- ---------------------------------------------------
S E L E C T E D F I N A N C I A L D A T A
- ---------------------------------------------------
Selected Consolidated Financial Data
(in millions, except per share data)
As Of Or For The Year Ended December 31 1996 1995(1) 1994 1993 1992(2)
..............................................................................................................
Income Statement Data
Investment income $ 796.4 $ 761.8 $ 695.1 $ 675.3 $ 710.0
Interest credited to policyholders (572.7) (555.8) (481.9) (504.2) (571.0)
-------- -------- -------- -------- -------
Investment spread 223.7 206.0 213.2 171.1 139.0
-------- -------- -------- -------- -------
Net realized investment gains (losses) 8.0 (4.0) (8.2) 11.4 3.1
-------- -------- -------- -------- -------
Fee income:
Investment advisory and administrative fees 196.4 155.8 95.9 98.9 88.0
Distribution and service fees 44.9 28.9 -- -- --
Transfer agency fees 43.9 30.8 4.0 5.4 5.0
Surrender charges and net commissions 34.7 23.4 20.0 22.9 24.2
Separate account fees 16.0 13.2 12.5 8.0 5.0
-------- -------- -------- -------- -------
Total fee income 335.9 252.1 132.4 135.2 122.2
-------- -------- -------- -------- -------
Expenses:
Operating expenses (277.9) (225.1) (174.9) (178.9) (175.8)
Amortization of deferred policy acquisition costs (60.2) (58.5) (52.2) (41.0) (17.0)
Amortization of deferred distribution costs (33.9) (18.8) -- -- --
Amortization of value of insurance in force (10.2) (9.5) (17.0) (22.4) (32.4)
Amortization of intangible assets (15.4) (12.2) (5.8) (15.0) (42.3)
Interest expense (19.7) (16.2) (4.2) -- --
-------- -------- -------- -------- -------
Total expenses (417.3) (340.3) (254.1) (257.3) (267.5)
-------- -------- -------- -------- -------
Pretax income (loss) 150.3 113.8 83.3 60.4 (3.2)
Income tax expense (49.6) (39.9) (32.5) (29.1) (9.3)
-------- -------- -------- -------- -------
Net income (loss) $ 100.7 $ 73.9 $ 50.8 $ 31.3 $ (12.5)
======== ======== ======== ======== =======
Per Share Data
Net income (loss) $ 3.36 $ 2.64 $ 2.15 $ 1.32 $ (0.55)
Cash dividends on common stock(3) 0.60 0.45 -- -- --
Dividends on convertible preferred stock 2.88 2.21 -- -- --
Book value 36.63 34.55 27.38 28.00 26.87
Balance Sheet Data
Total investments $11,537.9 $10,144.7 $8,590.2 $8,411.7 $8,151.6
Intangible assets 205.4 192.3 29.3 35.2 50.2
Total assets 14,427.7 12,749.4 10,968.8 10,324.6 9,798.3
Notes payable to affiliates 229.0 229.0 75.0 -- --
Series A redeemable convertible preferred stock 13.8 13.0 -- -- --
Stockholders' equity 1,051.4 956.4 624.7 638.8 612.7
Common stock outstanding 28.7 27.7 22.8 22.8 22.8
- ------------
1 Amounts for 1995 include data for The Colonial Group, Inc. which was acquired
on March 24, 1995. See Note 2 of Notes to the Consolidated Financial
Statements.
2 In 1992, the Company changed its estimate of the carrying value of certain
intangible assets in its asset management business, resulting in additional
amortization expense of $21.0 million. In addition, in 1992 the Company
accrued $28.2 million for anticipated guaranty fund assessments in its annuity
insurance business in connection with the failure of certain insurance
companies.
3 Amount for 1995 does not include a non-cash dividend of $30.0 million to an
affiliate of Liberty Mutual. See Note 5 of Notes to the Consolidated Financial
Statements.
23
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M A N A G E M E N T ' S D I S C U S S I O N
- ---------------------------------------------------
Management's Discussion and Analysis of Results of Operations and Financial
Condition
Results of Operations
Net Income was $100.7 million or $3.36 per share in 1996 compared to $73.9
million or $2.64 per share in 1995 and $50.8 million or $2.15 per share in 1994.
The improvement of $26.8 million in 1996 compared to 1995 resulted from higher
investment spread, higher fee income and net realized investment gains in 1996
compared to net realized investment losses in 1995. Partially offsetting these
items were increased operating expenses, amortization expense, interest expense
and income tax expense. The full-period consolidation of the 1995 Colonial and
Newport acquisitions resulted in an $8.9 million increase in 1996 net income
compared to 1995. The improvement of $23.1 million in 1995 compared to 1994
primarily resulted from higher fee income associated with the Colonial and
Newport acquisitions and lower net realized investment losses in 1995. Partially
offsetting these items were decreased investment spread and increased operating
expenses, amortization expense, interest expense and income tax expense.
Pretax Income was $150.3 million in 1996 compared to $113.8 million in 1995
and $83.3 million in 1994. The higher pretax income in 1996 compared to 1995
resulted from higher investment spread, higher fee income, and net realized
investment gains in 1996 compared to net realized investment losses in 1995. The
full-period consolidation of the 1995 Colonial and Newport acquisitions resulted
in an $11.9 million increase in 1996 pretax income compared to 1995. The higher
pretax income in 1995 compared to 1994 was primarily due to the Colonial and
Newport acquisitions, and to lower net realized investment gains. Partially
offsetting these increases in both years were the higher expenses referred to
above.
Investment Spread is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $223.7 million in 1996 compared to $206.0 million in 1995
and $213.2 million in 1994. 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 1996 was
1.89% compared to 1.90% for 1995 and 2.17% for 1994. Assuming a constant
interest rate environment, the Company anticipates that the investment spread
percentage in 1997 will be comparable to 1996.
Investment income was $796.4 million in 1996 compared to $761.8 million in
1995 and $695.1 million in 1994. Investment income increased in 1996 compared to
1995 primarily as a result of the higher level of average invested assets,
24
partially offset by a decrease in the average investment yield. The average
investment yield was 7.21% in 1996 compared to 7.57% in 1995. The decreased
investment yield in 1996 reflects the lower interest rates prevailing during the
latter half of 1995 and early 1996 and to amortization of S&P 500 Index options.
Investment income increased in 1995 compared to 1994 primarily as a result of
the higher level of average invested assets. The investment yield increased
slightly during 1995. The average investment yield was 7.53% in 1994.
Interest credited to policyholders totaled $572.7 million in 1996 compared
to $555.8 million in 1995 and $481.9 million in 1994. Interest credited to
policyholders increased in 1996 compared to 1995 primarily as a result of a
higher level of average policyholder balances, partially offset by a decrease in
the average interest credited rate. Policyholder balances averaged $10.8 billion
in 1996 compared to $9.8 billion in 1995. The average interest credited rate was
5.32% in 1996 compared to 5.67% in 1995. Interest credited to policyholders
increased in 1995 compared to 1994 primarily as a result of the higher level of
average policyholder balances and to an increase in the average interest
credited rate. Policyholder balances averaged $9.8 billion in 1995 compared to
$9.0 billion in 1994. The average interest credited rate was 5.36% in 1994.
Average Investments (computed without giving effect to SFAS 115), including
a portion of the Company's cash and cash equivalents, were $11.0 billion in 1996
compared to $10.1 billion in 1995 and $9.2 billion in 1994. The increase of $0.9
billion in 1996 compared to 1995 was primarily due to the coinsurance agreement
entered into with Fidelity & Guaranty Life Insurance during the third quarter
(the "F&G Life transaction") and sales of the Company's fixed and indexed
annuities offset, in part, by withdrawals of $1.1 billion. Fixed and indexed
annuity premiums totaled $1.2 billion for 1996 compared to $1.1 billion for 1995
and $1.2 billion in 1994. The increase in premiums in 1996 compared to 1995 was
primarily attributable to the sales of indexed annuities which were introduced
during 1995. Sales of indexed annuities in 1996 totaled $655.2 million compared
to $83.9 million in 1995. The decrease in total premiums in 1995 compared to
1994 was primarily due to lower interest rates prevailing during the latter half
of 1995, making fixed income products less competitive.
Net Realized Investment Gains were $8.0 million in 1996 compared to net
realized investment losses of $4.0 million in 1995 and net realized investment
losses of $8.2 million in 1994. The net realized investment gains in 1996 were
primarily attributable to sales of Keyport fixed maturity investments and sales
of investments received in the F&G Life transaction which were made to maximize
total return. The net realized investment losses in 1995 were attributable to
sales of Keyport fixed maturity investments which were made to maximize total
return. The net realized investment losses in 1994 were primarily due to
write-downs of investments whose declines in value were determined to be other
than temporary.
Investment Advisory and Administrative Fees are based on the market value
of assets managed for mutual funds, wealth management and institutional
investors. Investment advisory and administrative fees were $196.4 million in
1996 compared to $155.8 million in 1995 and $95.9 million in 1994. The increase
of $40.6 million in 1996 compared to 1995 primarily reflects a higher level of
average fee-based assets under management due to the full year consolidation of
25
Colonial and Newport. A substantial portion of the $59.9 million increase in
1995 compared to 1994 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.
The amount of fee-based assets under management are affected by product
sales and redemptions and by 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 December 31
--------------------------------
1996 1995 1994
.............................................................................
Mutual Funds:
Broker-distributed $16.1 $15.7 $1.3
Direct-marketed 6.6 4.8 4.5
Closed-end 1.9 1.8 0.8
Variable annuity 1.1 1.0 0.8
------ ------ -----
25.7 23.3 7.4
Wealth Management 5.3 4.5 4.1
Institutional 4.9 4.1 4.8
------ ------ -----
Total Fee-Based Assets Under Management $35.9 $31.9 $16.3
====== ====== =====
Changes in Fee-Based Assets Under Management
Year Ended December 31
--------------------------------
1996 1995 1994
................................................................................
Fee-based assets under management--beginning $31.9 $16.3 $21.7
Sales and reinvestments 7.5 4.8 2.6
Redemptions and withdrawals (5.7) (8.5) (6.7)
Acquisitions 0.3 14.9 --
Market appreciation (depreciation) 1.9 4.4 (1.3)
----- ----- -----
Fee-based assets under management--ending $35.9 $31.9 $16.3
===== ===== =====
Average fee-based assets under management were $33.9 billion in 1996
compared to $27.2 billion in 1995 and $19.7 billion in 1994. The increase of
$6.7 billion during 1996 compared to 1995 was primarily due to the full year
inclusion of the assets acquired in the Colonial and Newport acquisitions, net
mutual fund sales and market appreciation. The increase of $7.5 billion in 1995
compared to 1994 was due to the Colonial and Newport acquisitions and to market
appreciation. Investment advisory and administrative fees were 0.58% of average
fee-based assets under management in 1996, 0.57% in 1995 and 0.49% in 1994.
These increases in the effective fee rate in 1996 and 1995 were primarily due to
the increased proportion of higher fee-based mutual fund assets under
management.
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
26
fund assets. These fees totaled $44.9 million in 1996 compared to $28.9 million
in 1995. There were no such fees prior to the acquisition of Colonial. The
increase of $16.0 million in 1996 compared to 1995 was primarily attributable to
the higher asset levels of mutual funds without front-end sales loads. As a
percentage of weighted average assets, distribution and service fees
approximated 0.69% in each of 1996 and 1995.
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 $43.9 million on average assets of $22.6
billion in 1996, $30.8 million on average assets of $17.4 billion in 1995 and
$4.0 million on average assets of $5.6 billion in 1994. The increase of $13.1
million in 1996 compared to 1995 was primarily due to higher average assets in
direct-marketed mutual funds. The revenue increase of $26.8 million in 1995
compared to 1994 was due to the acquisition of Colonial. As a percentage of
total average mutual fund assets under management, transfer agency fees were
approximately 0.19%, 0.18% and 0.07% in 1996, 1995 and 1994, 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 such commissions
that are paid to the Company's client banks and brokers). Total surrender
charges and net commissions were $34.7 million in 1996 compared to $23.4 million
in 1995 and $20.0 million in 1994.
Surrender charges on fixed, indexed 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 during the first six years. Such charges totaled $19.8 million, $18.4
million and $11.5 million in 1996, 1995 and 1994, respectively. The increase in
1996 compared to 1995 was primarily attributable to the full-period
consolidation of Colonial. The increase in 1995 compared to 1994 was
attributable to the Colonial acquisition and higher earlier withdrawals subject
to surrender charges for annuity policyholders. Total fixed, indexed and
variable annuity withdrawals represented 11.6%, 9.9%, and 12.6% of the total
average annuity policyholder and separate account balances in 1996, 1995 and
1994, respectively.
Net commissions were $14.9 million in 1996, $5.0 million in 1995 and $8.5
million in 1994. The increase in 1996 compared to 1995 was primarily
attributable to the acquisition of Independent in March 1996. The decrease in
1995 compared to 1994 was primarily attributable to lower sales of investment
and insurance products in the Company's bank marketing business.
27
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 $16.0 million in 1996 compared to $13.2 million in 1995 and $12.5
million in 1994. Such fees represented 1.68%, 1.61%, and 1.63% of average
variable annuity and variable life separate account balances in 1996, 1995 and
1994, respectively.
Operating Expenses primarily represent compensation, marketing and other
general and administrative expenses. These expenses were $277.9 million in 1996
compared to $225.1 million in 1995 and $174.9 million in 1994. The increase in
1996 compared to 1995 was primarily due to increases in compensation and
marketing expenses relating to mutual fund sales and to the acquisition of
Independent. The increase in 1995 compared to 1994 includes $66.5 million of
operating expenses related to Colonial and Newport, offset, in part, by
decreases in guaranty fund association expense, stock option plan compensation
expense and certain other operating expenses. Operating expenses expressed as a
percent of average total assets under management were 0.61%, 0.59% and 0.59% in
1996, 1995, and 1994, respectively.
Amortization of Deferred Policy Acquisition Costs was $60.2 million in 1996
compared to $58.5 million in 1995 and $52.2 million in 1994. The increase in
amortization in 1996 compared to 1995 was primarily due to a decrease in
estimated amortization periods determined in the last quarter of 1995 due to
shorter average policy lives, and to the growth of business in force associated
with fixed, indexed and variable annuity sales. The increase in 1995 compared to
1994 was primarily attributable to a decrease in the estimated amortization
periods and lower projected fixed annuity surrender charges; in addition, this
increase was attributable to the growth in business in force during 1995 and
1994. Amortization expense represented 0.51%, 0.55% and 0.53% of the total
average policyholder and separate account balances in 1996, 1995 and 1994,
respectively.
Amortization of Deferred Distribution Costs relates to the deferred sales
commissions acquired in connection with the Colonial acquisition and the
distribution of mutual fund shares sold without front-end sales loads.
Amortization was $33.9 million in 1996 compared to $18.8 million in 1995. There
was no such expense prior to the acquisition of Colonial. The increase in 1996
was primarily attributable to the full period consolidation of Colonial, the
continuing sales of such fund shares during 1996 and 1995 and a $3.8 million
charge in the fourth quarter of 1996 relating to a reduction in the amortization
period.
Amortization of Value of Insurance in Force totaled $10.2 million in 1996
compared to $9.5 million in 1995 and $17.0 million in 1994. The increase in
amortization in 1996 compared to 1995 was primarily due to $2.7 million of
amortization recorded in 1996 relating to the F&G Life transaction, partially
offset by lower amortization in 1996 due to an increase in estimated
amortization periods in the last quarter of 1995 of the Company's closed block
of single premium whole life insurance. The decrease in amortization in 1995
compared to 1994 of $7.5 million was primarily related to the actual persistency
experience and higher expected future profits relating to the Company's closed
block of single premium whole life insurance.
28
Amortization of Intangible Assets was $15.4 million in 1996 compared to
$12.2 million in 1995 and $5.8 million in 1994. These increases were
attributable to the acquisitions of Independent, Colonial and Newport.
Interest Expense was $19.7 million in 1996 compared to $16.2 million in
1995 and $4.2 million in 1994. These increases are 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 an affiliate of Liberty Mutual.
Income Tax Expense was $49.6 million or 33.0% of pretax income in 1996
compared to $39.9 million, or 35.1% of pretax income in 1995, and $32.5 million,
or 39.0% of pretax income in 1994. The lower effective tax rates in 1996 and
1995 were attributable primarily to reductions in the deferred tax asset
valuation reserve. There was no such reduction prior to the acquisition of
Colonial in 1995. For all periods, substantially all the federal income tax
expense related to the Company's annuity insurance business.
Financial Condition
Stockholders' Equity as of December 31, 1996 was $1.05 billion compared to
$0.96 billion as of December 31, 1995. Net income in 1996 was $100.7 million,
and cash dividends on the Company's preferred and common stock totaled $3.9
million. Common stock totaling $8.5 million and $2.4 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 $12.7 million.
Book Value Per Share amounted to $36.63 at December 31, 1996 compared to
$34.55 at December 31, 1995. Excluding net unrealized gains on investments, book
value per share amounted to $34.04 at December 31, 1996 and $31.40 at December
31, 1995. As of December 31, 1996, there were 28.7 million common shares
outstanding compared to 27.7 million shares as of December 31, 1995.
Investments not including cash and cash equivalents, totaled $11.5 billion
at December 31, 1996 compared to $10.1 billion at December 31, 1995. This
increase reflects the investments received in the F&G Life transaction, fixed
and indexed annuity sales in 1996, withdrawals and a decrease in net unrealized
investment gains.
The Company manages the substantial 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 appropriate
tax planning, the Company classifies its entire fixed maturities investments as
"available for sale" and accordingly carries such investments at fair value.
29
The Company's total investments at December 31, 1996 reflected net
unrealized gains of $229.8 million relating to its fixed maturity and equity
portfolios. At December 31, 1995, such net unrealized investment gains were
$308.5 million. The decrease in net unrealized gains in 1996 principally
reflects the higher interest rates at the end of 1996.
Approximately $10.7 billion, or 99.8%, of the fixed maturities investments
at December 31, 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 December 31,
1996, the carrying value of investments in below investment grade securities
totaled $987.0 million, or 8.0% of total investments (including certain cash and
cash equivalents) of $12.3 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.
Management of the Company's Investments
Asset-liability duration management 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 rates, 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 duration management, liquidity and
credit quality.
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 and equity indexed products
incorporate surrender charges to encourage persistency, discourage withdrawals
and make the cost of its policyholder balances more predictable. Approximately
85.4% of the Company's fixed and indexed annuity policyholder balances were
subject to surrender charges at December 31, 1996.
As part of its asset-liability management 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 toward maintaining a desired investment spread between
the yield on portfolio assets and the rate paid on policyholder balances under a
variety of possible future interest rate scenarios. At December 31, 1996, the
effective duration of the Company's fixed maturities investments (including
certain cash and cash equivalents) was approximately 2.8 years.
30
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 (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 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 December 31, 1996, the Company had 39 outstanding
swap agreements with an aggregate notional principal amount of $2.3 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
December 31, 1996, the Company had call options with an estimated fair value of
$109.6 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, news reports, and other externally generated information concerning
the borrower'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 (which to date have been from affiliates of Liberty
Mutual).
31
Regulatory authorities permit dividend payments from Keyport to the Company
up to the lesser of (i) 10% of statutory surplus as of the preceding December 31
or (ii) the net gain from operations for the preceding fiscal year. As of
December 31, 1996, Keyport could pay dividends of up to $42.5 million without
the approval of the Department of Business Regulation of the State of Rhode
Island. As of December 31, 1996 under its credit facility, Colonial could pay
dividends of up to $44.7 million.
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 (assuming Liberty Mutual continues to
participate in 1997 in the Dividend Reinvestment Plan) 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.
Each of the Company's business segments has its own liquidity needs and
financial resources. In the Company's asset management business, liquidity needs
and financial resources pertain to the investment management and distribution of
mutual funds, wealth management and institutional accounts. 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 December 31,
1996, $8.8 billion of Keyport's investments, including short-term investments,
are considered readily marketable.
To the extent that unanticipated surrenders cause Keyport to sell for
liquidity purposes a material amount of securities prior to their maturity, such
surrenders could have a material adverse effect on the Company. However, Keyport
believes that liquidity to fund withdrawals would be available through incoming
cash flow, the sale of short-term or floating-rate instruments or investment
securities in its short duration portfolio, thereby precluding the sale of fixed
maturity investments in a potentially unfavorable market.
32
Effects of Inflation
Inflation has not had a material effect on the Company's consolidated
results of operations. The Company manages its investment portfolio in part to
reduce its exposure to interest rate fluctuations. In general, the market value
of the Company's fixed maturity portfolio increases or decreases in inverse
relationship with fluctuations in interest rates, and the Company's net
investment income increases or decreases in direct relationship with interest
rate changes. (If interest rates decline the Company's fixed maturity
investments generally will increase in market value, while net investment income
will decrease as fixed maturity investments mature or are sold and the proceeds
are reinvested at reduced rates.) However, inflation may result in increased
operating expenses that may not be readily recoverable in the prices of the
services charged by the Company.
33
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C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
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Liberty Financial Companies, Inc.
Consolidated Balance Sheets
($ in millions)
December 31 1996 1995
........................................................................................................... .
Assets
Assets:
Investments $11,537.9 $10,144.7
Cash and cash equivalents 875.8 875.3
Accrued investment income 146.8 132.9
Deferred policy acquisition costs 250.4 179.7
Value of insurance in force 70.8 44.0
Deferred distribution costs 114.4 114.6
Intangible assets 205.4 192.3
Other assets 134.7 106.7
Separate account assets 1,091.5 959.2
---------- ---------
$14,427.7 $12,749.4
========== =========
Liabilities and Stockholders' Equity
Liabilities:
Policy liabilities $11,637.5 $10,084.4
Notes payable to affiliates 229.0 229.0
Revolving credit facility 52.5 61.0
Payable for investments loaned 211.2 317.7
Other liabilities 172.1 149.2
Net deferred tax liability 42.5 49.6
Separate account liabilities 1,017.7 889.1
---------- ---------
Total liabilities 13,362.5 11,780.0
---------- ---------
Series A redeemable convertible preferred stock, par value $.01; authorized,
issued and outstanding 327,340 shares in 1996 and 327,741 shares in 1995 13.8 13.0
---------- ---------
Stockholders' Equity:
Common stock, $.01 par value, authorized 100,000,000 shares; issued and
outstanding 28,705,015 shares in 1996 and 27,682,536 shares in 1995 0.3 0.3
Additional paid-in capital 835.3 810.5
Net unrealized investment gains 74.4 87.1
Retained earnings 141.4 59.4
Unearned compensation -- (0.9)
---------- ---------
Total stockholders' equity 1,051.4 956.4
---------- ---------
$14,427.7 $12,749.4
========== =========
See accompanying notes to consolidated financial statements.
34
Liberty Financial Companies, Inc.
Consolidated Income Statements
(in millions, except per share data)
Year Ended December 31 1996 1995 1994
..............................................................................................
Investment income $ 796.4 $ 761.8 $ 695.1
Interest credited to policyholders (572.7) (555.8) (481.9)
------- ------- -------
Investment spread 223.7 206.0 213.2
------- ------- -------
Net realized investment gains (losses) 8.0 (4.0) (8.2)
------- ------- -------
Fee income:
Investment advisory and administrative fees 196.4 155.8 95.9
Distribution and service fees 44.9 28.9 --
Transfer agency fees 43.9 30.8 4.0
Surrender charges and net commissions 34.7 23.4 20.0
Separate account fees 16.0 13.2 12.5
------- ------- -------
Total fee income 335.9 252.1 132.4
------- ------- -------
Expenses:
Operating expenses (277.9) (225.1) (174.9)
Amortization of deferred policy acquisition costs (60.2) (58.5) (52.2)
Amortization of deferred distribution costs (33.9) (18.8) --
Amortization of value of insurance in force (10.2) (9.5) (17.0)
Amortization of intangible assets (15.4) (12.2) (5.8)
Interest expense (19.7) (16.2) (4.2)
------- ------- -------
Total expenses (417.3) (340.3) (254.1)
------- ------- -------
Pretax income 150.3 113.8 83.3
Income tax expense (49.6) (39.9) (32.5)
------- ------- -------
Net income $ 100.7 $ 73.9 $ 50.8
======= ======= =======
Net income per share $ 3.36 $ 2.64 $ 2.15
======= ======= =======
See accompanying notes to consolidated financial statements.
35
Liberty Financial Companies, Inc.
Consolidated Statements of Stockholders' Equity
(in millions)
Net
Additional Unrealized Total
Common Paid-In Investment Retained Treasury Unearned Stockholders'
Stock Capital Gains Earnings Stock Compensation Equity
--------- ------------- ------------- ----------- ----------- --------------- ---------------
Balance, December 31, 1993 $0.2 $659.8 $ 0.5 $ (21.7) $ 638.8
Adjustment to beginning
balance for change in
accounting principle, net of
taxes 41.6 41.6
------- --------
Proceeds from exercise of stock
options 0.1 0.1
Change in net unrealized
investment gains (106.6) (106.6)
Net income 50.8 50.8
---- ------ ------- ---- --------
Balance, December 31, 1994 0.2 659.9 (64.5) 29.1 624.7
Common stock issued in
Colonial merger 0.1 117.3 117.4
Proceeds from exercise of stock
options 0.7 0.7
Reclassification of accrued
option compensation liability 22.4 $ (2.1) 20.3
Contribution of treasury stock 7.1 $(7.1)
Unearned compensation 1.2 1.2
Accretion to face value of
preferred stock (0.6) (0.6)
Common stock dividends 3.1 (12.3) 7.1 (2.1)
Note issued in connection with
common stock dividend (30.0) (30.0)
Preferred stock dividends (0.7) (0.7)
Change in net unrealized
investment gains 151.6 151.6
Net income 73.9 73.9
---- ------ ------- ---- ---- --------
Balance, December 31, 1995 0.3 810.5 87.1 59.4 (0.9) 956.4
Common stock issued in
Independent acquisition 8.5 8.5
Proceeds from exercise of stock
options 2.4 2.4
Unearned compensation 0.9 0.9
Accretion to face value of
preferred stock (0.9) (0.9)
Common stock dividends 13.9 (16.9) (3.0)
Preferred stock dividends (0.9) (0.9)
Change in net unrealized
investment gains (12.7) (12.7)
Net income 100.7 100.7
---- ------ ------- ------- ------ ------ --------
Balance, December 31, 1996 $0.3 $835.3 $ 74.4 $ 141.4 $ -- $ -- $1,051.4
==== ====== ======= ======= ====== ====== =======
See accompanying notes to consolidated financial statements.
36
Liberty Financial Companies, Inc.
Consolidated Statements of Cash Flows
(in millions)
Year Ended December 31 1996 1995 1994
................................................................................................. .
Cash flows from operating activities:
Net income $ 100.7 $ 73.9 $ 50.8
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 74.3 51.6 30.9
Interest credited to policyholders 572.7 555.8 481.9
Net realized investment (gains) losses (8.0) 4.0 8.2
Net amortization (accretion) on investments (29.1) 9.7 12.2
Change in deferred policy acquisition costs (24.4) (24.6) (38.8)
Change in current and deferred income taxes 4.9 13.3 7.7
Net change in other assets and liabilities (81.8) (59.7) (16.1)
--------- --------- ---------
Net cash provided by operating activities 609.3 624.0 536.8
--------- --------- ---------
Cash flows from investing activities:
Investments purchased held to maturity -- -- (277.6)
Investments purchased available for sale (4,493.2) (2,851.0) (2,625.4)
Investments sold held to maturity -- 14.9 10.6
Investments sold available for sale 1,714.0 605.2 950.9
Investments matured held to maturity -- 317.8 576.0
Investments matured available for sale 1,387.7 906.5 854.4
Increase in policy loans, net (34.5) (21.0) (35.1)
Decrease in mortgage loans, net 7.5 55.0 26.5
Acquisitions, net of cash acquired (41.5) (106.0) --
--------- --------- ---------
Net cash used in investing activities (1,460.0) (1,078.6) (519.7)
--------- --------- ---------
Cash flows from financing activities:
Withdrawals from policyholder accounts (1,154.1) (933.8) (1,034.5)
Deposits to policyholder accounts 2,134.5 1,116.9 1,202.1
Securities lending (119.2) 317.7 --
Borrowings from affiliates -- 124.0 --
Repayments under revolving credit (8.5) (19.5) --
Exercise of stock options 2.4 0.7 --
Dividends paid (3.9) (2.8) --
--------- --------- ---------
Net cash provided by financing activities 851.2 603.2 167.6
--------- --------- ---------
Increase in cash and cash equivalents 0.5 148.6 184.7
Cash and cash equivalents at beginning of year 875.3 726.7 542.0
--------- --------- ---------
Cash and cash equivalents at end of year $ 875.8 $ 875.3 $ 726.7
========= ========= =========
Noncash Investing Activities: The Company made several acquisitions during 1995
using $106.0 million of cash, net of cash acquired. The fair value of assets
acquired was $352.6 million; total liabilities assumed were $108.8 million.
Noncash Financing Activities: Noncash financing activities relate to dividends
paid to an affiliate of Liberty Mutual in the amount of $13.9 million and $10.2
million in 1996 and 1995, respectively, pursuant to the Company's dividend
reinvestment plan with Liberty Mutual and, in 1995, $30.0 million in the form of
an 8.0% note due in 2000.
See accompanying notes to consolidated financial statements.
37
- --------------------------------------------------------------------------------
N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S
- --------------------------------------------------------------------------------
Liberty Financial Companies, Inc.
Notes to Consolidated Financial Statements
1. Accounting Policies
Organization
Liberty Financial Companies, Inc. ("the Company") is an asset accumulation
and management company providing investment management products and
retirement-oriented insurance products through multiple distribution channels.
The Company is a majority owned subsidiary of Liberty Mutual Insurance
Company ("Liberty Mutual").
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries, including Keyport Life Insurance Company ("Keyport"),
Stein Roe & Farnham Incorporated ("Stein Roe"), and, from the date of
acquisition: The Colonial Group, Inc. ("Colonial"), Newport Pacific Management,
Inc. ("Newport") and Independent Holdings, Inc. ("Independent"). All significant
intercompany balances and transactions have been eliminated. Certain prior year
amounts have been reclassified to conform to the current year's presentation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Investments
Effective January 1, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115 "Accounting for Certain Investments in Debt and
Equity Securities." Investments in debt and equity securities classified as
available for sale are carried at fair value, and after-tax unrealized gains and
losses (net of adjustments to deferred policy acquisition costs and value of
insurance in force) are reported as a separate component of stockholders'
equity. Realized investment gains and losses are calculated on a first-in,
first-out basis.
On December 31, 1995, pursuant to the "Guide to Implementation of Statement
115 on Accounting for Certain Investments in Debt and Equity Securities," the
Company made a one-time reclassification of certain fixed maturity
38
securities from held to maturity to available for sale. The amortized cost of
those securities at the time of transfer was $1.4 billion, and the unrealized
gain of $13.9 million was recorded net of taxes in stockholders' equity.
For the mortgage-backed bond portion of the fixed maturity investment
portfolio, the Company recognizes income using a constant effective yield based
on anticipated prepayments over the estimated economic life of the security.
When actual prepayments differ significantly from anticipated prepayments, the
effective yield is recalculated to reflect actual payments to date and
anticipated future payments; and any resulting adjustment is included in
investment income.
Mortgage loans are carried at amortized cost. Policy loans are carried at
the unpaid principal balances plus accrued interest.
Fee Income
Fees from asset management and investment advisory services and from
transfer agent, bookkeeping, distribution and service fees are recognized as
revenues when services are provided. Revenues from single premium deferred
annuities and single premium whole life policies include mortality charges,
surrender charges, policy fees and contract fees and are recognized when earned
under the respective contracts. Net commission revenue is recognized on the
trade date.
Deferred Policy Acquisition Costs
Policy acquisition costs are the costs of acquiring new business which vary
with, and are primarily related to, the production of new annuity business. Such
costs include commissions, costs of policy issuance and underwriting and selling
expenses. These costs are deferred and amortized in relation to the present
value of estimated gross profits from mortality, investment and expense margins.
Deferred policy acquisition costs are adjusted for amounts relating to
unrealized gains and losses on fixed maturity and equity securities the Company
has designated as available for sale. This adjustment, net of tax, is included
with the change in net unrealized gains or losses that is credited or charged
directly to stockholders' equity. Deferred policy acquisition costs were
decreased by $103.7 million at December 31, 1996 and $151.4 million at December
31, 1995, respectively, relating to this adjustment.
Value of Insurance in Force
Value of insurance in force represents the actuarially-determined present
value of projected future gross profits from policies in force at the date of
their acquisition. This amount is amortized in proportion to the projected
emergence of profits over periods not exceeding 15 years for annuities and 25
years for life insurance.
The value of insurance in force is adjusted for amounts relating to the
recognition of unrealized investment gains and losses. This adjustment, net of
tax, is included with the change in net unrealized gains or losses that is
credited or charged directly to stockholders' equity. Value of insurance in
force was decreased by $26.0 million and $32.5 million at December 31, 1996 and
1995, respectively, relating to this adjustment.
Deferred Distribution Costs
Sales commissions and other direct costs related to the sale of
Company-sponsored broker-distributed funds which do not charge front-end sales
commissions are recorded as deferred distribution costs. Amortization is
provided on a straight-
39
line basis over periods up to six years to match the estimated period in which
distribution fees will be earned. Contingent deferred sales charges (back-end
loads) received are applied to deferred distribution costs to the extent of the
estimated unamortized portion of such costs, with the remainder recognized as
additional distribution fee income.
Intangible Assets
Intangible assets consist of goodwill and certain identifiable intangible
assets arising from business combinations accounted for as a purchase.
Amortization is provided on a straight-line basis over estimated lives of the
acquired intangibles which range from 5 to 25 years. The carrying value of
intangible assets is adjusted when the expected present value of future gross
profits attributable to such assets is less than their carrying value.
Separate Account Assets and Liabilities
The assets and liabilities resulting from variable annuity and variable
life policies are segregated in separate accounts. Separate account assets,
which are carried at fair value, consist principally of investments in mutual
funds. Investment income and changes in asset values are allocated to the
policyholders, and therefore, do not affect the operating results of the
Company. The Company provides administrative services and bears the mortality
risk related to these contracts. Keyport also classified as separate account
assets investments in Company-sponsored mutual funds of $73.8 million and $72.5
million at December 31, 1996 and 1995, respectively.
Policy Liabilities
Policy liabilities consist of deposits received plus interest credited,
less accumulated policyholder charges, assessments, and withdrawals related to
deferred annuities and single premium whole life policies. Policy benefits that
are charged to expense include benefit claims incurred in the period in excess
of related policy account balances.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
Income Taxes
The Company is included in the consolidated federal income tax return filed
by Liberty Mutual. Income taxes have been provided using the liability method in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes," and are calculated as if the Company filed its own
consolidated income tax return.
40
Earnings Per Share
The calculation of earnings per share is based on the weighted average
number of shares of common stock and common stock equivalents outstanding during
each period as follows: 29.65 million in 1996, 27.70 million in 1995, and 23.63
million in 1994.
Cash Equivalents
Short-term investments having an original maturity of three months or less
are classified as cash equivalents.
Recent Accounting Pronouncement
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"). The
relevant provisions of SFAS 125 relating to securities lending, dollar rolls and
other similar secured transactions become effective after December 31, 1997. It
is not expected that the adoption of SFAS 125 will have a material effect on the
Company's consolidated financial position or results of operations.
2. Acquisitions
In March 1996, the Company acquired all the outstanding common stock of
Independent, a distributor of annuity and investment products through banks. In
April 1996, the Company acquired all the outstanding capital stock of KJMM
Investment Management Company, Inc., a registered investment advisor primarily
in the wealth management business. The purchase price for these two transactions
has totaled $18.7 million in cash and common stock, and the Company may be
obligated to make additional cash or stock payments through approximately 2000
based upon the attainment of certain performance objectives. These acquisitions
are not material to the financial condition or results of operation of the
Company.
In March 1995, the Company completed the acquisition of Colonial, an
investment advisor, distributor and transfer agent to mutual funds. The purchase
price was $264.8 million, consisting of $100.0 million in cash, 328,209 shares
of redeemable convertible preferred stock and 4,677,808 shares of common stock.
In April 1995 and September 1995, respectively, the Company acquired
Newport and American Asset Management Company, each a registered investment
advisor. The purchase price for these two transactions has totaled $27.8 million
in cash. In addition, at the time of the Newport acquisition the Company made a
capital contribution to Newport in the amount of $3.5 million. The Company may
be obligated in each transaction to make contingent additional cash payments
through approximately 1999 based upon the attainment of certain performance
objectives.
The above transactions were recorded using the purchase method of
accounting and resulted in the recording of intangible assets of $190.7 million,
including goodwill of $92.1 million. Each company's results of operations are
included in the Company's consolidated financial statements from the dates of
their acquisition. The following table
41
discloses 1995 pro forma results of operations (in millions) for the Company had
the 1995 acquisition occurred as of January 1, 1995. These pro forma results of
operations are not necessarily indicative of actual results which might have
occurred had the Company owned these companies since those dates.
Year Ended December 31 1995
...............................................................................
Revenues $1,044.5
Net income 79.0
Net income per share 2.72
In addition to the above acquisitions, in August 1996, Keyport entered into
a 100 percent coinsurance agreement for a $954.0 million block of single premium
deferred annuities issued by Fidelity & Guaranty Life Insurance Company ("F&G
Life"). Under this transaction, the investment risk of the annuity policies was
transferred to Keyport. However, F&G Life will continue to administer the
policies and will remain contractually liable for the performance of all policy
obligations. This transaction increased investments by $923.1 million and value
of insurance in force by $30.9 million.
3. Investments
Investments, all of which pertain to the Company's annuity insurance
operations, were comprised of the following (in millions):
December 31 1996 1995
...............................................................................
Fixed maturities $10,718.6 $9,536.0
Mortgage loans 67.0 74.5
Policy loans 532.8 498.3
Other invested assets 183.6 10.7
Equity securities 35.9 25.2
---------- ---------
$11,537.9 $10,144.7
========== =========
As of December 31, 1996, the Company did not have a material concentration
of financial instruments in a single investee, industry or geographic location
and no investment in any person or its affiliates (other than bonds issued by
agencies of the United States government) exceeded ten percent of stockholders'
equity.
As of December 31, 1996, $987.0 million of fixed maturities were below
investment grade. These securities represented 8.0% of the Company's total
investments, including certain cash and cash equivalents.
Fixed Maturities
As of December 31, 1996 and 1995, the Company did not hold any investments
in fixed maturities that were classified as held to maturity or as trading
securities. The amortized cost, gross unrealized gains and losses and fair value
of fixed maturity securities are as follows (in millions):
42
Gross Gross
Amortized Unrealized Unrealized
December 31, 1996 Cost Gains Losses Fair Value
............................................................................................................... .
U.S. Treasury securities $ 35.3 $ 0.2 $ (0.1) $ 35.4
Mortgage backed securities of U.S. government
corporations and agencies 1,666.1 41.4 (8.6) 1,698.9
Obligations of states and political subdivisions 23.9 0.4 (0.1) 24.2
Debt securities issued by foreign governments 246.3 11.7 (0.5) 257.5
Corporate securities 4,093.5 153.4 (12.3) 4,234.6
Other mortgage backed securities 2,413.0 47.6 (24.0) 2,436.6
Asset backed securities 1,736.0 15.5 (6.4) 1,745.1
Senior secured loans 286.3 -- -- 286.3
--------- ------ ------ ---------
Total fixed maturities $10,500.4 $270.2 $(52.0) $10,718.6
========= ====== ====== =========
Gross Gross
Amortized Unrealized Unrealized
December 31, 1995 Cost Gains Losses Fair Value
............................................................................................................... .
U.S. Treasury securities $ 360.2 $ 9.0 $ (0.2) $ 369.0
Mortgage backed securities of U.S. government
corporations and agencies 1,585.5 58.8 (5.2) 1,639.1
Obligations of states and political subdivisions 26.7 1.3 -- 28.0
Debt securities issued by foreign governments 57.4 4.3 -- 61.7
Corporate securities 3,479.6 224.3 (7.3) 3,696.6
Other mortgage backed securities 1,951.5 66.6 (71.8) 1,946.3
Asset backed securities 1,543.9 29.8 (1.5) 1,572.2
Senior secured loans 223.1 -- -- 223.1
-------- ------ ------ --------
Total fixed maturities $9,227.9 $394.1 $(86.0) $9,536.0
======== ====== ====== ========
At December 31, 1996, gross unrealized gains on equity securities, interest
rate cap agreements and investments in separate accounts aggregated $29.9
million, and gross unrealized losses aggregated $5.3 million, respectively. At
December 31, 1995, gross unrealized gains on equity securities, interest rate
cap agreements and investments in separate accounts aggregated $16.9 million,
and gross unrealized losses aggregated $9.3 million, respectively.
Contractual Maturities
The amortized cost and estimated fair value of fixed maturities by
contractual maturity as of December 31, 1996 are as follows (in millions):
Amortized Fair
December 31, 1996 Cost Value
..................................................................
Due in one year or less $ 487.4 $ 489.1
Due after one year through five years 1,522.4 1,559.8
Due after five years through ten years 2,013.4 2,084.9
Due after ten years 662.1 704.1
--------- --------
4,685.3 4,837.9
Mortgage and asset backed securities 5,815.1 5,880.7
--------- --------
$10,500.4 $10,718.6
========= ========
Actual maturities may differ from those shown above because borrowers may
have the right to call or prepay obligations.
43
Net Investment Income
Net investment income is summarized as follows (in millions):
Year Ended December 31 1996 1995 1994
..................................................................................
Fixed maturities $737.4 $682.0 $636.0
Policy loans 30.2 28.5 26.3
Equity securities 4.5 4.8 2.1
Mortgage loans and other invested assets 11.4 12.9 15.4
Cash and cash equivalents 36.1 41.6 20.7
------ ------ ------
Gross investment income 819.6 769.8 700.5
Investment expenses (6.7) (5.0) (4.6)
Amortization of options and interest rate caps (16.5) (3.0) (0.8)
------ ------ ------
Net investment income $796.4 $761.8 $695.1
====== ====== ======
There were no non-income producing fixed maturity investments as of
December 31, 1996 or 1995.
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) on the investments in the Company's
annuity insurance operations are summarized as follows (in millions):
Year Ended December 31 1996 1995 1994
................................................................................................... .
Fixed maturities held to maturity:
Gross gains $ -- $ 1.3 $ 3.5
Gross losses -- (0.1) (0.8)
Fixed maturities available for sale:
Gross gains 24.3 8.2 26.0
Gross losses (17.8) (16.0) (26.8)
Equity securities 0.9 1.3 (0.8)
Interest rate swaps -- (0.9) --
Other (0.2) -- (0.8)
Impairment writedowns -- -- (11.5)
------ ------ ------
Gross realized investment gains (losses) 7.2 (6.2) (11.2)
------ ------ ------
Amortization adjustments of deferred policy acquisition costs
and value of insurance in force (1.7) 2.2 3.0
------ ------ ------
Net realized investment gains (losses) $ 5.5 $ (4.0) $ (8.2)
====== ====== ======
Proceeds from sales of fixed maturities available for sale were $1.7
billion, $565.4 million and $927.8 million in 1996, 1995 and 1994, respectively.
In addition to the net realized investment gains (losses) shown above,
additional gains of $2.5 million were realized in 1996 relating to sales of
general corporate securities in the Company's asset management operations.
4. Off Balance Sheet Financial Instruments
The Company's primary objective in acquiring off balance sheet financial
instruments is the management of interest rate risk. Interest rate risk results
from a mismatch in the timing and amount of invested asset and policyholder
liability cash flows. The Company seeks to manage this risk through various
asset/liability management strategies such as the setting of renewal rates and
by investment portfolio actions designed to address the interest rate
sensitivity of asset cash flows in
44
relation to liability cash flows. Portfolio actions used to manage interest rate
risk primarily include managing the effective duration of portfolio securities
and utilizing interest rate swaps and caps. Outstanding off balance sheet
financial instruments, shown in notional amounts along with their carrying value
and estimated fair values, are as follows (in millions):
Assets (Liabilities)
----------------------------------------------------
1996 1995
------------------------ ---------------------------
Notional Amounts
----------------------- Carrying Fair Carrying Fair
December 31 1996 1995 Value Value Value Value
............................................................................................................
Interest rate cap agreements $ 450.0 $ 450.0 $ 6.2 $ 1.4 $ 8.8 $ 1.5
Interest rate swaps 2,275.0 1,975.0 (8.8) (8.8) (64.1) (64.1)
Indexed call options -- -- 109.6 109.6 7.8 7.8
The interest rate cap agreements, which expire in 1997 through 2000,
entitle the Company to receive payments from the counterparties on specified
future dates, contingent on future interest rates. For each cap, the amount of
such payment, if any, is determined by the excess of a market interest rate over
a specified cap rate times the notional amount. The premium paid for the
interest rate caps is included in other invested assets and is being amortized
over the terms of the agreements and is included in net investment income.
Interest rate contracts relating to investments designated as available for sale
are adjusted to fair value with the resulting unrealized gains and losses
included in stockholders' equity. Fair values for these contracts are based on
current settlement values. The current settlement values are based on quoted
market prices and brokerage quotes, which utilize pricing models or formulas
using current assumptions.
The Company uses indexed call options for purposes of hedging its
equity-indexed products. The call options hedge the interest credited on these 1
and 5 year term products, which is based on the changes in the Standard & Poor's
500 Composite Stock Price Index ("S&P Index"). Premiums paid on the call options
are amortized to interest expense over the terms of the underlying
equity-indexed products using the straight line method. Gains and losses, if
any, resulting from the early termination of the call options are deferred and
amortized to interest credited over the remaining term of the underlying
equity-indexed products.
At December 31, 1996 the Company had approximately $73.1 million of
unamortized premium in call option contracts. The call options' maturities range
from 1997 to 2001. The Company carries its S&P Index call options at market
value.
Deferred losses of $7.9 million and $10.6 million as of December 31, 1996
and 1995, respectively, resulting from terminated interest rate swap agreements
are included with the related fixed maturity securities to which the hedge
applied and are being amortized over the life of such securities.
The Company is exposed to potential credit loss in the event of
nonperformance by counterparties on interest rate cap agreements and interest
rate swaps. Nonperformance is not anticipated and, therefore, no collateral is
held or pledged. The credit risk associated with these agreements is minimized
by purchasing such agreements from investment-grade counterparties.
45
5. Indebtedness
The Company has notes payable to affiliates as follows (in millions):
December 31 1996 1995
.............................................................
8.0% promissory note due April 3, 2000 $99.0 $99.0
8.0% promissory note due March 31, 2000 30.0 30.0
8.5% promissory note due March 24, 2005 100.0 100.0
------ ------
$229.0 $229.0
====== ======
The $100 million 8.5% promissory note becomes due and payable in the event
Liberty Mutual ceases to own more than a 50% interest in the Company. The $30
million 8.0% promissory note was issued in connection with the payment of a
dividend to an affiliate of Liberty Mutual.
The Company has available an $80.0 million revolving credit facility (the
"Facility") which is utilized to finance deferred sales commissions paid in
connection with the distribution of mutual fund shares sold with no up-front
sales charges. This Facility is subject to annual renewal. If not renewed,
effective April 11, 1997, this Facility converts to a term loan which matures on
April 11, 2002. As of December 31, 1996 and 1995, balances of $52.5 million and
$61.0 million were outstanding under the Facility. Upon conversion to a term
loan, minimum quarterly payments of principal equal to 5% of outstanding
borrowings as of the conversion date are required. Interest accrues on the
outstanding borrowings of the Facility at floating rates based upon LIBOR
options plus 0.225%. The Facility contains certain covenants. The Company was in
compliance with these covenants at December 31, 1996.
Interest paid was $22.9 million, $19.2 million and $4.6 million in 1996,
1995 and 1994, respectively.
6. Income Taxes
Incomes tax expense is summarized as follows (in millions):
Year Ended December 31 1996 1995 1994
..............................................................
Current $ 54.8 $39.3 $18.5
Deferred (5.2) 0.6 14.0
---- ------ ------
$ 49.6 $39.9 $32.5
==== ====== ======
46
A reconciliation of income tax expense with expected federal income tax
expense computed at the applicable federal income tax rate of 35% is as follows
(in millions):
Year Ended December 31 1996 1995 1994
..........................................................................................................
Expected income tax expense $ 52.6 $ 39.9 $ 29.1
Increase (decrease) in income taxes resulting from:
Nontaxable investment income (1.2) (1.7) (2.2)
Change in deferred tax asset valuation allowance (6.7) (8.3) 1.0
Amortization of goodwill and other intangible assets 2.0 2.0 4.0
State taxes, net of federal tax benefit 2.5 1.0 0.3
Stock option plan compensation 0.8 6.0 --
Other, net (0.4) 1.0 0.3
---- ---- ----
Income tax expense $ 49.6 $ 39.9 $ 32.5
==== ==== ====
The components of deferred federal income taxes are as follows (in
millions):
December 31 1996 1995
......................................................................................
Deferred tax assets:
Policy liabilities $ 171.3 $ 141.0
Guaranty fund expense 6.3 7.7
Stock option plan compensation 3.8 4.9
Deferred compensation and other benefit plans 6.4 6.3
Excess of book over tax basis depreciation and amortization 1.6 1.6
Deferred gain on interest rate swaps -- 0.3
Net operating loss carryforwards 27.6 26.0
Distribution fees 14.8 10.9
Other 7.8 6.4
------- -------
Total deferred tax assets 239.6 205.1
Less: valuation allowance (17.0) (23.7)
------- -------
Net deferred tax assets 222.6 181.4
------- -------
Deferred tax liabilities:
Deferred policy acquisition costs (63.1) (44.5)
Value of insurance in force and intangible assets (20.5) (7.2)
Excess of book over tax basis of investments (125.7) (130.5)
Deferred loss on interest rate swaps -- (3.7)
Deferred revenue (2.0) (1.5)
Amortization of deferred distribution costs (49.8) (41.9)
Other (4.0) (1.7)
------- -------
Total deferred tax liabilities (265.1) (231.0)
------- -------
Net deferred tax liability $ (42.5) $ (49.6)
======= =======
As of December 31, 1996, the Company had net operating loss carryforwards
relating to certain of the Company's non-insurance operations of $71.1 million.
Utilization of these net operating losses is limited to use against future
taxable profits in these non-insurance operations. As of December 31, 1996, the
Company had approximately $7.6 million of purchased net operating loss
carryforwards (relating to an acquisition in its insurance operations).
Utilization of these net operating loss carryforwards, which expire through
2006, is limited to use against future profits in a component of the Company's
insurance operations. The Company believes that it is more likely than not that
it will realize the benefits of its net deferred tax asset.
47
Income taxes paid were $45.7 million, $43.2 million and $29.4 million in
1996, 1995 and 1994, respectively.
7. Redeemable Convertible Preferred Stock
The Series A Redeemable Convertible Preferred Stock (the "Preferred
Stock"), with a $50 face value, has an annual cumulative cash dividend rate of
$2.875 per share and is convertible into shares of Company Common Stock at a
rate of 1.0559 for each share of such Preferred Stock. The Preferred Stock is
redeemable at the option of the Company anytime after March 24, 1998 provided
that the market value of the Company's Common Stock exceeds a specified amount.
The Preferred Stock may also be put to the Company by the holders of such
Preferred Stock after March 24, 2000, for a period of sixty days, at face value
plus cumulative unpaid dividends. Each share of Preferred Stock is entitled to
that number of votes equal the number of common shares into which it is
convertible. The difference between the face value of the Preferred Stock and
its fair value at the time of its issuance is being added to the carrying value
of the Preferred Stock ratably over a five year period by a direct charge to
retained earnings.
8. Retirement Plans
The Company maintains a noncontributory defined benefit pension plan (the
"Plan") covering its employees (except employees of Stein Roe and Colonial, who
participate in separate profit sharing plans, and except employees of
Independent.) It is the Company's practice to fund amounts for the Plan
sufficient to meet the minimum requirements of the Employee Retirement Income
Security Act of 1974. Additional amounts are contributed from time to time when
deemed appropriate by the Company. Under the Plan, all employees are vested
after five years of service. Benefits are based on years of service, the
employee's average pay for the highest five consecutive years during the last
ten years of employment and the employee's estimated social security retirement
benefit. The Company also has an unfunded nonqualified Supplemental Pension Plan
("Supplemental Plan"), collectively with the Plan, (the "Plans"), to replace
benefits lost due to limits imposed on Plan benefits under the Internal Revenue
Code. Plan assets consist of investments in certain Company-sponsored mutual
funds.
The following table sets forth the Plans' funded status (in millions) as of
December 31, 1996 and 1995.
December 31 1996 1995
..........................................................................................
Actuarial present value of benefit obligations:
Vested benefit obligations $ 16.5 $ 13.7
Accumulated benefit obligation 1.8 1.9
------ ------
$ 18.3 $ 15.6
====== ======
Projected benefit obligation $ 23.4 $ 20.7
Plan assets at fair value (11.7) (10.2)
------ ------
Projected benefit obligation in excess of the Plans' assets 11.7 10.5
Unrecognized net actuarial loss (2.0) (2.8)
Prior service cost not yet recognized in net periodic pension cost (3.1) (3.6)
Adjustment for minimum liability -- 1.3
------ ------
Accrued pension cost $ 6.6 $ 5.4
====== ======
48
Pension cost includes the following components (in millions):
Year Ended December 31 1996 1995 1994
................................................................................
Service cost benefits earned during the period $ 1.6 $ 1.3 $ 1.6
Interest cost on projected benefit obligation 1.6 1.3 1.2
Actual return on Plan assets (1.3) (1.7) 0.1
Net amortization and deferred amounts 1.1 1.5 (0.1)
----- ----- -----
Total net periodic pension cost $ 3.0 $ 2.4 $ 2.8
===== ===== =====
The assumptions used to develop the actuarial present value of the
projected benefit obligation, and the expected long-term rate of return on plan
assets are as follows:
Year Ended December 31 1996 1995 1994
...........................................................................
Discount rate 7.50% 7.25% 8.25%
Rate of increase in compensation level 5.25% 5.25% 5.25%
Expected long-term rate of return on assets 8.50% 8.50% 8.50%
The Company provides various other funded and unfunded defined contribution
plans, which include savings and investment plans, supplemental savings plans,
profit sharing plans, and supplemental profit sharing plans. Expenses related to
these defined contribution plans totaled $7.6 million, $5.4 million and $3.8
million in 1996, 1995 and 1994, respectively.
9. Stock Option Plans
The Company has two stock-based compensation plans, the 1990 Stock Option
Plan (the "1990 Plan") and the 1995 Stock Incentive Plan (the "1995 Plan"). The
1990 Plan provided for grants of incentive and nonqualified stock options, which
were issued from 1990 through 1994. The 1995 Plan provides for grants of
incentive and nonqualified stock options, stock appreciation rights, restricted
stock, unrestricted stock and performance shares, as well as cash and other
awards. To date, only stock options have been granted under the 1995 Plan. A
maximum of 3,145,558 shares of the Company's common stock may be issued under
the 1990 and 1995 Plans. This amount does not include 607,800 nonqualified
options at prices ranging from $1.00 to $31.50 that were assumed by the Company
in connection with the Colonial acquisition.
All options granted under the 1990 Plan were granted at a price not less
than the fair market value of the Company's common stock (determined by the
valuation provisions of the 1990 Plan). All options granted under the 1995 Plan
have been granted at the market price of the Company's common stock on the grant
date. All granted options provide for vesting in four equal annual installments,
beginning one year after the date of grant, and expire 10 years after the grant
date. Compensation expense associated with these plans was $0.9 million, $1.3
million and $6.9 million in 1996, 1995 and 1994, respectively.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. As provided for
under SFAS 123, the fair value for these options was estimated using a
Black-Scholes option pricing model with the following assumptions for 1996 and
49
1995: risk free interest rate--6.26%; dividend yield--1.99%; expected volatility
of the market price of the Company's common stock--15%; and the weighted average
life of the options--6 years.
For pro forma disclosure purposes, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in millions, except for earnings per share
information):
1996 1995
...................................................
Pro forma net income $99.3 $73.6
Pro forma net income per share 3.33 2.63
Because SFAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1998.
A summary of the stock option activity, and related information for the
years ended December 31 follows (in thousands, except price data):
1996 1995 1994
----------------------- ----------------------- --------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise- Exercise- Exercise-
Options Price Options Price Options Price
...............................................................................................
Outstanding--beginning
of year 2,755 $ 14.37 2,121 $ 11.96 2,282 $ 10.24
Granted 612 33.00 481 25.75 306 22.96
Assumed -- -- 607 10.24 -- --
Exercised for shares (326) (7.21) (100) (6.80) (4) (10.09)
Forfeited or cashed out (52) (26.92) (354) (10.66) (463) (10.30)
------ ------- ------ ------- ------ -------
Outstanding--end of year 2,989 $ 18.74 2,755 $ 14.37 2,121 $ 11.96
====== ======= ====== ======= ====== =======
Exercisable--end of year 1,806 $ 12.90 1,727 $ 10.88 1,254 $ 10.19
====== ======= ====== ======= ====== =======
Available for grant 349 891
====== ======
Weighted-average fair
value of options granted
during year $ 7.97 $ 6.24
====== ======
Exercise prices for options outstanding as of December 31, 1996 ranged from
$1.00 to $33.00. The weighted-average remaining contractual life of these
options is 6.75 years.
10. Fair Value of Financial Instruments
The following discussion outlines the methodologies and assumptions used to
determine the estimated fair value of the Company's financial instruments. The
aggregate fair value amounts presented herein do not necessarily represent the
underlying value of the Company, and accordingly, care should be exercised in
deriving conclusions about the Company's business or financial condition based
on the fair value information presented herein.
50
The following methods and assumptions were used by the Company in
determining estimated fair values of financial instruments:
Fixed maturities and equity securities: Fair values for fixed maturity
securities are based on quoted market prices, where available. For fixed
maturities not actively traded, the estimated fair values are determined
using values from independent pricing services, or, in the case of private
placements, are determined by discounting expected future cash flows using a
current market rate applicable to the yield, credit quality, and maturity of
the securities. The estimated fair values for equity securities are based on
quoted market prices.
Mortgage loans: The estimated fair value of mortgage loans are determined by
discounting future cash flows to the present at current market rates, using
expected prepayment rates.
Policy loans: The carrying value of policy loans approximates fair value.
Policy liabilities: Deferred annuity contracts are assigned fair value equal
to current net surrender value. Annuitized contracts are valued based on the
present value of the future cash flows at current pricing rates.
Other invested assets, Cash: The carrying value for assets classified as
other invested assets and cash in the accompanying balance sheets
approximates their fair value.
Notes payable to affiliates, Revolving credit facility: Fair values for debt
are estimated using discounted cash flow analyses based on the Company's
incremental borrowing rate for similar types of borrowing arrangements.
The estimated fair values and carrying values of the Company's financial
instruments are as follows (in millions):
1996 1995
----------------------------- ---------------------------
Carrying Fair Carrying Fair
December 31 Value Value Value Value
........................................................................................
Assets:
Fixed maturity securities $10,718.6 $10,718.6 $9,536.0 $9,536.0
Equity securities 35.9 35.9 25.2 25.2
Mortgage loans 67.0 73.4 74.5 79.7
Policy loans 532.8 532.8 498.3 498.3
Other invested assets 183.6 183.6 10.7 10.7
Cash and cash equivalents 875.8 875.8 875.3 875.3
Liabilities:
Policy liabilities 11,637.5 11,127.4 10,084.4 9,650.1
Note payable to affiliates 229.0 229.0 229.0 229.0
Revolving credit facility 52.5 52.5 61.0 61.0
51
11. Industry Segment Information
The Company's operations are classified in two business segments: annuity
and asset management. Annuity operations relate principally to the issuance of
fixed, indexed and variable annuity products and a closed block of
investment-oriented life insurance products. Asset management includes mutual
funds, wealth management, and institutional asset management. Information by
industry segment for 1996, 1995 and 1994 is shown below (in millions).
Year Ended December 31 1996 1995 1994
.............................................................................................
Statement of Operations Data
Revenues:
Annuity:
Unaffiliated $ 840.8 $ 790.1 $ 719.0
Intersegment (8.6) (7.7) (6.7)
-------- -------- --------
Total annuity 832.2 782.4 712.3
-------- -------- --------
Asset management:
Unaffiliated 299.5 219.8 100.3
Intersegment 8.6 7.7 6.7
-------- -------- --------
Total asset management 308.1 227.5 107.0
-------- -------- --------
Total revenues $1,140.3 $1,009.9 $ 819.3
======== ======== ========
Income before income taxes:
Annuity:
Income before amortization of intangible assets $ 132.6 $ 101.6 $ 91.4
Amortization of intangible assets (1.1) (1.2) (1.3)
-------- -------- --------
Subtotal annuity 131.5 100.4 90.1
-------- -------- --------
Asset management:
Income before amortization of intangible assets 71.5 55.4 19.3
Amortization of intangible assets (14.1) (10.8) (4.3)
-------- -------- --------
Subtotal asset management 57.4 44.6 15.0
-------- -------- --------
Corporate:
Income before amortization of intangible assets (38.4) (31.0) (21.6)
Amortization of intangible assets (0.2) (0.2) (0.2)
-------- -------- --------
Subtotal corporate (38.6) (31.2) (21.8)
-------- -------- --------
Total income before income taxes $ 150.3 $ 113.8 $ 83.3
======== ======== ========
December 31 1996 1995 1994
............................................................................................... .
Balance Sheet Data
Identifiable Assets:
Annuity $13,924.6 $12,279.2 $10,873.6
Asset management 484.0 469.3 74.3
Corporate 22.0 17.2 28.2
Intercompany eliminations (2.9) (16.3) (7.3)
-------- -------- --------
Total $14,427.7 $12.749.4 $10.968.8
======== ======== ========
52
12. Quarterly Financial Data, in Millions, Except Per Share Amounts (unaudited)
March June September December
Quarter Ended 1996 31 30 30 31
............................................................................................
Investment income $ 189.2 $ 189.8 $ 201.7 $ 215.7
Interest credited to policyholders (138.1) (136.2) (146.0) (152.4)
------- ------- ------- -------
Investment spread 51.1 53.6 55.7 63.3
Net realized investment gains (losses) 3.8 (1.7) 0.7 5.2
Fee income 78.6 83.7 85.9 87.7
Pretax income 36.3 34.0 36.4 43.6
Net income 23.8 23.1 24.7 29.1
Net income per share 0.81 0.77 0.82 0.96
March June September December
Quarter Ended 19951 31 30 30 31
............................................................................................
Investment income $ 185.2 $ 190.9 $ 191.2 $ 194.5
Interest credited to policyholders (130.9) (139.2) (143.3) (142.4)
------- ------- ------- -------
Investment spread 54.3 51.7 47.9 52.1
Net realized investment gains (losses) (5.7) (0.7) 1.4 1.0
Fee income 33.3 70.0 72.6 76.2
Pretax income 18.2 32.3 32.7 30.6
Net income 10.1 21.1 21.9 20.8
Net income per share 0.42 0.72 0.76 0.71
- ------------
1 Includes the results of operations of Colonial since its acquisition date in
March 1995.
13. Statutory Information
Keyport is domiciled in Rhode Island and prepares its statutory financial
statements in accordance with accounting principles and practices prescribed or
permitted by the Department of Business Regulation of the State of Rhode Island.
Statutory surplus differs from shareholders' equity reported in accordance with
GAAP primarily because policy acquisition costs are expensed when incurred,
investment reserves and policy liabilities are based on different assumptions,
and income tax expense reflects only taxes paid or currently payable. Keyport's
statutory net income and surplus are as follows:
Year Ended December 31 1996 1995 1994
..........................................................
Statutory surplus $567.7 $535.2 $546.4
Statutory net income 40.2 38.3 23.4
14. Transactions with Affiliated Companies
Liberty Mutual from time to time provides management, legal, audit and
financial services to the Company. Reimbursements to Liberty Mutual for these
services totaled $0.6 million in 1996 and $0.9 million in 1995 and 1994. These
reimbursements are based on direct and indirect costs incurred by Liberty Mutual
and are allocated to the Company primarily based upon the amount of time spent
by Liberty Mutual's employees on the Company's behalf. The Company believes that
this allocation methodology is reasonable.
The Company provided asset management services to real estate limited
partnerships for which an affiliate of Liberty Mutual served as the general
partner. The affiliate paid the Company fees for such services which totaled
$6.7 million and $5.7 million in 1995 and 1994, respectively. These limited
partnerships were liquidated in 1995.
53
During 1996, the Company sold to a wholly owned subsidiary of Liberty
Mutual a wholly owned subsidiary which had provided real estate management
services to certain affiliates of Liberty Mutual. The sales price was $2.1
million, the net book value of the transferred subsidiary.
Regulatory authorities permit dividend payments from Keyport to the Company
up to the lesser of (i) 10% of statutory surplus as of the preceding December 31
or (ii) the net gain from operations for the preceding fiscal year. As of
December 31, 1996, Keyport could pay dividends of up to $42.5 million without
the approval of the Department of Business Regulation of the State of Rhode
Island. As of December 31, 1996 under its credit facility, Colonial could pay
dividends of up to $44.7 million.
15. Commitments and Contingencies
Leases: The Company leases data processing equipment, furniture and certain
office facilities from others under operating leases expiring in various years
through 2009. Rental expense (in millions) amounted to $16.0 million, $14.7
million and $10.6 million for the years ended December 31, 1996, 1995 and 1994,
respectively. For each of the next five years, and in the aggregate, as of
December 31, 1996, the following are the minimum future rental payments under
noncancelable operating leases having remaining terms in excess of one year (in
millions):
Year Payments
.....................
1997 $13.4
1998 12.8
1999 12.7
2000 12.7
2001 13.0
Thereafter 37.3
Legal Matters: The Company is involved at various times in litigation
common to its business. In the opinion of management, the resolution of any such
litigation is not expected to have a material adverse effect on the Company's
financial condition or its results of operations.
Regulatory Matters: Under existing guaranty fund laws in all states,
insurers licensed to do business in those states can be assessed for certain
obligations of insolvent insurance companies to policyholders and claimants. The
actual amount of such assessments will depend upon the final outcome of
rehabilitation proceedings and will be paid over several years. In 1996, 1995
and 1994, Keyport was assessed $10.0 million, $8.1 million, and $7.7 million,
respectively. During 1996, 1995 and 1994, Keyport recorded $1.0 million, $2.0
million, and $7.2 million respectively, of provisions for state guaranty fund
association expense. At December 31, 1996 and 1995, the reserve for such
assessments was $12.9 million and $21.9 million, respectively.
54
- -----------------------------------------------------------------
R E P O R T O F I N D E P E N D E N T A U D I T O R S
- -----------------------------------------------------------------
[ERNST & YOUNG LLP LOGO]
Shareholders and Board of Directors
Liberty Financial Companies, Inc.
We have audited the accompanying consolidated balance sheet of Liberty Financial
Companies, Inc. as of December 31, 1996, and the related consolidated statements
of income, stockholders' equity, and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The financial statements of Liberty Financial Companies, Inc. for the
years ended December 31, 1995 and 1994, were audited by other auditors whose
report dated February 16, 1996, expressed an unqualified opinion on those
statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and the significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1996 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Liberty
Financial Companies, Inc. at December 31, 1996, and the consolidated results of
its operations and its cash flows for the year then ended in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Boston, Massachusetts
February 5, 1997
55