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 June 30, 1996
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ------------ to -----------
Commission file number: 1-13654
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LIBERTY FINANCIAL COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
Massachusetts 04-3260640
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
600 Atlantic Avenue, Boston, Massachusetts 02210-2214
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(Address of principal executive offices) (Zip Code)
(617) 722-6000
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ] Yes [ ] No
There were 28,403,051 shares of the registrant's Common Stock, $.01 par
value, and 327,725 shares of the registrant's Series A Convertible Preferred
Stock, $.01 par value, outstanding as of July 31, 1996.
Exhibit index - Page 28 Page 1 of 31
LIBERTY FINANCIAL COMPANIES, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED JUNE 30, 1996
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
-----
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1996 and
December 31, 1995
Consolidated Statements of Income for the Three Months
and Six Months Ended June 30, 1996 and 1995
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1996 and 1995
Consolidated Statement of Stockholders' Equity for the
Six Months Ended June 30, 1996
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Part II. OTHER INFORMATION
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
Exhibit Index
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
Unaudited
June 30 December 31
1996 1995
------- -----------
ASSETS
Assets:
Investments $10,152,309 $10,144,742
Cash and cash equivalents 1,104,835 875,314
Accrued investment income 132,275 132,856
Deferred policy acquisition costs 304,221 179,672
Value of insurance in force 65,073 43,939
Deferred distribution costs 120,549 114,579
Intangible assets 209,092 192,301
Other assets 145,066 106,734
Separate account assets 1,013,051 959,224
----------- -----------
$13,246,471 $12,749,361
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policyholder balances $10,389,378 $10,084,392
Notes payable to affiliates 229,000 229,000
Payable for investments purchased
and loaned 454,329 317,715
Other liabilities 244,666 259,685
Separate account liabilities 955,587 889,107
----------- ----------
Total liabilities 12,272,960 11,779,899
----------- ----------
Redeemable convertible preferred
stock, par value $0.01; 327,725
shares authorized, issued and
outstanding in 1996; 327,741
shares in 1995 13,432 13,040
----------- ----------
Stockholders' Equity:
Common stock, $.01 par value, authorized
100,000,000 shares; issued and outstanding
28,365,996 shares in 1996; 27,682,536
shares in 1995 284 277
Additional paid-in capital 826,161 810,510
Net unrealized investment gains 37,137 87,158
Retained earnings 97,018 59,370
Unearned compensation (521) (893)
----------- -----------
Total stockholders' equity 960,079 956,422
=========== ===========
$13,246,471 $12,749,361
=========== ===========
See accompanying notes.
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share data)
Unaudited
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
1996 1995 1996 1995
------ ----- ---- ----
Investment income $193,814 $190,982 $385,826 $ 376,144
Interest credited to policyholders (140,210)(139,268) (281,107) (270,187)
-------- -------- -------- --------
Investment spread 53,604 51,714 104,719 105,957
-------- -------- -------- ---------
Net realized investment gains (losses) (1,684) (719) 2,090 (6,372)
-------- -------- -------- ---------
Fee income:
Investment advisory and administrative
fees 48,815 42,890 95,217 65,487
Distribution and service fees 11,075 8,891 21,694 9,593
Transfer agency fees 10,790 9,199 21,229 10,947
Surrender charges and net commissions 9,435 5,840 17,137 10,830
Separate account fees 3,574 3,210 7,036 6,421
-------- -------- -------- ---------
Total fee income 83,689 70,030 162,313 103,278
-------- -------- -------- ---------
Expenses:
Operating expenses (67,885) (58,296) (133,763) (101,228)
Amortization of deferred policy
acquisition costs (14,865) (12,367) (28,973) (26,161)
Amortization of deferred distribution
costs (7,384) (5,889) (14,168) (6,228)
Amortization of value of insurance
in force (1,850) (3,329) (3,568) (6,853)
Amortization of intangible assets (4,535) (3,529) (8,266) (5,069)
Interest expense (5,036) (5,266) (10,056) (6,769)
-------- -------- -------- ---------
Total expenses (101,555) (88,676) (198,794) (152,308)
-------- -------- -------- ---------
Pretax income 34,054 32,349 70,328 50,555
Income tax expense (10,996) (11,267) (23,448) (19,394)
-------- -------- -------- ---------
Net income $23,058 $21,082 $46,880 $31,161
======== ======== ======== =========
Net income per share $0.77 $0.72 $1.58 $1.17
======== ======== ======== =========
Common stock and common stock equivalents 29,611 28,784 29,437 26,513
======== ======== ======== =========
See accompanying notes
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Unaudited
Six Months Ended
June 30
---------------------
1996 1995
---- ----
Cash flows from operating activities:
Net income $ 46,880 $ 31,161
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 32,017 23,322
Interest credited to policyholders 281,107 270,187
Net realized investment (gains) losses (2,090) 6,372
Net amortization of investments 2,159 4,669
Change in deferred policy acquisition costs (9,830) (24,725)
Net change in assets and liabilities, net of effect
of acquisitions (60,267) (39,662)
---------- ----------
Net cash provided by operating activities 289,976 271,324
---------- ----------
Cash flows from investing activities:
Investments purchased held to maturity 0 (117,576)
Investments purchased available for sale (1,315,877) (1,274,799)
Investments sold held to maturity 0 14,929
Investments sold available for sale 18,634 183,619
Investments matured held to maturity 0 145,275
Investments matured available for sale 1,140,052 426,978
Acquisitions, net of cash acquired (7,085) (96,774)
Change in policy loans (13,535) (19,558)
Change in mortgage loans 3,984 3,797
---------- ----------
Net cash used in investing activities (173,827) (734,109)
---------- ----------
Cash flows from financing activities:
Withdrawals from policyholder accounts (548,205) (480,564)
Deposits to policyholder accounts 572,084 776,716
Securities lending 90,176 564,421
Borrowings from affiliates 0 124,000
Repayments under revolving credit facility 0 (5,500)
Exercise of stock options 1,228 78
Dividends paid (1,911) (961)
---------- ----------
Net cash provided by financing activities 113,372 978,190
---------- ----------
Increase in cash and cash equivalents 229,521 515,405
Cash and cash equivalents at beginning of period 875,314 726,711
---------- ----------
Cash and cash equivalents at end of period $1,104,835 $1,242,116
========== ==========
See accompanying notes
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Unaudited
Net
Additional Unrealized Total
Common Paid-In Investment Retained Unearned Stockholders'
Stock Capital Gains Earnings Compensation Equity
----- --------- ---------- --------- ---------- -----------
Balance,
December 31,
1995 $277 $810,510 $ 87,158 $ 59,370 $(893) $956,422
Common stock
issued in
Independent
acquisition 3 7,497 0 0 0 7,500
Proceeds from
exercise of
stock options 2 1,226 0 0 0 1,228
Unearned
compensation 0 0 0 0 372 372
Accretion to face
value of
preferred stock 0 0 0 (392) 0 (392)
Common stock
dividends 2 6,927 0 (8,369) 0 (1,440)
Preferred stock
dividends 0 0 0 (471) 0 (471)
Conversion of
preferred stock 0 1 0 0 0 1
Change in net
unrealized
gains 0 0 (50,021) 0 0 (50,021)
Net income 0 0 0 46,880 0 46,880
-------- -------- --------- -------- -------- --------
Balance, June
30, 1996 $284 $826,161 $ 37,137 $ 97,018 $(521) $960,079
======== ======== ========= ======== ======== ========
See accompanying notes
LIBERTY FINANCIAL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission, although the Company
believes the disclosures in these consolidated financial statements are
adequate to present fairly the information contained herein. These
consolidated financial statements should be read in conjunction with the
audited consolidated financial statements contained in the Company's 1995
Annual Report to Stockholders. The results of operations for the six months
ended June 30, 1996 are not necessarily indicative of the results to be
expected for the full year.
Certain prior period amounts in the accompanying unaudited
consolidated income statements have been reclassified to conform to the
current period presentation. The principal reclassifications relate to the
presentation of investment spread (the amount by which net investment
income exceeds interest credited to policyholder balances), fee income and
net commissions, and were made to provide additional information with
respect to the Company's major sources of revenue.
2. Industry Segment Information
The Company is an asset accumulator which operates in two industry
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 principally
at the Colonial Group, Inc. ("Colonial"), an investment advisor,
distributor and transfer agent to mutual funds, Stein Roe & Farnham
Incorporated ("Stein Roe"), a diversified investment advisor, and Newport
Pacific Management, Inc. ("Newport"), an investment advisor to mutual funds
and institutional accounts specializing in Asian equity markets. The asset
management business derives fee income from investment products and
services.
Approximately 60.1% of the Company's operating earnings for the six
months ended June 30, 1996 relates to the Company's annuity insurance
business, with the remaining 39.9% attributable to the Company's asset
management activities. This compares to approximately 72.4% and 27.6%,
respectively, for the year earlier period.
3. Acquisitions
On March 7, 1996, the Company acquired, for cash and common stock, all
the outstanding common stock of Independent Holdings, Inc. ("Independent").
In addition, the Company agreed to make contingent payments in common stock
upon the attainment of certain objectives. Independent is engaged in the
distribution of annuity and investment products through banks.
On April 11, 1996, the Company acquired for cash all the outstanding
capital stock of KJMM Investment Management Company, Inc. ("KJMM"), a
registered investment advisor primarily in the wealth management business.
KJMM had assets under management of approximately $400.0 million as of the
date of acquisition.
4. Investments
Investments, all of which pertain to Keyport, were comprised of the
following (in thousands):
June 30 December 31
1996 1995
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Fixed maturities $ 9,451,230 $ 9,535,948
Mortgage loans 70,521 74,505
Policy loans 511,861 498,326
Other invested assets 82,334 10,748
Equity securities at fair value 36,363 25,215
----------- -----------
Total $10,152,309 $10,144,742
=========== ===========
The Company's general investment policy is to hold fixed maturity assets
for long-term investment and, accordingly, the Company does not have a trading
portfolio. To provide for maximum portfolio flexibility and enable appropriate
tax planning, the Company classifies its entire fixed maturities investments as
"available for sale" which are carried at estimated fair value.
The following table summarizes Keyport's investments in fixed maturities as
of June 30, 1996 (in thousands):
Gross Gross
Amortized Urealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
U.S. Treasury securities $ 366,824 $ 1,179 $ (1,713) $ 366,290
Mortgaged backed securities of
U.S. government agencies
and corporations 738,331 15,521 (5,974) 747,878
Obligations of states and
political subdivisions 6,492 373 0 6,865
Debt securities issued by
foreign governments 82,881 962 (2,722) 81,121
Corporate securities 3,493,273 126,664 (29,285) 3,590,652
Other mortgage backed
securities 3,078,604 36,301 (58,632) 3,056,273
Asset backed securities 1,376,759 9,313 (14,377) 1,371,695
Senior secured loans 230,456 0 0 230,456
---------- -------- --------- ----------
Total fixed maturities $9,373,620 $190,313 $(112,703) $9,451,230
========== ======== ========= ==========
5. Net Income per Share
Net income per share is calculated by dividing applicable net income
by the weighted average number of shares of common stock outstanding during
each period adjusted for the incremental shares attributable to common
stock equivalents. Common stock equivalents consist of outstanding employee
stock options. In calculating net income per share, net income is reduced
by convertible preferred stock dividend requirements. Such preferred stock
earns cumulative dividends at the annual rate of $2.875 per share and is
redeemable at the option of the Company, subject to certain conditions,
anytime after March 24, 1998. At the time of issuance, the convertible
preferred stock was determined not to be a common stock equivalent.
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Results of Operations
Net Income was $23.1 million or $0.77 per share in the second quarter of
1996 compared to $21.1 million or $0.72 per share in the second quarter of 1995.
This higher net income in the second quarter of 1996 was due to higher
investment spread and fee income. Partially offsetting these items were
increased operating expenses and higher amortization expense. In the first half
of 1996, net income was $46.9 million or $1.58 per share compared to $31.2
million or $1.17 per share in the first half of 1995. The higher net income in
the first half of 1996 was attributable to higher fee income (primarily
associated with the Colonial and Newport acquisitions) and to net realized
investment gains in 1996 compared to net realized investment losses in 1995.
Partially offsetting these items were increased operating expense, amortization
and interest, and higher income tax expense.
Pretax Income was $34.1 million in the second quarter of 1996 compared to
$32.3 million in the second quarter of 1995. This higher pretax income in the
second quarter 1996 was primarily attributable to higher investment spread and
fee income. For the first half of 1996, pretax income was $70.3 million compared
to $50.6 million in the first half of 1995. The higher pretax income in the
first half of 1996 was primarily attributable to the Colonial and Newport
acquisitions, and to net realized investment gains in 1996 compared to net
realized investment losses in 1995.
Investment Spread is the amount by which investment income earned on the
Company's investments exceeds interest credited to policyholder balances.
Investment spread was $53.6 million in the second quarter of 1996 compared to
$51.7 million in the second quarter of 1995. These amounts represent 2.03% and
2.06%, respectively, of average monthly investments (computed without giving
effect to SFAS 115), which include a portion of the Company's cash and cash
equivalents, of $10.6 billion and $10.1 billion during 1996 and 1995,
respectively. The amount by which the average yield on investments exceeds the
average interest credited rate on policyholder balances is the investment spread
percentage. Such investment spread percentage in the second quarter of 1996 was
1.89% compared to 1.91% in the second quarter of 1995. For the first half of
1996, investment spread was $104.7 million compared to $106.0 million in the
first half of 1995. These amounts represent 2.00% and 2.14%, respectively, of
average monthly investments of $10.5 billion and $9.9 billion during 1996 and
1995, respectively. The investment spread percentage was 1.86% in the first half
of 1996 compared to 2.00% in the first half of 1995. For all of 1996, assuming a
constant interest rate environment, Keyport anticipates a lower investment yield
compared to 1995 and a lower interest credited rate. However, the interest
credited rate is expected to decrease more than the investment yield will
decrease, and, accordingly, the investment spread percentage and investment
spread is expected to increase slightly.
Investment income was $193.8 million in the second quarter of 1996,
compared to $191.0 million in the second quarter of 1995. Investment income
increased in the 1996 period primarily as a result of a higher level of average
invested assets, partially offset by a decrease in the average investment yield.
The average investment yield was 7.34% in the second quarter of 1996 compared to
7.60% in the 1995 period. The decreased investment yield in 1996 reflects the
lower interest rates prevailing during the latter half of 1995 and early 1996.
For the first half of 1996, investment income was $385.8 million compared to
$376.2 million in the first half of 1995. Investment income increased in the
1996 six-month period primarily as a result of the higher level of average
invested assets, partially offset by a decrease in the average investment yield.
The average investment yield was 7.36% in the first half of 1996 compared to
7.61% in the 1995 period. The decreased investment yield in 1996 reflects the
lower interest rates prevailing during the latter half of 1995 and early 1996.
Interest credited to policyholders totaled $140.2 million in the second
quarter of 1996 compared to $139.3 million in the second quarter of 1995.
Interest credited to policyholders increased in the 1996 period primarily as a
result of a higher level of policyholder balances, mostly offset by a decrease
in the average interest credited rate. Policyholder balances averaged $10.3
billion in the second quarter of 1996 compared to $9.8 billion in the second
quarter of 1995. The average interest credited rate was 5.45% in 1996 compared
to 5.69% in 1995. For the first half of 1996, interest credited to policyholders
was $281.1 million compared to $270.2 million in the first half of 1995.
Interest credited to policyholders increased in the 1996 six-month period
primarily as a result of the higher level of average policyholder balances,
partially offset by a decrease in the average interest credited rate.
Policyholder balances averaged $10.2 billion in the first half of 1996 compared
to $9.6 billion in the first half of 1995. The average interest credited rate
was 5.50% in 1996 compared to 5.61% in 1995.
Average Investments (computed without giving effect to SFAS 115), including
a portion of the Company's cash and cash equivalents, were $10.6 billion in the
second quarter of 1996 compared to $10.1 billion in the second quarter of 1995.
This increase of $0.5 billion was primarily due to sales of the Company's fixed
and indexed annuities during the period. Fixed and indexed annuity premiums
totaled $334.6 million in the second quarter of 1996 compared to $413.5 million
in the second quarter of 1995. The decrease in premiums in the 1996 period was
primarily attributable to the general decline in interest rates from the first
half of fiscal 1995 through the first quarter of 1996 which caused fixed annuity
products to be less attractive than other investment products. For the first
half of 1996, average investments were $10.5 billion compared to $9.9 billion in
the first half of 1995. Fixed and indexed annuity premiums totaled $526.6
million in the first half of 1996 compared to $733.6 million in the first half
of 1995. The decrease in the 1996 six-month period was also attributable to the
reduced market demand for fixed-rate products referred to above. Fixed and
indexed annuity premiums during 1996 include $307.0 million of the Company's
innovative KeyIndex product. This indexed annuity provides the investor with the
potential to participate in returns based upon the S&P 500, while providing a
guarantee of principal associated with a traditional annuity.
Net Realized Investment Losses totaled $1.7 million in the second quarter
of 1996 comnpared $0.7 million in the second quarter of 1995. For the first half
of 1996, net realized investment gains were $2.1 million compared to net
investment losses of $6.4 million in the first half of 1995. The net realized
gains in the 1996 period were primarily attributable to sales of corporate
investment securities. The realized losses in 1995 were attributable to sales of
Keyport fixed maturity investments to maximize total return.
Investment Advisory and Administrative Fees are based on the market value
of assets managed in mutual funds and for wealth management and institutional
investors. Investment advisory and administrative fees were $48.8 million in the
second quarter of 1996 compared to $42.9 million in the second quarter of 1995.
This increase of $5.9 million primarily reflects a higher level of average
assets under management. For the first half of 1996, investment advisory and
administrative fees were $95.2 million compared to $65.5 million in the first
half of 1995. A substantial portion of this increase of $29.7 million was
related to the fee income attributable to the assets acquired in the Colonial
acquisition in March 1995 and the Newport acquisition in April 1995 (whose
results of operations are included in the consolidated financial statements for
six months in 1996 and three months in 1995). In addition, the increase reflects
growth of assets under management during the period.
Investment advisory and administrative fees are based on the levels of
assets under management, which are affected by product sales and redemptions and
changes in the market values of the investments managed by the Company. Assets
under management and changes in assets under management are set forth in the two
tables below (in billions).
Assets Under Management
- -----------------------
As of June 30
-------------
1996 1995
---- ----
Mutual Funds:
Broker-distributed $15.6 $15.0
Direct-marketed 6.1 4.7
Closed-end 1.9 1.7
----- -----
Variable annuity 1.0 0.9
24.6 22.3
Wealth Management 4.7 4.0
Institutional 4.6 4.1
----- -----
Total Assets Under Management* $33.9 $30.4
===== =====
---------
* As of June 30, 1996, Keyport's investments of $10.8 billion bring total
assets under management to $44.7 billion.
Changes in Assets Under Management
- ----------------------------------
Three Months Ended Six Months Ended
June 30 June 30
------- -------
1996 1995 1996 1995
---- ---- ---- ----
Assets under management - beginning $32.7 $29.9 $31.9 $16.3
Sales and reinvestments 2.0 1.1 3.9 2.0
Redemptions and withdrawals (1.5) (2.5) (2.7) (4.8)
Acquisitions 0.4 0.7 0.4 14.3
Market appreciation 0.3 1.2 0.4 2.6
----- ----- ----- -----
Assets under management - ending $33.9 $30.4 $33.9 $30.4
===== ===== ===== =====
Average fee-based assets under management were $33.8 billion for the three
months ended June 30, 1996 compared to $30.6 billion for the three months ended
June 30, 1995. For the six months ended June 30, 1996, average fee-based assets
were $33.1 billion compared to $23.6 billion for the six months ended June 30,
1995. This increase in 1996 was due to the Colonial and Newport acquisitions,
net mutual fund sales and market appreciation. Investment advisory and
administrative fees were 0.58% of average assets under management in the second
quarter of 1996 and 0.56% in the second quarter of 1995. For the first half,
such amounts were 0.57% and 0.55%, respectively. These increases in the
effective fee rate were primarily due to a higher proportion of equity assets
under management during 1996.
Distribution and Service Fees are based on the market value of the
Company's broker-distributed mutual funds. Distribution fees of 0.75% are earned
on the average assets attributable to such funds sold without front-end sales
loads, and service fees of 0.25% (net of amounts passed on to selling brokers)
are earned on the total of such average mutual fund assets. These fees totaled
$11.1 million in the second quarter of 1996 compared to $8.9 million in the
second quarter of 1995. This increase of $2.2 million was primarily attributable
to the higher asset level of mutual funds sold without front-end sales loads.
For the first half of 1996, distribution and service fees were $21.7 million
compared to $9.6 million in the first half of 1995. This increase of $12.1
million was primarily attributable to the full period consolidation of Colonial.
As a percentage of weighted average assets, these fees approximated 0.70% in
each of the 1996 and 1995 periods.
Transfer Agency Fees are based on the market value of assets managed in the
Company's broker-distributed and direct-marketed mutual funds. Such fees were
$10.8 million on average assets of $21.7 billion in the second quarter of 1996
and $9.2 million on average assets of $19.7 billion in the second quarter of
1995. The increase of $1.6 million was primarily due to higher average assets of
direct-marketed mutual funds and a fee increase on such funds instituted during
the second quarter of 1995. As a percentage of total average mutual fund assets
in the second quarter of 1996 and 1995, respectively, transfer agency fees were
approximately 0.20% and 0.19%. For the first half of 1996, transfer agency fees
were $21.2 million on average assets of $21.4 billion and $10.9 million on
average assets of $12.6 billion in the first half of 1995. The increase of $10.3
million was primarily due to the full-period consolidation of Colonial and the
fee increase on direct-marketed funds. As a percentage of total average mutual
fund assets in the first half of 1996 and 1995, transfer agency fees were
approximately 0.20% and 0.17%, respectively.
Surrender Charges and Net Commissions are revenues earned on: a) the early
withdrawal of fixed, indexed and variable annuity policyholder balances, and
redemptions of the broker-distributed mutual funds which were sold without
front-end sales loads; b) the distribution of the Company's broker-distributed
mutual funds (net of the substantial portion of such commissions that is passed
on to the selling brokers); and c) the sales of non-proprietary investment
products in the Company's bank marketing businesses (net of the substantial
portion of such commissions that is passed on to the Company's client banks).
Total surrender charges and net commissions were $9.4 million in the second
quarter of 1996 compared to $5.8 million in the second quarter of 1995, and, for
the first half of 1996 were $17.1 million compared to $10.8 million in the first
half of 1995.
Surrender charges on fixed, indexed and variable annuity withdrawals
generally are assessed at declining rates applied to policyholder balances
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 during the first six years. Such charges totaled $5.0 million and $5.5
million in the second quarter of 1996 and 1995, respectively, and $9.9 million
and $9.3 million in the first half of 1996 and 1995, respectively. The decrease
in surrender charges in the second quarter of 1996 was primarily due to a
decrease in surrender charges on annuity withdrawals. The increase in the first
half of 1996 was primarily due to the mutual fund redemptions associated with
the full-period consolidation of Colonial. On an annualized basis, total fixed,
indexed and variable annuity withdrawals represented 10.6% and 10.5% of the
total average annuity policyholder and separate account balances in the second
quarter of 1996 and 1995, respectively, and 10.2% and 10.8% of the total average
policyholder and separate account balances in the first half of 1996 and 1995,
respectively.
Net commissions were $4.4 million in the second quarter of 1996 and $0.3
million in the second quarter of 1995. The increase in 1996 was primarily
attributable to the acquisition of Independent on March 7, 1996. For the first
half of 1996, net commissions were $7.2 million compared to $1.5 million in the
first half of 1995. The increase in the 1996 six-month period was primarily
attributable to the acquisition of Independent and the full period consolidation
of Colonial.
Separate Account Fees are primarily mortality and expense charges earned on
variable annuity and variable life policyholder balances. These fees, which are
based on the market values of the assets supporting the contracts in separate
accounts, were $3.6 million in the second quarter of 1996 compared to $3.2
million in the second quarter of 1995. Such fees represented 1.5% and 1.6%,
respectively, of average variable annuity and variable life separate account
balances. For the first half of 1996, these fees were $7.0 million compared to
$6.4 million in the first half of 1995. Such fees represented 1.5% and 1.6%,
respectively, of average variable annuity and variable life separate account
balances.
Operating Expenses primarily represent compensation and other general and
administrative expenses. These expenses were $67.9 million in the second quarter
of 1996, compared to $58.3 million in the second quarter of 1995, an increase of
$9.6 million. The increase in the second quarter of 1996 primarily was due to
the acquisition of Independent and to increases in compensation and marketing
expenses relating to mutual fund sales. For the first half of 1996, operating
expenses were $133.8 million compared to $101.2 million in the first half of
1995, an increase of $32.6 million. A substantial portion of the increase in the
first half of 1996 relates to Colonial, Newport and Independent but also
reflects decreases in certain operating expenses in the Company's asset
management activities. Also included in operating expenses in the first half of
1996 are restructuring charges of $1.9 million recognized in connection with the
planned consolidation of the Company's bank marketing business into
Independent's operations. In the first half of 1995, a restructuring charge of
$2.3 million was recognized in connection with a reorganization of research and
investment management activities in the Company's asset management business.
Amortization of Deferred Policy Acquisition Costs was $14.9 million in the
second quarter of 1996 compared to $12.4 million in the second quarter of 1995
and $29.0 million in the first half of 1996 compared to $26.2 million in the
first half of 1995. The increase in amortization during 1996 was primarily due
to a decrease in estimated amortization periods in the last quarter of 1995
relating to shorter average policy lives, and to the growth of business in force
associated with fixed, indexed and variable annuity sales. Amortization expense
represented 0.53% and 0.47%, on an annualized basis, of the total average
policyholder and separate account balances in the second quarter of 1996 and
1995, respectively, and 0.52% and 0.50% or the total average policyholder and
separate account balances in the first half of 1996 and 1995, respectively.
Amortization of Deferred Distribution Costs relates to the deferred sales
commissions acquired in connection with the Colonial acquisition and to the
distribution of mutual fund shares sold without front-end sales loads.
Amortization was $7.4 million in the second quarter of 1996 compared to $5.9
million in the second quarter of 1995 and $14.2 million in the first half of
1996 compared to $6.2 million in the first half of 1995. The increase during the
second quarter of 1996 was primarily attributable to continuing sales of such
fund shares during 1995 and 1996. The increase during the first half of 1996 was
primarily attributable to the full-period consolidation of Colonial.
Amortization of Value of Insurance in Force totaled $1.9 million in the
second quarter of 1996 compared to $3.3 million in the second quarter of 1995
and $3.6 million in the first half of 1996 compared to $6.9 million in the first
half of 1995. The decrease in amortization during 1996 was primarily due to an
increase in estimated amortization periods in the last quarter of 1995 relating
to longer average policy lives on the Company's closed block of whole life
insurance.
Amortization of Intangible Assets was $4.5 million in the second quarter of
1996 compared to $3.5 million in the second quarter of 1995 and $8.3 million in
the first half of 1996 compared to $5.1 million in the first half of 1995. These
increases were attributable to the acquisitions of Colonial, Newport and
Independent.
Interest Expense was $5.0 million in the second quarter of 1996 compared to
$5.3 million in the second quarter of 1995. For the first half of 1996 interest
expenses was $10.1 million compared to $6.8 million in the first half of 1995.
This increase in the first half of 1996 was primarily attributable to the $100.0
million note issued in connection with the Colonial acquisition, the $24.0
million note issued in connection with the Newport acquisition and the $30.0
million note issued in 1995 to Liberty Mutual.
Income Tax Expense was $11.0 million or 32.3% of income before income
taxes, in the second quarter of 1996 compared to $11.3 million, or 34.8% of
income before income taxes, in the second quarter of 1995. For the first half of
1996, income tax expense was $23.5 million or 33.3% of income before income
taxes compared to $19.4 million or 38.4% for the first half of 1995. The higher
effective tax rate in 1995 primarily reflects the impact of restructuring and
other costs in the Company's asset management operations for which no tax
benefit was provided. In both the 1996 and 1995 periods, substantially all the
income tax expense related to the Company's annuity insurance business.
Financial Condition
Stockholders' Equity as of June 30, 1996 was $960.1 million compared to
$956.4 million as of December 31, 1995. Net income during the period was $46.9
million, and cash dividends on the Company's Preferred and Common Stock totaled
$1.9 million. Common Stock totaling $7.5 million and $1.2 million was issued in
connection with the acquisition of Independent and upon the exercise of stock
options, respectively. A decrease in net unrealized investment gains during the
period decreased stockholders' equity by $50.0 million.
Book Value Per Share amounted to $33.85 at June 30, 1996 compared with
$34.55 at December 31, 1995. Excluding net unrealized gains on debt and equity
securities, book value per share amounted to $32.54 at June 30, 1996 and $31.40
at December 31, 1995. As of June 30, 1996, there were 28.4 million common shares
outstanding compared to 27.7 million shares as of December 31, 1995.
Investments, not including cash and cash equivalents, totaled $10.2 billion
as of June 30, 1996 compared to $10.1 billion as of December 31, 1995. This
increase reflects fixed and indexed annuity sales in the first half of 1996 and
a decrease in net unrealized investment gains of approximately $219.5 million.
The Company manages the majority of its invested assets internally. The
Company's general investment policy is to hold fixed maturity assets for
long-term investment and, accordingly, the Company does not have a trading
portfolio. To provide for maximum portfolio flexibility and enable appropriate
tax planning, the Company classifies its entire fixed maturities investments as
"available for sale" and accordingly classifies such investments at estimated
fair value.
The Company's total investments at June 30, 1996, had an aggregate fair
value that exceeded its amortized cost by $96.2 million including net unrealized
gains of $89.0 million on its available for sale fixed maturities and equity
portfolios. As of December 31, 1995, such net unrealized investment gains were
$308.5 million. The decrease in net unrealized gains in the first half of 1996
principally reflects the higher relative prevailing interest rates during the
period.
Approximately $8.8 billion, or 93.6%, of the fixed maturities investments
at June 30, 1996, was 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 June 30, 1996, the
carrying value of investments in below investment grade securities totaled
$824.0 million, or 7.6% of total investments (including a portion of cash and
cash equivalents) of $10.8 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 is usually more limited than for investment
grade securities.
Investment Management
Asset-liability matching is utilized by the Company to minimize the risks
of interest rate fluctuations and disintermediation. The Company believes that
its fixed and indexed policyholder balances should be backed by investments,
principally comprised of fixed maturities, that generate predictable rates of
return. The Company does not have a specific target rate of return. Instead, its
rates of return vary over time depending on the current interest rate
environment, the slope of the yield curve and the excess at which fixed
maturities are priced over the yield curve. Its portfolio strategy is designed
to achieve adequate risk-adjusted returns consistent with the investment
objectives of effective asset-liability matching, liquidity and safety.
The Company conducts its investment operations to closely match the
duration of the assets in its investment portfolio to its policyholder balances.
The Company seeks to achieve a predictable spread between what it earns on its
assets and what it pays on its policyholder balances by investing principally in
fixed maturities. The Company's fixed-rate products incorporate surrender
charges to encourage persistency, discourage withdrawals and make the cost of
its policyholder balances more predictable. Approximately 88.9% of the Company's
fixed annuity policyholder balances were subject to surrender charges at June
30, 1996.
As part of its asset-liability matching discipline, the Company conducts
detailed computer simulations that model its fixed-maturity assets and
liabilities under commonly used stress-test interest rate scenarios. Based on
the results of these computer simulations, the investment portfolio has been
constructed with a view to maintaining a desired investment spread between the
yield on portfolio assets and the rate paid on its policyholder balances under a
variety of possible future interest rate scenarios. At June 30, 1996 the
effective duration of the Company's fixed maturities investments (approximately
93.1% of total investments) was approximately 2.8 years.
As a component of its investment strategy, the Company utilizes interest
rate swap agreements ("swap agreements") to match assets more closely to
liabilities. Swap agreements are agreements to exchange with a counterparty
interest rate payments of differing character (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 swap agreements to reduce asset duration and to better match interest
rates earned on longer-term fixed rate assets with interest rates credited to
policyholders. At June 30, 1996, the Company had 38 outstanding swap agreements
with an aggregate notional principal amount of $2.2 billion. These agreements
mature in various years through 2001. In addition, with respect to the Company's
indexed annuity, the Company buys call options on the S&P 500 Index to manage
its obligation to provide returns based upon this Index. At June 30, 1996, the
Company had options with an estimated fair value of $40.9 million.
There are risks associated with some of the techniques the Company uses to
match its assets and liabilities. The primary risk associated with swap
agreements is the risk associated with counterparty nonperformance. The Company
believes that the counterparties to its swap agreements are financially
responsible and that the counterparty risk associated with these transactions is
minimal. In addition, swap agreements have interest rate risk. However, these
swap agreements hedge fixed-rate assets; any interest rate movements that
adversely affect the market value of swap agreements would be more than offset
by changes in the market values of such fixed rate assets.
The Company routinely reviews its portfolio of investment securities. The
Company identifies monthly any investments that require additional monitoring
and carefully reviews the carrying value of such investments at least quarterly
to determine whether specific investments should be placed on a nonaccrual basis
and to determine declines in value that may be other than temporary. In making
these reviews, the Company principally considers the adequacy of collateral (if
any), compliance with contractual covenants, the borrower's recent financial
performance, new reports and other externally generated information concerning
the creditor's affairs. In the case of publicly traded fixed maturities
investments, management also considers market value quotations if available.
Liquidity
The Company is a holding company whose liquidity needs include the
following: (i) operating expenses; (ii) debt service; (iii) dividends on
preferred stock and common stock; (iv) acquisitions; and (v) working capital
where needed to 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.
Regulatory authorities permit dividend payments from Keyport to the Company
up to the lesser of (i) 10% of statutory surplus as of the preceding December 31
or (ii) the net gain from operations for the preceding fiscal year. As of June
30, 1996, Keyport could declare dividends of up to $34.6 million without the
approval of the Commissioner of Insurance of the State of Rhode Island. Under
Colonial's credit facility, Colonial could pay dividends of approximately $40.4
million as of June 30, 1996.
Each of the Company's business segments have their 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. 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 net investment income,
annuity premiums and deposits, and from maturities of fixed investments.
Annuity premiums, maturing investments and net investment income have
historically been sufficient to meet Keyport's cash requirements. Keyport
monitors cash and cash equivalents in an effort to maintain sufficient liquidity
and has strategies in place to maintain sufficient liquidity in changing
interest rate environments. Consistent with the nature of its obligations,
Keyport has invested a substantial amount of its general account assets in
readily marketable securities. As of June 30, 1996, $7.6 billion of Keyport's
total investments, including short-term investments, are considered readily
marketable.
To the extent that unanticipated surrenders cause Keyport to sell a
material amount of securities prior to their maturity for liquidity purposes,
such surrenders could have a material adverse effect on the Company. However,
Keyport believes that liquidity to fund withdrawals would be available through
incoming cash flow, the sale of short-term or floating-rate instruments or
investment securities in its short duration portfolio, thereby precluding the
sale of fixed maturity investments in a potentially unfavorable market.
In the Company's asset management activities, liquidity needs and financial
resources pertain to the investment management and distribution of mutual funds,
wealth management and institutional accounts.
Based upon the historical cash flow of the Company, the Company's current
financial condition and the Company's expectation that there will not be a
material adverse change in the results of operations of the Company and its
subsidiaries during the next twelve months, the Company believes that cash flow
provided by operating activities over this period will provide sufficient
liquidity for the Company to meet its working capital, capital investment and
other operational cash needs, its debt service obligations, its obligations to
pay dividends on the Preferred Stock, and its intentions to pay dividends on the
Common Stock. The Company's cash flow may be influenced by, among other things,
general economic conditions, realized investment gains and losses, the interest
rate environment, the level of assets under management, market changes,
regulatory changes and tax law changes.
Effects of Inflation
Inflation has not had a material effect on the Company's consolidated
results of operations. 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. (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.) However, inflation may result in increased
operating expenses that may not be readily recoverable in the prices of the
services charged by the Company.
Item 5. Other Information
With this report the Company has revised its financial reporting format. In
particular, components of investment spread, which are from the Company's
retirement-oriented insurance products, are presented separately from fee
income, which is generated mainly from its investment management products. The
Company also has made corresponding changes in its Management's Discussion and
Analysis presentation.
Set forth below is a description of the Company's business formatted in a
similar manner built around the distinction between the Company's two core
business segments. The Company intends to follow this format in future SEC
filings. The following business description is not required in this report, but
is included to assist investors and analysts. The information presented below
does not include disclosures different in substance from the Company's prior SEC
filings.
Overview
Liberty Financial Companies, Inc. ("Liberty Financial" or the "Company") is
an asset accumulation and management company -- that is, Liberty Financial earns
revenues by accumulating financial assets from investors and savers and managing
those assets. Liberty Financial accumulates assets by offering diverse
investment and retirement-oriented insurance products through multiple
distribution channels.
The Company has two core product lines -- retirement-oriented insurance
products (principally annuities) and investment management products (mutual
funds, as well as wealth management and institutional investment management).
The Company's insurance products primarily produce spread income; the investment
management products produce fee income. The Company believes that these products
have attractive growth prospects due to important demographic and economic
trends. These trends include the aging baby boom generation's desire to increase
savings and investment, lower public confidence that government and
employer-provided retirement benefits will be adequate for future retirees,
longer life expectancies and rising health care costs.
Liberty Financial's efforts to capitalize on these growth prospects are
guided by four interrelated strategies:
Diversification. Within its two core product lines, the Company
develops and markets a range of products that serve individuals at
different stages of their life and earnings cycle. This mix is also
designed to include products that will be in demand under a variety of
economic and market conditions. Similarly, the Company reaches
customers through a variety of distribution channels. The Company
believes that the diversification in its products and distribution
channels allows it to increase its assets under management in different
market cycles, thereby reducing earnings volatility.
Innovation. Liberty Financial believes that product, service and
distribution innovations are essential in order to grow its asset base
and meet the ever changing financial needs of its customers. The
Company believes it has an impressive track record in such innovations.
Integration. Liberty Financial conducts business through several
operating units that are wholly owned subsidiaries. Liberty Financial
emphasizes integration of its operating units, with a view toward
accumulating additional assets or achieving scale economies in its
operating expense structure.
Acquisition. Where appropriate, the Company seeks acquisitions that
provide additional assets, investment management capabilities,
distribution capabilities or other integration opportunities in its
core product areas.
For the six months ended June 30, 1996, the Company had total product sales
of $4.5 billion. Sixty-four percent of these product sales were made through an
intermediary distributor, with the balance made directly to the investor or
policyholder.
At June 30, 1996, assets under management were $44.7 billion, consisting of
the following:
$10.8 billion in annuities and other insurance products;
$24.6 billion in mutual fund assets;
$4.7 billion attributable to wealth management; and
$4.6 billion attributable to institutional investment management.
For the six months ended June 30, 1996 products producing spread income
accounted for approximately 60% of the Company's pre-tax operating income, while
products producing fee income accounted for the remaining 40%. Liberty Financial
seeks to balance the spread income and fee income components of its pre-tax
operating income. The Company has made progress in achieving this goal since its
acquisitions of The Colonial Group, Inc. and Newport Pacific Management, Inc. in
the first half of 1995.
At June 30, 1996, 82% of Liberty Financial's voting stock was indirectly
owned by Liberty Mutual Insurance Company.
Retirement-Oriented Insurance Products
The Company offers a full range of retirement-oriented insurance products,
grouped according to whether they provide fixed, indexed or variable returns to
policyholders. Substantially all these products currently are annuities that are
underwritten and issued by Keyport Life Insurance Company ("Keyport"), an
operating unit of the Company. Annuities are insurance products designed to
offer individuals protection against the risk of outliving their income during
retirement. In addition to offering a tax-favored source of lifetime income,
annuities are also a tax-efficient means of accumulating savings for retirement
needs.
Fixed Annuities. The Company's principal fixed annuity products
are individual single premium deferred annuities ("SPDAs"). A SPDA
policyholder typically makes a single premium payment at the time
of issuance. The Company obligates itself to credit interest to
the policyholder's account at a rate that is guaranteed for an
initial term (typically one year) and is adjusted annually
thereafter, subject to a guaranteed minimum rate. At June 30,
1996, the Company's fixed annuity policyholder balances were $7.8
billion.
Equity-Indexed Annuities. Indexed annuities are an innovative
product first introduced in 1995 by the Company when it began
selling KeyIndex, an equity-indexed product. An equity-indexed
annuity credits a return to the policyholder at a "participation
rate" equal to a portion of the change in value of a specified
equity index. KeyIndex is currently offered for both one and
five-year terms with interest earnings based on a percentage of
the increase in the S&P 500 Index. With the five-year term, the
interest earnings are based on the highest anniversary value of
the S&P 500 Index during the term. KeyIndex also provides a
guarantee of principal at the end of the term. Thus, unlike a
direct equity investment, even if the S&P 500 Index declines,
there is no risk to principal. At June 30, 1996, the Company's
equity-indexed annuity policyholder balances were $400 million.
The Company has several versions of the equity-index annuity
concept under development.
Variable Annuities. Variable annuities offer a selection of
underlying investment alternatives, which may satisfy a variety of
policyholder objectives. In a variable annuity, separate account
investment options (similar to mutual funds) pass the investment
risk directly to the policyholder in return for the potential of
higher returns. The Company's Preferred Advisor variable annuity
currently offers 11 separate account investment choices and four
guaranteed fixed interest options. At June 30, 1996, the Company's
variable annuity separate account policyholder balances were $955
million.
Fixed and indexed annuities produce spread income; variable annuities
primarily produce fee income.
While the Company currently does not offer traditional life insurance
products, it manages a closed block of single premium whole life insurance
policies ("SPWLs"). SPWLs are a retirement-oriented tax-advantaged life
insurance product. The Company discontinued sales of SPWLs in response to the
Tax Reform Act of 1986. The Company had SPWL policyholder balances of $2.0
billion at June 30, 1996. SPWLs produce spread income.
Under current law, returns credited on annuities and life insurance
policies during the accumulation period (the period during which interest is
credited and payouts have not yet begun) are not subject to federal or state
income tax. Proceeds payable on death from a life insurance policy are also free
from such taxes. At the maturity or payment date of an annuity policy, the
policyholder is entitled to receive the original deposit plus accumulated
returns. The policyholder may elect to take this amount in either a lump sum or
an annuitized series of payments over time. The return component of such
payments is taxed at the time of receipt as ordinary income.
The Company's insurance products include important features designed to
promote both sales and asset retention, including interest crediting rates and
surrender charges. Interest crediting and participation rates significantly
influence the Company's ability to be competitive in the sale of new policies.
SPDA renewal rates impact retention of SPDA assets, particularly on policies
where surrender penalties have expired. All of the Company's annuities permit
the policyholder at anytime to withdraw all or any part of the accumulated
policy balance. Surrender charges provide a measure of protection against
premature withdrawal of policy balances. Surrender charges typically start at 7%
and then decline over a five- to seven-year period. All of the Company's
annuities currently are issued with surrender charges. With respect to spread
income products (fixed and indexed annuities), both crediting rates and
policyholder withdrawals affect the Company's management of asset/liability
matching and contribute to the achievement of investment spread targets.
The Company believes Keyport has a reputation for excellent service to its
intermediary distributors and its policyholders. Keyport has developed advanced
technology systems for immediate response to customer inquiries, and rapid
processing of policy issuances and commission payments (often at the point of
sale). These systems also play an important role in controlling costs. Keyport's
annualized operating expenses during the six months ended June 30, 1996 were
0.48% of assets, making Keyport one of the lowest cost operators in the annuity
business.
Keyport's strong financial ratings are important to its ability to
accumulate and retain policyholder balances. Keyport is rated "A+" (Superior) by
A.M. Best, "AA-" by Standard and Poor's and "A1" by Moody's. A.M. Best is an
independent insurance rating agency that assigns fifteen letter ratings to
insurance companies, ranging from "A++" (Superior) to "F" (In Liquidation).
Publications of A.M. Best indicate that "A++" and "A+" ratings are assigned to
those companies that in A.M. Best's opinion have achieved superior overall
performance when compared to the quantitative and qualitative standards
established by A.M. Best, and generally have demonstrated a strong ability to
meet their policyholder obligations over a long period of time. These ratings
are based upon information supplied to the rating agency, and are directed
toward the protection of policyholders, not investors.
The Company has two primary financial objectives for its
retirement-oriented insurance products: to increase policyholder balances
through new sales and asset retention and to earn targeted investment spreads on
its fixed and indexed return products.
New product sales are influenced primarily by overall market conditions
impacting the attractiveness of these products, and by product features,
including interest crediting and participation rates, and innovations that
distinguish the Company's products from those of its competitors. Sales of SPDAs
tend to be sensitive to prevailing interest rates. Sales can be expected to
increase in interest rate environments when SPDA crediting rates are higher than
rates offered by competing conservative fixed-return investments, such as bank
certificates of deposit. SPDA sales can be expected to decline in interest rate
environments when this differential in rates is not present.
Premiums on fixed and indexed annuities are deposited to Keyport's general
investment account. To achieve its targeted investment spreads, the Company must
earn returns on its general account sufficiently in excess of the fixed or
indexed returns credited to policyholders. The key element of this investment
process is asset/liability management. Successful asset/liability management
requires a quantitative assessment of overall policy liabilities (including
maturities, surrenders and crediting of returns) and prudent investment of
general account assets. The two most important tools in managing policy
liabilities are setting crediting rates and establishing surrender periods. The
asset side of the investment process requires portfolio techniques that earn
required yields while effectively managing both interest rate risk and credit
risk. The Company emphasizes a conservative approach to asset/liability
management, which is oriented toward reducing downside risk in adverse markets,
as opposed to maximizing spread in favorable markets. The approach is also
designed to reduce earnings volatility.
The majority of the Company's general account (85.8% at June 30, 1996) is
invested in fixed maturity securities. An additional 8.6% is maintained in cash
and cash equivalents for short term liquidity needs. The principal strategy for
managing interest rate risk is to maintain a relatively short duration of its
fixed income portfolio (2.8 years at June 30, 1996). The Company also employs
hedging strategies, including interest rate swaps and caps, to manage this risk.
In the case of KeyIndex, the Company purchases S&P 500 call options to hedge its
obligations to provide participation rate returns. Credit risk is managed by
careful credit analysis and monitoring. At June 30, 1996, 93% of the fixed
income component of the general account portfolio consisted of investment grade
securities (securities rated BBB- or higher by S&P, or Baa3 or higher by
Moody's), which had an overall average S&P rating of A+. The balance was
invested in below investment grade securities to enhance overall portfolio
yield. At June 30, 1996, less than 0.1% of the fixed income portfolio consisted
of securities in default.
Investment Management
Liberty Financial has three core types of investment management products:
mutual funds, wealth management, and institutional investment management. The
Company has four separate operating units engaged in investment management: The
Colonial Group, Inc. ("Colonial"), Stein Roe & Farnham Incorporated ("Stein
Roe"), Newport Pacific Management, Inc. ("Newport") and Liberty Asset Management
Company ("LAMCO").
Mutual Funds. The Company sponsors 71 open-end mutual funds, as
well as seven closed-end funds. The open-end funds include 40
intermediary-distributed Colonial funds, 20 direct-marketed Stein
Roe funds and 11 funds that are investment options under the
Company's variable annuities. The closed-end funds include five
Colonial funds and two LAMCO funds. At June 30, 1996, total fund
assets were $24.6 billion. At that date 44% of these assets were
invested in equity funds (compared to 35% at June 30, 1995), 29%
in taxable fixed income funds and 27% in tax-exempt fixed income
funds. The Company seeks to continue to increase equity mutual
fund assets under management.
Wealth Management. At June 30, 1996, the Company managed $4.7
billion in investment portfolios for high net worth individuals,
families and trusts, all of which is managed by Stein Roe.
Institutional Investment Management. At June 30, 1996, the
Company managed $4.6 billion of investment portfolios for
institutional investors such as insurance companies, public and
private retirement funds, endowments, foundations and other
institutions. Most of these assets are managed by Stein Roe. In
addition, Stein Roe manages $9.5 billion of Keyport's general
account portfolio.
The Company believes that the most important factors in accumulating and
retaining investment management assets are investment performance, customer
service and brand name recognition. Strong investment performance is crucial to
asset accumulation and retention, regardless of the product or distribution
channel. Performance is particularly important for mutual funds, whether
intermediary-distributed or direct-marketed. The Company believes that currently
the most important measure of performance influencing sales through
intermediaries is peer group rankings compiled by Lipper. For the one-year
period ended June 30, 1996, based on figures for Class A (front-end load)
shares, 30 of the Colonial funds (accounting for 48% of the $16.3 billion in
total Colonial fund assets at that date) were in the top two quartiles of their
respective Lipper peer groups, with 18 funds (with 20.77% of such assets) in the
top quartile. For direct-marketed funds, the Company believes that currently the
most important performance measure influencing sales is Morningstar ratings. Of
the 12 Stein Roe funds rated by Morningstar as of the date of this report, none
are less than three-star (an indication of strong and consistent investment
performance), with six funds having a four-star rating and one fund having the
maximum five-star rating. The Company's investment performance must remain
competitive for the Company to continue to grow investment management sales and
assets.
Excellent service to customers, including mutual fund shareholders and
distributors, is fundamental to successful asset retention. The Company acquired
Colonial, in part, because of its reputation for excellent customer service.
Following the acquisition of Colonial, the Company consolidated its mutual fund
transfer agency functions into Colonial.
The Company believes that, in light of the proliferation of mutual funds
and investment managers, strong brand name recognition in relevant distribution
channels is essential to asset accumulation and retention, particularly with
respect to mutual funds. The Company believes that the Colonial name carries
strong brand name recognition among brokers and other intermediaries selling
mutual funds, and that the Stein Roe name carries similar recognition in the
direct sales channel. Similarly, the Company believes that Stein Roe has a
franchise presence in the wealth market, and that Newport is a recognized leader
in investment management in Asian markets.
As with insurance products, sales of mutual funds and other investment
management products are subject to market forces, such as changes in interest
rates and stock market performance. Sales of the Company's equity mutual funds
have benefited in 1996 from the continued strong performance of the U.S. stock
market. Sales of the Company's fixed income mutual funds have been modest during
1996, given current market conditions. Changes in the financial markets,
including significant increases or decreases in interest rates or stock prices,
can increase or decrease fund sales and redemptions, as well as the values of
fund portfolios, all of which can impact the level of investment management
fees.
The Company's financial objectives with respect to its investment
management businesses are to grow assets under management in each of its three
core product areas, and to improve operating margins through increasing scale
and cost savings produced by integration. The investment management business,
particularly with respect to mutual funds, offers excellent opportunities to
grow operating profits and to achieve and attain attractive operating margins
for those participants whose asset base and investment and service
infrastructure reach critical mass levels. Since its acquisition of Colonial and
Newport in the first six months of 1995, the Company has generated annualized
cost savings of approximately $12.0 million per year through the consolidation
of various support and service functions in its mutual fund business.
Distribution and Sales
Liberty Financial sells its products through multiple distribution
channels. Total proprietary product sales for the six months ended June 30, 1996
were $4.5 billion. Sixty-four percent of these sales were made through
intermediaries, and the remaining 36% of sales were made directly to the
investor.
Distribution Through Intermediaries
The Company sells both annuities and mutual funds through various
intermediaries, including national and regional brokerage firms, banks,
financial planners and insurance agents. In the first six months of 1996, more
than 28,000 brokers and agents sold the Company's products. The Company's
annuities and mutual funds are most often sold to middle and upper-middle class
investors and savers. Many of these individuals, busy with their own careers,
families and other interests, seek the help of an investment professional in
selecting investment and retirement savings products. In each of these
intermediary channels, the Company provides products, as well as promotional
materials and other support services.
Reflecting its diversification strategy, the Company maintains distribution
relationships with several different types of intermediaries.
Intermediary-distributed mutual funds and annuities historically have been sold
through brokerage firms and insurance agents. In recent years banks and
financial planners also have become significant distributors of these products.
Banks have moved into selling mutual funds and annuities to counter the outflow
of customer deposits and to increase fee income. The Company was a pioneer in
selling through banks, both in terms of helping banks develop marketing programs
and in establishing wholesaling relationships with banks. Fee-based financial
planners also have emerged as a significant distribution channel.
The Company employs wholesalers for its annuities and for its
intermediary-distributed mutual funds. The wholesalers meet with intermediaries'
sales forces to educate them on matters such as product objectives, features,
performance records and other key selling points. The Company also produces
marketing material designed to help intermediaries sell the Company's products,
and provides after-sale support to both the intermediaries and their customers.
The degree and mix of these services vary with the requirements of the
particular intermediary. For example, a small brokerage or financial planning
firm typically will utilize more of these support services than a large national
brokerage firm.
Liberty Financial has two sales units that sell mutual funds and annuities
through banks: the Liberty Financial Bank Group and Independent Financial
Marketing Group, Inc. ("IFMG"). The Company acquired IFMG in March, 1996, and is
in the process of consolidating these two organizations into IFMG. These
businesses design and implement programs that sell such products through their
client banks, license and train sales personnel and provide administrative
support. Program structures and the degree of the Company's involvement vary
widely depending upon the particular needs of each bank. In some banks, the bank
provides space in its branches and the Company places its own sales
representatives in that space and fully operates the program. Products sold
include the Company's proprietary products, as well as non-proprietary products
(including in some cases the bank's own proprietary mutual funds). In other
cases, the Company's role may be limited to functions such as licensing and
training the bank's employees and wholesaling products. At June 30, 1996, these
operations had 175 bank relationships involving over 3,100 registered
salespersons.
The sales practices and support needs of the Company's distributors are
constantly evolving. The Company must respond to these changes in order to
maintain and increase its intermediary distribution relationships. Pricing
structures in these channels, particularly with respect to mutual funds, are
evolving from one-time up-front sales loads to options that shift investors'
payments over time and move toward fee-based pricing. Intermediaries also
increasingly demand that product providers supply new value-added services. The
Company's intermediary-distributed mutual funds now are sold with alternate
pricing structures. The Company is seeking to develop innovative new
technology-based service and support tools, such as asset allocation models and
on-line customer account management systems, designed to provide value-added
services to intermediaries and their customers. Some distributors have begun to
assess fee sharing payments or similar charges as additional compensation for
fund sales. The Company may have to choose in certain cases between absorbing
these charges or limiting its access to certain distributors.
Direct Distribution
The Company's direct-marketed mutual funds, as well as its wealth
management and institutional investment management services, are sold directly
to investors. The Company's direct-marketed mutual funds are purchased
predominantly by middle and upper middle class investors and savers who choose
to select their own funds and who wish to avoid paying sales loads and similar
fees. Wealth management clients typically are high net worth individuals and
families and smaller institutional investors. Institutional investment
management clients typically are larger institutional investors managed by
in-house professional staffs that select and oversee asset managers, often with
the advice of third party consultants. Direct sales of these products and
services requires that the Company perform all of the marketing and service
functions required to reach and retain these investors.
In each of the direct sales markets served by the Company, investment
performance is essential to generating sales and retaining customers. Mutual
fund sales also require robust marketing campaigns using print, radio and
television advertising and direct mail that highlight performance and other
selling points. The Company believes that certain of the technology-based
customer service and support tools it is developing, such as on-line account
access and asset allocation programs, will be important tools in accumulating
and retaining assets in the direct distribution channels. Stein Roe's reputation
as a high quality asset manager is the most important factor in generating new
wealth and institutional asset management clients. Active management of the
client relationship, including frequent personal contacts, is necessary to
retain these clients.
Diversification
The appeal of the Company's products varies according to an individual's
age, income, risk tolerance and financial goals. The Company's products vary
widely in financial objectives and risks. The Company's product diversity is
designed in part to serve individuals at various stages of their life and
earnings cycles, with an emphasis on retirement savings and income needs. The
Company also believes that its product mix will appeal to customers under a
variety of economic and market conditions. This diversification is designed to
smooth out the ebbs and flows of the financial markets. There are times when
equity mutual funds will sell more briskly than fixed income funds or annuities.
Conversely, there are other periods when the opposite will be the case.
Similarly, diversification of distribution channels allows the Company to reach
many distinct segments of the marketplace and lessens its dependence on any one
source of assets. The Company believes that the diversification in its products
and distribution channels allows it to increase assets in different market
cycles, thereby reducing earnings volatility.
Innovation
The Company believes that innovations creating new or enhanced products or
accessing new markets are essential in order to grow its asset base and meet the
ever-changing needs of its customers. Successful product innovation has been
critical to growth throughout the financial services industry. The Company
believes that, aside from excellent investment performance, continual
introduction of new and innovative products is the best strategy for generating
new sales. In addition, the Company believes that the distinctions which have
separated intermediary and direct distribution channels are blurring as a result
of the trend in intermediary channels toward fee-based pricing, the introduction
of asset allocation and other new value-added services and the emergence of new
sales mediums (such as the Internet). This is particularly the case for products
such as mutual funds that are purchased by individual investors. To succeed in
the future in maintaining and expanding its client base and distribution
relationships, the Company must respond by developing new products, pricing
structures and technology-driven tools.
The Company believes that it has an impressive record in product and
distribution innovations. Keyport was a leader in developing single premium
whole life insurance. Liberty Financial was a pioneer in the business of
distributing mutual funds and annuities through banks. The Colonial Newport
Tiger Fund was the first U.S.-based mutual fund to focus exclusively on the
"Tiger" countries of Asia. The Stein Roe Young Investor Fund was the first
mutual fund to be coupled with an educational program to teach younger people
about investing, while at the same time offering parents an excellent device to
save for educational and other family needs. The Company's ability to create new
products continued with its introduction in 1995 of KeyIndex, the first
equity-indexed annuity introduced into the marketplace.
Integration
Liberty Financial conducts business through several operating units that
are wholly owned subsidiaries. Integration of Liberty Financial's operating
companies is a fundamental operating philosophy. Leveragable talents and
resources include product development and design, distribution relationships,
investment management, investor servicing and technology development and
support. Where appropriate, the Company seeks to leverage those resources across
multiple operating units, with a view toward accumulating additional assets or
reducing expenses. Examples of successfully implemented integration efforts
include the following:
Upon the Company's acquisition of Newport in April, 1995,
Colonial assumed the marketing, sales, service and administration
of Newport's flagship Tiger Fund. The Fund's outstanding
investment performance has continued following the acquisition (it
remains ranked first in its Lipper peer group for the five-year
period ended June 30, 1996), and asset growth has been
exceptional, increasing 63.4% since that time. Colonial also has
benefited because the availability of the Colonial Newport Tiger
Fund has established distribution arrangements with new
intermediaries.
Stein Roe manages most of Keyport's general account fixed income
portfolio, and, together with, Colonial and Newport, manages
certain funds underlying Keyport's variable annuity product.
Colonial's transfer agency operations also perform these functions
for the Stein Roe funds.
During the six months ended June 30, 1996, the Company's bank
distribution units were the largest distributor of Keyport's
annuities, and the third largest distributor of the Colonial
funds, accounting for 9.0% and 6.0%, respectively, of total sales
of those products.
Acquisitions
Acquisitions are an integral part of the Company's business strategy.
Keyport, Colonial, Stein Roe, Newport, and, most recently, IFMG all joined
Liberty Financial through acquisition. Where appropriate, the Company continues
to seek opportunities to make acquisitions that can provide additional assets,
investment management capabilities, distribution capabilities, or other
integration opportunities. Current areas of focus for the Company's acquisition
efforts include the following:
Mutual funds, with particular focus on equities and foreign markets;
Additional distribution capabilities;
Wealth management firms that can become part of Stein Roe, and
can leverage and expand Stein Roe's franchise in the wealth
management market; and
Blocks of annuity assets that can be purchased or co-insured on
attractive terms.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11 Statement re Computation of Per Share Earnings
12 Statement re Computation of Ratios
27 Financial Data Schedule
(b) Reports on Form 8-K
On April 12, 1996, the Company filed a current report on Form 8-K dated
April 10, 1996 in connection with the appointment of Ernst & Young LLP as
its independent accountants.
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/ Gerald Rush
--------------------------------------
Gerald Rush
Vice President Finance
(Duly Authorized Officer and
Chief Accounting Officer)
Date: August 13, 1996
Exhibit Index
Exhibit No. Description
- ----------- -----------
11 Statement re Computation of Per Share Earnings
12 Statement re Computation of Ratios
27 Financial Data Schedule