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, 1996
------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ------------- to -------------
Commission file number: 1-13654
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LIBERTY FINANCIAL COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
Massachusetts 04-3260640
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
600 Atlantic Avenue, Boston, Massachusetts 02210-2214
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(Address of principal executive offices) (Zip Code)
(617) 722-6000
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ] Yes [ ] No
There were 28,527,612 shares of the registrant's Common Stock, $.01 par
value, and 327,725 shares of the registrant's Series A Convertible Preferred
Stock, $.01 par value, outstanding as of October 31, 1996.
Exhibit Index - Page 28 Page 1 of 31
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 1996
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1996
and December 31, 1995
Consolidated Income Statements for the Three Months
and Nine Months Ended September 30, 1996 and 1995
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1996 and 1995
Consolidated Statement of Stockholders' Equity for the
Nine Months Ended September 30, 1996
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Part II. OTHER INFORMATION
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
Exhibit Index
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<CAPTION>
September 30 December 31
1996 1995
------------ ------------
Unaudited
ASSETS
<S> <C> <C>
Assets:
Investments $11,443,517 $10,144,742
Cash and cash equivalents 1,059,300 875,314
Accrued investment income 157,573 132,856
Deferred policy acquisition costs 295,514 179,672
Value of insurance in force 90,656 43,939
Deferred distribution costs 119,662 114,579
Intangible assets 207,549 192,301
Other assets 156,729 106,734
Separate account assets 1,033,218 959,224
----------- -----------
$14,563,718 $12,749,361
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policyholder balances $11,559,719 $10,084,392
Notes payable to affiliates 229,000 229,000
Payable for investments purchased
and loaned 540,207 317,715
Other liabilities 252,714 259,685
Separate account liabilities 974,978 889,107
----------- -----------
Total liabilities 13,556,618 11,779,899
----------- -----------
Redeemable convertible preferred stock,
$0.01 par value;327,725 shares issued
and outstanding in 1996; 327,741 shares
in 1995 13,630 13,040
----------- -----------
Stockholders' Equity:
Common stock, $.01 par value, authorized
100,000,000 shares; 28,522,362 shares
issued and outstanding in 1996; 27,682,536
shares in 1995 285 277
Additional paid-in capital 830,792 810,510
Net unrealized investment gains 45,617 87,158
Retained earnings 117,036 59,370
Unearned compensation (260) (893)
----------- -----------
Total stockholders' equity 993,470 956,422
----------- -----------
$14,563,718 $12,749,361
============ ===========
See accompanying notes
</TABLE>
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share data)
Unaudited
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------- -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Investment income $ 207,696 $ 191,437 $ 593,522 $ 567,581
Interest credited to
policyholders (152,015) (143,571) (433,122) (413,758)
--------- --------- --------- ---------
Investment spread 55,681 47,866 160,400 153,823
--------- --------- --------- ---------
Net realized investment gains
(losses) 733 1,430 2,823 (4,942)
--------- --------- --------- ---------
Fee income:
Investment advisory and
administrative fees 49,522 43,163 144,739 108,650
Distribution and service fees 11,316 9,398 33,010 18,991
Transfer agency fees 11,381 9,682 32,610 20,629
Surrender charges and net
commissions 8,694 7,034 25,831 17,864
Separate account fees 4,982 3,317 12,018 9,738
--------- --------- --------- ---------
Total fee income 85,895 72,594 248,208 175,872
--------- --------- --------- ---------
Expenses:
Operating expenses (71,511) (59,730) (205,274) (160,958)
Amortization of deferred
policy acquisition costs (15,467) (12,025) (44,440) (38,186)
Amortization of deferred
distribution costs (7,782) (6,143) (21,950) (12,371)
Amortization of value of
insurance in force (2,407) (3,133) (5,975) (9,986)
Amortization of intangible
assets (3,810) (3,488) (12,076) (8,557)
Interest expense (4,930) (4,682) (14,986) (11,451)
--------- --------- --------- ---------
Total expenses (105,907) (89,201) (304,701) (241,509)
--------- --------- --------- ---------
Pretax income 36,402 32,689 106,730 83,244
Income tax expense (11,689) (10,733) (35,137) (30,127)
--------- --------- --------- ---------
Net income $ 24,713 $ 21,956 $ 71,593 $ 53,117
========= ========= ========= =========
Net income per share $0.82 $0.76 $2.40 $1.93
========= ========= ========= =========
Common stock and common stock
equivalents 29,708 28,763 29,527 27,267
========= ========= ========= =========
See accompanying notes
</TABLE>
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Unaudited
<CAPTION>
Nine Months Ended
September 30
-----------------
1996 1995
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 71,593 $ 53,117
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 50,374 39,120
Interest credited to policyholders 433,122 413,758
Net realized investment (gains) losses (2,823) 4,942
Net amortization of investments 2,769 6,651
Change in deferred policy acquisition costs (16,427) (29,359)
Net change in assets and liabilities, net of
effect of acquisitions (102,312) (66,986)
--------- ---------
Net cash provided by operating activities 436,296 421,243
--------- ---------
Cash flows from investing activities:
Investments purchased held to maturity 0 (227,966)
Investments purchased available for sale (3,116,451) (1,808,248)
Investments sold held to maturity 0 14,930
Investments sold available for sale 760,455 340,978
Investments matured held to maturity 0 205,673
Investments matured available for sale 927,439 672,353
Acquisitions, net of cash acquired (38,420) (96,774)
Change in policy loans (22,950) (14,334)
Change in mortgage loans 6,028 14,036
--------- ---------
Net cash used in investing activities (1,483,899) (899,352)
--------- ---------
Cash flows from financing activities:
Withdrawals from policyholder accounts (807,478) (680,636)
Deposits to policyholder accounts 1,849,683 935,045
Securities lending 194,932 544,009
Borrowings from affiliates 0 124,000
Repayments under revolving credit facility (4,000) (10,500)
Exercise of stock options 1,371 83
Dividends paid (2,919) (1,904)
--------- ---------
Net cash provided by financing activities 1,231,589 910,097
--------- ---------
Increase in cash and cash equivalents 183,986 431,988
Cash and cash equivalents at beginning of period 875,314 726,711
--------- ---------
Cash and cash equivalents at end of period $1,059,300 $1,158,699
========= =========
See accompanying notes
</TABLE>
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
Unaudited
<CAPTION>
Net
Additional Unrealized Total
Common Paid-In Investment Retained Unearned Stockholders'
Stock Capital Gains Earnings Compensation Equity
------ ---------- ---------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance,
December 31,
1995 $277 $810,510 $ 87,158 $ 59,370 $ (893) $956,422
Common stock
issued in
Independent
acquisition 3 8,497 0 0 0 8,500
Proceeds from
exercise
of stock
options 2 1,369 0 0 0 1,371
Unearned
compensation 0 0 0 0 633 633
Accretion to
face value of
preferred
stock 0 0 0 (590) 0 (590)
Common stock
dividends 3 10,415 0 (12,630) 0 (2,212)
Preferred
stock
dividends 0 0 0 (707) 0 (707)
Conversion of
preferred
stock 0 1 0 0 0 1
Change in net
unrealized
gains 0 0 (41,541) 0 0 (41,541)
Net income 0 0 0 71,593 0 71,593
------- ------- ------- ------- ------- -------
Balance,
September 30,
1996 $285 $830,792 $ 45,617 $117,036 $ (260) $993,470
======= ======== ======== ======== ======= ========
See accompanying notes
</TABLE>
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
1. General
The accompanying unaudited consolidated financial statements include all
adjustments, consisting of normal recurring accruals, that management
considers necessary for a fair presentation of the Company's financial
position and results of operations as of and for the interim periods
presented. Certain footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission, although the Company
believes the disclosures in these consolidated financial statements are
adequate to present fairly the information contained herein. These
consolidated financial statements should be read in conjunction with the
audited consolidated financial statements contained in the Company's 1995
Annual Report to Stockholders. The results of operations for the nine months
ended September 30, 1996 are not necessarily indicative of the results to be
expected for the full year.
Certain prior period amounts in the accompanying unaudited consolidated
income statements have been reclassified to conform to the current period
presentation. The principal reclassifications relate to the presentation of
investment spread (the amount by which net investment income exceeds interest
credited to policyholder balances) and the components of the Company's fee
income. These reclassifications were made to provide additional information
with respect to the Company's major sources of revenue.
2. Industry Segment Information
The Company is an asset accumulation and management company which operates
in two industry segments: retirement-oriented insurance (principally
annuities) and asset management. The annuity insurance business is conducted
at Keyport Life Insurance Company ("Keyport"). Keyport generates investment
spread income from the investment portfolio which supports policyholder
balances associated with its fixed and indexed annuity business and its
closed block of single premium whole life insurance. The annuity insurance
business also derives fee income from the administration of fixed, indexed
and variable annuity contracts. The asset management business is conducted
principally at the Colonial Group, Inc. ("Colonial"), an investment advisor,
distributor and transfer agent to mutual funds, Stein Roe & Farnham
Incorporated ("Stein Roe"), a diversified investment advisor, and Newport
Pacific Management, Inc. ("Newport"), an investment advisor to mutual funds
and institutional accounts specializing in Asian equity markets. The asset
management business derives fee income from investment products and services.
Approximately 62.3% of the Company's operating earnings for the nine
months ended September 30, 1996 was attributable to the Company's annuity
insurance business, with the remaining 37.7% attributable to the Company's
asset management activities. This compares to approximately 67.9% and 32.1%,
respectively, during the year earlier period.
3. Acquisitions
On March 7, 1996, the Company acquired, for cash and common stock, all the
outstanding common stock of Independent Holdings, Inc. ("Independent"). In
addition, the Company agreed to make contingent payments in common stock upon
the attainment of certain objectives. Independent is engaged in the
distribution of annuity and investment products through banks.
On April 11, 1996, the Company acquired for cash all the outstanding
capital stock of KJMM Investment Management Company, Inc. ("KJMM"), a
registered investment advisor primarily in the wealth management business.
KJMM had assets under management of approximately $400.0 million as of the
date of acquisition.
On August 9, 1996, Keyport entered into a 100% coinsurance agreement for
a $965.3 million block of single premium deferred annuities issued by
Fidelity & Guaranty Life Insurance Company ("F&G Life"). Under this agreement
("the F&G Life transaction"), the investment risk of the annuity policies was
transferred to Keyport. However, the policies will continue to be
administered by F&G Life, and F&G Life remains contractually liable for the
performance of all policy obligations. The F&G Life transaction resulted in a
$934.0 million increase in investments and a $31.3 million increase in the
value of insurance in force.
<PAGE>
4. Investments
Investments, all of which pertain to Keyport, were comprised of the
following (in thousands):
<TABLE>
<CAPTION>
September 30 December 31
1996 1995
------------ -----------
<S> <C> <C>
Fixed maturities $10,710,754 $9,535,948
Mortgage loans 68,477 74,505
Policy loans 521,276 498,326
Other invested assets 106,898 10,748
Equity securities 36,112 25,215
----------- -----------
Total $11,443,517 $10,144,742
=========== ===========
</TABLE>
The Company's general investment policy is to hold fixed maturity assets
for long-term investment and, accordingly, the Company does not have a
trading portfolio. To provide for maximum portfolio flexibility and enable
appropriate tax planning, the Company classifies its entire fixed maturities
investments as " available for sale" which are carried at estimated fair
value.
The following table summarizes Keyport's investments in fixed maturities
as of September 30, 1996 (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ---------- ----------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury
securities $ 430,957 $ 1,138 $ (1,559) $ 430,536
Mortgaged backed
securities of
U.S. government
agencies 1,714,844 34,903 (17,332) 1,732,415
Obligations of
states and
political subdivisions 56,365 715 (62) 57,018
Debt securities
issued by foreign
governments 50,787 2,558 (216) 53,129
Corporate securities 4,326,971 122,322 (27,150) 4,422,143
Other mortgage backed
securities 2,281,123 34,916 (39,291) 2,276,748
Asset backed securities 1,459,453 9,353 (12,205) 1,456,601
Senior secured loans 282,164 0 0 282,164
----------- ---------- ----------- -----------
Total fixed
maturities $10,602,664 $ 205,905 $ (97,815) $10,710,754
=========== ========== =========== ===========
</TABLE>
<PAGE>
5. Net Income per Share
Net income per share is calculated by dividing applicable net income
by the weighted average number of shares of common stock outstanding during
each period, adjusted for the incremental shares attributable to common
stock equivalents. Common stock equivalents consist of outstanding employee
stock options. In calculating net income per share, net income is reduced
by convertible preferred stock dividend requirements. Such preferred stock
earns cumulative dividends at the annual rate of $2.875 per share and is
redeemable at the option of the Company, subject to certain conditions,
anytime after March 24, 1998. At the time ofissuance, the convertible
preferred stock was determined not to be a common stock equivalent.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Results of Operations
Net Income was $24.7 million or $0.82 per share in the third quarter of 1996
compared to $22.0 million or $0.76 per share in the third quarter of 1995. This
higher net income in the third quarter of 1996 was due to higher investment
spread and fee income. Partially offsetting these items were increased operating
expenses and higher amortization expense. For the nine months ended September
30, 1996, net income was $71.6 million or $2.40 per share compared to $53.1
million or $1.93 per share for the nine months ended September 30, 1995. The
higher net income for the nine months ended September 30, 1996 was attributable
to higher investment spread, higher fee income (primarily associated with the
Colonial and Newport acquisitions early in 1995) and to 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 higher income tax expense.
Pretax Income was $36.4 million in the third quarter of 1996 compared to
$32.7 million in the third quarter of 1995. This higher pretax income in the
third quarter of 1996 was primarily attributable to higher investment spread and
fee income. For the nine months ended September 30, 1996, pretax income was
$106.7 million compared to $83.2 million for the nine months ended September 30,
1995. The higher pretax income for the nine months ended September 30, 1996 was
primarily due to higher investment spread, the higher income at Colonial and
Newport and to net realized investment gains in 1996 compared to net realized
investment losses in 1995.
Investment Spread is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $55.7 million in the third quarter of 1996 compared to
$47.9 million in the third quarter of 1995. The amount by which the average
yield on investments exceeds the average interest credited rate on policyholder
balances is the investment spread percentage. Such investment spread percentage
in the third quarter of 1996 was 1.84% compared to 1.70% in the third quarter of
1995. For the nine months ended September 30, 1996, investment spread was $160.4
million compared to $153.8 million for the nine months ended September 30, 1995.
The investment spread percentage was 1.84% for the nine months ended September
30, 1996 compared to 1.89% for the nine months ended September 30, 1995. For the
remainder of 1996, assuming a constant interest rate environment, Keyport
anticipates a lower investment yield and a lower interest credited rate compared
to 1995. The investment spread percentage for the remainder of the year is
expected to be comparable to the spread percentage for the first nine months.
Investment income was $207.7 million in the third quarter of 1996, compared
to $191.4 million in the third quarter of 1995. Investment income increased in
the 1996 period primarily as a result of a higher level of average invested
assets, partially offset by a decrease in the average investment yield. The
average investment yield was 7.37% in the third quarter of 1996 compared to
7.46% in the 1995 period. The decreased investment yield in 1996 reflects the
lower interest rates prevailing during the latter half of 1995 and early 1996.
For the nine months ended September 30, 1996, investment income was $593.5
million compared to $567.6 million for the nine months ended September 30, 1995.
Investment income increased in the 1996 nine-month period primarily as a result
of the higher level of average invested assets, partially offset by a decrease
in the average investment yield. The average investment yield was 7.34% for the
nine months ended September 30, 1996 compared to 7.56% in the 1995 period. The
decreased investment yield in 1996 reflects the lower interest rates prevailing
during the latter half of 1995 and early 1996.
Interest credited to policyholders totaled $152.0 million in the third
quarter of 1996 compared to $143.6 million in the third quarter of 1995.
Interest credited to policyholders increased in the 1996 period primarily as a
result of a higher level of policyholder balances, partially offset by a
decrease in the average interest credited rate. Policyholder balances averaged
$11.0 billion in the third quarter of 1996 compared to $10.0 billion in the
third quarter of 1995. The average interest credited rate was 5.53% in 1996
compared to 5.76% in 1995. For the nine months ended September 30, 1996,
interest credited to policyholders was $433.1 million compared to $413.8 million
for the nine months ended September 30, 1995. Interest credited to policyholders
increased in the 1996 nine-month period primarily as a result of the higher
level of average policyholder balances, partially offset by a decrease in the
average interest credited rate. Policyholder balances averaged $10.5 billion for
the nine months ended September 30, 1996 compared to $9.7 billion for the nine
months ended September 30, 1995. The average interest credited rate was 5.50% in
1996 compared to 5.67% in 1995.
Average Investments (computed without giving effect to SFAS 115), including a
portion of the Company's cash and cash equivalents, were $11.3 billion in the
third quarter of 1996 compared to $10.3 billion in the third quarter of 1995.
This increase of $1.0 billion was primarily due to the F&G Life transaction and
sales of the Company's fixed and indexed annuities during the period. Fixed and
indexed annuity premiums totaled $338.6 million in the third quarter of 1996
compared to $159.3 million in the third quarter of 1995. The increase in
premiums in the 1996 period was primarily attributable to the sales of indexed
annuities which were introduced during the third quarter of 1995. Indexed
annuities provide the investor with the potential to participate in returns
based upon the S&P 500, while providing a guarantee of principal associated with
a traditional annuity. In the 1996 three-month period, indexed annuity sales
were $167.9 million compared to $17.0 million in 1995. For the nine months ended
September 30, 1996, average investments were $10.8 billion compared to $10.0
billion for the nine months ended September 30, 1995. Fixed and indexed annuity
premiums totaled $865.3 million for the nine months ended September 30, 1996
compared to $892.9 million for the nine months ended September 30, 1995. The
decrease in the 1996 nine-month period was also attributable to the reduced
market demand for fixed-rate annuities earlier in 1996 offset by significantly
increased sales of indexed products. Sales of indexed annuities during 1996
totaled $474.9 million compared to $34.6 million in 1995.
Net Realized Investment Gains totaled $0.7 million in the third quarter of
1996 compared to $1.4 million in the third quarter of 1995. For the nine months
ended September 30, 1996, net realized investment gains were $2.8 million
compared to net investment losses of $4.9 million for the nine months ended
September 30, 1995. The net realized gains in the 1996 period were primarily
attributable to sales of corporate investment securities; the realized losses in
1995 were attributable to sales of Keyport fixed maturity investments to
maximize total return.
Investment Advisory and Administrative Fees are based on the market value of
assets managed in mutual funds and for wealth management and institutional
investors. Investment advisory and administrative fees were $49.5 million in the
third quarter of 1996 compared to $43.2 million in the third quarter of 1995.
This increase of $6.3 million primarily reflects a higher level of average
assets under management. For the nine months ended September 30, 1996,
investment advisory and administrative fees were $144.7 million compared to
$108.6 million for the nine months ended September 30, 1995. A substantial
portion of this increase of $36.1 million was related to the fee income
attributable to the assets acquired in the Colonial acquisition in March 1995
and the Newport acquisition in April 1995 (whose results of operations are
included in the consolidated financial statements for nine months in 1996 and
six months in 1995). In addition, the increase reflects growth of assets under
management during the period.
The levels of assets under management are affected by product sales and
redemptions and by changes in the market values of such assets under management.
Assets under management and changes in assets under management are set forth in
the two tables below (in billions).
<TABLE>
Assets Under Management
- -----------------------
<CAPTION>
As of September 30
------------------
1996 1995
---- ----
<S> <C> <C>
Mutual Funds:
Broker-distributed $15.7 $15.1
Direct-marketed 6.6 4.7
Closed-end 1.9 1.8
Variable annuity 1.1 1.0
---- ----
25.3 22.6
Wealth Management 5.0 4.6
Institutional 4.7 4.3
---- ----
Total Assets Under Management* $35.0 $31.5
==== ====
---------
* As of September 30, 1996, Keyport's investments of $11.9 billion bring total
assets under management to $46.9 billion.
</TABLE>
<TABLE>
Changes in Assets Under Management
- ----------------------------------
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ---------------------
1996 1995 1996 1995
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Assets under management -
beginning $33.9 $30.4 $31.9 $16.3
Sales and reinvestments 1.9 1.4 5.8 3.4
Redemptions and withdrawals (1.5) (1.8) (4.2) (6.6)
Acquisitions 0 0.6 0.4 14.9
Market appreciation 0.7 0.9 1.1 3.5
----- ----- ----- -----
Assets under management -
ending $35.0 $31.5 $35.0 $31.5
===== ===== ===== =====
</TABLE>
Average fee-based assets under management were $34.0 billion for the three
months ended September 30, 1996 compared to $30.4 billion for the three months
ended September 30, 1995. For the nine months ended September 30, 1996, average
fee-based assets were $33.3 billion compared to $25.9 billion for the nine
months ended September 30, 1995. This increase of $7.4 billion during the 1996
nine-month period was primarily due to the Colonial and Newport acquisitions,
net mutual fund sales and market appreciation. Investment advisory and
administrative fees were 0.59% of average assets under management in the third
quarter of 1996 and 0.57% in the third quarter of 1995. For nine months ended
September 30, such amounts were 0.58% and 0.56%, respectively. These increases
in the effective fee rate were primarily due to the higher proportion of equity
assets under management during 1996.
Distribution and Service Fees are based on the market value of the Company's
broker-distributed mutual funds. Distribution fees of 0.75% are earned on the
average assets attributable to such funds sold without front-end sales loads,
and service fees of 0.25% (net of amounts passed on to selling brokers) are
earned on the total of such average mutual fund assets. These fees totaled $11.3
million in the third quarter of 1996 compared to $9.4 million in the third
quarter of 1995. This increase of $1.9 million was primarily attributable to the
higher asset level of mutual funds without front-end sales loads. For the nine
months ended September 30, 1996, distribution and service fees were $33.0
million compared to $19.0 million for the nine months ended September 30, 1995.
This increase of $14.0 million was primarily attributable to the full period
consolidation of Colonial. As a percentage of weighted average assets, these
fees approximated 0.69% in each of the 1996 and 1995 periods.
Transfer Agency Fees are based on the market value of assets managed in the
Company's broker-distributed and direct-marketed mutual funds. Such fees were
$11.4 million on average assets of $22.0 billion in the third quarter of 1996
and $9.7 million on average assets of $19.9 billion in the third quarter of
1995. The revenue increase of $1.7 million was primarily due to higher average
assets of direct-marketed mutual funds. As a percentage of total average mutual
fund assets in the third quarter of 1996 and 1995, respectively, transfer agency
fees were approximately 0.21% and 0.19%. For the nine months ended September 30,
1996, transfer agency fees were $32.6 million on average assets of $21.6 billion
and $20.6 million on average assets of $15.0 billion for the nine months ended
September 30, 1995. The revenue increase of $12.0 million was primarily due to
the full-period consolidation of Colonial and a fee increase on direct marketed
funds instituted during the third quarter of 1995. As a percentage of total
average mutual fund assets for the nine months ended September 30, 1996 and
1995, transfer agency fees were approximately 0.20% and 0.18%, respectively.
Surrender Charges and Net Commissions are revenues earned on: a) the early
withdrawal of fixed, indexed and variable annuity policyholder balances, and
redemptions of the broker-distributed mutual funds which were sold without
front-end sales loads; b) the distribution of the Company's broker-distributed
mutual funds (net of the substantial portion of such commissions that is passed
on to the selling brokers); and c) the sales of non-proprietary investment
products in the Company's bank marketing businesses (net of the portion of such
commissions that is passed on to the Company's client banks). Total surrender
charges and net commissions were $8.7 million in the third quarter of 1996
compared to $7.0 million in the third quarter of 1995, and, for the nine months
ended September 30, 1996 were $25.8 million compared to $17.9 million for the
nine months ended September 30, 1995.
Surrender charges on fixed, indexed and variable annuity withdrawals
generally are assessed at declining rates applied to policyholder balances
during the first five to seven years of the contract; contingent deferred sales
charges on mutual fund redemptions are assessed at declining rates on amounts
redeemed during the first six years. Such charges totaled $4.6 million and $4.5
million in the third quarter of 1996 and 1995, respectively, and $14.5 million
and $13.8 million for the nine months ended September 30, 1996 and 1995,
respectively. The increase for the nine months ended September 30, 1996 was
primarily attributable to the full-period consolidation of Colonial. On an
annualized basis, total fixed, indexed and variable annuity withdrawals
represented 11.5% and 8.1% of the total average annuity policyholder and
separate account balances in the third quarter of 1996 and 1995, respectively,
and 10.7% and 9.9% of the total average policyholder and separate account
balances for the nine months ended September 30, 1996 and 1995, respectively.
The higher level of withdrawals in the 1996 third quarter was expected and was
attributable to surrenders of annuities acquired in the F&G Life transaction;
excluding these surrenders, the annualized surrender percentage in the third
quarter of 1996 was 8.9%.
Net commissions were $4.1 million in the third quarter of 1996 and $2.5
million in the third quarter of 1995. The increase in 1996 was almost entirely
attributable to the acquisition of Independent on March 7, 1996. For the nine
months ended September 30, 1996, net commissions were $11.3 million compared to
$4.1 million for the nine months ended September 30, 1995. The increase in the
1996 nine-month period was primarily attributable to the acquisition of
Independent and the full period consolidation of Colonial.
Separate Account Fees are primarily mortality and expense charges earned on
variable annuity and variable life policyholder balances. These fees, which are
based on the market values of the assets supporting the contracts in separate
accounts, were $5.0 million in the third quarter of 1996 compared to $3.3
million in the third quarter of 1995. For the nine months ended September 30,
1996, these fees were $12.0 million compared to $9.7 million for the nine months
ended September 30, 1995. Such fees represented 1.72% and 1.62%, respectively,
of average variable annuity and variable life separate account balances.
Operating Expenses primarily represent compensation, marketing and other
general and administrative expenses. These expenses were $71.5 million in the
third quarter of 1996, compared to $59.7 million in the third quarter of 1995,
an increase of $11.8 million. The increase in the third quarter of 1996 was
primarily due to increases in compensation and marketing expenses in the
Company's mutual fund businesses and to the acquisition of Independent. For the
nine months ended September 30, 1996, operating expenses were $205.3 million
compared to $161.0 million for the nine months ended September 30, 1995, an
increase of $44.3 million. A substantial portion of the increase for the nine
months ended September 30, 1996 relates to the full period consolidation of
Colonial and Newport. In addition, approximately $5.4 million was attributable
to the acquisition of Independent. The remainder of the increase was primarily
attributable to the higher levels of compensation and marketing expenses in the
mutual fund businesses.
Amortization of Deferred Policy Acquisition Costs was $15.5 million in the
third quarter of 1996 compared to $12.0 million in the third quarter of 1995 and
$44.4 million for the nine months ended September 30, 1996 compared to $38.2
million for the nine months ended September 30, 1995. The increase in
amortization during 1996 was primarily due to a decrease in estimated
amortization periods determined in the last quarter of 1995 relating to shorter
average policy lives, and to the growth of business in force associated with
fixed, indexed and variable annuity sales. Amortization expense represented
0.52% and 0.45%, on an annualized basis, of the total average policyholder and
separate account balances in the third quarter of 1996 and 1995, respectively,
and 0.52% and 0.48% of the total average policyholder and separate account
balances for the nine months ended September 30, 1996 and 1995, respectively.
Amortization of Deferred Distribution Costs relates to the deferred sales
commissions acquired in connection with the Colonial acquisition and to the
distribution of mutual fund shares sold without front-end sales loads.
Amortization was $7.8 million in the third quarter of 1996 compared to $6.1
million in the third quarter of 1995 and $21.9 million for the nine months ended
September 30, 1996 compared to $12.4 million for the nine months ended September
30, 1995. The increase during the third quarter of 1996 was primarily
attributable to continuing sales of such fund shares during 1995 and 1996. The
increase during the nine months ended 1996 was primarily attributable to the
full-period consolidation of Colonial.
Amortization of Value of Insurance in Force totaled $2.4 million in the third
quarter of 1996 compared to $3.1 million in the third quarter of 1995 and $6.0
million for the nine months ended September 30, 1996 compared to $10.0 million
for the nine months ended September 30, 1995. The decrease in amortization
during 1996 was primarily due to an increase in estimated amortization periods
in the last quarter of 1995 relating to longer average policy lives on the
Company's closed block of whole life insurance, partially offset by $0.5 million
of amortization recorded in the third quarter of 1996 relating to the F&G Life
transaction.
Amortization of Intangible Assets was $3.8 million in the third quarter of
1996 compared to $3.5 million in the third quarter of 1995 and $12.1 million for
the nine months ended September 30, 1996 compared to $8.6 million for the nine
months ended September 30, 1995. These increases were attributable to the
acquisitions of Colonial, Newport and Independent.
Interest Expense was $4.9 million in the third quarter of 1996 compared to
$4.7 million in the third quarter of 1995. For the nine months ended September
30, 1996 interest expense was $15.0 million compared to $11.5 million for the
nine months ended September 30, 1995. The increase for the nine months ended
September 30, 1996 was primarily attributable to the full-period inclusion of
the $100.0 million note issued in connection with the Colonial acquisition and
the $24.0 million note issued in connection with the Newport acquisition.
Income Tax Expense was $11.7 million or 32.1% of income before income taxes,
in the third quarter of 1996 compared to $10.7 million, or 32.8% of income
before income taxes, in the third quarter of 1995. For the nine months ended
September 30, 1996, income tax expense was $35.1 million or 32.9% of income
before income taxes compared to $30.1 million or 36.2% for the nine months ended
September 30, 1995. In both the 1996 and 1995 periods, substantially all the
federal income tax expense related to the Company's annuity insurance business.
Financial Condition
Stockholders' Equity as of September 30, 1996 was $993.5 million compared to
$956.4 million as of December 31, 1995. Net income during the period was $71.6
million; cash dividends on the Company's Preferred and Common Stock totaled $2.9
million. In addition, Common Stock totaling $8.5 million and $1.4 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 $41.5 million.
Book Value Per Share amounted to $34.83 at September 30, 1996 compared with
$34.55 at December 31, 1995. Excluding net unrealized gains on investments, book
value per share amounted to $33.23 at September 30, 1996 and $31.40 at December
31, 1995. As of September 30, 1996, there were 28.5 million common shares
outstanding compared to 27.7 million shares as of December 31, 1995.
Investments, excluding cash and cash equivalents, totaled $11.4 billion as of
September 30, 1996 compared to $10.1 billion as of December 31, 1995. This
increase reflects the F&G Life transaction, fixed and indexed annuity sales for
the nine months ended September 30, 1996 and a decrease in net unrealized
investment gains of approximately $188.1 million.
The Company manages the majority of its invested assets internally. The
Company's general investment policy is to hold fixed maturity assets for
long-term investment and, accordingly, the Company does not have a trading
portfolio. To provide for maximum portfolio flexibility and appropriate tax
planning, the Company classifies its entire fixed maturities investments as
"available for sale" and accordingly classifies such investments at estimated
fair value.
The Company's total investments at September 30, 1996 reflected net
unrealized gains of $120.4 million relating to its available for sale fixed
maturities and equity portfolios. As of December 31, 1995, such net unrealized
investment gains were $308.5 million. The decrease in net unrealized gains for
the nine months ended September 30, 1996 principally reflects the higher
relative prevailing interest rates during the period.
Approximately $10.5 billion, or 98.1%, of the fixed maturities investments at
September 30, 1996, was rated by Standard & Poor's Corporation, Moody's
Investors Service or under comparable statutory rating guidelines established by
the National Association of Insurance Commissioners ("NAIC"). At September 30,
1996, the carrying value of investments in below investment grade securities
totaled $966.3 million, or 8.1% of total investments (including a portion of
cash and cash equivalents) of $11.9 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.
Investment Management
Asset-liability matching is utilized by the Company to minimize the risks of
interest rate fluctuations and disintermediation. The Company believes that its
fixed and indexed policyholder balances should be backed by investments,
principally comprised of fixed maturities, that generate predictable rates of
return. The Company does not have a specific target rate of return. Instead, its
rates of return vary over time depending on the current interest rate
environment, the slope of the yield curve and the excess at which fixed
maturities are priced over the yield curve. Its portfolio strategy is designed
to achieve adequate risk-adjusted returns consistent with the investment
objectives of effective asset-liability matching, liquidity and safety.
The Company conducts its investment operations to closely match the duration
of the assets in its investment portfolio to its policyholder balances. The
Company seeks to achieve a predictable spread between what it earns on its
assets and what it pays on its policyholder balances by investing principally in
fixed maturities. The Company's fixed-rate products incorporate surrender
charges to encourage persistency, discourage withdrawals and make the cost of
its policyholder balances more predictable. Approximately 85.7% of the Company's
fixed and indexed annuity policyholder balances were subject to surrender
charges at September 30, 1996.
As part of its asset-liability matching discipline, the Company conducts
detailed computer simulations that model its fixed-maturity assets and
liabilities under commonly used stress-test interest rate scenarios. Based on
the results of these computer simulations, the investment portfolio has been
constructed with a view to maintaining a desired investment spread between the
yield on portfolio assets and the rate paid on its policyholder balances under a
variety of possible future interest rate scenarios. At September 30, 1996 the
effective duration of the Company's fixed maturities investments (approximately
93.6% of total investments) was approximately 2.7 years.
As a component of its investment strategy, the Company utilizes interest rate
swap agreements ("swap agreements") to match assets more closely to liabilities.
Swap agreements are agreements to exchange with a counterparty interest rate
payments of differing character (fixed-rate payments exchanged for variable-rate
payments) based on an underlying principal balance (notional principal) to hedge
against interest rate changes. The Company currently utilizes swap agreements to
reduce asset duration and to better match interest rates earned on longer-term
fixed rate assets with interest rates credited to policyholders. At September
30, 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 September 30, 1996, the Company had
options with an estimated fair value of $62.9 million.
There are risks associated with some of the techniques the Company uses to
match its assets and liabilities. The primary risk associated with swap
agreements is the risk associated with counterparty nonperformance. The Company
believes that the counterparties to its swap agreements are financially
responsible and that the counterparty risk associated with these transactions is
minimal. In addition, swap agreements have interest rate risk. However, these
swap agreements hedge fixed-rate assets; any interest rate movements that
adversely affect the market value of swap agreements would be more than offset
by changes in the market values of such fixed rate assets.
The Company routinely reviews its portfolio of investment securities. The
Company identifies monthly any investments that require additional monitoring
and carefully reviews the carrying value of such investments at least quarterly
to determine whether specific investments should be placed on a nonaccrual basis
and to determine declines in value that may be other than temporary. In making
these reviews, the Company principally considers the adequacy of collateral (if
any), compliance with contractual covenants, the borrower's recent financial
performance, new reports and other externally generated information concerning
the creditor's affairs. In the case of publicly traded fixed maturities
investments, management also considers market value quotations if available.
Liquidity
The Company is a holding company whose liquidity needs include the following:
(i) operating expenses; (ii) debt service; (iii) dividends on preferred stock
and common stock; (iv) acquisitions; and (v) working capital where needed to its
operating subsidiaries. The Company's principal sources of cash are dividends
from its operating subsidiaries, and, in the case of funding for acquisitions
and certain long-term capital needs of its subsidiaries, long-term borrowings.
Regulatory authorities permit dividend payments from Keyport to the Company
up to the lesser of (i) 10% of statutory surplus as of the preceding December 31
or (ii) the net gain from operations for the preceding fiscal year. As of
September 30, 1996, Keyport could declare dividends of up to $34.6 million
without the approval of the Commissioner of Insurance of the State of Rhode
Island. Under Colonial's credit facility, Colonial could pay dividends of
approximately $37.7 million as of September 30, 1996.
Each of the Company's business segments have their own liquidity needs and
financial resources. In the Company's annuity insurance operations, liquidity
needs and financial resources pertain to the management of the general account
assets and policyholder balances. In the Company's asset management activities,
liquidity needs and financial resources pertain to the investment management and
distribution of mutual funds, wealth management and institutional accounts.
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 September 30,
1996, $9.7 billion of Keyport's total investments, including short-term
investments, are considered readily marketable.
To the extent that unanticipated surrenders cause Keyport to sell a material
amount of securities prior to their maturity for liquidity purposes, such
surrenders could have a material adverse effect on the Company. However, Keyport
believes that liquidity to fund withdrawals would be available through incoming
cash flow, the sale of short-term or floating-rate instruments or investment
securities in its short duration portfolio, thereby precluding the sale of fixed
maturity investments in a potentially unfavorable market.
Based upon the historical cash flow of the Company, the Company's current
financial condition and the Company's expectation that there will not be a
material adverse change in the results of operations of the Company and its
subsidiaries during the next twelve months, the Company believes that cash flow
provided by operating activities over this period will provide sufficient
liquidity for the Company to meet its working capital, capital investment and
other operational cash needs, its debt service obligations, its obligations to
pay dividends on the Preferred Stock, and its intentions to pay dividends on the
Common Stock. The Company's cash flow may be influenced by, among other things,
general economic conditions, realized investment gains and losses, the interest
rate environment, the level of assets under management, market changes,
regulatory changes and tax law changes.
Effects of Inflation
Inflation has not had a material effect on the Company's consolidated results
of operations. The Company manages its investment portfolio in part to reduce
its exposure to interest rate fluctuations. In general, the market value of the
Company's fixed maturity portfolio increases or decreases in inverse
relationship with fluctuations in interest rates, and the Company's net
investment income increases or decreases in direct relationship with interest
rate changes. (If interest rates decline the Company's fixed maturity
investments generally will increase in market value, while net investment income
will decrease as fixed maturity investments mature or are sold and the proceeds
are reinvested at reduced rates.) However, inflation may result in increased
operating expenses that may not be readily recoverable in the prices of the
services charged by the Company.
<PAGE>
Item 5. Other Information
As previously reported, the Company revised its financial reporting format.
In particular, components of investment spread, which are from the Company's
retirement-oriented insurance products, are presented separately from fee
income, which is generated mainly from its investment management products. The
Company also has made corresponding changes in its Management's Discussion and
Analysis presentation.
Set forth below is a description of the Company's business formatted in a
similar manner built around the distinction between the Company's two core
business segments. The following business description is not required in this
report, but is included to assist investors and analysts. The information
presented below does not include disclosures different in substance from the
Company's prior SEC filings.
Overview
Liberty Financial Companies, Inc. ("Liberty Financial" or the "Company") is
an asset accumulation and management company -- that is, Liberty Financial earns
revenues by accumulating financial assets from investors and savers and managing
those assets. Liberty Financial accumulates assets by offering diverse
investment and retirement-oriented insurance products through multiple
distribution channels.
The Company has two core product lines -- retirement-oriented insurance
products (principally annuities) and investment management products (mutual
funds, as well as wealth management and institutional investment management).
The Company's insurance products primarily produce spread income; the investment
management products produce fee income. The Company believes that these products
have attractive growth prospects due to important demographic and economic
trends. These trends include the aging baby boom generation's desire to increase
savings and investment, lower public confidence that government and
employer-provided retirement benefits will be adequate for future retirees,
longer life expectancies and rising health care costs.
Liberty Financial's efforts to capitalize on these growth prospects are
guided by four interrelated strategies:
Diversification. Within its two core product lines, the Company develops
and markets a range of products that serve individuals at different stages
of their life and earnings cycle. This mix is also designed to include
products that will be in demand under a variety of economic and market
conditions. Similarly, the Company reaches customers through a variety of
distribution channels. The Company believes that the diversification in
its products and distribution channels allows it to increase its assets
under management in different market cycles, thereby reducing earnings
volatility.
Innovation. Liberty Financial believes that product, service and
distribution innovations are essential in order to grow its asset base and
meet the ever changing financial needs of its customers. The Company
believes it has an impressive track record in such innovations.
Integration. Liberty Financial conducts business through several
operating units that are wholly owned subsidiaries. Liberty Financial
emphasizes integration of its operating units, with a view toward
accumulating additional assets or achieving scale economies in its
operating expense structure.
Acquisition. Where appropriate, the Company seeks acquisitions that
provide additional assets, investment management capabilities,
distribution capabilities or other integration opportunities in its core
product areas.
For the nine months ended September 30, 1996, the Company had total product
sales of $6.7 billion. Sixty-two percent of these product sales were made
through an intermediary distributor, with the balance made directly to the
investor or policyholder.
At September 30, 1996, assets under management were $46.9 billion, consisting
of the following:
$11.9 billion in annuities and other insurance products;
$25.3 billion in mutual fund assets;
$5.0 billion attributable to wealth management; and
$4.7 billion attributable to institutional investment management.
For the nine months ended September 30, 1996 products producing spread income
accounted for approximately 62% of the Company's pre-tax operating income, while
products producing fee income accounted for the remaining 38%. Liberty Financial
seeks to balance the spread income and fee income components of its pre-tax
operating income. The Company has made progress in achieving this goal since its
acquisitions of The Colonial Group, Inc. and Newport Pacific Management, Inc. in
the first half of 1995.
At September 30, 1996, approximately 82% of Liberty Financial's voting stock
was indirectly owned by Liberty Mutual Insurance Company.
Retirement-Oriented Insurance Products
The Company offers a full range of retirement-oriented insurance products,
grouped according to whether they provide fixed, indexed or variable returns to
policyholders. Substantially all these products currently are annuities that are
underwritten and issued by Keyport Life Insurance Company ("Keyport"), an
operating unit of the Company. Annuities are insurance products designed to
offer individuals protection against the risk of outliving their income during
retirement. In addition to offering a tax-favored source of lifetime income,
annuities are also a tax-efficient means of accumulating savings for retirement
needs.
Fixed Annuities. The Company's principal fixed annuity products are
individual single premium deferred annuities ("SPDAs"). A SPDA
policyholder typically makes a single premium payment at the time of
issuance. The Company obligates itself to credit interest to the
policyholder's account at a rate that is guaranteed for an initial
term (typically one year) and is adjusted annually thereafter, subject
to a guaranteed minimum rate. At September 30, 1996, the Company's
fixed annuity policyholder balances were $8.8 billion.
Equity-Indexed Annuities. Indexed annuities are an innovative product
first introduced in 1995 by the Company when it began selling
KeyIndex, an equity-indexed product. An equity-indexed annuity credits
a return to the policyholder at a "participation rate" equal to a
portion of the change in value of a specified equity index. KeyIndex
is currently offered for both one and five-year terms with interest
earnings based on a percentage of the increase in the S&P 500 Index.
With the five-year term, the interest earnings are based on the
highest anniversary value of the S&P 500 Index during the term.
KeyIndex also provides a guarantee of principal at the end of the
term. Thus, unlike a direct equity investment, even if the S&P 500
Index declines, there is no risk to principal. At September 30, 1996,
the Company's equity-indexed annuity policyholder balances were $572
million. The Company has several versions of the equity-index annuity
concept under development.
Variable Annuities. Variable annuities offer a selection of underlying
investment alternatives, which may satisfy a variety of policyholder
objectives. In a variable annuity, separate account investment options
(similar to mutual funds) pass the investment risk directly to the
policyholder in return for the potential of higher returns. The
Company's Preferred Advisor variable annuity currently offers 11
separate account investment choices and four guaranteed fixed interest
options. At September 30, 1996, the Company's variable annuity
separate account policyholder balances were $975 million.
Fixed and indexed annuities produce spread income; variable annuities
primarily produce fee income.
While the Company currently does not offer traditional life insurance
products, it manages a closed block of single premium whole life insurance
policies ("SPWLs"). SPWLs are a retirement-oriented tax-advantaged life
insurance product. The Company discontinued sales of SPWLs in response to the
Tax Reform Act of 1986. The Company had SPWL policyholder balances of $2.1
billion at September 30, 1996. SPWLs produce spread income.
Under current law, returns credited on annuities and life insurance policies
during the accumulation period (the period during which interest is credited and
payouts have not yet begun) are not subject to federal or state income tax.
Proceeds payable on death from a life insurance policy are also free from such
taxes. At the maturity or payment date of an annuity policy, the policyholder is
entitled to receive the original deposit plus accumulated returns. The
policyholder may elect to take this amount in either a lump sum or an annualized
series of payments over time. The return component of such payments is taxed at
the time of receipt as ordinary income.
The Company's insurance products include important features designed to
promote both sales and asset retention, including interest crediting rates and
surrender charges. Interest crediting and participation rates significantly
influence the Company's ability to be competitive in the sale of new policies.
SPDA renewal rates impact retention of SPDA assets, particularly on policies
where surrender penalties have expired. All of the Company's annuities permit
the policyholder at anytime to withdraw all or any part of the accumulated
policy balance. Surrender charges provide a measure of protection against
premature withdrawal of policy balances. Surrender charges typically start at 7%
and then decline over a five- to seven-year period. All of the Company's
annuities currently are issued with surrender charges. With respect to spread
income products (fixed and indexed annuities), both crediting rates and
policyholder withdrawals affect the Company's management of asset/liability
matching and contribute to the achievement of investment spread targets.
The Company believes Keyport has a reputation for excellent service to its
intermediary distributors and its policyholders. Keyport has developed advanced
technology systems for immediate response to customer inquiries, and rapid
processing of policy issuances and commission payments (often at the point of
sale). These systems also play an important role in controlling costs. Keyport's
annualized operating expenses during the nine months ended September 30, 1996
were 0.45% of assets, making Keyport one of the lowest cost operators in the
annuity business.
Keyport's strong financial ratings are important to its ability to accumulate
and retain policyholder balances. Keyport is rated "A+" (Superior) by A.M. Best,
"AA-" by Standard and Poor's and "A1" by Moody's. A.M. Best is an independent
insurance rating agency that assigns fifteen letter ratings to insurance
companies, ranging from "A++" (Superior) to "F" (In Liquidation). Publications
of A.M. Best indicate that "A++" and "A+" ratings are assigned to those
companies that in A.M. Best's opinion have achieved superior overall performance
when compared to the quantitative and qualitative standards established by A.M.
Best, and generally have demonstrated a strong ability to meet their
policyholder obligations over a long period of time. These ratings are based
upon information supplied to the rating agency, and are directed toward the
protection of policyholders, not investors.
The Company has two primary financial objectives for its retirement-oriented
insurance products: to increase policyholder balances through new sales and
asset retention and to earn targeted investment spreads on its fixed and indexed
return products.
New product sales are influenced primarily by overall market conditions
impacting the attractiveness of these products, and by product features,
including interest crediting and participation rates, and innovations that
distinguish the Company's products from those of its competitors. Sales of SPDAs
tend to be sensitive to prevailing interest rates. Sales can be expected to
increase in interest rate environments when SPDA crediting rates are higher than
rates offered by competing conservative fixed-return investments, such as bank
certificates of deposit. SPDA sales can be expected to decline in interest rate
environments when this differential in rates is not present.
Premiums on fixed and indexed annuities are deposited to Keyport's general
investment account. To achieve its targeted investment spreads, the Company must
earn returns on its general account sufficiently in excess of the fixed or
indexed returns credited to policyholders. The key element of this investment
process is asset/liability management. Successful asset/liability management
requires a quantitative assessment of overall policy liabilities (including
maturities, surrenders and crediting of returns) and prudent investment of
general account assets. The two most important tools in managing policy
liabilities are setting crediting rates and establishing surrender periods. The
asset side of the investment process requires portfolio techniques that earn
required yields while effectively managing both interest rate risk and credit
risk. The Company emphasizes a conservative approach to asset/liability
management, which is oriented toward reducing downside risk in adverse markets,
as opposed to maximizing spread in favorable markets. The approach is also
designed to reduce earnings volatility.
The majority of the Company's general account (86.1% at September 30, 1996)
is invested in fixed maturity securities. An additional 8.0% is maintained in
cash and cash equivalents for short term liquidity needs. The principal strategy
for managing interest rate risk is to maintain a relatively short duration of
its fixed income portfolio (2.7 years at September 30, 1996). The Company also
employs hedging strategies, including interest rate swaps and caps, to manage
this risk. In the case of KeyIndex, the Company purchases S&P 500 call options
to hedge its obligations to provide participation rate returns. Credit risk is
managed by careful credit analysis and monitoring. At September 30, 1996, 91.9%
of the fixed income component of the general account portfolio consisted of
investment grade securities (securities rated BBB- or higher by S&P, or Baa3 or
higher by Moody's), which had an overall average S&P rating of A+. The balance
was invested in below investment grade securities to enhance overall portfolio
yield. At September 30, 1996, less than 0.1% of the fixed income portfolio
consisted of securities in default.
Investment Management
Liberty Financial has three core types of investment management products:
mutual funds, wealth management, and institutional investment management. The
Company has four separate operating units engaged in investment management: The
Colonial Group, Inc. ("Colonial"), Stein Roe & Farnham Incorporated ("Stein
Roe"), Newport Pacific Management, Inc. ("Newport") and Liberty Asset Management
Company ("LAMCO").
Mutual Funds. The Company sponsors 71 open-end mutual funds, as well
as seven closed-end funds. The open-end funds include 40
intermediary-distributed Colonial funds, 20 direct-marketed Stein Roe
funds and 11 funds that are investment options under the Company's
variable annuities. The closed-end funds include five Colonial funds
and two LAMCO funds. At September 30, 1996, total fund assets were
$25.3 billion. At that date 46% of these assets were invested in
equity funds (compared to 36% at September 30, 1995), 28% in taxable
fixed income funds and 26% in tax-exempt fixed income funds. The
Company seeks to continue to increase equity mutual fund assets under
management.
Wealth Management. At September 30, 1996, the Company managed $5.0
billion in investment portfolios for high net worth individuals,
families and trusts, all of which is managed by Stein Roe.
Institutional Investment Management. At September 30, 1996, the
Company managed $4.7 billion of investment portfolios for
institutional investors such as insurance companies, public and
private retirement funds, endowments, foundations and other
institutions. Most of these assets are managed by Stein Roe. In
addition, Stein Roe manages $9.6 billion of Keyport's general account
portfolio.
The Company believes that the most important factors in accumulating and
retaining investment management assets are investment performance, customer
service and brand name recognition. Strong investment performance is crucial to
asset accumulation and retention, regardless of the product or distribution
channel. Performance is particularly important for mutual funds, whether
intermediary-distributed or direct-marketed. The Company believes that currently
the most important measure of performance influencing sales through
intermediaries is peer group rankings compiled by Lipper. For the one-year
period ended September 30, 1996, based on figures for Class A (front-end load)
shares, 20 of the Colonial funds were in the top two quartiles of their
respective Lipper peer groups, with 11 funds in the top quartile. For
direct-marketed funds, the Company believes that currently the most important
performance measure influencing sales is Morningstar ratings. Of the 12 Stein
Roe funds rated by Morningstar as of the date of this report, none are less than
three-star (an indication of strong and consistent investment performance), with
four funds having a four-star rating and three funds having the maximum
five-star rating. The Company's investment performance must remain competitive
for the Company to continue to grow investment management sales and assets.
Excellent service to customers, including mutual fund shareholders and
distributors, is fundamental to successful asset retention. The Company acquired
Colonial, in part, because of its reputation for excellent customer service.
Following the acquisition of Colonial, the Company consolidated its mutual fund
transfer agency functions into Colonial.
The Company believes that, in light of the proliferation of mutual funds and
investment managers, strong brand name recognition in relevant distribution
channels is essential to asset accumulation and retention, particularly with
respect to mutual funds. The Company believes that the Colonial name carries
strong brand name recognition among brokers and other intermediaries selling
mutual funds, and that the Stein Roe name carries similar recognition in the
direct sales channel. Similarly, the Company believes that Stein Roe has a
franchise presence in the wealth market, and that Newport is a recognized leader
in investment management in Asian markets.
As with insurance products, sales of mutual funds and other investment
management products are subject to market forces, such as changes in interest
rates and stock market performance. Sales of the Company's equity mutual funds
have benefited in 1996 from the continued strong performance of the U.S. stock
market. Sales of the Company's fixed income mutual funds have been modest during
1996, given current market conditions. Changes in the financial markets,
including significant increases or decreases in interest rates or stock prices,
can increase or decrease fund sales and redemptions, as well as the values of
fund portfolios, all of which can impact the level of investment management
fees.
The Company's financial objectives with respect to its investment management
businesses are to grow assets under management in each of its three core product
areas, and to improve operating margins through increasing scale and cost
savings produced by integration. The investment management business,
particularly with respect to mutual funds, offers excellent opportunities to
grow operating profits and to achieve and attain attractive operating margins
for those participants whose asset base and investment and service
infrastructure reach critical mass levels. Since its acquisition of Colonial and
Newport in the first six months of 1995, the Company has generated annualized
cost savings of approximately $12.0 million per year through the consolidation
of various support and service functions in its mutual fund business.
Distribution and Sales
Liberty Financial sells its products through multiple distribution channels.
Total proprietary product sales for the nine months ended September 30, 1996
were $6.7 billion. Sixty-two percent of these sales were made through
intermediaries, and the remaining 38% of sales were made directly to the
investor.
Distribution Through Intermediaries
The Company sells both annuities and mutual funds through various
intermediaries, including national and regional brokerage firms, banks,
financial planners and insurance agents. In the first nine months of 1996,
almost 30,000 brokers and agents sold the Company's products. The Company's
annuities and mutual funds are most often sold to middle and upper-middle class
investors and savers. Many of these individuals, busy with their own careers,
families and other interests, seek the help of an investment professional in
selecting investment and retirement savings products. In each of these
intermediary channels, the Company provides products, as well as promotional
materials and other support services.
Reflecting its diversification strategy, the Company maintains distribution
relationships with several different types of intermediaries.
Intermediary-distributed mutual funds and annuities historically have been sold
through brokerage firms and insurance agents. In recent years banks and
financial planners also have become significant distributors of these products.
Banks have moved into selling mutual funds and annuities to counter the outflow
of customer deposits and to increase fee income. The Company was a pioneer in
selling through banks, both in terms of helping banks develop marketing programs
and in establishing wholesaling relationships with banks. Fee-based financial
planners also have emerged as a significant distribution channel.
The Company employs wholesalers for its annuities and for its
intermediary-distributed mutual funds. The wholesalers meet with intermediaries'
sales forces to educate them on matters such as product objectives, features,
performance records and other key selling points. The Company also produces
marketing material designed to help intermediaries sell the Company's products,
and provides after-sale support to both the intermediaries and their customers.
The degree and mix of these services vary with the requirements of the
particular intermediary. For example, a small brokerage or financial planning
firm typically will utilize more of these support services than a large national
brokerage firm.
Liberty Financial has two sales units that sell mutual funds and annuities
through banks: the Liberty Financial Bank Group and Independent Financial
Marketing Group, Inc. ("IFMG"). The Company acquired IFMG in March, 1996, and is
in the process of consolidating these two organizations into IFMG. These
businesses design and implement programs that sell such products through their
client banks, license and train sales personnel and provide administrative
support. Program structures and the degree of the Company's involvement vary
widely depending upon the particular needs of each bank. In some banks, the bank
provides space in its branches and the Company places its own sales
representatives in that space and fully operates the program. Products sold
include the Company's proprietary products, as well as non-proprietary products
(including in some cases the bank's own proprietary mutual funds). In other
cases, the Company's role may be limited to functions such as licensing and
training the bank's employees and wholesaling products. At September 30, 1996,
these operations had 163 bank relationships involving over 3,100 registered
salespersons.
The sales practices and support needs of the Company's distributors are
constantly evolving. The Company must respond to these changes in order to
maintain and increase its intermediary distribution relationships. Pricing
structures in these channels, particularly with respect to mutual funds, are
evolving from one-time up-front sales loads to options that shift investors'
payments over time and move toward fee-based pricing. Intermediaries also
increasingly demand that product providers supply new value-added services. The
Company's intermediary-distributed mutual funds now are sold with alternate
pricing structures. The Company is seeking to develop innovative new
technology-based service and support tools, such as asset allocation models and
on-line customer account management systems, designed to provide value-added
services to intermediaries and their customers. Some distributors have begun to
assess fee sharing payments or similar charges as additional compensation for
fund sales. The Company may have to choose in certain cases between absorbing
these charges or limiting its access to certain distributors.
Direct Distribution
The Company's direct-marketed mutual funds, as well as its wealth management
and institutional investment management services, are sold directly to
investors. The Company's direct-marketed mutual funds are purchased
predominantly by middle and upper middle class investors and savers who choose
to select their own funds and who wish to avoid paying sales loads and similar
fees. Wealth management clients typically are high net worth individuals and
families and smaller institutional investors. Institutional investment
management clients typically are larger institutional investors managed by
in-house professional staffs that select and oversee asset managers, often with
the advice of third party consultants. Direct sales of these products and
services requires that the Company perform all of the marketing and service
functions required to reach and retain these investors.
In each of the direct sales markets served by the Company, investment
performance is essential to generating sales and retaining customers. Mutual
fund sales also require robust marketing campaigns using print, radio and
television advertising and direct mail that highlight performance and other
selling points. The Company believes that certain of the technology-based
customer service and support tools it is developing, such as on-line account
access and asset allocation programs, will be important tools in accumulating
and retaining assets in the direct distribution channels. Stein Roe's reputation
as a high quality asset manager is the most important factor in generating new
wealth and institutional asset management clients. Active management of the
client relationship, including frequent personal contacts, is necessary to
retain these clients.
Diversification
The appeal of the Company's products varies according to an individual's age,
income, risk tolerance and financial goals. The Company's products vary widely
in financial objectives and risks. The Company's product diversity is designed
in part to serve individuals at various stages of their life and earnings
cycles, with an emphasis on retirement savings and income needs. The Company
also believes that its product mix will appeal to customers under a variety of
economic and market conditions. This diversification is designed to smooth out
the ebbs and flows of the financial markets. There are times when equity mutual
funds will sell more briskly than fixed income funds or annuities. Conversely,
there are other periods when the opposite will be the case. Similarly,
diversification of distribution channels allows the Company to reach many
distinct segments of the marketplace and lessens its dependence on any one
source of assets. The Company believes that the diversification in its products
and distribution channels allows it to increase assets in different market
cycles, thereby reducing earnings volatility.
Innovation
The Company believes that innovations creating new or enhanced products or
accessing new markets are essential in order to grow its asset base and meet the
ever-changing needs of its customers. Successful product innovation has been
critical to growth throughout the financial services industry. The Company
believes that, aside from excellent investment performance, continual
introduction of new and innovative products is the best strategy for generating
new sales. In addition, the Company believes that the distinctions which have
separated intermediary and direct distribution channels are blurring as a result
of the trend in intermediary channels toward fee-based pricing, the introduction
of asset allocation and other new value-added services and the emergence of new
sales mediums (such as the Internet). This is particularly the case for products
such as mutual funds that are purchased by individual investors. To succeed in
the future in maintaining and expanding its client base and distribution
relationships, the Company must respond by developing new products, pricing
structures and technology-driven tools.
The Company believes that it has an impressive record in product and
distribution innovations. Keyport was a leader in developing single premium
whole life insurance. Liberty Financial was a pioneer in the business of
distributing mutual funds and annuities through banks. The Colonial Newport
Tiger Fund was the first U.S.-based mutual fund to focus exclusively on the
"Tiger" countries of Asia. The Stein Roe Young Investor Fund was the first
mutual fund to be coupled with an educational program to teach younger people
about investing, while at the same time offering parents an excellent device to
save for educational and other family needs. The Company's ability to create new
products continued with its introduction in 1995 of KeyIndex, the first
equity-indexed annuity introduced into the marketplace.
Integration
Liberty Financial conducts business through several operating units that are
wholly owned subsidiaries. Integration of Liberty Financial's operating
companies is a fundamental operating philosophy. Leveragable talents and
resources include product development and design, distribution relationships,
investment management, investor servicing and technology development and
support. Where appropriate, the Company seeks to leverage those resources across
multiple operating units, with a view toward accumulating additional assets or
reducing expenses. Examples of successfully implemented integration efforts
include the following:
Upon the Company's acquisition of Newport in April, 1995, Colonial
assumed the marketing, sales, service and administration of Newport's
flagship Tiger Fund. The Fund's outstanding investment performance has
continued following the acquisition (it remains ranked first in its
Lipper peer group for the five-year period ended September 30, 1996),
and asset growth has been exceptional, more than tripling since that
time. Colonial also has benefited because the availability of the
Colonial Newport Tiger Fund has established distribution arrangements
with new intermediaries.
Stein Roe manages most of Keyport's general account fixed income
portfolio, and, together with, Colonial and Newport, manages certain
funds underlying Keyport's variable annuity product.
Colonial's transfer agency operations also perform these functions for
the Stein Roe funds.
During the nine months ended September 30, 1996, the Company's bank
distribution units were the largest distributor of Keyport's
annuities, and the second largest distributor of the Colonial funds,
accounting for 13.5% and 7.3%, respectively, of total sales of those
products.
Acquisitions
Acquisitions are an integral part of the Company's business strategy.
Keyport, Colonial, Stein Roe, Newport, and, most recently, IFMG all joined
Liberty Financial through acquisition. Where appropriate, the Company continues
to seek opportunities to make acquisitions that can provide additional assets,
investment management capabilities, distribution capabilities, or other
integration opportunities. Current areas of focus for the Company's acquisition
efforts include the following:
Mutual funds, with particular focus on equities and foreign markets;
Additional distribution capabilities;
Wealth management firms that can become part of Stein Roe, and can
leverage and expand Stein Roe's franchise in the wealth management
market; and
Blocks of annuity assets that can be purchased or co-insured on
attractive terms.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11 Statement re Computation of Per Share Earnings
12 Statement re Computation of Ratios
27 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended September
30, 1996.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LIBERTY FINANCIAL COMPANIES, INC.
/s/ Gerald Rush
-------------------------------------
Gerald Rush
Vice President Finance
(Duly Authorized Officer and
Chief Accounting Officer)
Date: November 8, 1996
<PAGE>
Exhibit Index
Exhibit No. Description Page
- ----------- ----------- ----
11 Statement re Computation of Per Share Earnings 29
12 Statement re Computation of Ratios 30
27 Financial Data Schedule 31
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
EXHIBIT 11 - Statement re Computation of Per Share Earnings (in
thousands, except share and per share amounts)
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ------------------
1996 1995 1996 1995
------ ------ ------ ------
<S> <C> <C> <C> <C>
Primary net income per common share:
Net income $ 24,713 $ 21,956 $ 71,593 $ 53,117
Less: cumulative preferred
dividends 236 236 707 490
---------- ---------- --------- ---------
Net income available for common
shareholders $ 24,477 $ 21,720 $ 70,886 $ 52,627
========== ========== ========= =========
Weighted average shares
outstanding 28,416,294 27,407,325 28,120,214 26,044,698
Common stock equivalents 1,291,825 1,355,660 1,407,138 1,222,729
---------- ---------- --------- ----------
Total 29,708,119 28,762,985 29,527,352 27,267,427
========== ========== ========== ==========
Primary net income per common
share $ 0.82 $ 0.76 $ 2.40 $ 1.93
========== =========== ========== ==========
Fully diluted net income per common share:
Net income $ 24,713 $ 21,956 $ 71,593 $ 53,117
Less: cumulative preferred
dividends 236 236 707 490
---------- ---------- ---------- ---------
Net income available for common
shareholders $ 24,477 $ 21,720 $ 70,886 $ 52,627
========== ========== ========== ==========
Weighted average shares
outstanding 28,416,294 27,407,325 28,120,214 26,044,698
Common stock equivalents 1,291,825 1,441,269 1,407,138 1,335,065
---------- ---------- ---------- ----------
Total 29,708,119 28,848,594 29,527,352 27,379,763
========== =========== ========== ==========
Fully diluted net income per
common share $ 0.82 $ 0.75 $ 2.40 $ 1.92
========== =========== ========== ==========
</TABLE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
EXHIBIT 12 - Statement re Computation of Ratios
($ in thousands)
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
---------------------- ----------------------
1996 1995 1996 1995
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Earnings:
Pretax income $36,402 $32,689 $106,730 $83,244
Add fixed charges:
Interest on indebtedness 4,930 4,682 14,986 11,451
Portion of rent representing
the interest factor 1,074 1,168 3,220 3,007
Preferred stock dividends 236 236 707 490
Accretion to face value
of redeemable convertible
preferred stock 197 197 590 395
-------- -------- -------- -------
Income as adjusted $42,839 $38,972 $126,233 $98,587
======== ======== ======== =======
Fixed charges:
Interest on indebtedness $4,930 $4,682 $14,986 $11,451
Portion of rent representing
the interest factor 1,074 1,168 3,220 3,007
Preferred stock dividends 236 236 707 490
Accretion to face value of
redeemable convertible preferred
stock 197 197 590 395
-------- -------- -------- --------
Total fixed charges $6,437 $6,283 $19,503 $15,343
======== ======== ======== ========
Ratio of earnings to fixed
charges 6.66 x 6.20 x 6.47 x 6.43 x
======== ======== ======== ========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 10,710,754
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 36,112
<MORTGAGE> 68,477
<REAL-ESTATE> 0
<TOTAL-INVEST> 11,443,517
<CASH> 1,059,300
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 295,514
<TOTAL-ASSETS> 14,563,718
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 11,559,719
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 229,000
0
13,630
<COMMON> 285
<OTHER-SE> 993,185
<TOTAL-LIABILITY-AND-EQUITY> 14,563,718
0
<INVESTMENT-INCOME> 593,522
<INVESTMENT-GAINS> 2,823
<OTHER-INCOME> 248,208
<BENEFITS> 0
<UNDERWRITING-AMORTIZATION> 44,440
<UNDERWRITING-OTHER> 205,274
<INCOME-PRETAX> 106,730
<INCOME-TAX> 35,137
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 71,593
<EPS-PRIMARY> 2.40
<EPS-DILUTED> 2.40
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
