
first nine months of 2001, interest expense, net was $30.5 million compared to
$13.0 million for the first nine months of 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 $3.3 million and $5.7 million for the quarters ended
September 30, 2001 and 2000, respectively. For the first nine months of 2001 and
2000, interest expense was net of interest income of $13.5 million and $17.4
million, respectively.
INCOME TAX (EXPENSE) BENEFIT was $26.3 million or 34.9% of pretax loss for
the quarter ended September 30, 2001 compared to $(5.2) million, or 19.0% of
pretax income for the quarter ended September 30, 2000. For the first nine
months of 2001, income tax (expense) benefit was $27.0 million or 38.8% of
pretax loss compared to $(46.9) million or 34.1% of pretax income for the first
nine months of 2000.
FINANCIAL CONDITION
STOCKHOLDERS' EQUITY was $1.40 billion as of September 30, 2001 compared to
$1.45 billion as of December 31, 2000. The net loss for the first nine months of
2001 was $103.4 million and cash dividends on the Company's preferred and common
stock totaled $15.1 million. Common stock totaling $4.5 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 $66.3 million.
BOOK VALUE PER SHARE amounted to $28.62 at September 30, 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 $27.89 at September 30, 2001 and
$30.30 at December 31, 2000. As of September 30, 2001, there were 49.0 million
common shares outstanding compared to 48.8 million shares as of December 31,
2000.
INVESTMENTS not including cash and cash equivalents, totaled $12.1 billion
at September 30, 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 September 30, 2001 and December
31, 2000 reflected gross unrealized gains (losses) of $245.9 million and $(62.0)
million, respectively.
Approximately $12.0 billion, or 78.2%, of the Company's general account and
certain separate account investments at September 30, 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 September 30, 2001, the carrying value of investments
in below investment grade securities totaled $1.2 billion or 7.6% 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
22
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 September 30, 2001 and December 31, 2000, the carrying value of fixed
maturity securities that were non-income producing was $97.4 million and $24.4
million, respectively.
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, interest rate cap agreements and treasury rate lock 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 99 and 69 outstanding swap agreements with an
aggregate notional principal amount of $4.1 billion and $3.8 billion as of
September 30, 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 September 30, 2001 and December 31, 2000.
The Company utilizes treasury rate lock agreements to reduce its exposure
to interest rate risk related to certain of its notes payable. Treasury rate
lock agreements are agreements to exchange with a counterparty payments based on
an underlying principal balance (notional principal) to hedge against interest
rate changes. The Company had 2 outstanding treasury rate lock agreements with
an aggregate notional principal amount of $395 million as of September 30, 2001.
There were no such agreements outstanding as of 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 $36.3 million and $337.7 million as of September 30, 2001 and December
31, 2000, respectively. The Company had open futures with a fair value of $(0.8)
million and $10.5 million as of September 30, 2001 and December 31, 2000,
respectively. The Company had total return swap agreements with a carrying value
of $21.1 million and $23.9 million as of September 30, 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
23
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.
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.
On October 15, 2001, the Company commenced a cash tender offer to
purchase all of its outstanding 6.75% notes due November 15, 2008 and its
7.625% debentures due November 15, 2028, collectively referred to as (the
"securities"). To date, the Company has received tenders on approximately 95%
of the securities. Payment, anticipated to occur on November 13, 2001, on the
securities will be made from the net proceeds received in the Sun Life and
Fleet transactions. In addition, debt of $200 million issued to Liberty
Mutual and its affiliates was liquidated on November 1, 2001.
The Company 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 September 30, 2001, the interest rate on borrowings under the
Facility was 3.40% 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 September 30, 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.
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
24
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 September 30, 2001, $12.3 billion, or 79.9%, of
Keyport's general account and certain separate 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 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 77.0% of the Company's fixed annuity policyholder balances were
subject to surrender charges or restrictions as of September 30, 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"), 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 and stock market performance; (2) the
impact of events such as the terrorist attacks that occurred on September 11,
2001, which can impact individual businesses (including potentially the
Company) or markets generally; (3) the result of any litigation or legal
proceedings involving the Company, including the stockholder suit described
in Part II, Item 1 of this report; (4) changes in generally accepted
accounting principles and the impact of accounting principles and
pronouncements on the Company's financial condition and results of
operations; (5) risks related to the consummation of the merger of the
Company with a wholly owned subsidiary of Liberty Mutual; (6) the failure of
conditions to the closing of the merger with Liberty Mutual to be satisfied
in a timely manner or at all; (7) risks that the actual consideration payable
to the Company's stockholders in the merger will be less than $33.44 per
share as a result of adjustments set forth in the merger agreement; (8) risks
that the actual after-tax gains and net proceeds on the sales to Sun Life and
Fleet may be different than estimates due to, among other things, changes in
estimated stockholders' equity including the effects of Statement of
Financial Accounting Standards No. 115 - net unrealized investment gains and
losses, changes in estimated income taxes on the sales, transaction costs and
other factors; and (9) 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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes during the first nine 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. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 5, 2001, a lawsuit seeking class action status was filed by
purported stockholders of the Company in the Superior Court of Suffolk
County, Massachusetts, against the Company, Fleet, Liberty Mutual and the
directors of the Company. The plaintiff in the lawsuit alleges, among other
things, that the Company, Liberty Mutual and the directors of the Company
have breached fiduciary duties owed to the Company's stockholders other than
Liberty Mutual and its affiliates, by not obtaining the best possible price
in the proposed Fleet transaction and the merger with Liberty Mutual. The
plaintiff seeks, among other things, an order enjoining the merger from being
consummated (or, if consummated, an order rescinding the transaction) and an
award of attorneys' fees and other costs of litigation. In the event the
merger is consummated, the plaintiff has indicated that it may choose to
continue its action and seek rescission of the merger, damages or both. The
Company believes that this lawsuit is without merit and intends to vigorously
defend it. On July 10, 2001, the Company, Liberty Mutual and the directors of
the Company moved to dismiss the plaintiff's complaint in its entirety. Also,
on July 11, 2001, the Company and its directors moved to stay all discovery
pending a decision on the motion to dismiss. Without responding to the
defendants' motion to dismiss, the plaintiff filed an Amended Complaint on
October 9, 2001. In its Amended Complaint, the plaintiff now alleges that the
defendants breached their fiduciary duties owed to the Company's stockholders
other than Liberty Mutual and its affiliates by negotiating a deal structured
as the purchase of Liberty Mutual's two business units instead of as a
merger, and thereby conferring upon Liberty Mutual tax advantages at the
expense of gains to the Company's public shareholders. The plaintiff also
alleges that the defendants violated the Massachusetts state anti-takeover
statute and made misleading statements in the Company's proxy statement, in
contravention of state blue sky statutes. The plaintiff seeks, among other
things, an order enjoining the merger from being consummated (or, if
consummated, an order rescinding the transaction) and an award of attorneys'
fees and other costs of litigation. Defendants' response to the Amended
Complaint is due November 19. The Company believes plaintiff's Amended
Complaint is without merit and intends to move to dismiss all claims.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
12 Statement re Computation of Ratios
99.1 Liberty Financial Companies, Inc. and Subsidiaries
Commissioned Employee Severance and Retention Plan
99.2 Liberty Financial Companies, Inc. and Subsidiaries
Non-Commissioned Employee Severance and Retention Plan
(b) REPORTS ON FORM 8-K
On October 15, 2001, the Company filed a report on Form 8-K under Item
5 of such form reporting the commencement of a cash tender offer and
consent solicitation with respect to the Company's outstanding 6.75% notes
due November 15, 2008, and its 7.625% debentures due November 15, 2028.
The related press release was filed as Exhibit No. 99.1 to the Form 8-K.
On October 16, 2001, the Company filed a report on Form 8-K under Item
5 of such form reporting the filing of an Amended Complaint in the matter
of Harbor Finance Partners v. Liberty Financial Companies, Inc., dated
October 9, 2001. The amended complaint was filed as Exhibit No. 99.1 to
the Form 8-K.
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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: November 8, 2001
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE
12 Statement re Computation of Ratios 29
99.1 Liberty Financial Companies, Inc. and Subsidiaries
Commissioned Employee Severance and Retention Plan 30
99.2 Liberty Financial Companies, Inc. and Subsidiaries
Non-Commissioned Employee Severance and Retention Plan 56
28