SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
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 numbers: ___333-01783, 333-13609___
KEYPORT LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
Massachusetts 05-0302931
(State of other jurisdiction of incorporation or organization) (I.R.S.
Employer Identification No.)
125 High Street, Boston, Massachusetts 02110-2712
(Address of principal executive offices) (Zip Code)
(617) 526-1400
(Registrant's telephone number, including area code)
(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 2,412,000 shares of the registrant's Common Stock, $1.25 par
value, outstanding as of September 30, 1997.
Exhibit Index - Page 16 Page 1 of 17
KEYPORT LIFE INSURANCE COMPANY
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30,
1997 and December 31, 1996 3
Consolidated Income Statements for the Three
Months and Nine Months Ended September 30, 1997
and 1996 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1997 and 1996 5
Notes to Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 8-13
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 15
Exhibit Index 1 16
KEYPORT LIFE INSURANCE COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30 December 31
ASSETS 1997 1996
(Unaudited)
Cash and investments:
Fixed maturities available for sale
(amortized cost: 1997 - $10,898,398;
1996 - $10,500,431) $ 11,207,337 $ 10,718,644
Equity securities, at fair value
(cost: 1997 - $20,703; 1996 - $19,412) 43,224 35,863
Mortgage loans 62,402 67,005
Policy loans 547,824 532,793
Other invested assets 420,953 183,622
Cash and cash equivalents 1,144,333 767,385
Total cash and investments 13,426,073 12,305,312
Accrued investment income 162,518 146,778
Deferred policy acquisition costs 211,675 250,355
Value of insurance in force 52,037 70,819
Intangible assets 18,340 19,186
Due from affiliates 35,290 -
Other assets 38,362 40,639
Separate account assets 1,261,980 1,091,468
Total assets $ 15,206,275 $ 13,924,557
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Policy liabilities $ 12,071,895 $ 11,637,528
Current federal income taxes 27,353 13,123
Deferred federal income taxes 91,679 25,747
Payable for investments purchased and loaned 675,149 211,234
Other liabilities 37,644 38,476
Separate account liabilities 1,212,473 1,017,667
Total liabilities 14,116,193 12,943,775
Stockholder's equity:
Common stock, $1.25 par value; authorized
8,000 shares; issued and outstanding 2,412
shares 3,015 3,015
Additional paid-in capital 505,933 505,933
Net unrealized investment gains 98,887 73,599
Retained earnings 482,247 398,235
Total stockholder's equity 1,090,082 980,782
Total liabilities and stockholder's equity $ 15,206,275 $ 13,924,557
See accompanying notes
KEYPORT LIFE INSURANCE COMPANY
CONSOLIDATED INCOME STATEMENTS
(in thousands)
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
Investment income $ 210,365 $ 200,253 $ 627,535 $ 576,315
Interest credited to
policyholders 150,875 146,071 445,412 420,341
Investment spread 59,490 54,182 182,123 155,974
Net realized investment
gains 4,951 755 20,417 319
Fee income:
Surrender charges 4,180 3,423 11,481 10,929
Separate account fees 4,774 4,982 12,723 12,018
Management fees 887 610 2,467 1,843
Total fee income 9,841 9,015 26,671 24,790
Expenses:
Policy benefits (920) (741) (3,075) (2,728)
Operating expenses (12,740) (10,480) (36,805) (32,529)
Amortization of
deferred policy
acquisition costs (18,273) (15,467) (54,013) (44,440)
Amortization of value
of insurance in force (2,191) (2,407) (7,258) (5,975)
Amortization of
intangible assets (282) (282) (846) (846)
Total expenses (34,406) (29,377) (101,997) (86,518)
Income before federal
income taxes expense 39,876 34,575 127,214 94,565
Federal income tax
expense (13,499) (12,286) (43,202) (32,645)
Net income $ 26,377 $ 22,289 $ 84,012 $ 61,920
See accompanying notes
KEYPORT LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months Ended
September 30
1997 1996
Cash flows from operating activities:
Net income $ 84,012 $ 61,920
Adjustments to reconcile net income to
net cash provided by operating activities:
Interest credited to policyholders 445,412 420,341
Net realized investment gains (20,417) (319)
Amortization of value of insurance
in force and intangible assets 8,104 6,821
Net amortization on investments 21,983 15,550
Change in deferred policy acquisition
costs (10,346) (16,427)
Change in current and deferred federal
income taxes 31,582 15,385
Net change in other assets and liabilities (16,695) (45,476)
Net cash provided by operating
activities 543,635 457,795
Cash flows from investing activities:
Investments purchased - available for sale (3,006,409) (3,116,451)
Investments sold - available for sale 1,414,198 760,455
Investments matured - available for sale 1,230,537 927,439
Increase in policy loans (15,031) (22,950)
Decrease in mortgage loans 4,603 6,028
Acquisition of value of insurance in force - (31,335)
Net cash used in investing activities (372,102) (1,476,814)
Cash flows from financing activities:
Withdrawals from policyholder accounts (948,879) (807,478)
Deposits to policyholder accounts 738,427 1,849,683
Securities lending 415,867 194,932
Net cash provided by financing
activities 205,415 1,237,137
Change in cash and cash equivalents 376,948 218,118
Cash and cash equivalents at beginning
of period 767,385 777,384
Cash and cash equivalents at end of period $ 1,144,333 $ 995,502
See accompanying notes
KEYPORT LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The accompanying unaudited consolidated financial statements of Keyport
Life Insurance Company (the Company) 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. Therefore these consolidated financial statements should be
read in conjunction with the audited consolidated financial statements
contained in the Company's 1996 Form 10-K. The results of operations for the
three and nine months ended September 30, 1997 are not necessarily
indicative of the results to be expected for the full year. Certain prior
period amounts in the accompanying unaudited consolidated income statement
have been reclassified to conform to the current period presentation.
2. Investments
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.
3. Other Financial Instruments
As a component of its investment strategy and to reduce its exposure to
interest rate risk, the Company utilizes interest rate swap ("swap
agreements") and interest rate cap agreements ("cap agreements") to match
assets more closely to liabilities. Swap agreements are agreements to
exchange with 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. The Company had 45
outstanding swap agreements with an aggregate notional principal amount of
$2.6 billion and 39 outstanding swap agreements with an aggregate notional
principal amount $2.3 billion, as of September 30, 1997 and December 31,
1996, respectively.
Cap agreements are agreements with a counterparty which require the
payment of a premium for the right to receive payments for the difference
between the cap interest rate and a market interest rate on specified future
dates based on an underlying principal balance (notional principal) to hedge
against rising interest rates. The Company had interest rate cap agreements
KEYPORT LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
(Unaudited)
with an aggregate notional amount of $450.0 million as of September 30, 1997
and December 31, 1996, respectively.
With respect to the Company's equity-indexed annuity, the Company buys
call options on the Standard & Poor's 500 Composite Stock Price Index ("S&P
500 Index") to hedge its obligations to provide returns based upon this
index. The Company had call options with a book value of $321.5 million and
$109.6 million as of September 30, 1997 and December 31, 1996, respectively.
Hedge accounting is applied after the Company determines that the items
to be hedged expose it to interest rate or price risk, designates the
instruments as hedges, and assesses whether the instruments reduce the
indicated risks through the measurement of changes in the value of the
instruments and the items being hedged at both inception and throughout the
hedge period. From time to time, interest rate swap agreements, cap
agreements and indexed call options are terminated. If the terminated
position was accounted for as a hedge, realized gains or losses are
amortized over the remaining lives of the hedged assets or liabilities.
Conversely, if the terminated position was not accounted for as a hedge, or
the assets and liabilities that were hedged no longer exist, the position is
"marked to market", and realized gains or losses are immediately recognized
in income.
The net differential to be paid or received on interest rate swap
agreements is recognized as a component of net investment income. Premiums
paid for interest rate cap agreements are deferred and amortized to net
investment income on a straight-line basis over the terms of the agreements.
The unamortized premium is included in other invested assets. Amounts earned
on interest rate cap agreements are recorded as an adjustment to net
investment income. Interest rate cap agreements and swap agreements hedging
investments designated as available for sale are adjusted to fair value with
the resulting unrealized gains and losses included in stockholder's equity.
Premiums paid on indexed call options are amortized to net investment
income over the terms of the contracts. The call options are included in
other invested assets and are carried at amortized cost plus intrinsic
value, if any, of the call options as of the valuation date. Changes in
intrinsic value of the call options are recorded as an adjustment to
interest credited to policyholders.
There are risks associated with some of the techniques the Company uses
to match its assets and liabilities. The primary risk associated with swap,
cap and call option agreements is the risk associated with counterparty
nonperformance. The Company believes that the counterparties to its swap and
call option agreements are financially responsible and that the counterparty
risk associated with these transactions is minimal.
KEYPORT LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
(Unaudited)
4. Recent Accounting Proposal
In August 1997, the Financial Accounting Standards Board issued a draft
of an accounting standard entitled "Accounting for Derivative Instruments
and for Hedging Activities." This accounting standard, if adopted in the
form in which it was issued, would require companies to report derivatives
on the balance sheet at fair value with changes in fair value recorded in
income or equity. The accounting standard would also change the accounting
for derivatives used in hedging strategies from traditional deferral
accounting to a current recognition approach which could impact a company's
income statement and balance sheet and expand the definition of a derivative
instrument. Management expects that this accounting standard, in whatever
form, will not be effective until 1999. The Company is evaluating the
impact of the proposed accounting standard.
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition
Results of Operations
Net income was $26.4 million for the third quarter of 1997 compared to
$22.3 million for the third quarter of 1996. For the first nine months of
1997, net income was $84.0 million compared to $61.9 million for the first
nine months of 1996. These increases resulted from higher investment
spread, higher fee income and higher net realized investment gains.
Partially offsetting these items were increased amortization of deferred
policy acquisition costs and federal income tax expense.
Investment spread is the amount by which investment income earned on the
Company's investments exceeds interest credited to policyholder balances.
Investment spread was $59.5 million for the third quarter of 1997 compared
to $54.2 million for the third quarter of 1996. 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 was 1.75% for the third quarter of 1997 compared to 1.79%
for the third quarter of 1996. For the first nine months of 1997,
investment spread was $182.1 million compared to $156.0 million for the
first nine months of 1996. The investment spread percentage was 1.84% for
the first nine months of 1997 compared to 1.80% for the first nine months of
1996.
Investment income was $210.4 million for the third quarter of 1997 compared
to $200.3 million for the third quarter of 1996. The increase of $10.1
million in 1997 compared to 1996 primarily relates to a $19.7 million
increase as a result of the higher level of average invested assets,
partially offset by a $9.6 million decrease resulting from a lower average
investment yield. The third quarter of 1997 included $13.6 million of S&P
500 Index call option amortization expense compared to $4.3 million for the
third quarter of 1996. The average investment yield was 6.77% for the third
quarter of 1997 compared to 7.11% for the third quarter of 1996. For the
first nine months of 1997, investment income was $627.5 million compared to
$576.3 million for the first nine months of 1996. The increase of $51.2
million for the first nine months of 1997 compared to the first nine months
of 1996 primarily relates to a $73.2 million increase as a result of the
higher level of average invested assets, partially offset by a $22.0 million
decrease resulting from a lower average investment yield. The first nine
months of 1997 included $31.2 million of S&P 500 Index call option
amortization expense compared to $7.8 million for the first nine months of
1996. The average investment yield was 6.86% for the first nine months of
1997 compared to 7.13% for the first nine months of 1996.
Interest credited to policyholders totaled $150.9 million for the third
quarter of 1997 compared to $146.1 million for the third quarter of 1996.
The increase of $4.8 million in 1997 compared to 1996 primarily relates to a
$12.9 million increase as a result of a higher level of average policyholder
balances, partially offset by an $8.1 million decrease resulting from a
lower average interest credited rate. Policyholder balances averaged $12.0
billion (including $10.7 billion of fixed annuities and $1.3 billion of
equity-indexed annuities) for the third quarter of 1997 compared to $11.0
billion (including $10.5 billion of fixed annuities and $0.5 billion of
equity-indexed annuities) for the third quarter of 1996. The average
interest credited rate was 5.02% (5.52% on fixed annuities and 0.85% on
equity-indexed annuities) for the third quarter of 1997 compared to 5.31%
(5.53% on fixed annuities and 0.85% on equity-indexed annuities) for the
third quarter of 1996. The Company's equity-indexed annuities credit
interest to the policyholder at a "participation rate" equal to a portion
(ranging for existing policies from 60% to 95%) of the change in value of
the S&P 500 Index. The Company's equity-indexed annuities also provide a
full guarantee of principal plus interest at 0.85% annually. For each of
the periods presented, the interest credited to equity-indexed policyholders
related to the participation rate was offset by investment income recognized
on the S&P 500 Index call options, resulting in an 0.85% net credited rate.
For the first nine months of 1997, interest credited to policyholders
totaled $445.4 million compared to $420.3 million for the first nine months
of 1996. The increase of $25.1 million for the first nine months of 1997
compared to the first nine months of 1996 primarily relates to a $50.0
million increase as a result of a higher level of average policyholder
balances, partially offset by a $24.9 million decrease resulting from a
lower average interest credited rate. Policyholder balances averaged $11.8
billion (including $10.7 billion of fixed annuities and $1.1 billion of
equity-indexed annuities) for the first nine months of 1997 compared to
$10.5 billion (including $10.2 billion of fixed annuities and $0.3 billion
of equity-indexed annuities) for the first nine months of 1996. The average
interest credited rate was 5.02% (5.44% on fixed annuities and 0.85% on
equity-indexed annuities) for the first nine months of 1997 compared to
5.33% (5.47% on fixed annuities and 0.85% on equity-indexed annuities) for
the first nine months of 1996.
Average investments (computed without giving effect to SFAS 115), including
a portion of the Company's cash and cash equivalents, were $12.4 billion for
the third quarter of 1997 compared to $11.3 billion for the third quarter of
1996. For the first nine months of 1997, such average investments were $12.2
billion compared to $10.8 billion for the first nine months of 1996. These
increases primarily relate to a 100 percent coinsurance agreement with
respect to a $954.0 million block of single premium deferred annuities
("SPDAs") entered into with Fidelity & Guaranty Life Insurance Company ("F&G
Life") during the third quarter of 1996. Under the F&G Life transaction,
the investment risk of the policies was transferred to the Company, while
F&G Life continues to administer the policies.
Net realized investment gains were $5.0 million for the third quarter of
1997 compared to $0.8 million for the third quarter of 1996. For the first
nine months of 1997, net realized investment gains were $20.4 million
compared to $0.3 million for the first nine months of 1996. Sales of fixed
maturity investments generally are made to maximize total return. The net
realized investment gains in 1997 included gains on the sales of fixed
maturity investments of $12.7 million and gains on redemption of seed money
investments in separate account mutual funds sponsored by the Company of
$7.7 million. The net realized investment gains in 1996 were attributable
to sales of fixed maturity investments.
Surrender charges are revenues earned on the early withdrawal of annuity
policyholder balances. Surrender charges on fixed and variable annuity
withdrawals generally are assessed at declining rates applied to
policyholder withdrawals during the first five to seven years of the
contract. Total surrender charges were $4.2 million for the third quarter of
1997 compared to $3.4 for the third quarter of 1996. For the first nine
months of 1997, surrender charges were $11.5 million compared to $10.9
million for the first nine months of 1996.
On an annualized basis, annuity withdrawals represented 10.9% and 11.6% of
the total average annuity policyholder and separate account balances for the
third quarter of 1997 and 1996, respectively, and 11.0% and 10.7% of the
total average annuity policyholder and separate account balances for the
first nine months of 1997 and 1996, respectively. The increase in
withdrawals in 1997 was primarily attributable to surrenders of annuities
acquired in the F&G Life transaction; excluding these surrenders, the
withdrawal percentage for the first nine months of 1997 would have been
9.9%.
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 $4.8 million for the third quarter of 1997 compared
to $5.0 million for the third quarter of 1996. Such fees represented 1.6%
of average variable annuity and variable life separate account balances for
the third quarter of 1997 compared to 2.1% for the third quarter of 1996.
For the first nine months of 1997, separate account fees were $12.7 million
compared to $12.0 million for the first nine months of 1996. These fees
represented 1.6% of average variable annuity and variable life separate
account balances for the first nine months of 1997 compared to 1.7% for the
first nine months of 1996.
Management fees are primarily investment advisory fees related to the
separate account assets. The 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. Management fees were $0.9
million for the third quarter of 1997 compared to $0.6 million for the third
quarter of 1996. The increase of $0.3 million in 1997 compared to 1996
primarily reflects a higher level of average assets under management. For
the first nine months of 1997, management fees were $2.5 million compared to
$1.8 million in 1996. The increase of $0.7 million in 1997 compared to 1996
primarily reflects a higher level of average assets under management.
Operating expenses primarily represent compensation and other general and
administrative expenses. These expenses were $12.8 million for the third
quarter of 1997 compared to $10.5 million for the third quarter of 1996.
For the first nine months of 1997, operating expenses were $36.8 million
compared to $32.5 million for the first nine months of 1996. The increase
in 1997 compared to 1996 was primarily due to higher employee related
expenses.
Amortization of deferred policy acquisition costs relates to the costs of
acquiring new business which vary with, and are primarily related to, the
production of new annuity business. Such costs include commissions, costs
of policy issuance and underwriting and selling expenses. Amortization was
$18.3 million for the third quarter of 1997 compared to $15.5 million for
the third quarter of 1996. Amortization of deferred policy acquisition costs
was $54.0million for the nine months ended September 30, 1997 compared to
$44.4 million for the nine months ended September 30, 1996. The increase in
amortization in 1997 compared to 1996 was primarily related to the increase
in investment spread from the growth of business in force associated with
fixed and equity-indexed products and the increased sales of variable
annuity products. Amortization expense represented 30.7% and 28.6% of
investment spread for the third quarter of 1997 and 1996, respectively. For
the first nine months of 1997 and 1996, the corresponding percentages were
29.7% and 28.5%, respectively.
Amortization of value of insurance in force relates to the actuarially-
determined present value of projected future gross profits from policies in
force at the date of acquisition. Amortization totaled $2.2 million for the
third quarter of 1997 compared to $2.4 million for the third quarter of
1996. The third quarter of 1997 included increased amortization of $1.1
million related to the F&G Life transaction offset by decreased amortization
related to a change in mortality assumptions. Amortization of value of
insurance in force totaled $7.3 million for the nine months ended September
30, 1997 compared to $6.0 million for the nine months ended September 30,
1996. The first nine months of 1997 included increased amortization of $4.2
million related to the F&G Life transaction partially offset by decreased
amortization related to a change in mortality assumptions.
Federal income tax expense was $13.5 million or 33.9% of pretax income for
the third quarter of 1997 compared to $12.3 million, or 35.5% of pretax
income for the third quarter of 1996. For the first nine months of 1997,
federal income tax expense was $43.2 million or 34.0% of pretax income,
compared to $32.6 million or 34.5% of pretax income for the first nine
months of 1996.
Effective July 18, 1997, due to changes in ownership of the Company's
parent, the Company is no longer included in the consolidated federal income
tax return of Liberty Mutual Insurance Company. The Company does not expect
this change to have a material effect on its financial condition or results
from operations. It is expected that the Company will file a separate
federal income tax return until the Company is eligible to file a
consolidated federal income tax return with Liberty Financial in 2003.
Financial Condition
Stockholder's equity as of September 30, 1997 was $1.09 billion compared to
$0.98 billion as of December 31, 1996. The increase in stockholder's equity
was due to a $25.3 million increase in net unrealized gains and $84.0
million of net income for the period.
The Company's total investments at September 30, 1997 reflected net
unrealized gains of $327.5 million. At December 31, 1996, such net
unrealized investment gains were $229.8 million.
Approximately $10.8 billion, or 96.7% of the fixed maturity investments at
September 30, 1997, were rated by Standard & Poor's Corporation, Moody's
Investors Service or under comparable statutory rating guidelines
established by the National Association of Insurance Commissioners. At
September 30, 1997, the carrying value of investments in below investment
grade securities totaled $1.0 billion, or 7.7% of total cash and investments
of $13.4 billion compared to $1.0 billion, or 8.0% of total cash and
investments of $12.3 billion at December 31, 1996. 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.
Management of the Company's Investments
Asset-liability management is utilized by the Company to minimize the risks
of interest rate fluctuations and policyholder withdrawals. The Company
believes that its fixed and equity-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 acceptable risk-adjusted returns by
effectively managing portfolio 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 an acceptable spread between what it
earns on its assets and interest credited on its policyholder balances by
investing principally in fixed maturities. The Company's fixed-rate products
incorporate surrender charges to encourage persistency and make the cost of
its policyholder balances more predictable. Approximately 85.7% of the
Company's fixed annuity policyholder balances were subject to surrender
charges at September 30, 1997 compared to 85.4% 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 to maintaining a desired investment spread
between the yield on portfolio assets and the interest credited on its
policyholder balances under a variety of possible future interest rate
scenarios. At September 30, 1997 and December 31, 1996, the effective
duration of the Company's fixed maturities investments (including certain
cash and cash equivalents) was approximately 2.8. Effective duration is a
common measure for the price sensitivity of a fixed-income portfolio to
changes in interest rates. It measures the approximate percentage change in
the market value of a portfolio when interest rates change by 100 basis
points. This measure includes the impact of estimated changes in portfolio
cash flows from features, such as prepayments and bond calls.
As a component of its investment strategy and to reduce its exposure to
interest rate risk, the Company utilizes interest rate swap and interest
rate cap agreements to match assets more closely to liabilities. Swap
agreements are agreements to exchange with 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
credited to policyholders. The Company had 45 outstanding swap agreements
with an aggregate notional principal amount of $2.6 billion and 39
outstanding swap agreements and with an aggregate notional principal amount
$2.3 billion, as of September 30, 1997 and December 31, 1996, respectively.
Cap agreements are agreements with a counterparty which require the payment
of a premium for the right to receive payments for the difference between
the cap interest rate and a market interest rate on specified future dates
based on an underlying principal balance (notional principal) to hedge
against rising interest rates. The Company had interest rate cap agreements
with an aggregate notional amount of $450.0 million as of September 30, 1997
and December 31, 1996, respectively.
With respect to the Company's equity-indexed annuity, the Company buys call
options on the S&P 500 Index to hedge its obligations provide returns based
upon this index. The Company had call options with a book value of $321.5
million and $109.6 million as of September 30, 1997 and December 31, 1996,
respectively.
There are risks associated with some of the techniques the Company uses to
match its assets and liabilities. The primary risk associated with swap, cap
and call option agreements is counterparty nonperformance. The Company
believes that the counterparties to its swap and call option agreements are
financially responsible and that the counterparty risk associated with these
transactions is minimal. In addition, swap agreements have interest rate
risk and call options have stock market risk. However, the swap agreements
hedge fixed-rate assets; the Company expects that any interest rate
movements that adversely affect the market value of swap agreements would be
offset by changes in the market values of such fixed rate assets.
Similarly, the call options hedge the Company's obligations to provide
returns on equity-indexed annuities based upon the S&P 500 Index, and the
Company believes that any stock market movements that adversely affect the
market value of S&P call options would be substantially offset by a
reduction in policyholder liabilities. However, there can be no assurance
that these hedges will be effective in offsetting the potentially adverse
effects of changes in S&P 500 Index levels. The Company's profitability
could be adversely affected if the value of its S&P 500 call options
increase less than (or decrease more than) the value of the guarantees made
to equity-indexed policyholders.
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. There were no non-income producing investments in the
Company's fixed maturity portfolio at September 30, 1997 or December 30,
1996. 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 creditor's affairs. In the case of
publicly traded fixed maturity investments, management also considers market
value quotations, if available.
Liquidity
The Company's liquidity needs and financial resources pertain to the
management of the general account assets and policyholder balances. The
Company uses cash for the payment of annuity and life insurance benefits,
operating expenses and policy acquisition costs, and the purchase of
investments. The Company generates cash from annuity premiums and deposits,
net investment income, and from maturities and sales of its investments.
Annuity premiums, maturing investments and net investment income have
historically been sufficient to meet the Company's cash requirements. The
Company 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, the Company has invested a substantial amount of its
general account assets in readily marketable securities. At September 30,
1997, $10.1 billion, or 75.4%, of the Company's general account investments
are considered readily marketable.
To the extent that unanticipated surrenders cause the Company 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, the Company 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.
Current Rhode Island insurance law permits the payment of dividends or
distributions from the Company to Liberty Financial, which, together with
dividends and distributions paid during the preceding 12 months, do not
exceed 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. Any proposed dividend in excess of this amount is called an
"extraordinary dividend" and may not be paid until it is approved by the
Commissioner of Insurance of the State of Rhode Island. As of September 30,
1997, the amount of dividends that the Company could pay without such
approval was $42.5 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 liquidity needs. The
Company's cash flow may be influenced by, among other things, general
economic conditions, realized investment gains and losses, the interest rate
environment, 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 to date. The Company manages its investment portfolio
in part to reduce its exposure to interest rate fluctuations. In general,
the fair value of the Company's fixed maturity portfolio increases or
decreases in inverse relationship with fluctuations in interest rates, and
the Company's net investment income increases or decreases in direct
relationship with interest rate changes. For example, if interest rates
decline the Company's fixed maturity investments generally will increase in
fair 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 6. Exhibits and Reports on Form 8-K
(a) Exhibit
#27 Financial Data Schedule - page 16
(b) Reports on Form 8-K
There were no reports filed on Form 8-K during the quarter ended
September 30, 1997.
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.
KEYPORT LIFE INSURANCE COMPANY
___________________________________
Bernhard M. Koch
(Duly Authorized Officer and Chief Financial Officer)
____________________________________
Jeffery J. Whitehead
(Duly Authorized Officer and Chief Accounting Officer)
Date: November 13, 1997
Exhibit Index
Exhibit No. Description Page
27 Financial Data Schedule 17
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