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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-13654
LIBERTY FINANCIAL COMPANIES, INC.
(Exact name of registrant as specified in its charter)
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Massachusetts 04-3260640
(State of incorporation) (I.R.S. Employer Identification No.)
600 Atlantic Avenue 02210-2214
Boston, Massachusetts (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 722-6000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- ------------------------------------------- ------------------------
Common Stock, Par Value $.01 per share New York Stock Exchange
Boston Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of common stock held by non-affiliates of the
registrant as of February 27, 1998 (based on the closing sale price of the
Common Stock on the New York Stock Exchange on such date) was approximately
$428 million.
There were 44,876,928 shares of the registrant's Common Stock, $.01 par
value, and 326,236 shares of the registrant's Series A Convertible Preferred
Stock, $0.01 par value, outstanding as of February 27, 1998.
----------------
Documents Incorporated by Reference
Portions of the Company's 1997 Annual Report to Stockholders (Part II, Items 6,
7 and 8, and Part IV - Item 14(a)1).
Portions of the Company's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on or about May 11, 1998 (Part III, Items 10, 11, 12,
and 13).
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<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
<TABLE>
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Page
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<S> <C> <C>
Part I
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Item 1. Business 1
Item 2. Properties 16
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Executive Officers of the Registrant 17
Part II
- ----------
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 18
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 19
Item 8. Financial Statements and Supplementary Data 19
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 19
Part III
- ----------
Item 10. Directors and Executive Officers of the Registrant 19
Item 11. Executive Compensation 19
Item 12. Security Ownership of Certain Beneficial Owners and Management 19
Item 13. Certain Relationships and Related Transactions 19
Part IV
- ----------
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 20
</TABLE>
<PAGE>
PART I
Item 1. Business
Overview
Liberty Financial Companies, Inc. ("Liberty Financial" or the "Company")
is a leading asset accumulation and management company. The Company has two
core product lines--retirement-oriented insurance products and investment
management products. Retirement-oriented insurance products consist
substantially of annuities. Investment management products consist of mutual
funds, wealth management and institutional asset management. The Company sells
its products through multiple distribution channels, including brokerage firms,
banks and other depository institutions, financial planners and insurance
agents, as well as directly to investors. The Company's net operating income
(i.e., net income excluding net realized investment gains and losses, net of
related income taxes) was $112.4 million in 1997; $94.8 million in 1996 and
$76.5 million in 1995. The following table sets forth the Company's assets
under management as of December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
Assets Under Management
------------------------------------
As of December 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
(dollars in billions)
<S> <C> <C> <C>
Retirement-oriented insurance
products .............................. $ 12.8 $ 12.1 $ 10.6
Mutual funds ........................... 26.8 25.7 23.3
Wealth management ...................... 6.6 5.3 4.5
Institutional asset management ......... 5.3 4.9 4.1
------- ------- -------
Total ................................ $ 51.5 $ 48.0 $ 42.5
======= ======= =======
</TABLE>
Multiple Asset Accumulation Products. The Company sells a full range of
retirement-oriented insurance products, grouped by whether they provide fixed,
indexed or variable returns to policyholders. Substantially all of these
products currently are annuities that are written by the Company's wholly-owned
subsidiary, Keyport Life Insurance Company ("Keyport"), one of the country's
leading and most innovative annuity companies. Annuities are insurance products
which provide a tax-deferred means of accumulating savings for retirement
needs, as well as a tax-efficient source of income in the payout period. The
Company's principal fixed annuity products are individual single premium
deferred fixed annuities ("SPDAs"), which represented $8.4 billion of
policyholder liabilities as of December 31, 1997. In addition to SPDAs, the
Company also sells equity-indexed and variable annuities. Equity-indexed
annuities are an innovative product first introduced to the marketplace by the
Company when it began selling its KeyIndex[RegTM] product in 1995. The
Company's equity-indexed annuities credit interest to the policyholder at a
"participation rate" equal to a portion of the change in value of a specified
equity index (in the case of the Company's equity-indexed products, the
Standard & Poor's 500 Composite Stock Index ("S&P 500 Index")).*
The Company has four 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"), each of which carries strong brand name
recognition in the markets it serves. As of December 31, 1997, the Company
sponsored 67 open-end mutual funds, as well as seven closed-end funds. The
open-end funds consist of 37 intermediary-distributed Colonial mutual funds, 18
direct-marketed Stein Roe funds and 12 other funds included among the
investment options available under the Company's variable annuities. The
closed-end funds consist of five Colonial funds and two LAMCO funds.
Fifty-three of the Company's 67 open-end mutual funds are long-term funds
(defined as open-end funds having at least a three-year performance record,
excluding funds that invest solely in money market securities). Thirty-eight of
those 53 funds (representing 81% of the total assets in those 53 funds as of
December 31, 1997) were ranked by Lipper Analytical Services, Inc. ("Lipper")
in the top two quartiles of their respective peer groups for the three-year
period ended that date.
- ----------
*"S&P," "S&P 500" and "Standard & Poor's 500" are registered trademarks of The
McGraw-Hill Companies, Inc., and have been licensed for use by Keyport.
1
<PAGE>
Multiple Distribution Channels. Liberty Financial sells its products
through multiple distribution channels. The Company distributes its products
through all the major third party intermediary channels, including national and
regional brokerage firms, banks and other depository institutions, financial
planners and insurance agents. To capitalize on the importance of banks and
other depository institutions as intermediaries for its products, the Company
also operates its own distribution unit which sells annuities and mutual funds
through such entities. Certain of the Company's products also are sold directly
to investors, including its mutual funds sold without a sales load, wealth
management and institutional asset management products. The Company believes
that it is one of the few asset accumulators with a significant presence in
both the intermediary and direct channels. Total product sales for 1997 were
$7.5 billion (including $1.0 billion of reinvested dividends). During 1997, 59%
of sales were made through intermediary distributors, with the balance made
directly to the investor. Over 34,000 individual brokers and other
intermediaries sold Liberty Financial products in 1997.
Business Strategy. The Company's business strategy has four interrelated
elements:
[bullet] Diversification. The Company believes that the
diversification in its products and distribution channels allows it
to accumulate assets in different market cycles, thereby reducing
earnings volatility. Within its two core product lines, the Company
sells a range of products that serve individuals at different stages
of their life and earnings cycle. This mix also is 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. Diversification of
distribution channels allows the Company to reach many segments of
the marketplace and lessens its dependence on any one source of
assets.
[bullet] Innovation. Liberty Financial believes that product 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 that it has an impressive track record in such
innovations. For example, Newport created the first U.S.-based
mutual fund to focus exclusively on the "Tiger" countries of Asia.
This fund had $1.0 billion of assets under management as of December
31, 1997. The Stein Roe Young Investor[TM] Fund was the first mutual
fund to be coupled with an educational program to teach young people
about investing, while offering parents an excellent device to save
for educational and other family needs. The Stein Roe Young Investor
Fund had $533.2 million of assets under management and over 107,000
shareholders of record as of December 31, 1997. The Company
introduced the first equity-indexed annuity product to the
marketplace. At December 31, 1997, the Company's equity-indexed
annuity policyholder balances were $1.5 billion. The Company is also
recognized as a leader in electronic commerce on the Internet. For
example, in early 1997, the Company introduced a new Web site for
the Stein Roe funds which incorporates state-of-the-art security and
customization features.
[bullet] Integration. Liberty Financial actively promotes
integration of its operating units and believes that such efforts
will enable it to accumulate additional assets by leveraging
distribution capabilities and to reduce expenses by consolidating
redundant back office functions. For example, 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 availability of the Newport Tiger Fund has
facilitated new intermediary distribution relationships for
Colonial, including approximately 6,000 new broker relationships.
Stein Roe manages the majority of Keyport's general account assets
and together with Colonial and Newport manages certain of the funds
underlying Keyport's variable annuity products. Colonial's transfer
agency operations perform these functions for the Stein Roe funds.
Independent Financial Marketing Group, Inc. ("Independent"), the
Company's bank distribution unit, was the largest distributor of
Keyport's annuities and the second largest distributor of the
Colonial funds in 1997.
[bullet] Acquisitions. Where appropriate, the Company seeks
acquisitions that provide additional assets, new or complementary
investment management capabilities, distribution capabilities or
other integration or diversification opportunities in its core
product areas. Acquisitions are an integral part of Liberty
Financial's business strategy. Stein Roe (acquired in 1986), Keyport
(acquired in 1988), Colonial (acquired in 1995), Newport (acquired
in 1995) and major components of the Company's
2
<PAGE>
bank distribution unit (including Independent, acquired in 1996) all
joined Liberty Financial by acquisition. The Company has also made
asset acquisitions, including most recently a coinsurance agreement
with respect to a $954.0 million block of SPDAs entered into in
August, 1996. While the Company is constantly evaluating acquisition
opportunities, as of the date it filed this Report with the
Securities and Exchange Commission, the Company has not entered into
any definitive agreement for a material acquisition.
The Company's business strategy is based on its belief that its products have
attractive growth prospects due to important demographic and economic trends.
These trends include the need for the aging baby boom generation to increase
savings and investment, lower public confidence in the adequacy of government
and employer-provided retirement benefits, longer life expectancies, and rising
health care costs. The Company believes that its product mix and distribution
strength are well suited to exploit these demographic and economic trends and
will help the Company maintain and enhance its position as a leading asset
accumulation and management company.
At March 20, 1998, approximately 72.3% of the combined voting power of Liberty
Financial's voting stock was indirectly owned by Liberty Mutual Insurance
Company ("Liberty Mutual").
Liberty Financial's principal executive offices are located at 600 Atlantic
Avenue, Boston, Massachusetts 02210-2214. Its telephone number is (617)
722-6000.
Retirement-Oriented Insurance Products
The Company sells a full range of retirement-oriented insurance products,
grouped by whether they provide fixed, indexed or variable returns to
policyholders. Substantially all of these products are annuities that are
written by Keyport. Annuities offer a tax-deferred means of accumulating
savings for retirement needs and provide a tax-efficient source of income in
the payout period. The Company earns spread income from fixed and indexed
annuities; variable annuities primarily produce fee income for the Company. The
Company's primary financial objectives for its annuities business are to
increase policyholder balances through new sales and asset retention and to
earn acceptable investment spreads on its fixed and indexed return products.
Products
The Company's principal retirement-oriented insurance products are
categorized as follows:
[bullet] Fixed Annuities. The Company's principal fixed annuity
products are 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
reset annually thereafter, subject to a guaranteed minimum rate.
Interest crediting continues until the policy is surrendered or the
policyholder retires or turns age 90.
[bullet] Equity-Indexed Annuities. Equity-indexed annuities are an
innovative product first introduced to the marketplace in 1995 by
the Company when it began selling its KeyIndex product. 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 a
specified equity index. KeyIndex is currently offered for one, five
and seven-year terms with interest earnings based on a percentage of
the increase in the S&P 500 Index. With the five and seven-year
terms, the interest earnings are based on the highest policy
anniversary date 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 market risk to the policyholder's
principal. In late 1996, the Company introduced a market value
adjusted ("MVA") annuity product, KeySelect, which offers a choice
between an equity-indexed account similar to KeyIndex and a fixed
annuity-type interest account. KeySelect offers terms for each
equity-indexed account of one, three, five, six and seven years, as
well as a ten-year term for the fixed interest account. KeySelect
shifts some investment risk to the policyholder, since surrender of
the policy before the end of the policy term will result in
increased or decreased account values based on the change in rates
of designated Treasury securities since the beginning of the term.
The Company is continuing to develop new versions of its
equity-indexed annuities, including versions registered under the
Securities Act which are designed to be sold through major national
brokerage firms.
3
<PAGE>
[bullet] Variable Annuities. Variable annuities offer a selection of
underlying investment alternatives which may satisfy a variety of
policyholder risk/return objectives. Under a variable annuity, the
policyholder has the opportunity to select separate account
investment options (consisting of underlying mutual funds) which
pass the investment risk directly to the policyholder in return for
the potential of higher returns. Variable annuities also include
guaranteed fixed interest options. The Company's Keyport Advisor
variable annuity currently offers 18 separate account investment
choices (substantially all of the assets of which are managed by the
Company) and four guaranteed fixed-interest options.
While the Company currently does not offer traditional life insurance products,
it manages a closed block of single premium whole life insurance policies
("SPWLs"), a retirement-oriented tax-advantaged life insurance product. The
Company discontinued sales of SPWLs in response to certain tax law changes in
the 1980s. The Company had SPWL policyholder balances of $2.0 billion as of
December 31, 1997.
Under the Internal Revenue Code (the "Code"), returns credited on annuities and
life insurance policies during the accumulation period (the period during which
interest or other returns are credited) are not subject to federal or state
income tax. Proceeds payable on death from a life insurance policy are also
free from such taxes. At the maturity or payment date of an annuity policy, the
policyholder is entitled to receive the original deposit plus accumulated
returns. The policyholder may elect to take this amount in either a lump sum or
an annuitized series of payments over time. The return component of such
payments is taxed at the time of receipt as ordinary income at the recipient's
then applicable tax rate. The demand for the Company's retirement-oriented
insurance products could be adversely affected by changes in this tax
treatment.
The Company's mix of annuity products is designed to include products in demand
under a variety of economic and market conditions. Sales of SPDAs tend to be
sensitive to prevailing interest rates. Sales can be expected to increase and
surrenders to decrease in interest rate environments when SPDA 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 and
surrenders to increase in interest rate environments when this differential in
rates is not present (as is the case at the date of filing of this Report).
SPDA sales also can be adversely affected by low interest rates (as is the case
at the date of filing of this Report).
The following table sets forth certain information regarding Keyport's
retirement-oriented insurance products and its reserves for the periods
indicated.
<TABLE>
<CAPTION>
As of or for the Year Ended
December 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
(dollars in millions, except policy
data)
<S> <C> <C> <C>
Policy and Separate Account Liabilities:
Fixed annuities ........................ $ 8,417 $ 8,641 $ 7,772
Indexed annuities ...................... 1,527 788 84
Variable annuities ..................... 1,277 1,083 950
Life insurance ......................... 2,129 2,142 2,168
------- ------- -------
Total ................................. $13,350 $12,654 $10,974
======= ======= =======
Number of In Force Policies:
Fixed annuities ........................ 222,903 236,574 224,238
Indexed annuities ...................... 39,224 24,174 2,778
Variable annuities ..................... 27,429 25,177 25,037
Life insurance ......................... 24,921 26,850 28,489
------- ------- -------
Total ................................. 314,477 312,775 280,542
======= ======= =======
Average In Force Policy Amount:
Fixed annuities ........................ $37,710 $36,479 $34,611
Indexed annuities ...................... $38,943 $32,591 $30,207
Variable annuities ..................... $46,542 $43,035 $37,941
Life insurance ......................... $83,709 $79,207 $75,728
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
As of or for the Year Ended
December 31,
------------------------------------------
1997 1996 1995
------------- ----------- ------------
(dollars in millions, except policy data)
<S> <C> <C> <C>
Premiums (statutory basis):
Fixed annuities ................................. $ 425 $ 493 $ 977
Indexed annuities ............................... 524 655 84
Variable annuities .............................. 173 97 80
Life insurance (net of reinsurance) ............. (1) -- (1)
--------- -------- ---------
Total .......................................... $1,121 $ 1,245 $1,140
======== ======== =========
New Contracts and Policies:
Fixed annuities ................................. 13,744 11,358 30,043
Indexed annuities ............................... 16,076 21,396 2,778
Variable annuities .............................. 4,333 1,814 1,789
-------- -------- ---------
Total .......................................... 34,153 34,568 34,610
======== ======== =========
Aggregate Amount Subject to Surrender Charges and
Similar Penalties:
Fixed annuities ................................. $6,982 $ 7,371 $6,904
Indexed annuities ............................... $1,527 $ 788 $ 84
Withdrawals and Terminations (statutory basis):
Fixed Annuities:
Death .......................................... $ 60 $ 25 $ 15
Maturity ....................................... $ 110 $ 87 $ 76
Surrender ...................................... $1,000 $ 966 $ 693
Indexed Annuities:
Death .......................................... $ 4 $ 0.1 --
Maturity ....................................... -- -- --
Surrender ...................................... $ 19 $ 3 --
Variable Annuities:
Death .......................................... $ 4 $ 2 $ 0.4
Maturity ....................................... $ 28 $ 21 $ 14
Surrender ...................................... $ 105 $ 77 $ 92
Life Insurance:
Death .......................................... $ 66 $ 53 $ 54
Surrender ...................................... $ 96 $ 98 $ 95
Surrender Rates:
Fixed annuities ................................. 11.74% 11.79% 9.34%
Indexed annuities ............................... 1.68% 0.69% 0.12%
Variable annuities .............................. 8.86% 7.55% 10.46%
Life insurance .................................. 4.57% 4.58% 4.36%
</TABLE>
Sales and Asset Retention
Product sales are influenced primarily by overall market conditions
impacting the attractiveness of the Company's retirement-oriented insurance
products, and by product features including interest crediting and
participation rates, and innovations and services that distinguish the
Company's products from those of its competitors.
The Company's insurance products include important features designed to
promote both sales and asset retention, including crediting rates and surrender
charges. Initial interest crediting and participation rates on fixed and
indexed products significantly influence the sale of new policies. Resetting of
rates on SPDAs impacts retention of SPDA assets, particularly on policies where
surrender penalties have expired. At December 31, 1997, crediting rates on
95.0% of the Company's in force SPDA policy liabilities
5
<PAGE>
were subject to reset during the succeeding 12 months. In setting crediting and
participation rates, the Company takes into account yield characteristics on
its investment portfolio, surrender rate assumptions and competitive industry
pricing. Interest crediting rates on the Company's in force SPDAs ranged from
4.30% to 7.94% at December 31, 1997. Such policies had guaranteed minimum rates
ranging from 3.0% to 5.5% as of such date. Initial interest crediting rates on
new policies issued in 1997 ranged from 4.60% to 7.94%. Guaranteed minimum
rates on new policies issued during 1997 ranged from 3.0% to 5.5%.
All of the Company's insurance products permit the policyholder at anytime
to withdraw all or any part of the accumulated policy value. Premature
termination of a policy results in the loss by the Company of anticipated
future earnings related to the premium deposit and the accelerated recognition
of the expenses related to policy acquisition (principally commissions), which
otherwise are deferred and amortized over the life of the policy. Surrender
charges provide a measure of protection against premature withdrawal of policy
values. Substantially all of the Company's insurance products currently are
issued with surrender charges or similar penalties. Such surrender charges for
all policies except KeyIndex typically start at 7% of the policy premium and
then decline to zero over a five- to seven-year period. KeyIndex imposes a
penalty on surrender of up to 10% of the premium deposit for the life of the
policy. At December 31, 1997, 83.0% of the Company's SPDAs remained in the
surrender charge period. Surrender charges generally do not apply to
withdrawals by policyholders of, depending on the policy, either up to 10% per
year of the then accumulated value or the accumulated returns. In addition,
certain policies may provide for charge-free withdrawals in certain
circumstances and at certain times. All policies except for certain variable
annuities also are subject to "free look" risk (the legal right of the
policyholder to cancel the policy and receive back the initial premium deposit,
without interest, for a period ranging from ten days to one year, depending
upon the policy). To the extent a policyholder exercises the "free look"
option, the Company may realize a loss as a result of any investment losses on
the underlying assets during the free look period, as well as the commissions
paid on the sale of the policy. While SPWLs also permit withdrawal, the
withdrawal generally would produce significant adverse tax consequences to the
policyholder.
Keyport's strong financial ratings are important to its ability to
accumulate and retain assets. Keyport is rated "A+" (Superior) by A.M. Best,
"AA" (excellent financial security) by S&P, "A1" (good financial strength) by
Moody's and AA- (very high claims paying ability) by Duff & Phelps. "A+" is
A.M. Best's second highest rating. S&P raised Keyport's rating from "AA-" to
"AA" in February, 1998. These ratings are based upon information supplied to
the rating agency by Keyport. These ratings reflect the opinion of the rating
agency as to the relative financial strength of Keyport and Keyport's ability
to meet its contractual obligations to its policyholders. Such ratings are not
"market" ratings or recommendations to use or invest in Keyport or Liberty
Financial and should not be relied upon when making a decision to invest in the
Company. Many financial institutions and broker-dealers focus on the
claims-paying ability rating of an insurer in determining whether to market the
insurer's annuities. If any of Keyport's ratings were downgraded from their
current levels or if the ratings of Keyport's competitors improved and
Keyport's did not, sales of Keyport's products, the level of surrenders on
existing policies and the Company's relationships with distributors could be
materially adversely affected. No assurance can be given that Keyport will be
able to maintain its financial ratings.
Customer service also is essential to asset accumulation and retention.
The Company believes Keyport has a reputation for excellent service to its
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 for 1997 were 0.40% of assets, which reflects Keyport's low
cost operations.
General Account Investments
Premium deposits on fixed and indexed annuities are credited to the
Company's general account investments (which at December 31, 1997 totaled $13.5
billion). General account investments include cash and cash equivalents. To
maintain its investment spreads at acceptable levels, 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
6
<PAGE>
management requires both a quantitative assessment of overall policy
liabilities (including maturities, surrenders and crediting of interest) 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 investment process requires portfolio techniques that
earn acceptable 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. Various factors can impact the
Company's investment spread, including changes in interest rates and other
factors affecting the Company's general account investments.
The bulk of the Company's general account investments are invested in
fixed maturity securities (83.3% at December 31, 1997). The Company's principal
strategy for managing interest rate risk is to closely match the duration of
its general account investment portfolio and its policyholder balances. At
December 31, 1997, the duration of its fixed maturity portfolio was
approximately 2.9. The Company also employs hedging strategies to manage this
risk, including interest rate swaps and caps. In the case of equity-indexed
products, the Company purchases S&P 500 Index call options to hedge its
obligations to provide participation rate returns. Credit risk is managed by
careful credit analysis and monitoring. At December 31, 1997, the Company's
fixed maturity portfolio had an overall average S&P rating of A+. A portion of
general account investments (7.9% at December 31, 1997) are invested in below
investment grade fixed maturity securities to enhance overall portfolio yield.
Below investment grade securities pose greater risks than investment grade
securities. The Company actively manages its below investment grade portfolio
in an effort to optimize its risk/return profile. There were no non-income
producing investments in the Company's fixed maturity portfolio at December 31,
1997. For a more detailed description of the management of the Company's
general account investments see "Management's Discussion and Analysis of
Results of Operations and Financial Condition--Management of the Company's
Investments" beginning at page 31 of the Company's 1997 Annual Report To
Shareholders (the "1997 Annual Report").
Stein Roe manages the majority ($7.7 billion at December 31, 1997) of the
Company's general account investments. In addition, several unaffiliated
parties manage portions of its general account investments in order to obtain
diversification of investment styles and asset classes.
The Company's general account investments, all of which pertain to the
Company's annuity insurance operations, were comprised of the following as of
the dates indicated (in millions):
<TABLE>
<CAPTION>
As of
December 31,
----------------------------
1997 1996
------------- ------------
<S> <C> <C>
Fixed maturities available for sale ......... $11,246.5 $10,718.6
Mortgage loans .............................. 60.7 67.0
Policy loans ................................ 554.7 532.8
Other invested assets ....................... 440.8 183.6
Equity securities ........................... 40.8 35.9
--------- ---------
Investments ............................... 12,343.5 11,537.9
Cash and cash equivalents ................... 1,162.4 767.4
--------- ---------
General account investments ................. $ 13,505.9 $ 12,305.3
========== ==========
</TABLE>
As of December 31, 1997, the Company owned approximately $3.5 billion of
mortgage-backed securities (26.2% of its general account investments), 97.4% of
which were investment grade. Mortgage-backed securities are subject to
significant prepayment and extension risks, since the underlying mortgages may
be repaid more or less rapidly than scheduled.
As of December 31, 1997, approximately $3.2 billion (23.8% of the
Company's general account investments) were invested in securities which were
sold without registration under the Securities Act and were not freely
tradeable under the Securities Act or which were otherwise illiquid. These
securities may be resold pursuant to an exemption from registration under the
Securities Act. If the Company sought
7
<PAGE>
to sell such securities, it might be unable to do so at the then current
carrying values and might have to dispose of such securities over extended
periods of time at uncertain levels.
Investment Management
Liberty Financial has three types of investment management products:
mutual funds, wealth management, and institutional asset management. The
Company has four separate operating units engaged in investment management:
Colonial, Stein Roe, Newport and LAMCO. The Company's primary financial
objectives with respect to its investment management businesses are to increase
assets under management in each of its three core products, and to improve
operating margins through increasing scale and cost savings produced by
integration.
Products and Services
[bullet] Mutual Funds. As of December 31, 1997 the Company sponsors 67
open-end mutual funds, as well as seven closed-end funds. The
open-end funds include the 37 intermediary-distributed Colonial
mutual funds, 18 direct-marketed Stein Roe funds and 12 other funds
included among the investment options available under the Company's
variable annuities. The closed-end funds include five Colonial funds
and two LAMCO funds. At December 31, 1997, total mutual fund assets
were $26.8 billion. At December 31, 1997, 49.5% of these assets were
invested in equity funds, 26.3% in taxable fixed income funds and
24.2% in tax-exempt fixed income funds. The Company seeks to increase
equity mutual fund assets, which generally carry higher fees than
funds that invest in fixed income securities.
[bullet] Wealth Management. At December 31, 1997, the Company managed $6.6
billion in investment portfolios for high net worth individuals and
families and smaller institutional investors, all of which are
managed by Stein Roe.
[bullet] Institutional Asset Management. At December 31, 1997, the Company
managed $5.3 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. Stein Roe also manages the majority
of Keyport's general account assets supporting Keyport's insurance
products. See "--Retirement-Oriented Insurance Products--General
Account Investments."
The Company's investment management business focuses on managing the
investments of each client's portfolios in accordance with the client's
investment objectives and policies. The Company also provides related
administrative and support services to clients, such as portfolio pricing,
accounting and reporting. Investment management fees and related administrative
and support fees generally are charged as a percentage of assets under
management. Client accounts are managed pursuant to a written agreement which,
with limited exceptions, is terminable at any time upon relatively short notice
(typically 30-60 days).
In the case of mutual fund clients, all services provided by the Company
are subject to the supervision of the fund's Board of Trustees. Additional
administrative services provided to mutual funds include provision of office
space, other facilities and personnel, marketing and distribution services, and
transfer agency and other shareholder support services. Investment management
fees paid by a mutual fund must be approved annually by the fund's Board of
Trustees, including a majority of the independent Trustees. Any increases in
such fees also must be approved by fund shareholders. Most of the Company's
mutual fund assets are held in open-end funds. Shareholders of open-end funds
generally can redeem their shares on any business day.
The Company's direct-market mutual funds are sold without a sales load.
The Company's intermediary- distributed mutual funds generally offer investors
a choice of three pricing options: (1) a traditional front-end load option, in
which the investor pays a sales charge at the time of purchase; (2) a
contingent deferred sales charge, in which the investor pays no sales charge at
the time of purchase, but is subject to an asset-based sales charge paid by the
fund generally for eight years after purchase and a declining contingent
deferred sales charge paid by the investor if shares are redeemed generally
within six years after purchase; and (3) a level-load option, in which the
investor pays a small initial sales
8
<PAGE>
charge, and is subject to an on-going asset-based sales charge paid by the fund
and a small contingent deferred sales charge paid by the investor if shares are
redeemed within one year after purchase. Colonial is a party to a revolving
credit facility with certain lenders, pursuant to which such lenders have
agreed to lend up to $60.0 million to Colonial to finance the sale of shares of
the mutual funds sponsored by Colonial which have contingent deferred sales
charges.
The following tables present certain information regarding the Company's
assets under management as of or for each year in the three-year period ended
December 31, 1997. Such information includes Keyport's assets (including its
general account investments managed by Stein Roe, as well as loans to
policyholders and Keyport's general account investments managed by unaffiliated
investment managers). In addition, certain information is provided separately
for mutual fund assets.
<TABLE>
<CAPTION>
As of December 31,
------------------------------------
1997 1996 1995
Total Assets Under Management ---------- ---------- ----------
(dollars in billions)
<S> <C> <C> <C>
Mutual funds:
Intermediary-distributed ...................... $ 16.1 $ 16.1 $ 15.7
Direct-marketed ............................... 7.2 6.6 4.8
Closed-end .................................... 2.2 1.9 1.8
Variable annuity .............................. 1.3 1.1 1.0
------- ------- -------
Total mutual funds ........................... 26.8 25.7 23.3
Wealth management .............................. 6.6 5.3 4.5
Institutional asset management ................. 5.3 4.9 4.1
Retirement-oriented insurance products ......... 12.8 12.1 10.6
------- ------- -------
Total ...................................... $ 51.5 $ 48.0 $ 42.5
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------
Total Assets Under Management 1997 1996 1995
By Asset Class (1) ---------- ---------- ----------
(dollars in billions)
<S> <C> <C> <C>
Fee-based assets:
Equity ........................................ $ 18.2 $ 16.1 $ 11.4
Fixed-income .................................. 20.5 19.8 20.5
------- ------- -------
Total fee-based assets ....................... 38.7 35.9 31.9
Retirement-oriented insurance products ......... 12.8 12.1 10.6
------- ------- -------
Total ...................................... $ 51.5 $ 48.0 $ 42.5
======= ======= =======
</TABLE>
- ----------------
(1) Balanced funds are classified as equity funds; all categories include cash
and other short-term investments in applicable portfolios.
<TABLE>
<CAPTION>
As of December 31,
--------------------------------------
Total Mutual Fund Assets Under 1997 1996 1995
Management By Asset Class (1) ---------- ---------- ---------
(dollars in billions)
<S> <C> <C> <C>
Equity funds ................... $ 13.3 $ 12.1 $ 8.6
Fixed-income funds:
Taxable ....................... 7.0 7.0 7.4
Tax-exempt .................... 6.5 6.6 7.3
------- ------- ------
Total ........................ $ 26.8 $ 25.7 $ 23.3
======= ======= ======
</TABLE>
- ----------------
(1) Balanced funds are classified as equity funds; all categories include cash
and other short-term investments in applicable portfolios.
9
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31,
------------------------------------
Total Assets Under Management-- 1997 1996 1995
Asset Flow Summary ---------- ---------- ----------
(dollars in billions)
<S> <C> <C> <C>
Assets under management--beginning ......... $ 48.0 $ 42.5 $ 25.6
Sales and reinvestments .................... 7.5 8.6 5.8
Redemptions and withdrawals ................ ( 7.8) ( 6.9) ( 9.4)
Asset acquisitions ......................... -- 1.2 14.9
Net insurance cash flows ................... 0.7 0.7 0.6
Market appreciation ........................ 3.1 1.9 5.0
------- ------- -------
Assets under management--ending ............ $ 51.5 $ 48.0 $ 42.5
======= ======= =======
</TABLE>
Sales and Asset Retention
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. Fifty-three of the Company's 67
open-end mutual funds were long-term funds as of December 31,1997 (defined as
open-end funds having at least a three-year performance record, excluding funds
that invest solely in money market securities). Thirty-eight of those 53 funds
(representing 81% of the total assets in those 53 funds as of December 31,
1997) were ranked by Lipper in the top two quartiles of their respective peer
groups for the three-year period ended that date. The Company believes that
over time, more sophisticated tools, such as those employed by consultants to
institutional investors, will become available to consumers for analyzing
mutual fund performance and risk. The Company's investment performance must
remain competitive for the Company to continue to grow investment management
product sales and assets.
Excellent service to investors and distributors is a prerequisite to asset
retention. Excellent service to its distributors was a factor in the Company's
decision to acquire Colonial. In November, 1997, Dalbar, Inc., an independent
research and publishing company covering the mutual fund industry, named
Colonial the top-ranked mutual fund group for marketing and operational support
in its annual survey of broker-dealers.
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 management market and that Newport is a
recognized leader in investments in the Asian markets.
Sales of mutual funds and other investment management products are subject to
market forces, such as changes in interest rates and stock market performance.
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 assets in such portfolios, all of which
impact investment management fees.
Distribution
Liberty Financial sells its products through multiple distribution
channels. Total product sales during 1997 were $7.5 billion (including $1.0
billion of reinvested dividends and similar reinvested returns). During 1997
59% of these sales were made through intermediary distributors, with the
balance made directly to the investor. Over 34,000 individual brokers and other
intermediaries sold Liberty Financial products in 1997.
Distribution Through Intermediaries
The Company sells both annuities and mutual funds through various
intermediaries, including national and regional brokerage firms, banks and
other depository institutions, financial planners and
10
<PAGE>
insurance agents. The Company's annuities and mutual funds are most often sold
to middle and upper-middle class investors and savers. Many of these
individuals seek the help of an investment professional in selecting investment
and retirement income and 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
distributed through brokerage firms and insurance agents. Banks and financial
planners also have become significant distributors of these products.
The Company employs wholesalers and other sales professionals to promote
sales of its intermediary-distributed products. These representatives 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.
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. Liberty Financial operates a sales unit, Independent,
that sells mutual funds and annuities through banks. The Company acquired
Independent in March, 1996. Since the acquisition, the Company has consolidated
its prior bank sales unit, the Liberty Financial Bank Group, with Independent.
These businesses design and implement programs that sell annuities and mutual
funds through their client banks, license and train sales personnel, and
provide related financial services and administrative support. Program
structures and the degree of the Company's involvement vary widely depending
upon the particular needs of each bank. In some cases, 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 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 December 31, 1997, Independent had over 100 bank
relationships involving over 3,100 registered salespersons.
The proliferation of competing products and the market presence of certain
large competitors requires the Company to compete to establish and maintain
distribution relationships and to maintain "shelf space" with distributors.
Many of the larger distributors have begun to reduce the number of companies
for whom they distribute. Product features, relative performance, pricing and
support services to distributors and their customers are important factors in
competing for distribution relationships. Some distributors assess fee sharing
payments or similar charges as additional compensation for fund sales. The
Company can be confronted with the choice of absorbing these charges or
limiting its access to certain distributors. An interruption in the Company's
continuing relationship with certain of these distributors could materially
adversely affect the Company's ability to sell its products. There can be no
assurance that the Company would be able to find alternative sources of
distribution in a timely manner.
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 grow its intermediary distribution relationships. Pricing
structures in these channels, particularly with respect to mutual funds, have
expanded in recent years from one-time up-front sales loads to add options that
shift investors' payments over time and move somewhat toward fee-based pricing.
The Company's intermediary-distributed mutual funds now are sold with alternate
pricing structures. Intermediaries also increasingly demand that product
providers supply new value-added services.
Direct Distribution
The Company's direct-marketed mutual funds, as well as its wealth
management and institutional asset management services, are sold directly to
investors. The Company's directed-marketed mutual funds are purchased
predominantly by middle and upper-middle class investors and savers who choose
11
<PAGE>
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. Institutional asset 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.
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 technology-based customer
service and support tools it is developing, including on-line account access
and interactive illustrative investment tools, can become important devices 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.
So-called "mutual fund supermarkets," such as Charles Schwab & Co., Inc.'s
OneSource[RegTM], have become an important source of customers for
direct-marketed mutual funds. During 1997, 38% of the total new sales of the
Stein Roe mutual funds were through mutual fund supermarkets and similar
arrangements. To access these marketplaces, the Company pays the supermarket
sponsor a fee based upon a percentage of mutual fund assets held by supermarket
customers in return for certain services provided by the supermarket sponsor,
such as omnibus shareholder accounting. Financial planners and similar
unaffiliated advisors sometimes serve as sources of referrals for wealth
management clients, in some cases in return for referral fees or other
compensation.
Industry Segment Information
Liberty Financial conducts its business in two industry segments: annuity
insurance and asset management. Annuity insurance operations relate primarily
to the Company's fixed, indexed and variable annuities and its closed-block of
SPWLs. Asset management operations relate to its mutual funds, wealth
management and institutional asset management products. For information on
these industry segments, see Note 11 of Notes to the Consolidated Financial
Statements of the Company contained in the 1997 Annual Report.
Regulation
Overview
The Company's business activities are extensively regulated. The following
briefly summarizes the principal regulatory requirements and certain related
matters. The regulatory requirements applicable to the Company include, among
other things, (i) regulation of the form and in certain cases the content of
the Company's products, (ii) regulation of the manner in which those products
are sold and (iii) compliance oversight of the Company's business units,
including frequent reporting obligations to and inspections by regulators.
Changes in or the failure by the Company to comply with applicable law and
regulations could have a material adverse effect on the Company.
Annuity Insurance
The Company's retirement-oriented insurance products generally are issued
as individual policies. The policy is a contract between the issuing insurance
company and the policyholder. Policy forms, including all principal contract
terms, are regulated by state law. In most cases, the policy form must be
approved by the insurance department or similar agency of a state in order for
the policy to be sold in that state.
Keyport issues most of the Company's retirement-oriented insurance
products. Independence Life & Annuity Company ("Independence Life") and
American Benefit Life Insurance Company, to be renamed "Keyport Benefit Life
Insurance Company" on or about April 1, 1998 ("Keyport Benefit"), Keyport
subsidiaries, also issue certain policies. Keyport and Independence Life are
each chartered in the state of Rhode Island, and the Rhode Island Department of
Business Regulation is their primary oversight regulator. Keyport Benefit is
chartered in the state of New York, and the New York Department
12
<PAGE>
of Insurance is its primary oversight regulator. Keyport Benefit, acquired by
Keyport in January, 1998, operates exclusively in New York and Rhode Island.
Keyport and Independence Life also must be licensed by the state insurance
regulators in each other jurisdiction in which they conduct business. They
currently are licensed to conduct business in 49 states (the exception being
New York), and in the District of Columbia. State insurance laws generally
provide regulators with broad powers related to issuing licenses to transact
business, regulating marketing and other trade practices, operating guaranty
associations, regulating certain premium rates, regulating insurance holding
company systems, establishing reserve requirements, prescribing the form and
content of required financial statements and reports, performing financial and
other examinations, determining the reasonableness and adequacy of statutory
capital and surplus, regulating the type and amount of investments permitted,
limiting the amount of dividends that can be paid and the size of transactions
that can be consummated without first obtaining regulatory approval, and other
related matters. The regulators also make periodic examinations of individual
companies and review annual and other reports on the financial conditions of
all companies operating within their respective jurisdictions.
Keyport prepares its statutory-basis financial statements in accordance
with accounting practices prescribed or permitted by the Rhode Island
Department of Business Regulation. Certain statutory accounting practices are
prescribed by state law. Permitted statutory accounting practices encompass all
accounting practices that are not proscribed; such practices may differ between
the states and companies within a state. The National Association of Insurance
Commissioners (the "NAIC") is currently in the process of codifying statutory
accounting practices, the result of which is expected to constitute the only
source of prescribed statutory accounting practices. That project, which is
expected to be completed in 1998 may result in changes to the accounting
practices that Keyport uses to prepare its statutory-basis financial
statements. The impact of any such changes on Keyport's statutory surplus
cannot be determined at this time. No assurance can be given that such changes
would not have a material adverse effect on the Company.
Risk-Based Capital Requirements. In recent years, various states have
adopted new quantitative standards promulgated by the NAIC. These standards are
designed to reduce the risk of insurance company insolvencies, in part by
providing an early warning of financial or other difficulties. These standards
include the NAIC's risk-based capital ("RBC") requirements. RBC requirements
attempt to measure statutory capital and surplus needs based on the risks in a
company's mix of products and investment portfolio. The requirements provide
for four different levels of regulatory attention which implement increasing
levels of regulatory control (ranging from development of an action plan to
mandatory receivership). As of December 31, 1997, Keyport's capital and surplus
exceeded the level at which the least severe of these regulatory attention
levels would be triggered.
Guaranty Fund Assessments. Under the insurance guaranty fund laws existing
in each state, insurers can be assessed for certain obligations of insolvent
insurance companies to policyholders and claimants. Because assessments
typically are not made for several years after an insurer fails, Keyport cannot
accurately determine the precise amount or timing of its exposure to known
insurance company insolvencies at this time. For certain information regarding
Keyport's historical and estimated future assessments in respect of insurance
guaranty funds, see Note 16 to the Notes to the Consolidated Financial
Statements. The insolvency of large life insurance companies in future years
could result in material assessments to Keyport by state guaranty funds. No
assurance can be given that such assessments would not have a material adverse
effect on the Company.
Insurance Holding Company Regulation. Current Rhode Island insurance law
imposes prior approval requirements for certain transactions with affiliates
and generally regulates dividend payments by a Rhode Island-chartered insurance
subsidiary to its parent company. Keyport may not make distributions or
dividend payments, together with distributions and dividends paid during the
preceding 12 months, in excess of the lesser of (i) 10% of its statutory
surplus as of the preceding December 31 or (ii) its statutory net gain from
operations for the preceding fiscal year without prior approval by the Rhode
Island Department of Business Regulation. As of December 31, 1997, such
restriction would limit dividends without such approval to $70.3 million.
However, Keyport has not paid any dividends since its acquisition in December,
1988. In addition, no person or group may acquire, directly or indirectly, 10%
13
<PAGE>
or more of the voting stock or voting power of Liberty Financial unless such
person has provided such required information to the Rhode Island Department of
Business Regulation and such acquisition is approved by the Department.
General Regulation at Federal Level and Certain Related Matters. Although
the federal government generally does not directly regulate the insurance
business, federal initiatives often have an impact on the business in a variety
of ways. Current and proposed federal measures that may significantly affect
the insurance business include limitations on antitrust immunity, minimum
solvency requirements and the removal of barriers restricting banks from
engaging in the insurance business. In particular, several proposals to repeal
or modify the Bank Holding Company Act of 1956 (which prohibits banks from
being affiliated with insurance companies) have been made by members of
Congress and the Clinton Administration. Moreover, the United States Supreme
Court held in 1995 in NationsBank of North Carolina v. Variable Annuity Life
Insurance Company that annuities are not insurance for purposes of the National
Bank Act. In addition, the Supreme Court also held in 1995 in Barnett Bank of
Marion City v. Nelson that state laws prohibiting national banks from selling
insurance in small town locations are preempted by federal law. The Office of
the Comptroller of the Currency adopted a ruling in November 1996 that permits
national banks, under certain circumstances, to expand into other financial
services, thereby increasing competition for the Company. At present, the
extent to which banks can sell insurance and annuities without regulation by
state insurance departments is being litigated in various courts in the United
States. Although the effect of these recent developments on the Company and its
competitors is uncertain, there can be no assurance that such developments
would not have a material adverse effect on the Company.
Asset Management Products
The primary sources of regulation of the Company's asset management
operations are the federal securities laws. Asset management products are
subject to the Advisers Act. The mutual funds and closed-end funds sponsored by
the Company also are subject to the Investment Company Act. Mutual fund shares
are securities, and, as such, must be registered under the federal securities
laws. The foregoing laws impose various restrictions on the Company's asset
management products, including fee structures, the timing and content of
advertising, and, in the case of the funds, certain investment restrictions.
Mutual funds also must be managed to comply with certain other investment
restrictions imposed by the Internal Revenue Code. Accounts subject to the
Employee Retirement Income Security Act of 1974 ("ERISA") must comply with
certain investment and other restrictions imposed by ERISA.
The Company's subsidiaries directly engaged in asset management (including
Colonial, Stein Roe, Newport and LAMCO) are registered with the Securities and
Exchange Commission (the "SEC") as investment advisers under the Advisers Act.
They also are subject to the Investment Company Act insofar as it relates to
investment advisers to registered investment companies. These securities laws
and the related regulations of the SEC require reporting, maintenance of books
and records in prescribed forms, mandatory custodial arrangements, approval of
employees and representatives and other compliance procedures. Possible
sanctions in the event of noncompliance include the suspension of individual
employees, limitations on the firm's engaging in business for specified periods
of time, revocation of the firm's registrations, censures and fines.
In the ordinary course of its investment management business, the Company
enters into investment advisory agreements with mutual funds and others. As
required by the Investment Company Act and the Advisers Act, Liberty
Financial's investment advisory agreements provide that the agreements
terminate automatically upon their "assignment." The Investment Company Act and
the Advisers Act define the term "assignment" to include any "direct or
indirect transfer" of a "controlling block of the voting securities" of the
issuer's outstanding voting securities. The Investment Company Act presumes
that any person holding more than 25% of the voting stock of any person
"controls" such person. Sales by Liberty Mutual or other stockholders or new
issuances of capital stock by Liberty Financial, among other things, may raise
issues relating to assignments of the Company's investment advisory agreements.
The Restated Articles include provisions limiting the voting power of shares of
the Company's Voting Stock held by holders of 20% or more of such Voting Stock
in certain circumstances. These provisions do not apply to Liberty Mutual,
subsidiaries or affiliates of Liberty Mutual, direct or indirect subsidiaries
of the Company and certain employee plans established or to be established by
the Company or certain of its subsidiaries. Liberty Financial's Board of
14
<PAGE>
Directors may approve the exemption of other persons or groups from the
provisions described above. While this voting limitation is in place to reduce
the likelihood, under certain circumstances, of inadvertent terminations of
Liberty Financial's advisory agreements as a result of "assignments" thereof,
there can be no assurances that this limitation will prevent such a termination
from occurring. In addition, such limitation could be deemed to have an
anti-takeover effect and to make changes in management more difficult.
Several proposals to repeal or modify the Glass-Steagall Act of 1933
(which restricts banks from engaging in securities-related businesses) have
been made by members of Congress and the Clinton Administration. Although the
effect that any such proposals if adopted would have on the Company and its
competitors is uncertain, there can be no assurance that such proposals if
adopted would not have a material adverse effect on the Company.
Distribution
Sales of the Company's annuities and mutual funds are also subject to
extensive regulation. Annuities must be sold through an entity registered as an
insurance agency in the particular state. The sales person must be properly
licensed under state insurance law. Variable annuities and certain indexed
annuities also require the sales person to be registered with the National
Association of Securities Dealers ("NASD") and the applicable state securities
commission. Mutual fund shares must be sold through an entity registered as a
broker-dealer under the Exchange Act and applicable state law. The sales person
must be registered with the NASD and the applicable state securities
commission.
Various business units of the Company are registered as broker-dealers.
These include certain units which operate the Company's bank marketing
business, as well as other units through which mutual fund and certain
annuities are sold. Certain bank marketing units also are registered as
insurance agencies in states where they sell annuities. These laws regulate the
licensing of sales personnel and sales practices. They impose minimum net
capital requirements. They also impose reporting, records maintenance, and
other requirements, and provide for penalties in the event of non-compliance,
similar in scope to the regulations applicable to asset managers.
Certain securities sales through the Company's bank marketing units are
conducted in accordance with the provisions of a "no-action" letter issued by
the staff of the Commission requiring, among other things, that securities
sales activities be conducted by sales personnel who are registered
representatives of the Company and are subject to its supervision and control.
The letter limits the functions of non-registered bank personnel to ministerial
duties. The letter is not binding on the courts, however, and no assurance can
be given that the Commission will not change its position.
Banks are an important distribution channel for the Company's annuities
and mutual funds. The recent growth in sales of mutual funds, annuities and
other investment and insurance products through or at banks and similar
institutions has prompted increased scrutiny by federal bank regulators, the
SEC and other regulators. Regulations promulgated by federal banking
authorities impose additional restrictions and duties with respect to bank
sales practices, including obligations to disclose that the products are not
subject to deposit insurance.
Competition
The Company's businesses operate in extremely competitive markets. These
markets are highly fragmented, although in the case of annuities and mutual
funds, a few companies do have relatively substantial market shares. Certain of
the Company's competitors are significantly larger and have access to
significantly greater financial and other resources.
The Company's products compete with every other investment or savings
vehicle available to a prospective customer, including those offered by other
insurance companies, investment management firms and banks. The Company
believes that the most important competitive factor affecting the marketability
of its products is the degree to which they meet customer expectations, both in
terms of returns (after fees and expenses) and service. These competitive
pressures apply to competition for customers in general, as well as competition
to access and maintain distribution relationships, in the case of products sold
through intermediaries. Product and service innovations also are important
devices for
15
<PAGE>
generating new sales and maintaining distribution relationships. Sales of
particular products may be affected by conditions in the financial markets,
such as increases or decreases in interest rates or stock prices.
Product features of particular relevance to annuities include interest
crediting and participation rates, surrender charges and innovation in product
design. Maintenance of Keyport's financial ratings also is important. The
Company believes that the most important factors affecting competition for
investment management clients are investment performance, customer service and
brand name recognition. Pricing policies and product innovations also are
important competitive factors. The Company's ability to increase and retain
clients' assets could be materially adversely affected if client accounts
underperform the market or competing products or if key investment managers
leave the Company. The ability of the Company's asset management subsidiaries
to compete with other asset management products also is dependent, in part, on
the relative attractiveness of their underlying investment philosophies and
methods under prevailing market conditions.
Employees
As of December 31, 1997, the Company had 2,050 full-time employees
summarized by activity as follows: 412 in annuity insurance operations; 1,130
in asset management activities; 459 in marketing and distribution operations;
and 49 in general corporate. The Company provides its employees with a broad
range of employee benefit programs. The Company believes that its relations
with its employees are excellent.
Item 2. Properties
As of December 31, 1997, the Company leased its various office facilities.
The Company's principal leasing arrangements can be summarized as follows: The
Company's principal executive offices occupy approximately 30,300 square feet
in a single facility in downtown Boston under a lease which expires in 2002.
Keyport leases approximately 76,000 square feet in a single facility in
downtown Boston under a lease which expires in 2002, and approximately 19,800
square feet in Lincoln, Rhode Island under a lease which expires in 2007.
Colonial leases approximately 149,000 square feet of office space in a single
facility in downtown Boston under a lease which expires in 2006 and
approximately 21,700 square feet in Aurora, Colorado under a lease which
expires in 2000. Stein Roe leases 141,300 square feet in downtown Chicago under
to a lease which expires in 2009. Independent leases approximately 29,500
square feet in Purchase, New York under a lease which expires in 2007.
Item 3. Legal Proceedings
The Company is from time to time involved in litigation incidental to its
businesses. In the opinion of Liberty Financial's management, the resolution of
such litigation is not expected to have a material adverse effect on the
Company's financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
None
16
<PAGE>
Executive Officers of the Registrant
<TABLE>
<CAPTION>
Name Age Position
- ----------------------- ----- ------------------------------------------------
<S> <C> <C>
Gary L. Countryman 58 Chairman and Director
Kenneth R. Leibler 48 Chief Executive Officer, President and Director
John A. Benning 63 Senior Vice President, General Counsel and
Clerk
John V. Carbery 50 Senior Vice President
Harold W. Cogger 62 Executive Vice President
Lindsay Cook 45 Executive Vice President
J. Scott Hansen 45 Senior Vice President, Corporate Development
J. Andy Hilbert 39 Senior Vice President, Chief Financial Officer
and Treasurer
C. Allen Merritt, Jr. 57 Chief Operating Officer
Porter P. Morgan 57 Senior Vice President, Marketing
John W. Rosensteel 57 President and Chief Executive Officer of
Keyport
</TABLE>
Mr. Countryman has been Chief Executive Officer of Liberty Mutual and
Liberty Mutual Fire Insurance Company (an affiliate of Liberty Mutual) since
1986, and has been Chairman of both companies since 1991. He currently serves
as a director of the Company, Liberty Mutual and certain of its affiliates,
BankBoston Corporation, Boston Edison Company and Harcourt General, Inc.
Mr. Leibler became Chief Executive Officer of Liberty Financial on January
1, 1995, has been President of Liberty Financial since August, 1990, and was
Chief Operating Officer from August, 1990, until December, 1994. Mr. Leibler
currently serves as a director of the Company and the Boston Stock Exchange.
Mr. Benning has been Senior Vice President, General Counsel and Clerk of
Liberty Financial since October, 1989.
Mr. Carbery joined Liberty Financial as Senior Vice President in February,
1998. Prior to that time he was a Managing Director of Salomon Brothers Inc.
Mr. Cogger became Executive Vice President and director of Liberty
Financial at the time it acquired Colonial in March, 1995. He was President of
Colonial from November, 1994 to December, 1996 and Chief Executive Officer from
March, 1995 to December, 1996. He was President of its principal subsidiary,
Colonial Management Associates, Inc. from 1993 to December, 1996, and Chief
Executive Officer from March, 1995 to December, 1996.
Mr. Cook became Executive Vice President of Liberty Financial in February,
1997. He became a Senior Vice President of Liberty Financial in February, 1994,
having been a Vice President prior to that time.
Mr. Hansen became Senior Vice President, Corporate Development in May,
1996. Prior to that time he was Vice President, Corporate Development.
Mr. Hilbert joined the Company as Senior Vice President and Chief
Financial Officer in March, 1997. He became Treasurer in March, 1998. From
October 1995 until that time, he was Senior Vice President and Chief Financial
Officer of Paul Revere Corporation. Prior to joining Paul Revere, Mr. Hilbert
was a partner at Price Waterhouse.
Mr. Merritt became Chief Operating Officer of Liberty Financial in March,
1998. From February, 1997 to March, 1998 he was Executive Vice President. He
was Senior Vice President of Liberty Financial prior to that time.
Mr. Morgan has been Senior Vice President, Marketing of Liberty Financial
since 1991.
Mr. Rosensteel has been President and Chief Executive Officer of Keyport
since 1993.
17
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is listed on the New York Stock Exchange
("NYSE") under the symbol "L". The Common Stock is also listed on the Boston
Stock Exchange. On December 31, 1997, the closing price of the Company's Common
Stock on the NYSE was $37.75 per share. Per share amounts have been adjusted to
reflect the Company's 3 for 2 common stock split effected in the form of a 50
percent stock dividend on December 10, 1997. As of February 28, 1998 there were
approximately 217 shareholders of record. In addition, the Company estimates
that there are approximately 2,500 beneficial shareholders whose shares are
held in street name. The high and low sales prices for each quarter during 1997
and 1996, as traded on the NYSE Composite Tape, were as follows:
<TABLE>
<CAPTION>
1997
Quarter High Low
- -------------------- ---------- ----------
<S> <C> <C>
January-March $30-7/16 $ 25-3/4
April-June 34-1/16 25-1/4
July-September 37-1/8 32-13/16
October-December 38-1/4 33-5/16
</TABLE>
<TABLE>
<CAPTION>
1996
Quarter High Low
- -------------------- ---------- ---------
<S> <C> <C>
January-March $ 21-9/16 $ 20
April-June 22-11/16 20-1/2
July-September 22-9/16 17-7/16
October-December 26 20-9/16
</TABLE>
The Company's practice has been to pay quarterly cash dividends of $0.10
per share (adjusted for such stock split). The declaration and payment of any
dividends on the Common Stock are dependent upon the Company's results of
operations, financial condition, cash requirements, capital requirements,
regulatory considerations and other relevant factors, and in all events are
subject to the discretion of the Board of Directors and to any preferential
dividend rights of the outstanding Series A Convertible Preferred Stock
("Preferred Stock") of Liberty Financial. The holders of the issued and
outstanding shares of Preferred Stock are entitled to receive cumulative cash
dividends at the rate of $2.875 per annum per share, payable in equal quarterly
installments. The terms of the Preferred Stock preclude the payment of any
dividends on the Common Stock unless cumulative dividends on the outstanding
Preferred Stock have been paid or declared in full. Accordingly, there is no
requirement, and no assurances can be given, that dividends will be paid on the
Common Stock.
The Company's Board of Directors established an optional dividend
reinvestment plan ("DRIP") for holders of Common Stock and Preferred Stock.
Liberty Mutual has participated in the DRIP since its inception. Such
participation may be terminated at any time. Based upon Liberty Financial's
current expectations as to its liquidity and cash needs, Liberty Financial's
ability to pay dividends on the Common Stock may be dependent upon Liberty
Mutual's continued participation in the DRIP. See "Management's Discussion and
Analysis of Results of Operations and Financial Condition--Liquidity" in the
1997 Annual Report.
For a discussion of certain restrictions on the Company's ability to pay
dividends in cash on its Common stock, see "Management's Discussion and
Analysis of Results of Operations and Financial Condition--Liquidity" in the
1997 Annual Report.
Sales of Unregistered Securities
Liberty Financial issued shares of its Common Stock during 1997 without
registration under the Securities Act of 1933 (the "Securities Act") in the
transactions described below.
On March 7, 1996, Liberty Financial acquired Independent in a
stock-for-stock exchange with four individuals who were the shareholders of
Independent. The acquisition agreement provides for certain subsequent payments
of additional shares based upon certain conditions. In July, 1997, Liberty
Financial issued an additional 115,383 shares in the aggregate (as adjusted for
the stock split described above)
18
<PAGE>
to such persons in satisfaction of certain of such payments. Such issuances
were exempt from registration under the Securities Act pursuant to Section 4(2)
thereof.
Item 6. Selected Financial Data
The Selected Consolidated Financial Data, which appears on page 24 in the
1997 Annual Report, are incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Results of Operations and
Financial Condition, which appears beginning on page 25 in the 1997 Annual
Report, is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Not applicable.
Item 8. Financial Statements and Supplementary Data
The Company's Consolidated Financial Statements which appear beginning on
page 35 in the 1997 Annual Report, and the report thereon of Ernst & Young LLP
as of and for the year ended December 31, 1997, which appears on page 55 in the
1997 Annual Report, are incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Part III
Item 10. Directors and Executive Officers of the Registrant
Information relating to the executive officers of the registrant appears
under the caption "Executive Officers of the Registrant" included in Part I of
this Form 10-K following Item 4.
Information relating to the directors of the registrant is incorporated
herein by reference from Liberty Financial's definitive Proxy Statement for the
Annual Meeting of Stockholders to be held on or about May 11, 1998 to be mailed
prior to March 31, 1998 (the "Proxy Statement") under the caption "Election of
Directors."
In addition, the information appearing in the Proxy Statement under the
caption "Security Ownership of Management and Certain Beneficial
Owners--Section 16(a) Beneficial Ownership Reporting Compliance" is
incorporated herein by reference.
Item 11. Executive Compensation
Information relating to executive compensation is incorporated herein by
reference from the Proxy Statement under the following captions: "Compensation
of Executive Officers" (excluding, however, the portions thereof under the
subcaptions "Compensation Committee Report on Executive Compensation" and
"Stockholder Return Comparisons") and "Election of Directors--1997 Meetings and
Standard Fee Arrangements."
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information relating to security ownership of certain beneficial owners
and management is incorporated herein by reference from the Proxy Statement
under the caption "Security Ownership of Management and Certain Beneficial
Owners" (excluding the material under the sub-caption "Section 16(a) Beneficial
Ownership Reporting Compliance").
Item 13. Certain Relationships and Related Transactions
Information relating to Certain Relationships and Related Transactions is
incorporated herein by reference from the Proxy Statement under the captions
"Certain Relationships and Related Transactions."
19
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements
The following Consolidated Financial Statements of the Company, which
appear beginning on page 35 of the 1997 Annual Report, are incorporated herein
by reference:
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Income Statements for the Years Ended December 31, 1997,
1996 and 1995
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
The following financial statement schedules are included as part of this
Report:
I Summary of Investments
II Condensed Financial Information of Registrant
III Supplementary Insurance Information
All other schedules are omitted because they are not applicable or are not
required, or because the required information is included in the Consolidated
Financial Statements or notes thereto.
3. Exhibits
The exhibits filed as part of this Report are listed on the Exhibit Index
immediately following the financial statement schedules included in this
report.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Registrant during the fourth
quarter of 1997.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 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, in the City of Boston and the
Commonwealth of Massachusetts on March 23, 1998.
LIBERTY FINANCIAL COMPANIES, INC.
By: /s/ Kenneth R. Leibler
------------------------------------
Kenneth R. Leibler
Chief Executive Officer,
President and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and as of the dates stated.
<TABLE>
<CAPTION>
Signature Title Date
- ---------------------------- --------------------------------------- ---------------
<S> <C> <C>
/s/ Kenneth R. Leibler Chief Executive Officer, President March 23, 1998
- ------------------------- and Director
Kenneth R. Leibler
/s/ J. Andy Hilbert Senior Vice President and Chief March 23, 1998
- ------------------------- Financial Officer (Principal Financial
J. Andy Hilbert and Accounting Officer)
/s/ Gary L. Countryman Director March 23, 1998
- -------------------------
Gary L. Countryman
/s/ Gregory H. Adamian Director March 23, 1998
- -------------------------
Gregory H. Adamian
/s/ Gerald E. Anderson Director March 23, 1998
- -------------------------
Gerald E. Anderson
/s/ Michael J. Babcock Director March 23, 1998
- -------------------------
Michael J. Babcock
/s/ Harold W. Cogger Director March 23, 1998
- -------------------------
Harold W. Cogger
/s/ Paul J. Darling, II Director March 23, 1998
- -------------------------
Paul J. Darling, II
/s/ David F. Figgins Director March 23, 1998
- -------------------------
David F. Figgins
/s/ John B. Gray Director March 23, 1998
- -------------------------
John B. Gray
/s/ John P. Hamill Director March 23, 1998
- -------------------------
John P. Hamill
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
Signature Title Date
- ----------------------------- ---------- ---------------
<S> <C> <C>
/s/ Marian L. Heard Director March 23, 1998
- -------------------------
Marian L. Heard
/s/ Raymond H. Hefner, Jr. Director March 23, 1998
- -------------------------
Raymond H. Hefner, Jr.
/s/ Edmund F. Kelly Director March 23, 1998
- -------------------------
Edmund F. Kelly
/s/ Sabino Marinella Director March 23, 1998
- -------------------------
Sabino Marinella
/s/ Thomas J. May Director March 23, 1998
- -------------------------
Thomas J. May
/s/ Ray B. Mundt Director March 23, 1998
- -------------------------
Ray B. Mundt
/s/ Glenn P. Strehle Director March 23, 1998
- -------------------------
Glenn P. Strehle
/s/ Stephen J. Sweeney Director March 23, 1998
- -------------------------
Stephen J. Sweeney
</TABLE>
22
<PAGE>
Schedule I
LIBERTY FINANCIAL COMPANIES, INC.
SUMMARY OF INVESTMENTS
(in millions)
<TABLE>
<CAPTION>
December 31, 1997
--------------------------------------------
Balance
Amortized Sheet
Type of Investment Cost Fair Value Amount
- ------------------------------------------------------------- ------------- ------------ -------------
<S> <C> <C> <C>
Fixed maturities:
U.S. Treasury securities and obligations of U.S. government
corporations and agencies ................................ $ 1,218.4 $ 1,267.4 $ 1,267.4
Foreign governments ....................................... 272.5 280.2 280.2
Corporate and other securities ............................ 7,164.8 7,293.7 7,293.7
Mortgage backed securities ................................ 2,325.9 2,405.2 2,405.2
---------- ---------- ----------
Total fixed maturities ................................... 10,981.6 11,246.5 11,246.5
Equity securities:
Common stocks:
Industrial, miscellaneous and all other ................... 21.9 40.8 40.8
Mortgage loans on real estate (1) ........................... 60.7 63.0 60.7
Policy loans ................................................ 554.7 554.7 554.7
Other long term investments ................................. 444.4 462.7 440.8
---------- ---------- ----------
Total investments ........................................ $ 12,063.3 $ 12,367.7 $ 12,343.5
========== ========== ==========
</TABLE>
- ------------
1 Includes mortgage notes relating to certain investment property owned by
Liberty Mutual in the amount of $39.5 million at December 31, 1997.
23
<PAGE>
Schedule II
LIBERTY FINANCIAL COMPANIES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in millions, except per share data)
Balance Sheets
<TABLE>
<CAPTION>
December 31
--------------------------
1997 1996
------------ -----------
<S> <C> <C>
Assets:
Cash and cash equivalents ...................... $ 19.4 $ 7.4
Investments in subsidiaries .................... 1,183.4 1,060.3
Notes receivable--subsidiaries ................. 160.9 160.2
Accounts receivable--subsidiaries .............. 20.8 15.2
Other assets ................................... 44.0 33.7
--------- ---------
$ 1,428.5 $ 1,276.8
========= =========
Liabilities:
Note payable to parent ......................... $ 199.0 $ 199.0
Accounts payable and accrued expenses .......... 16.0 12.6
--------- ---------
215.0 211.6
--------- ---------
Redeemable convertible preferred stock ......... 14.6 13.8
--------- ---------
Stockholders' Equity:
Common stock ................................... 0.4 0.3
Additional paid-in capital ..................... 866.5 835.3
Net unrealized investment gains ................ 83.0 74.4
Retained earnings .............................. 251.5 141.4
Cost of common stock held in treasury .......... ( 0.3) --
Unearned compensation .......................... ( 2.2) --
--------- ---------
Total stockholders' equity .................... 1,198.9 1,051.4
--------- ---------
$ 1,428.5 $ 1,276.8
========= =========
</TABLE>
Income Statements
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Interest income, principally from subsidiaries ......... $ 13.0 $ 12.1 $ 12.0
Realized investment losses ............................. 0.6 -- --
Operating expenses ..................................... 15.6 16.3 15.1
-------- -------- -------
Loss before income taxes ............................... (3.2) (4.2) ( 3.1)
Benefit for income taxes ............................... (19.2) (21.9) (15.7)
Equity in net income of subsidiaries ................... 113.5 83.0 61.3
-------- -------- -------
Net income ............................................. $ 129.5 $ 100.7 $ 73.9
======== ======== =======
Net income per share--basic ............................ $ 2.94 $ 2.36 $ 1.85
======== ======== =======
Net income per share--assuming dilution ................ $ 2.77 $ 2.24 $ 1.76
======== ======== =======
</TABLE>
See Notes to Consolidated Financial Statements contained in the 1997 Annual
Report incorporated herein by reference.
24
<PAGE>
Schedule II (continued)
LIBERTY FINANCIAL COMPANIES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in millions)
Statements of Cash Flows
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .................................................. $ 129.5 $ 100.7 $ 73.9
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Equity in net income of subsidiaries ..................... (113.5) ( 83.0) ( 61.3)
Increase in notes receivable--subsidiaries ............... ( 0.7) ( 1.2) ( 24.6)
Net change in accounts receivable--subsidiaries,
other assets and accounts payable ...................... ( 9.2) ( 41.2) 8.6
-------- -------- --------
Net cash provided by (used in) operating activities ......... ( 6.1) ( 24.7) ( 3.4)
-------- -------- --------
Cash flows from investing activities:
Acquisitions ................................................ -- ( 8.1) (106.4)
Capital contributions to subsidiaries ....................... ( 25.0) ( 8.0) ( 36.0)
-------- -------- --------
Net cash used in investing activities ....................... ( 25.0) ( 16.1) (142.4)
-------- -------- --------
Cash flows from financing activities:
Dividends, net .............................................. 23.3 36.1 20.1
Exercise of stock options ................................... 7.5 2.4 0.7
Common stock issued to 401(k) plan .......................... 0.1 -- --
Debt borrowing from parent .................................. -- -- 124.0
-------- -------- --------
Net cash provided by financing activities ................... 30.9 38.5 144.8
-------- -------- --------
Increase (decrease) in cash and cash equivalents ............ 12.0 ( 2.3) ( 1.0)
Cash and cash equivalents at beginning of year .............. 7.4 9.7 10.7
-------- -------- --------
Cash and cash equivalents at end of year .................... $ 19.4 $ 7.4 $ 9.7
======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements contained in the 1997 Annual
Report incorporated herein by reference.
25
<PAGE>
Schedule III
LIBERTY FINANCIAL COMPANIES, INC.
SUPPLEMENTARY INSURANCE INFORMATION
(in millions)
Three Years Ended December 31, 1997
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
- ------------------- ------------- --------------- ---------- ----------------
Policy
Policyholder contract
Deferred account claims and
policy balances and other
acquisition future policy Unearned policyholders'
costs benefits premiums funds
<S> <C> <C> <C> <C>
December 31, 1997
Interest sensitive
products ......... $ 232.0 $ 12,031.8 NA $ 54.3
======= ========== ======
December 31, 1996
Interest sensitive
products ......... $ 250.4 $ 11,610.4 NA $ 27.1
======= ========== ======
December 31, 1995
Interest sensitive
products ......... $ 179.7 $ 10,063.3 NA $ 21.1
======= ========== ======
<CAPTION>
Column A Column F Column G Column H Column I Column J Column K
- ------------------- ----------- ------------ --------------- -------------- ----------- ---------
Interest
credited to Amortization
policyholders of deferred
Net and policy policy Other
Insurance investment benefits and acquisition operating Premiums
revenues income claims costs expenses written
<S> <C> <C> <C> <C> <C> <C>
December 31, 1997
Interest sensitive
products ......... $ 33.1 $ 853.1 $ 598.0 $ 75.9 $ 61.6 NA
====== ======= ======= ====== ======
December 31, 1996
Interest sensitive
products ......... $ 30.9 $ 796.4 $ 576.2 $ 60.2 $ 55.1 NA
====== ======= ======= ====== ======
December 31, 1995
Interest sensitive
products ......... $ 27.9 $ 761.8 $ 560.2 $ 58.5 $ 55.1 NA
====== ======= ======= ====== ======
</TABLE>
26
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit
Number Description
- ----------------- -----------------------------------------------------------------------------------
<S> <C>
3.1 (1) Form of Restated Articles of Organization of the Company
3.2 (1) Form of Certificate of Designation of Series A Convertible Preferred Stock of the
Company
3.3 Restated By-laws of the Company, as amended
4.1 (1) Form of Certificate for Common Stock of the Company
4.2 (1) Form of Certificate for Series A Convertible Preferred Stock of the Company
10.1 (1) Form of Intercompany Agreement between Liberty Mutual and the Company
10.2 (2) Form of Registration Rights Agreement between Liberty Mutual and the Company
10.3 (2) Form of Tax Sharing Agreement between Liberty Mutual and the Company
10.4 (1) Form of 1990 Stock Option Plan of the Company, together with amendments 1
and 2 thereto
10.5 (1) Form of Savings and Investment Plan and Trust of the Company
10.5.1 (3) Amendment No. 1 to Savings and Investment Plan
10.6 (1) Form of Amended and Restated Supplemental Savings Plan of the Company
10.7 (1) Form of Stein Roe Profit Sharing Plan and amendments thereto
10.8 (1) Form of Pension Plan of the Company
10.8.1 (3) Amendment No. 1 to Pension Plan
10.9 (1) Form of Amended and Restated Supplemental Pension Plan of the Company
10.10(4) Form of Amended and Restated 1995 Stock Incentive Plan of the Company
10.11(2) Form of 1995 Employee Stock Purchase Plan of the Company
10.12(1) Form of Deferred Compensation Plan of the Company
10.12.1 (1) Letters from the Company, setting forth additional retirement benefits for John A.
Benning and Sabino Marinella
10.13(1) Form of Keyport Deferred Compensation Plan
10.14(1) Form of Stein Roe Deferred Compensation Plan
10.14.1 (1) Form of Stein Roe Non-Qualified Supplemental Retirement Plan
10.14.2 (1) Form of Stein Roe Long Term Incentive Plan
10.15(5) Form of Promissory Note in the principal amount of $99.0 million dated April 5,
1995
10.16(1) Lease Agreement with respect to 600 Atlantic Avenue, Boston, Massachusetts
10.17(1) Lease Agreement with respect to 125 High Street, Boston, Massachusetts, as
amended
10.18(1) Lease Agreement with respect to One South Wacker Drive, Chicago, Illinois, as
amended
10.19(1) Unconditional Guarantee Agreement dated November 7, 1991 executed by
Liberty Mutual and related Mortgage Maintenance Agreement by and among LRE
Properties, Inc., Atlantic Real Estate Limited Partnership and Keyport Life
Insurance Company
10.20(1) Administrative Services Agreement dated as of June 9, 1993 between Liberty Life
Assurance Company of Boston and Keyport Life Insurance Company
10.21(5) Lease Agreement with respect to One Financial Center, Boston, Massachusetts
10.22(1) $100 Million of Mortgage Notes owned by Keyport issued by indirect subsidiaries
of Liberty Mutual
10.23(2) Promissory Notes dated March 24, 1995 of the Company issued to Liberty Mutual
and two of its affiliates in the aggregate principal amount of $100.0 million
10.24(1) Form of Promissory Note dated January 29, 1995 of SteinRoe Services, Inc. in the
principal amount of $30.0 million
10.26(2) Form of Employment Agreement among the Company, Colonial and Harold W.
Cogger
10.27(2) Credit agreement among Colonial and The First National Bank of Boston, as
agent for itself and certain other lenders named therein (and Amendments No. 1
and 2 thereto)
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------------------ ------------------------------------------------------------------------------
<S> <C>
10.27.1 (3) Amendment No. 3 to Credit Agreement
10.27.2 (5) Amendment No. 4 to Credit Agreement
10.28(3) Colonial Profit Sharing Plan (and Amendment Nos. 1-3 thereto)
10.29(3) Colonial Split-Dollar Insurance Coverage description
10.30(5) Coinsurance Agreement between Fidelity and Guaranty Life Insurance Company
and Keyport Life Insurance Company, and first and second amendments thereto
10.31(6) Dividend Reinvestment Plan of the Company
12 Statement re computation of ratios
13 Portions of Annual Report to Stockholders incorporated by reference into this
Report
21 Subsidiaries of the Company
23.1 Consent of Ernst & Young LLP
23.2 Report and Consent of KPMG Peat Marwick LLP
27.1 Article 7 FDS for 1997 10-K
27.2 Restated Article 7 FDS for 1996 10-K Filing
27.3 Restated Article 7 FDS for 1996 10-Q Filings
27.4 Restated Article 7 FDS for 1997 10-Q Filings
99.3 (1) Form of Stockholders' Agreement among the Company, Liberty Mutual Insurance
Company and certain holders of the Company's Series A Convertible Preferred
Stock
</TABLE>
- ------------
(1) Incorporated by reference to the same Exhibit Number in the Company's
Registration Statement on Form S-4 (filed under the name NEW LFC, INC.)
(Registration No. 33-88824).
(2) Incorporated by reference to the same Exhibit Number in the Company's 1994
Annual Report on Form 10-K filed March 30, 1995.
(3) Incorporated by reference to the same Exhibit Number in the Company's 1995
Annual Report on Form 10-K filed March 29, 1996.
(4) Incorporated by reference to the same Exhibit Number in the Company's
Registration Statement on Form S-3 (Registration Number 333-29315).
(5) Incorporated by reference to the same Exhibit Number in the Company's 1996
Annual Report on Form 10-K filed March 28, 1997.
(6) Incorporated by reference to Prospectus contained in the Company's
Registration Statement on Form S-3 (Registration Number 333-20067).
28
<PAGE>
Selected Exhibits
29
<PAGE>
LFC-10K-98
RESTATED BY-LAWS
(as amended through February 13, 1998)
of
LIBERTY FINANCIAL COMPANIES, INC.
(Formerly known as "New LFC, Inc.)
Section 1. ARTICLES OF ORGANIZATION
The name and purposes of the corporation shall be as set forth in the
Restated Articles of Organization of the corporation (the "Articles of
Organization"). These By-laws, the powers of the corporation and of its
directors and stockholders, or of any class of stockholders if there shall be
more than one class of stock, and all matters concerning the conduct and
regulation of the business and affairs of the corporation shall be subject to
such provisions in regard thereto, if any, as are set forth in the Articles of
Organization as from time to time in effect. Capitalized terms used in these
By-laws which are defined in the Articles of Organization are used in these
By-laws with the meanings so defined.
Section 2. STOCKHOLDERS
2.1. Annual Meeting./1/ The annual meeting of stockholders shall be
held at 11:00 a.m. on the second Monday in May in each year (unless that day be
a legal holiday at the place where the meeting is to be held, in which case the
meeting shall be held at the same hour on the next succeeding day not a legal
holiday) or at such other date and time as shall be determined from time to time
by the board of directors. Purposes for which an annual meeting is to be held,
additional to those prescribed by law, by the Articles of Organization or by
these By-laws, may be specified by the president or by the directors.
2.2. Special Meetings. A special meeting of the stockholders may be
called at any time by the chairman of the board of directors, the chief
executive officer, the president or the board of directors. A special meeting of
the stockholders shall be called by the clerk, or in the case of the death,
absence, incapacity or refusal of the clerk, by an assistant clerk or some other
officer, upon application of the chairman of the board of directors, the chief
executive officer, the president or a majority of the directors or the holders
of shares of Voting Stock representing not less than sixty-seven percent (67%)
of the combined voting power of the then outstanding shares of Voting Stock
entitled to vote generally in elections of directors (or such lesser percentage
of shares entitled by law which cannot be modified by these By-laws to call a
special meeting of the stockholders). Any such application shall state the
purpose or purposes of the proposed meeting. Any such call shall state the
place, date, hour and purposes of the meeting.
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/1/ (Section 2.1 was amended (i) on August 9, 1995 by a vote of the Board of
Directors, changing the meeting date from the third Wednesday in May to the
second Wednesday in May and (ii) on February 13, 1998 by a vote of the Board of
Directors, changing the meeting date to the second Monday in May.)
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2.3. Place of Meetings. All meetings of the stockholders shall be held
at the principal office of the corporation in Massachusetts or, to the extent
permitted by the Articles of Organization, at such other place within the United
States as shall be fixed by the chairman of the board of directors, the chief
executive officer, the president or the board of directors. Any adjourned
session of any meeting of the stockholders shall be held at the same city or
town as the initial session, or within Massachusetts, in either case at the
place designated in the vote of adjournment.
2.4. Notice of Meetings. Except as otherwise provided by law, a written
notice of each meeting of stockholders stating the place, day and hour thereof
and the purposes for which the meeting is called shall be given not less then
ten (10) nor more than sixty (60) days before the meeting to each stockholder
entitled to vote thereat, and to each stockholder who, by law, by the Articles
of Organization or by these By-laws, is entitled to notice, by leaving such
notice with him or at his residence or usual place of business, or by depositing
it in the United States mail, postage prepaid, and addressed to such stockholder
at his address as it appears in the records of the corporation. Such notice
shall be given by the clerk, or by an officer or person designated by the board
of directors. As to any adjourned session of any meeting of stockholders, notice
of the adjourned session of any meeting need not be given if the time and place
thereof are announced at the meeting at which the adjournment was taken except
that if the adjournment is for more than thirty (30) days or if after the
adjournment a new record date is set for the adjourned session, notice of any
such adjourned session of the meeting shall be given in the manner heretofore
described.
No notice of any meeting of stockholders or any adjourned session
thereof need be given to a stockholder if a written waiver of notice, executed
before or after the meeting or such adjourned session by such stockholder, is
filed with the records of the meeting or if the stockholder attends such meeting
without objecting at the beginning of the meeting to the transaction of any
business because the meeting is not lawfully called or convened. Neither the
business to be transacted at, nor the purpose of, any meeting of the
stockholders or any adjourned session thereof need be specified in any written
waiver of notice.
2.5. Business at Meetings. Unless otherwise determined by the board of
directors prior to a meeting of the stockholders, the chairman of such meeting,
determined in accordance with these By-laws, shall determine the order of
business and shall have the authority in his discretion to regulate the conduct
of such meeting, including, without limitation, to impose restrictions on the
persons (other than stockholders of the corporation or their duly appointed
proxies) who may attend such meeting, to regulate and restrict the making of
statements or asking of questions at such meeting and to cause the removal from
such meeting of any person who has disrupted or appears likely to disrupt the
proceedings at such meeting.
At a meeting of the stockholders, only such business shall be conducted
as shall have been properly brought before the meeting. If a stockholder is
entitled under applicable law to propose that an item of business be brought
before an annual meeting of stockholders, such stockholder shall be required to
make such proposal in accordance with the following procedures: The stockholder
shall give timely notice thereof in writing to the clerk of the corporation and
the
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<PAGE>
stockholder must be a stockholder of record at the time such notice is given. To
be timely, a stockholder's notice must be delivered to or mailed and received at
the principal executive offices of the corporation not less than sixty (60) days
nor more than ninety (90) days prior to the meeting; provided, however, that in
the event that the date of the meeting is not publicly announced by the
corporation by mail, press release or otherwise more than seventy (70) days
prior to the meeting, notice by the stockholder to be timely must be delivered
to the clerk of the corporation not later than the close of business on the
tenth (10th) day following the day on which such announcement of the date of the
meeting was made.
A stockholder's notice to the clerk shall set forth as to each matter
the stockholder proposes to bring before the meeting (a) a brief description of
the business desired to be brought before the meeting and the reasons for
conducting such business at the meeting, (b) the name and address, as they
appear on the corporation's books, of the stockholder proposing such business,
(c) the class and number of shares of the corporation which are beneficially
owned by the stockholder, and (d) any material financial interest of the
stockholder in such business. As provided in Section 2.2 hereof, holders of the
requisite amount of shares of Voting Stock may apply to call a special meeting
of stockholders. Such application shall state, inter alia, the purpose or
purposes of the proposed meeting and the holders making such application shall
provide, with respect to each matter such holders propose to bring before the
meeting, the information specified by the second immediately preceding sentence.
The chairman of the meeting shall, if the facts warrant, determine and
declare to the meeting that business was not properly brought before the meeting
and in accordance with the provisions of this Section 2.5, and if he should so
determine, he shall so declare to the meeting and any such business not properly
brought before the meeting shall not be transacted. Notwithstanding the
foregoing provisions of this Section 2.5, a stockholder shall also comply with
all applicable requirements of the Securities Exchange Act of 1934, as amended,
and the rules and regulations thereunder with respect to the matters set forth
in this Section 2.5.
2.6. Quorum of Stockholders. At any meeting of the stockholders, a
quorum as to any matter shall consist of a majority of the votes entitled to be
cast on the matter, except when a larger quorum is required by law, by the
Articles of Organization or by these By-laws. Stock owned directly or indirectly
by the corporation, if any, shall not be deemed outstanding for this purpose.
Any meeting may be adjourned from time to time by a majority of the votes
properly cast upon the question, whether or not a quorum is present, and the
meeting may be held as adjourned without further notice.
2.7. Action by Vote. When a quorum is present at any meeting, a
plurality of the votes properly cast for election to any office shall elect to
such office, and a majority of the votes properly cast upon any question other
than an election to an office shall decide the question, except when a larger
vote is required by law, by the Articles or Organization or by these By-laws. No
ballot shall be required for any election unless requested by a stockholder
present or represented at the meeting and entitled to vote in the election or
unless directed by the presiding officer at the meeting.
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2.8. Voting. Stockholders entitled to vote shall have one vote for each
share of stock entitled to vote held by them of record according to the records
of the corporation, unless otherwise provided by the Articles of Organization.
The corporation shall not, directly or indirectly, vote any share of its own
stock.
2.9. Proxies. To the extent permitted by law, stockholders entitled to
vote may vote either in person or by proxy. Except to the extent permitted by
law, no proxy dated more than six (6) months before the meeting named therein
shall be valid. Unless otherwise specifically limited by their terms, such
proxies shall entitle the holders thereof to vote at any adjournment of such
meeting but shall not be valid after the final adjournment of such meeting.
Section 3. BOARD OF DIRECTORS
3.1. Number. Except as otherwise provided in the Articles of
Organization, a board of directors of not more than twenty-six (26) nor less
than three (3) directors, the exact number of directors to be determined from
time to time by the directors, divided into classes and elected for terms as
provided in the Articles of Organization, shall be elected at the annual meeting
of the stockholders by such stockholders as have the right to vote at such
election. Subject to the foregoing limitations and the requirements of the
Articles of Organization, the number of directors may be increased at any time
or from time to time to any number of not more than thirty (30) by the directors
by vote of a majority of the directors then in office. The number of directors
may be decreased to any number not less than three (3) at any time or from time
to time by the directors by a vote of a majority of the directors then in
office, but only to eliminate vacancies existing by reason of the death,
resignation or removal of one or more directors.
3.2. Notification of Nominations. Except as otherwise provided in the
Articles of Organization, nominations for the election of directors may be made
by the board of directors or by any stockholder entitled to vote for the
election of directors. Any stockholder entitled to vote for the election of
directors at a meeting may nominate persons for election as directors by giving
timely notice thereof in proper written form to the clerk accompanied by a
petition signed by at least 100 record holders of capital stock of the
corporation which shows the class and number of shares held by each person and
which represent in the aggregate at least one percent (1%) of the combined
voting power of the then outstanding shares of Voting Stock entitled to vote
generally in the election of directors.
To be timely, notice shall be delivered to or mailed and received at
the principal executive offices of the corporation not less than sixty (60) days
nor more than ninety (90) days prior to the meeting; provided, however, that in
the event that less than seventy (70) days' notice or prior public disclosure of
the date of the meeting is given or made to the stockholders, to be timely,
notice by the stockholder must be received at the principal executive offices
not later than the close of business on the tenth (10th) day following the date
on which such notice of the date of the meeting was mailed or such public
disclosure was made.
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<PAGE>
To be in proper written form, a stockholder's notice shall set forth in
writing (i) as to each person whom the stockholder proposes to nominate for
election or reelection as a director, all information relating to such person
that is required to be disclosed in solicitations of proxies for election of
directors, or is otherwise required, in each case pursuant to Regulation 14A
under the Securities Exchange Act of 1934, as amended (or any successor rules or
regulations), including, without limitation, such person's written consent to
being named in the proxy statement as a nominee and to serving as a director if
elected, and (ii) as to the stockholder giving the notice (x) the name and
address, as they appear on the corporation's books, of such stockholder, and (y)
the class and number of shares of the corporation which are beneficially owned
by such stockholder. At the request of the board of directors, any person
nominated by the board of directors for election as a director shall furnish to
the clerk the information required to be set forth in a stockholder's notice of
nomination which pertains to the nominee. In the event that a stockholder seeks
to nominate one or more directors, the clerk shall determine whether a
stockholder has complied with this Section 3.2. If the clerk shall determine
that a stockholder has not complied with this Section 3.2, the clerk shall
direct the chairman of the meeting to declare to the meeting that a nomination
was not made in accordance with the procedures prescribed by these By-laws, and
the chairman of the meeting shall so declare to the meeting and the defective
nomination shall be disregarded.
3.3. Tenure. The directors shall hold office as provided in the
Articles of Organization.
3.4. Powers. Except as reserved to the stockholders by law, by the
Articles of Organization or by these By-laws, the business of the corporation
shall be managed by the directors who shall have and may exercise all the powers
of the corporation. In particular, and without limiting the generality of the
foregoing, the directors may at any time issue all or from time to time any part
of the unissued capital stock of the corporation from time to time authorized
under the Articles of Organization and may determine, subject to any
requirements of law, the consideration for which stock is to be issued and the
manner of allocating such consideration between capital and surplus.
3.5. Vacancies. Vacancies and any newly created directorships resulting
from any increase in the number of directors may be filled only by vote of a
majority of the directors then in office, although less than a quorum, or by a
sole remaining director. When one or more directors shall resign from the board
of directors, effective at a future date, a majority of the directors then in
office, including those who have resigned, shall have power to fill such vacancy
or vacancies, the vote or action by writing thereon to take effect when such
resignation or resignations shall become effective. The directors shall have and
may exercise all their powers notwithstanding the existence of one or more
vacancies in their number, subject to any requirements of law or the Articles of
Organization or of these By-laws as to the number of directors required for a
quorum or for any vote or other actions.
3.6. Committees. The directors may, by vote of a majority of the
directors then in office, elect from their number such committees and delegate
to such committees some or all of the powers of the directors except those which
by law, by the Articles of Organization or by these By-Laws they are prohibited
from delegating. Such committees shall serve at the pleasure of the
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<PAGE>
board of directors. Except as the directors may otherwise determine, any
committee of the board of directors may make rules for the conduct of its
business, but unless otherwise provided by the directors or such rules, its
business shall be conducted as nearly as may be in the same manner as is
provided by these By-laws for the conduct of business by the directors.
3.7. Executive Committee. The board of directors may designate an
executive committee of the board of directors, which shall have and may
exercise, in the interval between meetings of the board of directors, all of the
powers of the board of directors and the management of the business and affairs
of the corporation, except that such committee shall not have such power or
authority in reference to amending the Articles of Organization, adopting an
agreement of merger or consolidation, recommending to the stockholders the sale,
lease or exchange of all or substantially all of the corporation's property and
assets, recommending to the stockholders a dissolution of the corporation or
revocation of a dissolution, or amending the by-laws of the corporation, or to
declare a dividend, to authorize the issuance of stock of the corporation, or to
authorize and affirm any action requiring the affirmative vote of more than a
majority of the directors then in office.
3.8. Compensation Committee. The board of directors may designate a
compensation committee of the board of directors, which shall be empowered to
fix the salaries and other compensation of the officers of the corporation and
shall have the powers and authority vested in it by any compensation or
incentive plan of the corporation with respect to officers and employees and
such other power and authority as determined by the board of directors.
3.9. Stock Option Plan Committee. The board of directors may designate
a stock option plan committee of the board of directors, which shall be
empowered to grant options to eligible directors, officers and key employees of
the corporation and its affiliates and determine the terms thereof and shall
perform such other duties as determined by the board of directors.
3.10. Audit Committee. The board of directors may designate an audit
committee of the board of directors, which shall be empowered to recommend to
the board of directors the selection of independent certified public
accountants, shall review the scope and terms of the audit and recommendations
of such accountant concerning the financial practices and procedures of the
corporation and shall report to the board of directors thereon and shall perform
such other duties as determined by the board of directors.
3.11. Regular Meetings. Regular meetings of the directors may be held
without call or notice at such places and at such times as the directors may
from time to time determine, provided that reasonable notice of the first
regular meeting following any such determination shall be given to absent
directors. A regular meeting of the directors may be held without call or notice
immediately after and at the same place as the annual meeting of the
stockholders.
3.12. Special Meetings. Special meetings of the directors may be held
at any time and at any place designated in the call of the meeting, when called
by the chairman of the board, if any, the chief executive officer, the president
or the treasurer or by two or more directors, reasonable
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<PAGE>
notice thereof being given to each director by the secretary or an assistant
secretary, or, if there be none, by the clerk or an assistant clerk, or by the
officer or one of the directors calling the meeting.
3.13. Notice. It shall be sufficient notice to a director to send
notice by mail at least forty-eight hours or by telegram or facsimile
transmission at least twenty-four hours before the meeting addressed to him at
his usual or last known business or residence address or to give notice to him
in person or by telephone at least twenty-four hours before the meeting. Notice
of a meeting need not be given to any director if a written waiver of notice,
executed by him before or after the meeting, is filed with the records of the
meeting, or to any director who attends the meeting without protesting prior
thereto or at its commencement the lack of notice to him. Neither notice of a
meeting nor a waiver of a notice need specify the purposes of the meeting.
3.14. Quorum. At any meeting of the directors a majority of the
directors then in office shall constitute a quorum. Any meeting may be adjourned
from time to time by a majority of the votes cast upon the question, whether or
not a quorum is present, and the meeting may be held as adjourned without
further notice.
3.15. Action by Vote. When a quorum is present at any meeting, a
majority of the directors present may take any action, except when a larger vote
is required by law, by the Articles of Organization or by these By-laws.
3.16. Action by Writing. Unless the Articles of Organization otherwise
provide, any action required or permitted to be taken at any meeting of the
directors may be taken without a meeting if all the directors consent to the
action in writing and the written consents are filed with the records of the
meetings of the directors. Such consents shall be treated for all purposes as a
vote taken at a meeting.
3.17. Presence Through Communications Equipment. Unless otherwise
provided by law or the Articles of Organization, members of the board of
directors may participate in a meeting of such board by means of a conference
telephone or similar communications equipment by means of which all persons
participating in the meeting can hear each other at the same time and
participation by such means shall constitute presence in person at a meeting.
Section 4. OFFICERS
4.1. Enumeration. The officers of the corporation shall consist of a
president, a treasurer and a clerk. The board of directors may select such
additional officers, including, without limitation, a chairman of the board of
directors, a chief executive officer, a chief financial officer, a controller, a
secretary and one or more executive vice presidents, vice presidents or
assistant vice presidents, assistant treasurers, assistant clerks, assistant
secretaries, and assistant controllers as the board of directors may from time
to time determine, and such additional officers shall have such authority and
perform such duties as may from time to time be prescribed by the board of
directors.
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4.2. Qualifications. No officer need be a stockholder or a director.
The same person may hold at the same time one or more offices unless otherwise
provided by law. The clerk shall be a resident of Massachusetts unless the
corporation shall have a resident agent. Any officer may be required by the
board of directors to give a bond for the faithful performance of his duties in
such form and with such sureties as the board may determine.
4.3. Elections. The president, treasurer and clerk shall be elected
annually by the board of directors at its first meeting following the annual
meeting of the stockholders. All other officers shall be chosen or appointed by
the board of directors.
4.4. Term. Except as otherwise provided by law, by the Articles of
Organization or by these By-laws, the president, treasurer and clerk shall hold
office until the first meeting of the board of directors following the next
annual meeting of the stockholders and until their respective successors are
chosen and qualified. All other officers shall hold office until the first
meeting of the board of directors following the next annual meeting of the
stockholders, unless a shorter time is specified in the vote choosing or
appointing such officer or officers.
4.5. Certain Duties and Powers. The officers designated below, subject
at all times to these By-laws and to the direction and control of the board of
directors, shall have and may exercise the respective duties and powers set
forth below:
The Chairman of the Board of Directors. The chairman of
the board of directors, if there be one, shall, when present, preside
at all meetings of the board of directors and shall perform such other
duties as may be imposed by law, these By-laws or by the board of
directors.
The Chief Executive Officer. The chief executive officer
shall have general charge and oversight of the business and affairs of
the corporation and shall enforce and execute the orders and
instructions of the board of directors. In the absence of the chairman
of the board of directors, he shall, when present, preside at all
meetings of the stockholders, and, if a director, at all meetings of
the board of directors.
The President. The president shall be the chief operating
officer of the corporation and shall have general operating charge of
its business subject to the direction of the board of directors, the
chairman of the board of directors and the chief executive officer. In
the absence of the chairman of the board of directors and the chief
executive officer, he shall, when present, preside at all meetings of
the stockholders, and, if a director, at all meetings of the board of
directors.
The Vice Presidents. The board of directors may designate
any vice president to exercise the powers and discharge the duties of
the chief executive officer or the chief operating officer during the
absence or inability to act of both the chairman of the board of
directors and the president. A vice president not specifically
designated as aforesaid shall have such powers and discharge such
duties
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as may be from time to time conferred or imposed upon him by the board
of directors, the chairman of the board of directors, the chief
executive officer or the president.
The Treasurer. The treasurer shall cause to be kept
accurate books of account.
The Clerk. The clerk shall keep a record of all
proceedings of the stockholders and, if there be no secretary, shall
also keep a record of all proceedings of the board of directors. In the
absence of the clerk from any meeting of the stockholders or, if there
be no secretary, from any meeting of the board of directors, an
assistant clerk, if there be one, otherwise a clerk pro tempore
designated by the person presiding at the meeting, shall perform the
duties of the clerk at such meeting.
The Secretary. The secretary, if there be one, shall keep
a record of all proceedings of the board of directors. In the absence
of the secretary, if there be one, from any meeting of the board of
directors, an assistant secretary, if there be one, otherwise a
secretary pro tempore designated by the person presiding at the
meeting, shall perform the duties of the secretary at such meeting.
4.6. Other Duties and Powers. Each officer, subject at all times to
these By-laws and to the direction and control of the board of directors, shall
have and may exercise, in addition to the duties and powers specifically set
forth in these By-laws, such duties and powers as are prescribed by law, such
duties and powers as are commonly incident to his office and such duties and
powers as the board of directors may from time to time prescribe.
Section 5. RESIGNATIONS AND REMOVALS
Any director or officer may resign at any time by delivering his or her
resignation in writing to the chairman of the board of directors, if any, the
chief executive officer, the president, the treasurer or the clerk or to a
meeting of the directors. Such resignation shall be effective upon receipt
unless specified to be effective at some other time, and without in each case
the necessity of it being accepted unless the resignation shall so state. The
directors may be removed only as provided in the Articles of Organization. The
directors may remove any officer elected or appointed by them with or without
cause by the vote of a majority of the directors then in office. An officer may
be removed for cause only after a reasonable notice and opportunity to be heard
by the board of directors or by a standing or special committee of the board of
directors designated for the purpose.
Except where a right to receive compensation shall be expressly
provided in a duly authorized written agreement with the corporation, no
director or officer resigning and no director or officer removed shall have any
right to any compensation as such director or officer for any period following
his or her resignation or removal, or any right to damages on account of
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such removal, whether his or her compensation be by the month or by the year or
otherwise; unless, in the case of a resignation, the directors, or in the case
of a removal, the body acting on the removal, shall in their or its discretion
provide for compensation.
Section 6. VACANCIES
The directors shall elect a successor if the office of the president,
treasurer or clerk becomes vacant and may elect a successor if any other office
becomes vacant. Each such successor shall hold office for the unexpired term and
in the case of the president, treasurer and clerk until his successor is chosen
and qualified, or in each case until he sooner dies, resigns, is removed or
becomes disqualified. Any vacancy of a directorship shall be filled as specified
in Section 3.5 of these By-laws.
Section 7. CAPITAL STOCK
7.1. Number and Par Value. The total number of shares and the par
value, if any, of each class of stock which the corporation is authorized to
issue shall be as stated in the Articles of Organization.
7.2. Shares Represented by Certificates and Uncertificated Shares. The
board of directors may provide by resolution that some or all of any or all
classes and series of shares shall be uncertificated shares. Unless such a
resolution has been adopted, a stockholder shall be entitled to a certificate
stating the number and the class and the designation of the series, if any, of
the shares held by him, in such form as shall, in conformity to law, be
prescribed from time to time by the directors. Such certificate shall be signed
by the chairman of the board of directors, if any, the chief executive officer,
the president or a vice president and by the treasurer or an assistant
treasurer. Such signatures may be facsimiles if the certificate is signed by a
transfer agent, or by a registrar, other than a director, officer or employee of
the corporation. In case any officer who has signed or whose facsimile signature
has been placed on such certificate shall have ceased to be such officer before
such certificate is issued, it may be issued by the corporation with the same
effect as if he were such officer at the time of its issue.
7.3. Loss of Certificates. In the case of the alleged loss or
destruction or the mutilation of a certificate of stock, a duplicate certificate
may be issued in place thereof, upon such conditions as the directors may
prescribe.
Section 8. TRANSFER OF SHARES OF STOCK
8.1. Transfer on Books. Subject to the restrictions, if any, stated or
noted on the stock certificates, shares of stock may be transferred on the books
of the corporation by the surrender to the corporation or its transfer agent of
the certificate therefor properly endorsed or accompanied by a written
assignment and power of attorney properly executed, with necessary transfer
stamps affixed, and with such proof of the authenticity of signature as the
directors or the transfer agent of the corporation may reasonably require.
Except as may be otherwise required by
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law, by the Articles of Organization or by these By-laws, the corporation shall
be entitled to treat the record holder of stock as shown on its books as the
owner of such stock for all purposes, including the payment of dividends and the
right to receive notice and to vote with respect thereto, regardless of any
transfer, pledge or other disposition of such stock until the shares have been
transferred on the books of the corporation in accordance with the requirements
of these By-laws.
It shall be the duty of each stockholder to notify the corporation of
his post office address.
8.2. Record Date and Closing Transfer Books. The directors may fix in
advance a time, which shall not be more than sixty (60) days before the date of
any meeting of stockholders or the date for the payment of any dividend or
making of any distribution to stockholders or the last date on which the consent
or dissent of stockholders may be effectively expressed for any purpose, as the
record date for determining the stockholders having the right to notice of and
to vote at such meeting and any adjournment thereof or the right to receive such
dividend or distribution or the right to give such consent or dissent, and in
such case only stockholders of record on such record date shall have such right,
notwithstanding any transfer of stock on the books of the corporation after the
record date; or without fixing such record date the directors may for any of
such purposes close the transfer books for all or any part of such period. If no
record date is fixed and the transfer books are not closed:
(1) the record date for determining stockholders having the
right to notice of or to vote at a meeting of stockholders shall be at
the close of business on the date next preceding the day on which
notice is given; and
(2) the record date for determining stockholders for any other
purpose shall be at the close of business on the day on which the board
of directors acts with respect thereto.
Section 9. CORPORATE SEAL
The seal of the corporation shall, subject to alteration by the
directors, consist of a flat- faced circular die with the word "Massachusetts",
together with the name of the corporation and the year of its organization, cut
or engraved thereon.
Section 10. EXECUTION OF PAPERS
Except as the directors may generally or in particular cases authorize
the execution thereof in some other manner, all deeds, leases, transfers,
contracts, bonds, notes, checks, drafts and other obligations made, accepted or
endorsed by the corporation shall be signed by the chairman of the board of
directors, if any, the chief executive officer, the president, a vice president
or the treasurer.
- --------------------------------------------------------------------------------
Amended and Restated Bylaws:
Liberty Financial Companies, Inc. 11-12 2/13/98
<PAGE>
Section 11. FISCAL YEAR
The fiscal year of the corporation shall end on December 31.
Section 12. BUSINESS COMBINATIONS
The provisions of Chapter 110F of the Massachusetts General Laws shall
not apply to any business combination (as defined in said Chapter 110F)
involving the corporation effected subsequent to March 24, 1996, or to any
business combination involving the corporation and Liberty Mutual.
Section 13. CONTROL SHARE ACQUISITIONS
The provisions of Chapter 110D of the Massachusetts General Laws shall
not apply to any control share acquisition (as defined in said Chapter 110D)
involving the corporation.
Section 14. AMENDMENTS
These By-laws may be altered, amended or repealed at any annual or
special meeting of the stockholders called for the purpose, of which the notice
shall specify the subject matter of the proposed alteration, amendment or repeal
or the sections to be affected thereby, by vote of the stockholders, or if there
shall be two or more classes or series of stock entitled to vote on the
question, by vote of each such class or series. The affirmative vote of a
majority of the total number of votes of the then outstanding shares of Voting
Stock, voting together as a single class shall be required for any alteration,
amendment or repeal of Section 2.2, Section 2.5, Section 3.1, Section 3.2,
Section 3.5, the third sentence of Section 5, Section 12, Section 13 or this
Section 14.
These By-laws may also be altered, amended or repealed by vote of the
majority of the directors then in office, except with respect to any provision
which by law, the Articles of Organization or these By-laws requires action by
the stockholders. Action by the stockholders is required to amend, alter or
repeal this Section 14 so as to increase the power of the directors, or to
reduce the power of the stockholders, to amend, alter or repeal these By-laws.
The directors shall not take any action with respect to the alteration,
amendment or repeal of these By-laws which would provide for indemnification of
directors, unless permitted by law.
Any By-law altered, amended or repealed by the directors may be further
altered or amended or reinstated by the stockholders in the above manner.
- --------------------------------------------------------------------------------
Amended and Restated Bylaws:
Liberty Financial Companies, Inc. 12-12 2/13/98
Exhibit 12
LIBERTY FINANCIAL COMPANIES, INC.
STATEMENT RE COMPUTATION OF RATIOS
($ in millions)
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Earnings:
Income before income taxes ................................ $ 192.1 $ 150.3 $ 113.8
Add fixed charges:
Interest on indebtedness ................................. 21.4 19.7 16.2
Portion of rent representing the interest factor ......... 3.7 4.0 3.7
Preferred stock dividends ................................ 0.9 0.9 0.7
Accretion to face value of redeemable convertible
preferred stock ........................................ 0.8 0.9 0.6
------- ------- -------
Income as adjusted ........................................ $ 218.9 $ 175.8 $ 135.0
======= ======= =======
Fixed charges:
Interest on indebtedness .................................. $ 21.4 $ 19.7 $ 16.2
Portion of rent representing the interest factor .......... 3.7 4.0 3.7
Preferred stock dividends ................................. 0.9 0.9 0.7
Accretion to face value of redeemable convertible
preferred stock ......................................... 0.8 0.9 0.6
------- ------- -------
Total fixed charges ....................................... $ 26.8 $ 25.5 $ 21.2
======= ======= =======
Ratio of earnings to fixed charges ......................... 8.17x 6.89x 6.39x
======= ======= =======
</TABLE>
EXHIBIT 13
Portions of Annual Report to Stockholders
Incorporated into this Filing
Selected Financial Data
Selected Consolidated Financial Data(1)
(in millions, except per share data)
<TABLE>
<CAPTION>
As of or for the Year Ended December 31 1997 1996 1995 1994 1993
.......................................................................................................................
<S> <C> <C> <C> <C> <C>
Income Statement Data
Investment income $ 853.1 $ 796.4 $ 761.8 $ 695.1 $ 675.3
Interest credited to policyholders (594.1) (572.7) (555.8) (481.9) (504.2)
---------- ---------- ---------- --------- ---------
Investment spread 259.0 223.7 206.0 213.2 171.1
---------- ---------- ---------- --------- ---------
Net realized investment gains (losses) 25.9 8.0 (4.0) (8.2) 11.4
---------- ---------- ---------- --------- ---------
Fee income:
Investment advisory and administrative fees 217.9 196.4 155.8 95.9 98.9
Distribution and service fees 49.2 44.9 28.9 -- --
Transfer agency fees 47.7 43.9 30.8 4.0 5.4
Surrender charges and net commissions 36.1 34.7 23.4 20.0 22.9
Separate account fees 17.1 16.0 13.2 12.5 8.0
---------- ---------- ---------- --------- ---------
Total fee income 368.0 335.9 252.1 132.4 135.2
---------- ---------- ---------- --------- ---------
Expenses:
Operating expenses(2) (309.7) (277.9) (225.1) (174.9) (178.9)
Amortization of deferred policy acquisition costs (75.9) (60.2) (58.5) (52.2) (41.0)
Amortization of deferred distribution costs (34.2) (33.9) (18.8) -- --
Amortization of value of insurance in force (10.5) (10.2) ( 9.5) (17.0) (22.4)
Amortization of intangible assets (13.5) (15.4) (12.2) ( 5.8) (15.0)
Interest expense, net (17.0) (19.7) (16.2) ( 4.2) --
---------- ---------- ---------- --------- ---------
Total expenses (460.8) (417.3) (340.3) (254.1) (257.3)
---------- ---------- ---------- --------- ---------
Pretax income 192.1 150.3 113.8 83.3 60.4
Income tax expense (62.6) (49.6) (39.9) (32.5) (29.1)
---------- ---------- ---------- --------- ---------
Net income $ 129.5 $ 100.7 $ 73.9 $ 50.8 $ 31.3
========== ========== ========== ========= =========
Per Share Data(3)
Net income per share--basic $ 2.94 $ 2.36 $ 1.85 $ 1.49 $ 0.91
Net income per share--assuming dilution 2.77 2.24 1.76 1.43 0.88
Dividends on common stock(4) 0.40 0.40 0.30 -- --
Dividends on convertible preferred stock 2.88 2.88 2.21 -- --
Book value 26.82 24.42 23.03 18.25 18.67
Other Operating Data
Net operating income(5) $ 112.4 $ 94.8 $ 76.5 $ 56.2 $ 23.9
Net realized investment gains (losses), net of taxes 17.1 5.9 (2.6) (5.4) 7.4
---------- ---------- ---------- --------- ---------
Net income $ 129.5 $ 100.7 $ 73.9 $ 50.8 $ 31.3
========== ========== ========== ========= =========
Balance Sheet Data
Total investments $12,343.5 $11,537.9 $10,144.7 $ 8,590.2 $ 8,411.7
Intangible assets 199.0 205.4 192.3 29.3 35.2
Total assets 15,851.6 14,427.7 12,749.4 10,968.8 10,324.6
Notes payable to affiliates 229.0 229.0 229.0 75.0 --
Series A redeemable convertible preferred stock 14.6 13.8 13.0 -- --
Stockholders' equity 1,198.9 1,051.4 956.4 624.7 638.8
Shares of common stock outstanding3 44.7 43.1 41.5 34.2 34.2
</TABLE>
- -------------
1 Includes data for acquired entities from and after the applicable
acquisition date (the most significant being Colonial, which was acquired
on March 24, 1995). See Note 2 of Notes to the Consolidated Financial
Statements. The data presented should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto and other financial
information included herein and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION."
2 In 1993, the Company recognized a $22.1 million option plan compensation
charge, which primarily reflected a revision in the benefit plan formula
from an earnings-based formula to one based upon 104% of book value.
3 Share and per share amounts have been adjusted for a three-for-two common
stock split effected in the form of a 50 percent stock dividend distributed
on December 10, 1997. In addition, net income per share amounts were
prepared in accordance with Statement of Financial Accounting Standards No.
128, "Earnings per Share."
4 The amount for 1995 does not include a non-cash dividend of $30.0 million
to an affiliate of Liberty Mutual. See Note 5 of Notes to the Consolidated
Financial Statements.
5 Net operating income is defined as net income, excluding net realized
investment gains and losses, net of related income taxes.
24
<PAGE>
Management's Discussion
Management's Discussion and Analysis of Results of Operations and Financial
Condition
Results of Operations
Net Income was $129.5 million or $2.77 per share in 1997 compared to $100.7
million or $2.24 per share in 1996 and $73.9 million or $1.76 per share in
1995. The increase in 1997 compared to 1996 resulted from higher investment
spread, higher fee income, higher net realized investment gains and lower
interest expense, net. Partially offsetting these items were increased
operating expenses, amortization expense and income tax expense. The increase
in 1996 compared to 1995 resulted from higher investment spread, higher fee
income and net realized investment gains in 1996 compared to net realized
investment losses in 1995. Partially offsetting these items were increased
operating expenses, amortization expense, interest expense, net and income tax
expense. The full-period consolidation of the 1995 Colonial and Newport
acquisitions resulted in an $8.9 million increase in 1996 net income compared
to 1995.
Pretax Income was $192.1 million in 1997 compared to $150.3 million in 1996 and
$113.8 million in 1995. The higher pretax income in 1997 compared to 1996
resulted from higher investment spread, higher fee income, higher net realized
investment gains and lower interest expense, net. Partially offsetting these
items were increased operating expenses and amortization expense. The higher
pretax income in 1996 compared to 1995 resulted from higher investment spread,
higher fee income and net realized investment gains in 1996 compared to net
investment losses in 1995. The full-period consolidation of the 1995 Colonial
and Newport acquisitions resulted in an $11.9 million increase in 1996 pretax
income compared to 1995. Partially offsetting these items were increased
operating expenses, amortization expense and interest expense, net.
Investment Spread is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $259.0 million in 1997 compared to $223.7 million in 1996
and $206.0 million in 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 1997
was 1.96% compared to 1.89% for 1996 and 1.90% for 1995.
Investment income was $853.1 million in 1997 compared to $796.4 million in 1996
and $761.8 million in 1995. The increase of $56.7 million in 1997 compared to
1996 primarily relates to an $86.2 million increase as a result of the higher
level of average invested assets, partially offset by a $29.5 million decrease
resulting from a lower average investment yield. The 1997 investment income was
net of $47.6 million of S&P 500 Index call option amortization expense related
to the Company's equity-indexed annuities compared to $14.0 million in 1996.
The average investment yield was 6.95% in 1997 compared to 7.21% in 1996.
Investment income increased in 1996 compared to 1995 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 7.21% in 1996
compared to 7.57% in 1995.
Interest credited to policyholders totaled $594.1 million in 1997 compared to
$572.7 million in 1996 and $555.8 million in 1995. The increase of $21.4
million in 1997 compared to 1996 primarily relates to a $56.4 million increase
as a result of a higher level of average policyholder balances, partially
offset by a $35.0 million decrease resulting from a lower average interest
credited rate. Policyholder balances averaged $11.9 billion (including $10.8
billion of fixed products, consisting of
25
<PAGE>
fixed annuities and the closed block of single premium whole life insurance,
and $1.1 billion of equity-indexed annuities) in 1997 compared to $10.8 billion
(including $10.4 billion of fixed products and $0.4 billion of equity-indexed
annuities) in 1996. The average interest credited rate was 4.99% (5.45% on
fixed products and 0.85% on equity-indexed annuities) in 1997 compared to 5.32%
(5.50% on fixed products and 0.85% on equity-indexed annuities) in 1996.
Keyport'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. Keyport's equity-indexed
annuities also provide a full guarantee of principal if held to term, 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 a 0.85% net credited rate. Interest credited to policyholders
increased in 1996 compared to 1995 primarily as a result of a higher level of
average policyholder balances, partially offset by a decrease in the average
interest credited rate. Policyholder balances averaged $10.8 billion in 1996
compared to $9.8 billion in 1995. The average interest credited rate was 5.67%
in 1995.
Average investments in the Company's general account (computed without giving
effect to SFAS 115), including a portion of the Company's cash and cash
equivalents, were $12.3 billion in 1997 compared to $11.0 billion in 1996 and
$10.1 billion in 1995. The increase of $1.3 billion in 1997 compared to 1996
was primarily due 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 and net insurance cash flows of $0.7 billion. The
increase of $0.9 billion in 1996 compared to 1995 was primarily due to the F&G
Life transaction and net insurance cash flows of $0.7 billion.
Net Realized Investment Gains were $25.9 million in 1997 compared to $8.0
million in 1996 and net realized investment losses of $4.0 million in 1995.
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 $16.8 million and gains on redemption of seed
money investments in separate account mutual funds sponsored by the Company of
$7.9 million. In addition, there were $1.2 million in gains related to sales of
general corporate securities in the Company's asset management and corporate
operations. The net realized investment gains in 1996 were primarily
attributable to sales of fixed maturity investments and sales of investments
received in the F&G Life transaction. The net realized investment losses in
1995 were attributable to sales of fixed maturity investments.
Investment Advisory and Administrative Fees are based on the market value of
assets managed for mutual funds, wealth management and institutional investors.
Investment advisory and administrative fees were $217.9 million in 1997
compared to $196.4 million in 1996 and $155.8 million in 1995. The increase in
1997 compared to 1996 primarily reflects a higher level of average fee-based
assets under management. The increase in 1996 compared to 1995 primarily
reflects a higher level of average fee-based assets under management due to the
full year consolidation of Colonial and Newport.
Average fee-based assets under management were $37.2 billion in 1997 compared
to $33.9 billion in 1996 and $27.2 billion in 1995. The increase during 1997
compared to 1996 was primarily due to market appreciation. The increase during
1996 compared to 1995 was primarily due to the full year inclusion of the
assets acquired in the Colonial and Newport acquisitions, net mutual fund sales
and market appreciation. Investment advisory and administrative fees were 0.59%
of average fee-based assets under management in 1997, 0.58% in 1996 and 0.57%
in 1995. These increases in the effective fee
26
<PAGE>
rate in 1997 and 1996 were primarily due to the increased proportion of higher
average fee-based mutual fund assets under management.
The amount of fee-based assets under management are affected by product sales
and redemptions and by changes in the market values of such assets under
management. Fee-based assets under management and changes in such assets are
set forth in the tables below (in billions).
Fee-Based Assets Under Management
<TABLE>
<CAPTION>
As of December 31
--------------------------------
1997 1996 1995
.............................................................................
<S> <C> <C> <C>
Mutual Funds:
Intermediary-distributed $16.1 $16.1 $15.7
Direct-marketed 7.2 6.6 4.8
Closed-end 2.2 1.9 1.8
Variable annuity 1.3 1.1 1.0
----- ----- -----
26.8 25.7 23.3
Wealth management 6.6 5.3 4.5
Institutional 5.3 4.9 4.1
----- ----- -----
Total fee-based assets under management* $38.7 $35.9 $31.9
===== ===== =====
</TABLE>
* As of December 31, 1997, 1996 and 1995, Keyport's insurance assets of $12.8
billion, $12.1 billion and $10.6 billion, respectively, bring total assets
under management to $51.5 billion, $48.0 billion and $42.5 billion,
respectively.
Changes in Fee-Based Assets Under Management
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------
1997 1996 1995
..............................................................................
<S> <C> <C> <C>
Fee-based assets under management--beginning $35.9 $31.9 $16.3
Sales and reinvestments 6.6 7.5 4.8
Redemptions and withdrawals (6.6) (5.7) (8.5)
Acquisitions -- 0.3 14.9
Market appreciation 2.8 1.9 4.4
----- ----- -----
Fee-based assets under management--ending $38.7 $35.9 $31.9
===== ===== =====
</TABLE>
Distribution and Service Fees are based on the market value of the Company's
intermediary-distributed mutual funds. Distribution fees of 0.75% are generally
earned on the average assets attributable to such funds sold with contingent
deferred sales charges and service fees of 0.25% (net of amounts passed on to
selling brokers) are generally earned on the total of such average mutual fund
assets. These fees totaled $49.2 million in 1997 compared to $44.9 million in
1996 and $28.9 million in 1995. These increases in 1997 and 1996 were primarily
attributable to the higher asset levels of mutual
27
<PAGE>
funds with contingent deferred sales charges. As a percentage of weighted
average assets, distribution and service fees were approximately 0.71% in 1997
and 0.69% in each of 1996 and 1995.
Transfer Agency Fees are based on the market value of the assets managed in the
Company's intermediary-distributed and direct-marketed mutual funds. Such fees
were $47.7 million on average assets of $24.1 billion in 1997, $43.9 million on
average assets of $22.6 billion in 1996 and $30.8 million on average assets of
$17.4 billion in 1995. These increases in 1997 and 1996 were primarily due to
higher average assets in direct-marketed mutual funds. As a percentage of total
average mutual fund assets under management, transfer agency fees were
approximately 0.20%, 0.19% and 0.18% in 1997, 1996 and 1995, respectively.
Surrender Charges and Net Commissions are revenues earned on: a) the early
withdrawal of annuity policyholder balances and redemptions of the
intermediary-distributed mutual funds which were sold with contingent deferred
sales charges; b) the distribution of the Company's intermediary-distributed
mutual funds (net of the substantial portion of commissions that is passed on
to the selling brokers); and c) the sales of non-proprietary products in the
Company's bank marketing businesses (net of commissions that are paid to the
Company's client banks and brokers). Total surrender charges and net
commissions were $36.1 million in 1997 compared to $34.7 million in 1996 and
$23.4 million in 1995.
Surrender charges on fixed and variable annuity withdrawals generally are
assessed at declining rates applied to policyholder withdrawals during the
first five to seven years of the contract; contingent deferred sales charges on
mutual fund redemptions are assessed at declining rates on amounts redeemed
generally during the first six years. Such charges totaled $21.4 million, $19.8
million and $18.4 million in 1997, 1996 and 1995, respectively. Total annuity
withdrawals represented 11.6%, 11.6% and 9.9% of the total average annuity
policyholder and separate account balances in 1997, 1996 and 1995,
respectively. Excluding surrenders from the older block of annuities acquired
in the F&G Life transaction, the withdrawal percentages were 10.6% and 10.0% in
1997 and 1996, respectively.
Net commissions were $14.7 million in 1997, $14.9 million in 1996 and $5.0
million in 1995. The increase in 1996 compared to 1995 was primarily
attributable to the acquisition of Independent in March 1996.
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 in separate accounts supporting the
contracts, were $17.1 million in 1997 compared to $16.0 million in 1996 and
$13.2 million in 1995. Such fees represented 1.54%, 1.68% and 1.61% of average
variable annuity and variable life separate account balances in 1997, 1996 and
1995, respectively.
Operating Expenses primarily represent compensation, marketing and other
general and administrative expenses. These expenses were $309.7 million in 1997
compared to $277.9 million in 1996 and $225.1 million in 1995. The increase in
1997 compared to 1996 was primarily due to increases in compensation and
marketing expenses. The increase in 1996 compared to 1995 was primarily due to
increases in compensation and marketing expenses and to the acquisition of
Independent. Operating expenses expressed as a percent of average total assets
under management were 0.63%, 0.62% and 0.60% in 1997, 1996 and 1995,
respectively.
28
<PAGE>
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 $75.9
million in 1997 compared to $60.2 million in 1996 and $58.5 million in 1995.
These increases in amortization in 1997 and 1996 were primarily related to the
increase in investment spread from the growth of business in force associated
with fixed and indexed products and the increased sales of variable annuity
products. Amortization expense represented 29.3%, 26.9% and 28.4% of investment
spread in 1997, 1996 and 1995, respectively.
Amortization of Deferred Distribution Costs relates to the deferred sales
commissions acquired in connection with the Colonial acquisition and the
distribution of mutual fund shares sold with contingent deferred sales charges.
Amortization was $34.2 million in 1997 compared to $33.9 million in 1996 and
$18.8 million in 1995. The increase in amortization in 1997 compared to 1996
was primarily attributable to the continuing sales of such fund shares during
1997 and 1996 partially offset by a $3.8 million charge in the fourth quarter
of 1996 relating to a reduction in the amortization period. The increase in
1996 was primarily attributable to the full period consolidation of Colonial,
the continuing sales of such fund shares during 1996 and 1995 and the $3.8
million charge in the fourth quarter of 1996.
Amortization of Value 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 $10.5 million in 1997 compared to
$10.2 million in 1996 and $9.5 million in 1995. The increase in amortization in
1997 compared to 1996 included increased amortization of $4.0 million related
to the F&G Life transaction partially offset by decreased amortization related
to a change in mortality assumptions. The increase in amortization in 1996
compared to 1995 was primarily due to $2.7 million of amortization recorded in
1996 relating to the F&G Life transaction, partially offset by lower
amortization in 1996 due to an increase in estimated amortization periods in
the last quarter of 1995 of the Company's closed block of single premium whole
life insurance.
Amortization of Intangible Assets relates to goodwill and certain identifiable
intangible assets arising from business combinations accounted for as
purchases. Amortization was $13.5 million in 1997 compared to $15.4 million in
1996 and $12.2 million in 1995. The decrease in amortization in 1997 compared
to 1996 was primarily attributable to certain assets becoming fully amortized
in the third quarter of 1996. The increase in amortization in 1996 compared to
1995 was primarily attributable to the acquisitions of Independent, Colonial
and Newport.
Interest Expense, Net was $17.0 million in 1997 compared to $19.7 million in
1996 and $16.2 million in 1995. The decrease in 1997 compared to 1996 was due
to lower interest expense related to Colonial's credit facility which is
utilized to finance the sale of shares of the mutual funds which have
contingent deferred sales charges and to higher interest income which is netted
against interest expense. The increase in 1996 compared to 1995 was primarily
attributable to the full year impact of the $100.0 million note issued in
connection with the Colonial acquisition, the $24.0 million note issued in
connection with the Newport acquisition and the $30.0 million note issued in
1995 to an affiliate of Liberty Mutual.
Income Tax Expense was $62.6 million or 32.6% of pretax income in 1997 compared
to $49.6 million or 33.0% of pretax income in 1996 and $39.9 million or 35.1%
of pretax income in 1995. The lower effective tax rates in 1997 and 1996 were
29
<PAGE>
attributable primarily to reductions in the deferred tax asset valuation
reserve. For all periods, substantially all the federal income tax expense
related to the Company's annuity insurance business.
Effective July 18, 1997, the Company is no longer included in the consolidated
tax return of Liberty Mutual. The Company will be required to file a separate
life return and a consolidated non-life return. The Company does not expect
this change to have a material effect on its financial condition or its results
of operations.
Financial Condition
Stockholders' Equity as of December 31, 1997 was $1.20 billion compared to
$1.05 billion as of December 31, 1996. Net income in 1997 was $129.5 million
and cash dividends on the Company's Preferred and Common Stock totaled $4.9
million. Common stock totaling $7.5 million and $2.5 million was issued in
connection with the exercise of stock options and for earn-out stock payments
related to the acquisition of Independent, respectively. In addition, the
exercise of certain stock options resulted in a federal income tax benefit to
the Company of $4.7 million which was credited to additional paid-in capital.
An increase in net unrealized investment gains, net of adjustments to deferred
policy acquisition costs and value of insurance in force, during the period
increased stockholders' equity by $8.6 million.
Book Value Per Share amounted to $26.82 at December 31, 1997 compared to $24.42
at December 31, 1996. Excluding net unrealized gains on investments, book value
per share amounted to $24.97 at December 31, 1997 and $22.70 at December 31,
1996. As of December 31, 1997, there were 44.7 million common shares
outstanding compared to 43.1 million shares as of December 31, 1996.
Investments not including cash and cash equivalents, totaled $12.3 billion at
December 31, 1997 compared to $11.5 billion at December 31, 1996. The increase
primarily reflects general account investment earnings.
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 carries such investments at fair value.
The Company's total investments at December 31, 1997 and 1996 reflected net
unrealized gains of $280.2 million and $229.8 million, respectively, relating
to its fixed maturity and equity portfolios. The increase in net unrealized
gains in 1997 principally reflects the lower interest rates at the end of 1997.
Approximately $11.0 billion or 81.7% of the Company's general account
investments at December 31, 1997 was rated by Standard & Poor's Corporation,
Moody's Investors Service or under comparable statutory rating guidelines
established by the National Association of Insurance Commissioners ("NAIC"). At
December 31, 1997, the carrying value of investments in below investment grade
securities totaled $1.1 billion or 7.9% of general account investments of $13.5
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.
30
<PAGE>
Management of the Company's Investments
Asset-liability duration management is utilized by the Company to minimize the
risks of interest rate fluctuations and policyholder withdrawals. The Company
believes that its fixed and indexed policyholder balances should be backed by
investments, principally comprised of fixed maturities, that generate
predictable rates of return. The Company does not have a specific target rate
of return. Instead, its rates of return vary over time depending on the current
interest rates, the slope of the yield curve and the excess at which fixed
maturities are priced over the yield curve. Its portfolio strategy is designed
to achieve 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 to make the cost of its
policyholder balances more predictable. Approximately 83.0% of the Company's
fixed annuity policyholder balances were subject to surrender charges at
December 31, 1997.
As part of its asset-liability management discipline, the Company conducts
detailed computer simulations that model its fixed-maturity assets and
liabilities under commonly used stress-test interest rate scenarios. Based on
the results of these computer simulations, the investment portfolio has been
constructed with a view toward maintaining a desired investment spread between
the yield on portfolio assets and the interest credited on policyholder
balances under a variety of possible future interest rate scenarios. At
December 31, 1997, the effective duration of the Company's fixed maturities
investments (including certain cash and cash equivalents) was approximately
2.9. 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 prepayment 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 agreements and
interest rate cap agreements to match assets more closely to liabilities. Swap
agreements are agreements to exchange with a counterparty interest rate
payments of differing character (e.g. fixed-rate payments exchanged for
variable-rate payments) based on an underlying principal balance (notional
principal) to hedge against interest rate changes. The Company currently
utilizes swap agreements to reduce asset duration and to better match interest
rates earned on longer-term fixed rate assets with interest 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 of $2.3 billion as of December 31,
1997 and 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 $250.0 million and $450.0 million as of December 31, 1997
and 1996, respectively.
31
<PAGE>
With respect to the Company's equity-indexed annuities, the Company buys call
options on the S&P 500 Index to hedge its obligation to provide returns based
upon this index. The Company had call options with a book value of $323.3
million and $109.7 million as of December 31, 1997 and 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, cap and call option agreements are
financially responsible and that the counterparty risk associated with these
transactions is minimal. In addition, swap and cap agreements have interest
rate risk and call options have stock market risk. These swap and cap
agreements hedge fixed-rate assets and the Company expects that any interest
rate movements that adversely affect the market value of swap and cap
agreements would be offset by changes in the market values of such fixed rate
assets. However, there can be no assurance that these hedges will be effective
in offsetting the potential adverse effects of changes in interest rates.
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 500 Index 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. Keyport's profitability could be adversely affected if
the value of its swap and cap agreements increase less than (or decrease more
than) the change in the market value of its fixed rate assets and/or if the
value of its S&P 500 Index call options 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 December 31, 1997 or 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 borrower's
affairs. In the case of publicly traded fixed maturities investments,
management also considers market value quotations if available.
Liquidity
The Company is a holding company whose liquidity needs include the following:
(i) operating expenses; (ii) debt service; (iii) dividends on Preferred Stock
and Common Stock; (iv) acquisitions; and (v) working capital where needed by
its operating subsidiaries. The Company's principal sources of cash are
dividends from its operating subsidiaries, and, in the case of funding for
acquisitions and certain long-term capital needs of its subsidiaries, long-term
borrowings, which to date have been from affiliates of Liberty Mutual Insurance
Company ("Liberty Mutual").
Current Rhode Island insurance law applicable to Keyport permits the payment of
dividends or distributions, which, together with dividends and distributions
paid during the preceding 12 months, do not exceed the lesser of (i) 10% of
Keyport's statutory surplus as of the preceding December 31 or (ii) Keyport's
statutory net gain from operations for the preceding fiscal year. Any proposed
dividend in excess of this amount is called an "extraordinary dividend" and may
not
32
<PAGE>
be paid until it is approved by the Commissioner of Insurance of the State of
Rhode Island. As of December 31, 1997, the amount of dividends that Keyport
could pay without such approval was $70.3 million. However, Keyport has not
paid any dividends since its acquisition in 1988.
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 and the assumption that Liberty
Mutual will continue to participate in the Dividend Reinvestment Plan, 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 anticipates that
it would require external sources of liquidity in order to finance material
acquisitions where the purchase price is not paid in equity.
Each of the Company's business segments has its own liquidity needs and
financial resources. In the Company's annuity insurance operations, liquidity
needs and financial resources pertain to the management of the general account
assets and policyholder balances. In the Company's asset management business,
liquidity needs and financial resources pertain to the investment management
and distribution of mutual funds, wealth management and institutional accounts.
The Company expects that, based upon their historical cash flow and current
prospects, these operating subsidiaries will be able to meet their liquidity
needs from internal sources and, in the case of Colonial, from its credit
facility used to finance sales of mutual fund shares sold with contingent
deferred sales charges.
Keyport uses cash for the payment of annuity and life insurance benefits,
operating expenses and policy acquisition costs, and the purchase of
investments. Keyport generates cash from annuity premiums and deposits, net
investment income, and from the sales and maturities of fixed investments.
Annuity premiums, maturing investments and net investment income have
historically been sufficient to meet Keyport's cash requirements. Keyport
monitors cash and cash equivalents in an effort to maintain sufficient
liquidity and has strategies in place to maintain sufficient liquidity in
changing interest rate environments. Consistent with the nature of its
obligations, Keyport has invested a substantial amount of its general account
assets in readily marketable securities. As of December 31, 1997, $10.3
billion, or 76.2 % of Keyport's general account investments are considered
readily marketable.
To the extent that unanticipated surrenders cause Keyport to sell for liquidity
purposes a material amount of securities prior to their maturity, such
surrenders could have a material adverse effect on the Company. Although no
assurances can be given, Keyport believes that liquidity to fund anticipated
withdrawals would be available through incoming cash flow and the sale of
short-term or floating-rate instruments, thereby precluding the sale of fixed
maturity investments in a potentially unfavorable market.
33
<PAGE>
Year 2000
Many companies and organizations have computer programs that use only two
digits to identify a year in the date field. These programs were designed and
developed without considering the impact of the upcoming change in the century.
If not corrected, this could cause a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions.
In addressing the Year 2000 issue, the Company has substantially completed an
inventory of its computer programs and assessed its Year 2000 readiness. The
Company's computer programs include internally developed programs, third-party
purchased programs and third-party custom developed programs. For programs
which were identified as not being Year 2000 ready, the Company is in the
process of implementing a remedial plan which includes repairing or replacing
the programs and appropriate testing for Year 2000. In addition, the Company
has initiated communications with third parties to determine the extent to
which the Company's interface systems are vulnerable to those third parties'
failure to remediate their own Year 2000 issues.
If such modifications and conversions are not made, or are not timely
completed, or if the systems of the companies on which the Company's interface
system relies are not timely converted, the Year 2000 issue could have a
material impact on the operations of the Company. However, the Company believes
that with modifications to existing software and conversions to new software,
the Year 2000 issue will not pose significant operational problems for its
computer systems.
In the opinion of management, the cost of addressing the Year 2000 issue is not
expected to have a material adverse effect on the Company's financial condition
or its results of operations.
Effects of Inflation
Inflation has not had a material effect on the Company's consolidated results
of operations to date. The Company manages its investment portfolio in part to
reduce its exposure to interest rate fluctuations. In general, the market value
of the Company's fixed maturity portfolio increases or decreases in inverse
relationship with fluctuations in interest rates, and the Company's net
investment income increases or decreases in direct relationship with interest
rate changes. For example, if interest rates decline, the Company's fixed
maturity investments generally will increase in market value, while net
investment income will decrease as fixed maturity investments mature or are
sold and the proceeds are reinvested at reduced rates. However, inflation may
result in increased operating expenses that may not be readily recoverable in
the prices of the services charged by the Company.
34
<PAGE>
Liberty Financial Companies, Inc.
Consolidated Balance Sheets
($ in millions)
<TABLE>
<CAPTION>
December 31 1997 1996
..................................................................................................
<S> <C> <C>
Assets
Assets:
Investments $12,343.5 $11,537.9
Cash and cash equivalents 1,290.1 875.8
Accrued investment income 165.0 146.8
Deferred policy acquisition costs 232.0 250.4
Value of insurance in force 53.3 70.8
Deferred distribution costs 108.1 114.4
Intangible assets 199.0 205.4
Other assets 131.4 134.7
Separate account assets 1,329.2 1,091.5
--------- ---------
$15,851.6 $14,427.7
========= =========
Liabilities and Stockholders' Equity
Liabilities:
Policyholder balances $12,086.1 $11,637.5
Notes payable to affiliates 229.0 229.0
Payable for investments purchased and loaned 722.1 211.2
Other liabilities 336.9 267.1
Separate account liabilities 1,264.0 1,017.7
--------- ---------
Total liabilities 14,638.1 13,362.5
--------- ---------
Series A redeemable convertible preferred stock, par value $.01;
authorized, issued and outstanding 327,006 shares in 1997 and 327,340
shares in 1996 14.6 13.8
--------- ---------
Stockholders' Equity:
Common stock, $.01 par value, authorized 100,000,000 shares; issued
44,706,398 shares in 1997 and 43,057,523 shares in 1996 0.4 0.3
Additional paid-in capital 866.5 835.3
Net unrealized investment gains 83.0 74.4
Retained earnings 251.5 141.4
Cost of common stock held in treasury (9,465 shares at
December 31, 1997) (0.3) --
Unearned compensation (2.2) --
--------- ---------
Total stockholders' equity 1,198.9 1,051.4
--------- ---------
$15,851.6 $14,427.7
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE>
Liberty Financial Companies, Inc.
Consolidated Income Statements
(in millions, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
.........................................................................................
<S> <C> <C> <C>
Investment income $ 853.1 $ 796.4 $ 761.8
Interest credited to policyholders (594.1) (572.7) (555.8)
-------- -------- --------
Investment spread 259.0 223.7 206.0
-------- -------- --------
Net realized investment gains (losses) 25.9 8.0 (4.0)
-------- -------- --------
Fee income:
Investment advisory and administrative fees 217.9 196.4 155.8
Distribution and service fees 49.2 44.9 28.9
Transfer agency fees 47.7 43.9 30.8
Surrender charges and net commissions 36.1 34.7 23.4
Separate account fees 17.1 16.0 13.2
-------- -------- --------
Total fee income 368.0 335.9 252.1
-------- -------- --------
Expenses:
Operating expenses (309.7) (277.9) (225.1)
Amortization of deferred policy acquisition costs (75.9) (60.2) (58.5)
Amortization of deferred distribution costs (34.2) (33.9) (18.8)
Amortization of value of insurance in force (10.5) (10.2) (9.5)
Amortization of intangible assets (13.5) (15.4) (12.2)
Interest expense, net (17.0) (19.7) (16.2)
-------- -------- --------
Total expenses (460.8) (417.3) (340.3)
-------- -------- --------
Pretax income 192.1 150.3 113.8
Income tax expense (62.6) (49.6) (39.9)
-------- -------- --------
Net income $ 129.5 $ 100.7 $ 73.9
======== ======== ========
Net income per share--basic $ 2.94 $ 2.36 $ 1.85
======== ======== ========
Net income per share--assuming dilution $ 2.77 $ 2.24 $ 1.76
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE>
Liberty Financial Companies, Inc.
Consolidated Statements of Stockholders' Equity
(in millions)
<TABLE>
<CAPTION>
Net
Additional Unrealized Total
Common Paid-In Investment Retained Treasury Unearned Stockholders'
Stock Capital Gains Earnings Stock Compensation Equity
................................................................................................................................
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 $0.2 $659.9 $(64.5) $29.1 $ 624.7
Common stock issued in Colonial merger 0.1 117.3 117.4
Effect of stock-based compensation plans 0.7 $1.2 1.9
Reclassification of accrued option
compensation liability 22.4 (2.1) 20.3
Contribution of treasury stock 7.1 $(7.1)
Accretion to face value of preferred stock (0.6) (0.6)
Common stock dividends 3.1 (12.3) 7.1 (2.1)
Note issued in connection with common
stock dividend (30.0) (30.0)
Preferred stock dividends (0.7) (0.7)
Change in net unrealized investment gains 151.6 151.6
Net income 73.9 73.9
---- ------ ------ ------ ----- ----- --------
Balance, December 31, 1995 0.3 810.5 87.1 59.4 (0.9) 956.4
Common stock issued in Independent
acquisition 8.5 8.5
Effect of stock-based compensation plans 2.4 0.9 3.3
Accretion to face value of preferred stock (0.9) (0.9)
Common stock dividends 13.9 (16.9) (3.0)
Preferred stock dividends (0.9) (0.9)
Change in net unrealized investment gains (12.7) (12.7)
Net income 100.7 100.7
---- ------ ------ ------ ----- ----- --------
Balance, December 31, 1996 0.3 835.3 74.4 141.4 1,051.4
3 for 2 common stock split effected in the
form of a 50 percent stock dividend 0.1 (0.1)
Common stock issued in Independent
acquisition 2.5 2.5
Effect of stock-based compensation plans 15.2 (0.4) (2.2) 12.6
Accretion to face value of preferred stock (0.8) (0.8)
Common stock dividends 13.5 (17.6) 0.1 (4.0)
Preferred stock dividends (0.9) (0.9)
Change in net unrealized investment gains 8.6 8.6
Net income 129.5 129.5
---- ------ ------ ------ ----- ----- --------
Balance, December 31, 1997 $0.4 $866.5 $ 83.0 $251.5 $(0.3) $(2.2) $1,198.9
==== ====== ====== ====== ===== ===== ========
</TABLE>
See accompanying notes to consolidated financial statements.
37
<PAGE>
Liberty Financial Companies, Inc.
Consolidated Statements of Cash Flows
(in millions)
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
...........................................................................................
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 129.5 $ 100.7 $ 73.9
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 74.4 74.3 51.6
Interest credited to policyholders 594.1 572.7 555.8
Net realized investment (gains) losses (25.9) ( 8.0) 4.0
Net amortization (accretion) on investments 29.9 (29.1) 9.7
Change in deferred policy acquisition costs (10.3) (24.4) (24.6)
Change in current and deferred income taxes 66.9 4.9 13.3
Net change in other assets and liabilities (33.2) (81.8) (59.7)
--------- -------- ---------
Net cash provided by operating activities 825.4 609.3 624.0
--------- -------- ---------
Cash flows from investing activities:
Investments purchased available for sale (4,592.3) (4,493.2) (2,851.0)
Investments sold held to maturity -- -- 14.9
Investments sold available for sale 2,563.5 1,714.0 605.2
Investments matured held to maturity -- -- 317.8
Investments matured available for sale 1,531.6 1,387.7 906.5
Increase in policy loans, net (21.9) (34.5) (21.0)
Decrease in mortgage loans, net 6.4 7.5 55.0
Acquisitions, net of cash acquired -- (41.5) (106.0)
--------- -------- ---------
Net cash used in investing activities (512.7) (1,460.0) (1,078.6)
--------- -------- ---------
Cash flows from financing activities:
Withdrawals from policyholder accounts (1,320.8) (1,154.1) (933.8)
Deposits to policyholder accounts 950.5 2,134.5 1,116.9
Securities lending 495.2 (119.2) 317.7
Borrowings from affiliates -- -- 124.0
Repayments under revolving credit (26.0) (8.5) (19.5)
Exercise of stock options 7.5 2.4 0.7
Common stock issued to 401(k) Plan 0.1 -- --
Dividends paid (4.9) (3.9) (2.8)
--------- -------- ---------
Net cash provided by financing activities 101.6 851.2 603.2
--------- -------- ---------
Increase in cash and cash equivalents 414.3 0.5 148.6
Cash and cash equivalents at beginning of year 875.8 875.3 726.7
--------- -------- ---------
Cash and cash equivalents at end of year $ 1,290.1 $ 875.8 $ 875.3
========= ======== =========
</TABLE>
Noncash Investing Activities: The Company made several acquisitions during 1995
using $106.0 million of cash, net of cash acquired. The fair value of assets
acquired was $352.6 million; total liabilities assumed were $108.8 million.
Noncash Financing Activities: Noncash financing activities relate to dividends
paid primarily to an affiliate of Liberty Mutual in the amount of $13.6
million, $13.9 million and $10.2 million in 1997, 1996 and 1995, respectively,
pursuant to the Company's dividend reinvestment plan and, in 1995, $30.0
million in the form of an 8.0% note due in 2000.
See accompanying notes to consolidated financial statements.
38
<PAGE>
Notes to Consolidated Financial Statements
Liberty Financial Companies, Inc.
Notes to Consolidated Financial Statements
1. Accounting Policies
Organization
Liberty Financial Companies, Inc. (the "Company") is an asset accumulation and
management company providing investment management products and
retirement-oriented insurance products through multiple distribution channels.
The Company is a majority owned subsidiary of Liberty Mutual Insurance Company
("Liberty Mutual").
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries, including Keyport Life Insurance Company ("Keyport"), Stein
Roe & Farnham Incorporated ("Stein Roe") and, from the date of acquisition: The
Colonial Group, Inc. ("Colonial"), Newport Pacific Management, Inc. ("Newport")
and Independent Holdings, Inc. ("Independent"). All significant intercompany
balances and transactions have been eliminated. Certain prior year amounts have
been reclassified to conform to the current year's presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
Investments
Investments in debt and equity securities classified as available for sale are
carried at fair value, and after-tax unrealized gains and losses (net of
adjustments to deferred policy acquisition costs and value of insurance in
force) are reported as a separate component of stockholders' equity. The cost
basis of securities is adjusted for declines in value that are determined to be
other than temporary. Realized investment gains and losses are calculated on a
first-in, first-out basis.
On December 31, 1995, pursuant to the "Guide to Implementation of Statement 115
on Accounting for Certain Investments in Debt and Equity Securities," the
Company made a one-time reclassification of certain fixed maturity securities
from held to maturity to available for sale. The amortized cost of those
securities at the time of transfer was $1.4 billion, and the unrealized gain of
$13.9 million was recorded net of taxes in stockholders' equity.
For the mortgage-backed bond portion of the fixed maturity investment
portfolio, the Company recognizes income using a constant effective yield based
on anticipated prepayments over the estimated economic life of the security.
When actual prepayments differ significantly from anticipated prepayments, the
effective yield is recalculated to reflect actual payments to date and
anticipated future payments; and any resulting adjustment is included in
investment income.
Mortgage loans are carried at amortized cost. Policy loans are carried at the
unpaid principal balances plus accrued interest. Partnerships are accounted for
by using the equity method of accounting. Partnership investments totaled
$117.3 million and $72.6 million at December 31, 1997 and 1996, respectively.
Derivatives
The Company uses interest rate swap and cap agreements to manage its interest
rate risk and 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 utilizes interest rate swap agreements ("swap agreements") and
interest rate cap agreements ("cap agreements") to match assets more closely to
liabilities. Swap agreements are agreements to exchange with a counterparty
interest rate payments of differing character (e.g., fixed-rate payments
exchanged for variable-rate payments) based on an underlying principal balance
(notional principal) to hedge against interest rate changes. The Company
currently utilizes swap agreements to reduce asset duration and to better match
interest rates earned on longer-term fixed rate assets with interest rates
credited to policyholders.
39
<PAGE>
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.
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 call options are terminated.
If the terminated position was accounted for as a hedge, realized gains or
losses are deferred and 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 swap agreements and cap agreements hedging investments designated as
available for sale are adjusted to fair value with the resulting unrealized
gains and losses included in stockholders' equity.
Premiums paid on 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.
Fee Income
Fees from asset management and investment advisory services and from transfer
agent, bookkeeping, distribution and service fees are recognized as revenues
when services are provided. Revenues from fixed and variable annuities and
single premium whole life policies include mortality charges, surrender
charges, policy fees and contract fees and are recognized when earned under the
respective contracts. Net commission revenue is recognized on the trade date.
Deferred Policy Acquisition Costs
Policy acquisition costs are the costs of acquiring new business which vary
with, and are primarily related to, the production of new annuity business.
Such costs include commissions, costs of policy issuance and underwriting and
selling expenses. These costs are deferred and amortized in relation to the
present value of estimated gross profits from mortality, investment spread and
expense margins. Deferred policy acquisition costs are adjusted for amounts
relating to unrealized gains and losses on fixed maturity securities the
Company has designated as available for sale. This adjustment, net of tax, is
included with the change in net unrealized investment gains or losses that is
credited or charged directly to stockholders' equity. Deferred policy
acquisition costs were decreased by $126.9 million at December 31, 1997 and
$103.7 million at December 31, 1996, respectively, relating to this adjustment.
Value of Insurance in Force
Value of insurance in force represents the actuarially-determined present value
of projected future gross profits from policies in force at the date of their
acquisition. This amount is amortized in proportion to the projected emergence
of profits over periods not exceeding 15 years for annuities and 25 years for
life insurance.
The value of insurance in force is adjusted for amounts relating to the
recognition of unrealized investment gains and losses. This adjustment, net of
tax, is included with the change in net unrealized investment gains or losses
that is credited or charged directly to stockholders' equity. Value of
insurance in force was decreased by $31.8 million and $26.0 million at December
31, 1997 and 1996, respectively, relating to this adjustment.
40
<PAGE>
Deferred Distribution Costs
Sales commissions and other direct costs related to the sale of
Company-sponsored intermediary-distributed funds which charge contingent
deferred sales commissions are recorded as deferred distribution costs.
Amortization is provided on a straight-line basis over periods up to six years
to match the estimated period in which the associated fees will be earned.
Contingent deferred sales charges (back-end loads) received are applied to
deferred distribution costs to the extent of the estimated unamortized portion
of such costs, with the remainder recognized as additional distribution fee
income.
Intangible Assets
Intangible assets consist of goodwill and certain identifiable intangible
assets arising from business combinations accounted for as a purchase.
Amortization is provided on a straight-line basis over estimated lives of the
acquired intangibles which range from 5 to 25 years. The carrying value of
intangible assets is adjusted when the expected present value of future gross
profits attributable to such assets is less than their carrying value.
Separate Account Assets and Liabilities
The assets and liabilities resulting from variable annuity and variable life
policies are segregated in separate accounts. Separate account assets, which
are carried at fair value, consist principally of investments in mutual funds.
Investment income and changes in asset values are allocated to the
policyholders, and therefore, do not affect the operating results of the
Company. The Company provides administrative services and bears the mortality
risk related to these contracts. Keyport also classified as separate account
assets investments in Company-sponsored mutual funds and other investments of
$65.2 million and $73.8 million at December 31, 1997 and 1996, respectively.
Policy Liabilities
Policy liabilities consist of deposits received plus interest credited, less
accumulated policyholder charges, assessments, and withdrawals related to
deferred annuities and single premium whole life policies. Policy benefits that
are charged to expense include benefit claims incurred in the period in excess
of related policy account balances.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") requires use of option valuation models that were not developed for use
in valuing employee stock options. Under APB 25, because the exercise price of
the Company's employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized.
Income Taxes
Prior to July 18, 1997, the Company was included in the consolidated federal
income tax return filed by Liberty Mutual. Effective July 18, 1997, the Company
is no longer included in the consolidated tax return of Liberty Mutual. The
Company will be required to file a separate life return and a consolidated
non-life return. Income taxes have been provided using the liability method in
accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," and, for periods prior to July 18, 1997, were
calculated as if the Company filed its own consolidated income tax return.
Earnings Per Share
In 1997, the Financial Accounting Standards Board (the "FASB") issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128").
SFAS 128 replaced the calculation of primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented to conform to the SFAS 128
requirements.
41
<PAGE>
Cash Equivalents
Short-term investments having an original maturity of three months or less are
classified as cash equivalents.
Recent Accounting Pronouncements
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). SFAS 131 establishes standards for the reporting of financial
information from operating segments in annual and interim financial statements.
SFAS 131 requires that financial information be reported on the basis that it
is reported internally for evaluating segment performance and deciding how to
allocate resources to segments. It is not expected that the adoption will have
a material effect on the Company's financial statements. SFAS 131 will become
effective in 1998.
In June 1996, the FASB issued Statement of Financial Accounting Standards No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("SFAS 125"). The relevant provisions of SFAS
125 relating to securities lending, dollar rolls and other similar secured
transactions become effective after December 31, 1997. It is not expected that
the adoption of SFAS 125 will have a material effect on the Company's
consolidated financial position or results of operations.
In January 1998, the FASB voted to proceed with the drafting of an accounting
standard entitled "Accounting for Derivative Instruments and for Hedging
Activities." This accounting standard requires companies to report derivatives
on the balance sheet at fair value with changes in fair value recorded in
income or equity. The accounting standard also changes the accounting for
derivatives used in hedging strategies from traditional deferral accounting to
a current recognition approach which could impact a company's results of
operations and financial position and expand the definition of a derivative
instrument. The Company is evaluating the impact of this accounting standard.
This accounting standard will become effective in 2000.
2. Acquisitions
In March 1996, the Company acquired all the outstanding common stock of
Independent, a distributor of annuity and investment products through banks. In
April 1996, the Company acquired all the outstanding capital stock of KJMM
Investment Management Company, Inc., a registered investment advisor primarily
in the wealth management business. The purchase price for these two
transactions has totaled $22.7 million in cash and Common Stock, and the
Company may be obligated to make additional cash or stock payments through
approximately 2000 based upon the attainment of certain performance objectives.
These acquisitions are not material to the financial condition or results of
operation of the Company.
In March 1995, the Company completed the acquisition of Colonial, an investment
advisor, distributor and transfer agent to mutual funds. The purchase price was
$264.8 million, consisting of $100.0 million in cash, 328,209 shares of
redeemable convertible preferred stock and 7,016,712 shares of common stock.
In April 1995 and September 1995, respectively, the Company acquired Newport
and American Asset Management Company, each a registered investment advisor.
The purchase price for these two transactions has totaled $32.9 million in
cash. In addition, at the time of the Newport acquisition the Company made a
capital contribution to Newport in the amount of $3.5 million. The Company may
be obligated in each transaction to make contingent additional cash payments
through approximately 1999 based upon the attainment of certain performance
objectives.
The above transactions were recorded using the purchase method of accounting
and have resulted in the recording of intangible assets of $204.8 million,
including goodwill of $105.2 million. Each company's results of operations are
included in the Company's consolidated financial statements from the dates of
their acquisition. The following table discloses 1995 pro forma results of
operations (in millions) for the Company had the 1995 acquisitions occurred as
of January 1, 1995. These pro forma results of operations are not necessarily
indicative of actual results which might have occurred had the Company owned
these companies on that date.
42
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31 1995
....................................................
<S> <C>
Revenues $1,044.5
Net income 79.0
Net income per share--assuming dilution 1.88
</TABLE>
In addition to the above acquisitions, in August 1996, Keyport entered into a
100 percent coinsurance agreement for a $954.0 million block of single premium
deferred annuities issued by Fidelity & Guaranty Life Insurance Company ("F&G
Life"). Under this transaction, the investment risk of the annuity policies was
transferred to Keyport. However, F&G Life will continue to administer the
policies and will remain contractually liable for the performance of all policy
obligations. This transaction increased investments by $923.1 million and value
of insurance in force by $30.9 million.
3. Investments
Investments, all of which pertain to the Company's annuity insurance
operations, were comprised of the following (in millions):
<TABLE>
<CAPTION>
December 31 1997 1996
.....................................................
<S> <C> <C>
Fixed maturities $11,246.5 $10,718.6
Equity securities 40.8 35.9
Mortgage loans 60.7 67.0
Policy loans 554.7 532.8
Other invested assets 440.8 183.6
--------- ---------
$12,343.5 $11,537.9
========= =========
</TABLE>
As of December 31, 1997, the Company did not have a material concentration of
financial instruments in a single investee, industry or geographic location and
no investment in any person or its affiliates (other than bonds issued by
agencies of the United States government) exceeded ten percent of stockholders'
equity.
As of December 31, 1997, $1.1 billion of fixed maturities were below investment
grade. These securities represented 7.9% of the Company's total investments,
including certain cash and cash equivalents.
Fixed Maturities
As of December 31, 1997 and 1996, the Company did not hold any investments in
fixed maturities that were classified as held to maturity or as trading
securities. The amortized cost, gross unrealized gains and losses and fair
value of fixed maturity securities are as follows (in millions):
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
December 31, 1997 Cost Gains Losses Fair Value
............................................................................................................
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 128.6 $ 1.1 $ -- $ 129.7
Mortgage backed securities of U.S. government
corporations and agencies 1,089.8 49.5 ( 1.6) 1,137.7
Debt securities issued by foreign governments 272.5 12.7 ( 5.0) 280.2
Corporate securities 4,744.2 189.4 (83.6) 4,850.0
Other mortgage backed securities 2,325.9 81.9 ( 2.6) 2,405.2
Asset backed securities 2,200.7 26.2 ( 3.1) 2,223.8
Senior secured loans 219.9 -- -- 219.9
--------- ------ ------ ---------
Total fixed maturities $10,981.6 $360.8 $(95.9) $11,246.5
========= ====== ====== =========
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
December 31, 1996 Cost Gains Losses Fair Value
............................................................................................................
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 35.3 $ 0.2 $ (0.1) $ 35.4
Mortgage backed securities of U.S. government
corporations and agencies 1,690.0 41.8 ( 8.7) 1,723.1
Debt securities issued by foreign governments 246.3 11.7 ( 0.5) 257.5
Corporate securities 4,093.5 153.4 (12.3) 4,234.6
Other mortgage backed securities 2,413.0 47.6 (24.0) 2,436.6
Asset backed securities 1,736.0 15.5 ( 6.4) 1,745.1
Senior secured loans 286.3 -- -- 286.3
--------- ------ ------ ---------
Total fixed maturities $10,500.4 $270.2 $(52.0) $10,718.6
========= ====== ====== =========
</TABLE>
At December 31, 1997, gross unrealized gains on equity securities, interest
rate cap agreements and investments in separate accounts aggregated $27.4
million, and gross unrealized losses aggregated $6.9 million, respectively. At
December 31, 1996, gross unrealized gains on equity securities, interest rate
cap agreements and investments in separate accounts aggregated $29.9 million,
and gross unrealized losses aggregated $5.3 million, respectively.
Contractual Maturities
The amortized cost and estimated fair value of fixed maturities by contractual
maturity as of December 31, 1997 are as follows (in millions):
<TABLE>
<CAPTION>
Amortized Fair
December 31, 1997 Cost Value
.....................................................................
<S> <C> <C>
Due in one year or less $ 147.2 $ 147.5
Due after one year through five years 1,925.7 1,926.4
Due after five years through ten years 2,350.3 2,419.8
Due after ten years 942.0 986.1
--------- ---------
5,365.2 5,479.8
Mortgage and asset backed securities 5,616.4 5,766.7
---------- ---------
$10,981.6 $11,246.5
========= =========
</TABLE>
Actual maturities may differ from those shown above because borrowers may have
the right to call or prepay obligations.
Net Investment Income
Net investment income is summarized as follows (in millions):
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
.........................................................................................
<S> <C> <C> <C>
Fixed maturities $811.7 $737.4 $682.0
Policy loans 32.2 30.2 28.5
Equity securities 5.4 4.5 4.8
Mortgage loans and other invested assets 27.8 11.4 12.9
Cash and cash equivalents 34.5 36.1 41.6
------ ------ ------
Gross investment income 911.6 819.6 769.8
Investment expenses (9.2) (6.7) (5.0)
Amortization of call options and interest rate caps (49.3) (16.5) (3.0)
------ ------ ------
Net investment income $853.1 $796.4 $761.8
====== ====== ======
</TABLE>
There were no non-income producing fixed maturity investments as of December
31, 1997 or 1996.
44
<PAGE>
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) on the investments in the Company's
annuity insurance operations are summarized as follows (in millions):
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
...............................................................................................
<S> <C> <C> <C>
Fixed maturities held to maturity:
Gross gains $ -- $ -- $ 1.3
Gross losses -- -- ( 0.1)
Fixed maturities available for sale:
Gross gains 42.5 24.3 8.2
Gross losses (19.1) (17.8) (16.0)
Equity securities ( 0.1) 1.5 ( 0.4)
Investments in separate accounts 7.9 ( 0.6) 1.7
Interest rate swaps -- -- ( 0.9)
Other -- ( 0.2) --
------- ------- -------
Gross realized investment gains (losses) 31.2 7.2 ( 6.2)
Amortization adjustments of deferred policy acquisition costs
and value of insurance in force ( 6.5) ( 1.7) 2.2
------- ------- -------
Net realized investment gains (losses) $ 24.7 $ 5.5 $ (4.0)
======= ======= =======
</TABLE>
Proceeds from sales of fixed maturities available for sale were $2.6 billion,
$1.7 billion and $565.4 million in 1997, 1996 and 1995, respectively.
Deferred tax liabilities for the Company's unrealized holding gains and losses,
net of adjustments to deferred policy acquisition costs and value of insurance
in force were $44.3 million and $39.5 million at December 31, 1997 and 1996,
respectively.
In addition to the net realized investment gains (losses) shown above,
additional gains of $1.2 million and $2.5 million were realized in 1997 and
1996, respectively, relating to sales of general corporate securities in the
Company's asset management and corporate operations.
4. Derivatives
Outstanding derivatives, shown in notional amounts along with their carrying
values and estimated fair values, are as follows (in millions):
<TABLE>
<CAPTION>
Assets (Liabilities)
---------------------------------------
1997 1996
-------------------- ------------------
Notional Amounts
-----------------------
Carrying Fair Carrying Fair
December 31 1997 1996 Value Value Value Value
..........................................................................................
<S> <C> <C> <C> <C> <C> <C>
Interest rate cap agreemen $ 250.0 $ 450.0 $ 0.1 $ 0.1 $ 1.4 $ 1.4
Interest rate swaps 2,575.0 2,275.0 (42.1) (42.1) ( 8.8) ( 8.8)
Indexed call options -- -- 323.3 345.3 109.7 122.4
- ------------------------------------------------------------------------------------------
</TABLE>
The interest rate swap agreements expire in 1998 to 2001. The interest rate cap
agreements expire in 1999 through 2000. The call options' maturities range from
1998 to 2002.
45
<PAGE>
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. Cap agreements are used to hedge against
rising interest rates. Call options are used for purposes of hedging the
Company's equity-indexed products. The call options hedge the interest credited
on these 1, 5 and 7 year term products, which is based on the changes in the
S&P 500 Index. At December 31, 1997 and 1996, the Company had approximately
$155.0 million and $73.1 million, respectively, of unamortized premium in call
option contracts.
Fair values for swap and cap agreements are based on current settlement values.
The current settlement values are based on quoted market prices and brokerage
quotes, which utilize pricing models or formulas using current assumptions.
Fair values for call options are based upon quoted market prices.
Deferred losses of $5.1 million and $7.9 million as of December 31, 1997 and
1996, respectively, resulting from terminated interest rate swap agreements are
included with the related fixed maturity securities to which the hedge applied
and are being amortized over the life of such securities.
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, cap
and call option agreements are financially responsible and that the
counterparty risk associated with these transactions is minimal.
5. Indebtedness
The Company has notes payable to affiliates as follows (in millions):
<TABLE>
<CAPTION>
December 31 1997 1996
...................................................................
<S> <C> <C>
8.0% promissory note due April 3, 2000 $ 99.0 $ 99.0
8.0% promissory note due March 31, 2000 30.0 30.0
8.5% promissory notes due March 24, 2005 100.0 100.0
------ ------
$229.0 $229.0
====== ======
</TABLE>
The $100.0 million 8.5% promissory notes become due and payable in the event
Liberty Mutual ceases to own more than a 50% interest in the Company. The $30.0
million 8.0% promissory note was issued in connection with the payment of a
dividend to an affiliate of Liberty Mutual.
The Company has available a $60.0 million revolving credit facility (the
"Facility") which is utilized to finance deferred sales commissions paid in
connection with the distribution of mutual fund shares sold with contingent
deferred sales charges. This Facility is subject to annual renewal. If not
renewed, effective April 11, 1998, this Facility converts to a term loan which
matures on April 11, 2003. As of December 31, 1997 and 1996, balances of $26.5
million and $52.5 million, respectively, were outstanding under the Facility
and were included in other liabilities. Upon conversion to a term loan, minimum
quarterly payments of principal equal to 5.0% of outstanding borrowings as of
the conversion date are required. Interest accrues on the outstanding
borrowings of the Facility at floating rates based upon LIBOR options plus
0.225%. The Facility contains certain covenants. The Company was in compliance
with these covenants at December 31, 1997.
Interest paid was $21.7 million, $22.9 million and $19.2 million in 1997, 1996
and 1995, respectively.
6. Income Taxes
Income tax expense is summarized as follows (in millions):
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
...........................................................
<S> <C> <C> <C>
Current $(42.0) $54.8 $39.3
Deferred 104.6 (5.2) 0.6
------ ----- -----
$ 62.6 $49.6 $39.9
====== ===== =====
</TABLE>
46
<PAGE>
A reconciliation of income tax expense with expected federal income tax expense
computed at the applicable federal income tax rate of 35% is as follows (in
millions):
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
........................................................................................
<S> <C> <C> <C>
Expected income tax expense $ 67.3 $52.6 $39.9
Increase (decrease) in income taxes resulting from:
Nontaxable investment income (1.4) (1.2) (1.7)
Change in deferred tax asset valuation allowance (10.0) (6.7) (8.3)
Amortization of goodwill and other intangible assets 3.1 2.0 2.0
State taxes, net of federal tax benefit 1.2 2.5 1.0
Stock option plan compensation -- 0.8 6.0
Other, net 2.4 (0.4) 1.0
------ ----- -----
Income tax expense $ 62.6 $49.6 $39.9
====== ===== =====
</TABLE>
The components of deferred federal income taxes are as follows (in millions):
<TABLE>
<CAPTION>
December 31 1997 1996
......................................................................................
<S> <C> <C>
Deferred tax assets:
Policy liabilities $ 124.3 $ 171.3
Guaranty fund expense 2.8 6.3
Stock option plan compensation 1.0 3.8
Deferred compensation and other benefit plans 11.4 6.4
Excess of book over tax basis depreciation and amortization -- 1.6
Net operating loss carryforwards 13.1 31.2
Distribution fees 17.8 14.8
Other 3.4 7.8
------- -------
Total deferred tax assets 173.8 243.2
Less: valuation allowance ( 10.6) (20.6)
------- -------
Net deferred tax assets 163.2 222.6
------- -------
Deferred tax liabilities:
Deferred policy acquisition costs ( 56.3) (63.1)
Value of insurance in force and intangible assets ( 18.0) (20.5)
Excess of book over tax basis of investments (181.3) (125.7)
Deferred revenue ( 4.1) ( 2.0)
Amortization of deferred distribution costs ( 34.8) ( 49.8)
Other ( 8.2) ( 4.0)
------- -------
Total deferred tax liabilities (302.7) (265.1)
------- -------
Net deferred tax liability $(139.5) $ (42.5)
======= =======
</TABLE>
As of December 31, 1997, the Company had net operating loss carryforwards
relating to certain of the Company's non-insurance operations of $31.6 million.
Utilization of these net operating losses is limited to use against future
profits in these non-insurance operations. Additionally, as of December 31,
1997, the Company had approximately $6.0 million of purchased net operating
loss carryforwards (relating to an acquisition in its insurance operations).
Utilization of these net operating loss carryforwards, which expire through
2006, is limited to use against future profits in a component of the Company's
insurance operations. The Company believes that it is more likely than not that
it will realize the benefits of its net deferred tax asset.
Income taxes paid (refunded) were ($4.2) million, $45.7 million and $43.2
million in 1997, 1996 and 1995, respectively.
47
<PAGE>
7. Redeemable Convertible Preferred Stock
The Series A Redeemable Convertible Preferred Stock (the "Preferred Stock"),
with a $50 face value, has an annual cumulative cash dividend rate of $2.875
per share and is convertible into shares of Company Common Stock at a rate of
1.58385 for each share of such Preferred Stock. The Preferred Stock is
redeemable at the option of the Company anytime after March 24, 1998 provided
that the market value of the Company's Common Stock exceeds a specified amount.
The Preferred Stock may also be put to the Company by the holders of such
Preferred Stock after March 24, 2000, for a period of sixty days, at face value
plus cumulative unpaid dividends. Each share of Preferred Stock is entitled to
that number of votes equal the number of common shares into which it is
convertible. The difference between the face value of the Preferred Stock and
its fair value at the time of its issuance is being added to the carrying value
of the Preferred Stock ratably over a five year period by a direct charge to
retained earnings.
8. Retirement Plans
The Company maintains a noncontributory defined benefit pension plan (the
"Plan") covering its employees (except employees of Stein Roe and Colonial, who
participate in separate profit sharing plans, and except employees of
Independent). It is the Company's practice to fund amounts for the Plan
sufficient to meet the minimum requirements of the Employee Retirement Income
Security Act of 1974. Additional amounts are contributed from time to time when
deemed appropriate by the Company. Under the Plan, all employees are vested
after five years of service. Benefits are based on years of service, the
employee's average pay for the highest five consecutive years during the last
ten years of employment and the employee's estimated social security retirement
benefit. The Company also has an unfunded nonqualified Supplemental Pension
Plan ("Supplemental Plan"), collectively with the Plan, (the "Plans"), to
replace benefits lost due to limits imposed on Plan benefits under the Internal
Revenue Code. Plan assets consist of investments in certain Company-sponsored
mutual funds.
The following table sets forth the Plans' funded status (in millions) as of
December 31, 1997 and 1996.
<TABLE>
<CAPTION>
December 31 1997 1996
..........................................................................................
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligations $ 19.8 $ 16.5
Accumulated benefit obligation 2.0 1.8
------- -------
$ 21.8 $ 18.3
======= =======
Projected benefit obligation $ 27.1 $ 23.4
Plan assets at fair value (14.7) (11.7)
------- -------
Projected benefit obligation in excess of the Plans' assets 12.4 11.7
Unrecognized net actuarial loss (2.0) (2.0)
Prior service cost not yet recognized in net periodic pension cost (2.2) (3.1)
------- -------
Accrued pension cost $ 8.2 $ 6.6
======= =======
</TABLE>
Pension cost includes the following components (in millions):
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
...........................................................................
<S> <C> <C> <C>
Service cost benefits earned during the period $ 1.6 $ 1.6 $ 1.3
Interest cost on projected benefit obligation 1.8 1.6 1.3
Actual return on Plan assets (1.7) (1.3) (1.7)
Net amortization and deferred amounts 1.2 1.1 1.5
----- ----- -----
Total net periodic pension cost $ 2.9 $ 3.0 $ 2.4
===== ===== =====
</TABLE>
The assumptions used to develop the actuarial present value of the projected
benefit obligation, and the expected long-term rate of return on plan assets
are as follows:
48
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
...........................................................................
<S> <C> <C> <C>
Discount rate 7.25% 7.50% 7.25%
Rate of increase in compensation level 5.00% 5.25% 5.25%
Expected long-term rate of return on assets 8.50% 8.50% 8.50%
</TABLE>
The Company provides various other funded and unfunded defined contribution
plans, which include savings and investment plans, supplemental savings plans,
profit sharing plans, and supplemental profit sharing plans. Expenses related
to these defined contribution plans totaled $8.5 million, $7.6 million and $5.4
million in 1997, 1996 and 1995, respectively.
9. Stockholders' Equity
On December 10, 1997, the Company effected a three-for-two common stock split
in the form of a 50 percent stock dividend.
The Company has two stock-based compensation plans, the 1990 Stock Option Plan
(the "1990 Plan") and the 1995 Stock Incentive Plan (the "1995 Plan"). The 1990
Plan provided for grants of incentive and nonqualified stock options, which
were issued from 1990 through 1994. The 1995 Plan provides for grants of
incentive and nonqualified stock options, stock appreciation rights, nonvested
stock, unrestricted stock and performance shares, as well as cash and other
awards. To date, only stock options and nonvested stock have been granted under
the 1995 Plan. For any year, the Company may issue awards under the Plan
providing for the issuance of not more than two percent of the total number of
shares outstanding as of December 31 of the preceding year, subject to certain
adjustments and to certain carryovers for expired and forfeited awards. This
amount does not include 911,700 nonqualified options at prices ranging from
$0.67 to $21.00 that were assumed by the Company in connection with the
Colonial acquisition.
All options granted under the 1990 Plan were granted at a price not less than
the fair market value of the Company's Common Stock (determined by the
valuation provisions of the 1990 Plan). All options granted under the 1995 Plan
have been granted at the market price of the Company's Common Stock on the
grant date. All granted options provide for vesting in four equal annual
installments, beginning one year after the date of grant, and expire 10 years
after the grant date. Compensation expense associated with these option plans
was $0.9 million and $1.3 million in 1996 and 1995, respectively. There was no
such compensation expense in 1997.
In April 1997, the Company instituted a nonvested stock plan. The nonvested
shares issued to employees vest generally after the end of six years. Such
vesting date may accelerate if the Company achieves certain performance
targets. Upon termination, any unvested shares would be forfeited. The Company
recorded $0.4 million in compensation expense for the year ended December 31,
1997.
Pro forma information regarding net income and earnings per share is required
by SFAS 123, which also requires that the information be determined as if the
Company accounted for its employee stock options granted subsequent to December
31, 1994 under the fair value method of that Statement. As provided for under
SFAS 123, the fair value for these options was estimated using a Black-Scholes
option pricing model with the following assumptions: risk free interest rate
- --5.73% for 1997 and 6.26% for 1996 and 1995; dividend yield--1.25% for 1997
and 1.99% for 1996 and 1995; expected volatility of the market price of the
Company's Common Stock--19.1% for 1997 and 15.0% for 1996 and 1995; and the
weighted average life of the options--6 years for all three periods.
For pro forma disclosure purposes, the estimated fair value of the options is
amortized to expense over the options' vesting period. The Company's pro forma
information follows (in millions, except for earnings per share information):
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
........................................................................
<S> <C> <C> <C>
Net income $127.1 $99.3 $73.6
Net income per share--basic 2.88 2.32 1.84
Net income per share--assuming dilution 2.73 2.21 1.75
</TABLE>
Because SFAS 123 is applicable only to options granted subsequent to December
31, 1994, its pro forma effect will not be fully reflected until 1998.
49
<PAGE>
A summary of the stock option activity, and related information for the years
ended December 31 follows (in thousands, except price data):
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ ---------------------- ---------------------
Options Weighted Options Weighted Options Weighted
Average Average Average
Exercise Exercise Exercise
Price Price Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding--beginning of year 4,484 $ 12.49 4,133 $ 9.58 3,182 $ 7.97
Granted 699 28.67 918 22.00 722 17.17
Assumed -- -- -- -- 912 6.83
Exercised for shares (1,027) (7.56) (489) (4.81) (150) (4.53)
Forfeited or cashed out (118) (20.74) (78) (17.95) (533) (7.11)
------ -------- ------ -------- ------ -------
Outstanding--end of year 4,038 $ 16.31 4,484 $ 12.49 4,133 $ 9.58
====== ======== ====== ======== ====== =======
Exercisable--end of year 2,346 $ 11.11 2,709 $ 8.60 2,591 $ 7.25
====== ======== ====== ======== ====== =======
Weighted-average fair value of options
granted during year $ 8.15 $ 5.31 $ 4.16
====== ====== ======
</TABLE>
Exercise prices for options outstanding as of December 31, 1997 ranged from
$0.67 to $37.08. The weighted-average remaining contractual life of these
options is 6.79 years.
10. Net Income per Share
The following table sets forth the computation of net income per share--basic
and net income per share--assuming dilution:
<TABLE>
<CAPTION>
1997 1996 1995
...........................................................................................................
<S> <C> <C> <C>
Numerator:
Net income $ 129.5 $ 100.7 $ 73.9
Preferred stock dividends (0.9) (0.9) (0.7)
----------- ----------- -----------
Numerator for net income per share--basic--income available to
common stockholders 128.6 99.8 73.2
Effect of dilutive securities:
Preferred stock dividends 0.9 0.9 0.7
----------- ----------- -----------
0.9 0.9 0.7
----------- ----------- -----------
Numerator for net income per share--assuming dilution--income
available to common stockholders after assumed conversions $ 129.5 $ 100.7 $ 73.9
Denominator:
Denominator for net income per share--basic--weighted-average
shares 43,808,904 42,353,927 39,645,722
Effect of dilutive securities:
Employee stock options 2,403,729 2,115,125 1,897,842
Convertible preferred stock 518,081 519,012 401,316
----------- ----------- -----------
Dilutive potential common shares 2,921,810 2,634,137 2,299,158
Denominator for net income per share--assuming dilution--
adjusted weighted-average shares and assumed conversions 46,730,714 44,988,064 41,944,880
=========== =========== ===========
Net income per share--basic $2.94 $2.36 $1.85
=========== =========== ===========
Net income per share--assuming dilution $2.77 $2.24 $1.76
=========== =========== ===========
</TABLE>
50
<PAGE>
11. Fair Value of Financial Instruments
The following discussion outlines the methodologies and assumptions used to
determine the fair value of the Company's financial instruments. The aggregate
fair value amounts presented herein do not necessarily represent the underlying
value of the Company, and accordingly, care should be exercised in deriving
conclusions about the Company's business or financial condition based on the
fair value information presented herein.
The following methods and assumptions were used by the Company in determining
fair values of financial instruments:
Fixed maturities and equity securities: Fair values for fixed maturity
securities are based on quoted market prices, where available. For fixed
maturities not actively traded, the estimated fair values are determined using
values from independent pricing services, or, in the case of private
placements, are determined by discounting expected future cash flows using a
current market rate applicable to the yield, credit quality, and maturity of
the securities. The estimated fair values for equity securities are based on
quoted market prices.
Mortgage loans: The estimated fair value of mortgage loans are determined by
discounting future cash flows to the present at current market rates, using
expected prepayment rates.
Other invested assets, Cash: With the exception of call options, the carrying
value for assets classified as other invested assets and cash in the
accompanying balance sheets approximates their fair value. Fair values for call
options are based on quoted market prices.
Policy liabilities: Deferred annuity contracts are assigned fair value equal to
current net surrender value. Annuitized contracts are valued based on the
present value of the future cash flows at current pricing rates.
Notes payable to affiliates, Revolving credit facility: Fair values for debt
are estimated using discounted cash flow analyses based on the Company's
incremental borrowing rate for similar types of borrowing arrangements.
The fair values and carrying values of the Company's financial instruments are
as follows (in millions):
<TABLE>
<CAPTION>
1997 1996
------------------------------- ------------------------------
Carrying Fair Carrying Fair
December 31 Value Value Value Value
...................................................................................................
<S> <C> <C> <C> <C>
Assets:
Fixed maturity securities $11,246.5 $11,246.5 $10,718.6 $10,718.6
Equity securities 40.8 40.8 35.9 35.9
Mortgage loans 60.7 63.0 67.0 73.4
Other invested assets 440.8 462.7 183.6 196.3
Cash and cash equivalents 1,290.1 1,290.1 875.8 875.8
Liabilities:
Policy liabilities 12,086.1 11,366.5 11,637.5 11,127.4
Notes payable to affiliates 229.0 229.0 229.0 229.0
Revolving credit facility 26.5 26.5 52.5 52.5
</TABLE>
12. Industry Segment Information
The Company's operations are classified in two business segments: annuity and
asset management. Annuity operations relate principally to the issuance of
fixed, indexed and variable annuity products and a closed block of
investment-oriented life insurance products. Asset management includes mutual
funds, wealth management and institutional asset management. Information by
industry segment for 1997, 1996 and 1995 is shown below (in millions):
51
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
......................................................................................
<S> <C> <C> <C>
Statement of Operations Data
Revenues:
Annuity:
Unaffiliated $ 922.4 $ 840.8 $ 790.1
Intersegment (9.3) (8.6) (7.7)
-------- -------- --------
Total annuity 913.1 832.2 782.4
-------- -------- --------
Asset management:
Unaffiliated 324.6 299.5 219.8
Intersegment 9.3 8.6 7.7
-------- -------- --------
Total asset management 333.9 308.1 227.5
-------- -------- --------
Total revenues $1,247.0 $1,140.3 $1,009.9
======== ======== ========
Income before income taxes:
Annuity:
Income before amortization of intangible assets $ 167.8 $ 132.6 $ 101.6
Amortization of intangible assets (1.1) (1.1) (1.2)
-------- -------- --------
Subtotal annuity 166.7 131.5 100.4
-------- -------- --------
Asset management:
Income before amortization of intangible assets 81.7 71.5 55.4
Amortization of intangible assets (12.2) (14.1) (10.8)
-------- -------- --------
Subtotal asset management 69.5 57.4 44.6
-------- -------- --------
Corporate:
Income before amortization of intangible assets (43.9) (38.4) (31.0)
Amortization of intangible assets (0.2) (0.2) (0.2)
-------- -------- --------
Subtotal corporate (44.1) (38.6) (31.2)
-------- -------- --------
Total income before income taxes $ 192.1 $ 150.3 $ 113.8
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31 1997 1996 1995
......................................................................
<S> <C> <C> <C>
Balance Sheet Data
Identifiable Assets:
Annuity $15,342.2 $13,924.6 $12,279.2
Asset management 477.1 484.0 469.3
Corporate 34.0 22.0 17.2
Intercompany eliminations (1.7) (2.9) (16.3)
----------- --------- ---------
Total $15,851.6 $14,427.7 $12,749.4
========= ========= =========
</TABLE>
52
<PAGE>
13. Quarterly Financial Data, in Millions, Except Per Share Amounts (unaudited)
<TABLE>
<CAPTION>
March June September December
Quarter Ended 1997 31 30 30 31
...............................................................................................................
<S> <C> <C> <C> <C>
Investment income $ 208.0 $ 212.2 $ 212.0 $ 220.9
Interest credited to policyholders (147.3) (147.2) (150.9) (148.7)
-------- -------- -------- ---------
Investment spread 60.7 65.0 61.1 72.2
Net realized investment gains 12.9 3.1 6.1 3.8
Fee income 89.4 89.1 95.2 94.3
Pretax income 51.8 43.9 47.8 48.6
Net income 35.0 30.0 32.9 31.6
Net income per share--basic 0.80 0.68 0.74 0.71
Net income per share--assuming dilution 0.76 0.65 0.70 0.67
March June September December
Quarter Ended 1996 31 30 30 31
...............................................................................................................
Investment income $ 189.2 $ 189.8 $ 201.7 $ 215.7
Interest credited to policyholders (138.1) (136.2) (146.0) (152.4)
--------- --------- -------- ---------
Investment spread 51.1 53.6 55.7 63.3
Net realized investment gains (losses) 3.8 (1.7) 0.7 5.2
Fee income 78.6 83.7 85.9 87.7
Pretax income 36.3 34.0 36.4 43.6
Net income 23.8 23.1 24.7 29.1
Net income per share--basic 0.57 0.54 0.57 0.67
Net income per share--assuming dilution 0.54 0.51 0.55 0.64
</TABLE>
The 1996 and first three quarters of 1997 earnings per share amounts have been
restated to comply with Statement of Financial Accounting Standards No. 128,
"Earnings per Share."
14. Statutory Information
Keyport is domiciled in Rhode Island and prepares its statutory financial
statements in accordance with accounting principles and practices prescribed or
permitted by the State of Rhode Island Insurance Department. Statutory surplus
and statutory net income differ from shareholders' equity and net income
reported in accordance with GAAP primarily because policy acquisition costs are
expensed when incurred, policy liabilities are based on different assumptions,
and income tax expense reflects only taxes paid or currently payable. Keyport's
statutory surplus and net income are as follows:
<TABLE>
<CAPTION>
Year Ended December 31 1997 1996 1995
..........................................................
<S> <C> <C> <C>
Statutory surplus $702.6 $567.7 $535.2
Statutory net income 107.1 40.2 38.3
</TABLE>
15. Transactions with Affiliated Companies
Liberty Mutual from time to time provides management, legal, audit and
financial services to the Company. Reimbursements to Liberty Mutual for these
services totaled $0.7 million, $0.6 million and $0.9 million in 1997, 1996 and
1995, respectively. These reimbursements are based on direct and indirect costs
incurred by Liberty Mutual and are allocated to the Company primarily based
upon the amount of time spent by Liberty Mutual's employees on the Company's
behalf. The Company believes that this allocation methodology is reasonable.
53
<PAGE>
The Company provided asset management services to real estate limited
partnerships in 1995 for which an affiliate of Liberty Mutual served as the
general partner. The affiliate paid the Company fees for such services which
totaled $6.7 million in 1995. These limited partnerships were liquidated in
1995.
During 1996, the Company sold to a wholly owned subsidiary of Liberty Mutual a
wholly owned subsidiary which had provided real estate management services to
certain affiliates of Liberty Mutual. The sales price was $2.1 million, the net
book value of the transferred subsidiary.
Regulatory authorities permit dividend payments from Keyport to the Company up
to the lesser of (i) 10% of statutory surplus as of the preceding December 31
or (ii) the net gain from operations for the preceding fiscal year. As of
December 31, 1997, Keyport could pay dividends of up to $70.3 million without
the approval of the Commissioner of Insurance of the State of Rhode Island.
16. Commitments and Contingencies
Leases: The Company leases data processing equipment, furniture and certain
office facilities from others under operating leases expiring in various years
through 2009. Rental expense amounted to $15.0 million, $16.0 million and $14.7
million for the years ended December 31, 1997, 1996 and 1995, respectively. For
each of the next five years, and in the aggregate, as of December 31, 1997, the
following are the minimum future rental payments under noncancelable operating
leases having remaining terms in excess of one year (in millions):
<TABLE>
<CAPTION>
Year Payments
<S> <C>
.........................................
1998 $14.3
1999 14.4
2000 14.2
2001 14.7
2002 10.1
Thereafter 29.5
</TABLE>
Legal Matters: The Company is involved at various times in litigation common to
its business. In the opinion of management, the resolution of any such
litigation is not expected to have a material adverse effect on the Company's
financial condition, results of operations or cash flows.
Regulatory Matters: Under existing guaranty fund laws in all states, insurers
licensed to do business in those states can be assessed for certain obligations
of insolvent insurance companies to policyholders and claimants. The actual
amount of such assessments will depend upon the final outcome of rehabilitation
proceedings and will be paid over several years. In 1997, 1996 and 1995,
Keyport was assessed $5.9 million, $10.0 million and $8.1 million,
respectively. During 1997, 1996 and 1995, Keyport recorded $1.0 million, $1.0
million and $2.0 million, respectively, of provisions for state guaranty fund
association expense. At December 31, 1997 and 1996, the reserve for such
assessments was $8.0 million and $12.9 million, respectively.
54
<PAGE>
Report of Independent Auditors
[Logo] Ernest & Young LLP
Shareholders and Board of Directors
Liberty Financial Companies, Inc.
We have audited the accompanying consolidated balance sheets of Liberty
Financial Companies, Inc. as of December 31, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. The financial statements of Liberty
Financial Companies, Inc. for the year ended December 31, 1995 were audited by
other auditors whose report dated February 16, 1996, expressed an unqualified
opinion on the statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and the significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the 1997 and 1996 financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Liberty Financial Companies, Inc. at December 31, 1997 and 1996, and the
consolidated results of its operations and its cash flows for the years then
ended in conformity with generally accepted accounting principles.
[Signature of Ernest & Young LLP]
Boston, Massachusetts
February 3, 1998
55
Exhibit 21
LIBERTY FINANCIAL COMPANIES, INC.
SUBSIDIARIES OF THE COMPANY
<TABLE>
<S> <C> <C>
Jurisdiction of
Incorporation or
Subsidiary Immediate Parent Organization
- ------------------------------------------------------- ------------------ -----------------
The Colonial Group, Inc. ("CGI")* The Company Massachusetts
Liberty Newport Holdings, Limited ("LNHL") The Company Delaware
Liberty Financial Services, Inc. ("LFS")* The Company Massachusetts
Independent Holdings, Inc. ("IHI") The Company Massachusetts
SteinRoe Services, Inc. ("SSI")* The Company Massachusetts
Liberty Real Estate Group, Inc. The Company Delaware
The PAMCO Group, Inc. The Company Delaware
Stein Roe & Farnham Incorporated ("Stein Roe")* SSI Delaware
Keyport Life Insurance Company ("Keyport")* SSI Rhode Island
SteinRoe Futures, Inc. Stein Roe Illinois
Keyport Financial Services Corp. Keyport Massachusetts
Liberty Advisory Services Corp. Keyport Massachusetts
American Benefit Life Insurance Company+ Keyport New York
Independence Life & Annuity Company* Keyport Rhode Island
Colonial Advisory Services, Inc. CGI Massachusetts
Colonial Management Associates, Inc. ("CMA")* CGI Massachusetts
Colonial Investors Service Center, Inc.* CGI Massachusetts
Liberty Financial Investments, Inc.* CMA Massachusetts
AlphaTrade, Inc. CMA Massachusetts
Newport Pacific Management, Inc. ("NPMI")* LNHL California
Newport Fund Management, Inc.* NPMI Virginia
Liberty Asset Management Company
("LAMCO") LFS Delaware
Liberty Investment Services, Inc. ("LIS") LFS Massachusetts
Copley Venture Capital, Inc. LFS Massachusetts
Liberty International Advisors, S.A. LAMCO Luxembourg
Liberty Financial Advisors, Inc. LIS Delaware
Liberty Securities Corporation* LIS Delaware
LSC Insurance Agency of Arizona, Inc. LIS Arizona
LSC Insurance Agency of Maine, Inc. LIS Maine
LSC Insurance Agency of New Mexico, Inc. LIS New Mexico
LSC Insurance Agency of Nevada, Inc. LIS Nevada
Financial Centre Insurance Agency, Inc. LIS Massachusetts
Liberty Financial International, S.A. LIS Luxembourg
Amigo Insurance Agency, Inc. LIS New Mexico
Independent Financial Marketing Group, Inc. ("IFMG")* IHI New York
<PAGE>
Jurisdiction of
Incorporation or
Subsidiary Immediate Parent Organization
- ------------------------------------------------------- ------------------ -----------------
Independent Financial Securities, Inc. IFMG New York
IFS Agencies, Inc. IFMG New York
IFS Agencies of Alabama, Inc. IFMG Alabama
IFS Agencies of New Mexico, Inc. IFMG New Mexico
IFMG Agencies of Maine, Inc. IFMG Maine
IFS Insurance Agencies of Ohio, Inc. IFMG Ohio
</TABLE>
- ----------
* Significant Subsidiaries, as defined in SEC Regulation S-X.
+ To be renamed "Keyport Benefit Life Insurance Company" on or about April 1,
1998.
Exhibit 23.1
Report and Consent of Independent Auditors
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Liberty Financial Companies, Inc. of our report dated February 3, 1998,
included in the 1997 Annual Report to Shareholders of Liberty Financial
Companies, Inc.
Our audit also included the 1996 and 1997 financial statement schedules of
Liberty Financial Companies, Inc. listed in Item 14(a). These schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audit. In our opinion, the 1996 and 1997 financial
statement schedules referred to above, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
We also consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-90626) pertaining to the Liberty Financial Companies, Inc.
1990 Stock Option Plan, the Liberty Financial Companies, Inc. 1995 Stock
Incentive Plan and the Liberty Financial Companies, Inc. 1995 Employee Stock
Purchase Plan and in the Registration Statement (Form S-3 No. 333-20067)
pertaining to the Liberty Financial Companies, Inc. Dividend Reinvestment Plan
of our report dated February 3, 1998 with respect to the 1996 and 1997
consolidated financial statements incorporated herein by reference, and our
report included in the preceding paragraph with respect to said financial
statement schedules included in this Annual Report (Form 10-K) of Liberty
Financial Companies, Inc.
Ernst & Young LLP
Boston, Massachusetts
March 25, 1998
Exhibit 23.2
REPORT AND CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Liberty Financial Companies, Inc.:
Under date of February 16, 1996, we reported on the consolidated statements of
income, stockholders' equity and cash flows for the year ended December 31,
1995 as contained in the 1995 annual report to stockholders. In connection with
our audit of the aforementioned consolidated financial statements, we also
audited the related financial statement schedules for the year ended December
31, 1995, listed in Item 14(a)2 of the Form 10-K for 1997. These financial
statement schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statement schedules
based on our audit. In our opinion, such financial statement schedules, when
considered in relation to the consolidated financial statements taken as a
whole, present fairly in all material respects the information set forth
therein.
We consent to incorporation by reference in the registration statement (No.
33-90626) on Form S-8 pertaining to the Liberty Financial Companies, Inc. 1990
Stock Option Plan, the Liberty Financial Companies, Inc. 1995 Stock Incentive
Plan and the Liberty Financial Companies, Inc. 1995 Employee Stock Purchase
Plan and in the registration statement (No. 333-20067) on Form S-3 pertaining
to the Liberty Financial Companies, Inc. Dividend Reinvestment Plan of our
report dated February 16, 1996, relating to the 1995 consolidated financial
statements incorporated herein by reference, and our report included in the
preceding paragraph with respect to the 1995 financial statement schedules
included in this annual report on Form 10-K of Liberty Financial Companies,
Inc.
KPMG Peat Marwick LLP
Boston, Massachusetts,
March 25, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 11,247
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 41
<MORTGAGE> 61
<REAL-ESTATE> 0
<TOTAL-INVEST> 12,344
<CASH> 1,291
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 232
<TOTAL-ASSETS> 15,852
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 12,086
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 229
0
15
<COMMON> 0
<OTHER-SE> 1,199
<TOTAL-LIABILITY-AND-EQUITY> 15,852
0
<INVESTMENT-INCOME> 853
<INVESTMENT-GAINS> 26
<OTHER-INCOME> 368
<BENEFITS> 0
<UNDERWRITING-AMORTIZATION> 76
<UNDERWRITING-OTHER> 310
<INCOME-PRETAX> 192
<INCOME-TAX> 63
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 130
<EPS-PRIMARY> 2.94
<EPS-DILUTED> 2.77
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 10,719
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 36
<MORTGAGE> 67
<REAL-ESTATE> 0
<TOTAL-INVEST> 11,538
<CASH> 876
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 250
<TOTAL-ASSETS> 14,428
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 11,638
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 229
0
14
<COMMON> 0
<OTHER-SE> 1,051
<TOTAL-LIABILITY-AND-EQUITY> 14,428
0
<INVESTMENT-INCOME> 796
<INVESTMENT-GAINS> 8
<OTHER-INCOME> 336
<BENEFITS> 0
<UNDERWRITING-AMORTIZATION> 60
<UNDERWRITING-OTHER> 278
<INCOME-PRETAX> 150
<INCOME-TAX> 50
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 101
<EPS-PRIMARY> 2.36
<EPS-DILUTED> 2.24
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-END> MAR-31-1996 JUN-30-1996 SEP-30-1996
<DEBT-HELD-FOR-SALE> 9,546,612 9,451,230 10,710,754
<DEBT-CARRYING-VALUE> 0 0 0
<DEBT-MARKET-VALUE> 0 0 0
<EQUITIES> 29,376 36,363 36,112
<MORTGAGE> 72,774 70,521 68,477
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 10,178,616 10,152,309 11,443,517
<CASH> 1,011,718 1,104,835 1,059,300
<RECOVER-REINSURE> 0 0 0
<DEFERRED-ACQUISITION> 263,455 304,221 295,514
<TOTAL-ASSETS> 13,092,388 13,246,471 14,563,718
<POLICY-LOSSES> 0 0 0
<UNEARNED-PREMIUMS> 0 0 0
<POLICY-OTHER> 10,191,629 10,389,378 11,559,719
<POLICY-HOLDER-FUNDS> 0 0 0
<NOTES-PAYABLE> 229,000 229,000 229,000
0 0 0
13,237 13,432 13,630
<COMMON> 281 284 285
<OTHER-SE> 947,573 959,795 993,185
<TOTAL-LIABILITY-AND-EQUITY> 13,092,388 13,246,471 14,563,718
0 0 0
<INVESTMENT-INCOME> 192,012 385,826 593,522
<INVESTMENT-GAINS> 3,774 2,090 2,823
<OTHER-INCOME> 84,124 162,313 248,208
<BENEFITS> 1,166 0 0
<UNDERWRITING-AMORTIZATION> 14,108 28,973 44,440
<UNDERWRITING-OTHER> 63,296 133,763 205,274
<INCOME-PRETAX> 36,274 70,328 106,730
<INCOME-TAX> 12,452 23,448 35,137
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 23,822 46,880 71,593
<EPS-PRIMARY> .57 1.11 1.68
<EPS-DILUTED> .54 1.05 1.60
<RESERVE-OPEN> 0 0 0
<PROVISION-CURRENT> 0 0 0
<PROVISION-PRIOR> 0 0 0
<PAYMENTS-CURRENT> 0 0 0
<PAYMENTS-PRIOR> 0 0 0
<RESERVE-CLOSE> 0 0 0
<CUMULATIVE-DEFICIENCY> 0 0 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<DEBT-HELD-FOR-SALE> 10,684 11,051 11,207
<DEBT-CARRYING-VALUE> 0 0 0
<DEBT-MARKET-VALUE> 0 0 0
<EQUITIES> 37 41 43
<MORTGAGE> 65 64 62
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 11,542 12,033 12,282
<CASH> 1,124 1,310 1,264
<RECOVER-REINSURE> 0 0 0
<DEFERRED-ACQUISITION> 322 253 212
<TOTAL-ASSETS> 14,759 15,429 15,683
<POLICY-LOSSES> 0 0 0
<UNEARNED-PREMIUMS> 0 0 0
<POLICY-OTHER> 11,688 11,942 12,072
<POLICY-HOLDER-FUNDS> 0 0 0
<NOTES-PAYABLE> 229 229 229
0 0 0
14 14 14
<COMMON> 0 0 0
<OTHER-SE> 1,043 1,119 1,181
<TOTAL-LIABILITY-AND-EQUITY> 14,759 15,429 15,683
0 0 0
<INVESTMENT-INCOME> 208 420 632
<INVESTMENT-GAINS> 13 16 22
<OTHER-INCOME> 89 179 274
<BENEFITS> 0 0 0
<UNDERWRITING-AMORTIZATION> 16 36 54
<UNDERWRITING-OTHER> 76 151 229
<INCOME-PRETAX> 52 96 144
<INCOME-TAX> 17 31 46
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 35 65 98
<EPS-PRIMARY> .80 1.49 2.23
<EPS-DILUTED> .76 1.40 2.10
<RESERVE-OPEN> 0 0 0
<PROVISION-CURRENT> 0 0 0
<PROVISION-PRIOR> 0 0 0
<PAYMENTS-CURRENT> 0 0 0
<PAYMENTS-PRIOR> 0 0 0
<RESERVE-CLOSE> 0 0 0
<CUMULATIVE-DEFICIENCY> 0 0 0
</TABLE>
