SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
----------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 1-13654
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LIBERTY FINANCIAL COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
Massachusetts 04-3260640
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
600 Atlantic Avenue, Boston, Massachusetts 02210-2214
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(Address of principal executive offices) (Zip Code)
(617) 722-6000
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ] Yes [ ] No
There were 45,077,187 shares of the registrant's Common Stock, $.01 par
value, and 326,036 shares of the registrant's Series A Convertible Preferred
Stock, $.01 par value, outstanding as of April 30, 1998.
Exhibit Index - Page 19 Page 1 of 21
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED MARCH 31, 1998
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements
Consolidated Balance Sheets as of March
31, 1998 and December 31, 1997
Consolidated Income Statements for the
Three Months Ended March 31, 1998 and 1997
Consolidated Statements of Cash Flows for
the Three Months Ended March 31, 1998 and 1997
Consolidated Statement of Stockholders'
Equity for the Three Months Ended March 31, 1998
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signatures
Exhibit Index
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
($ in millions)
<CAPTION>
March 31 December 31
1998 1997
---------- -----------
Unaudited
ASSETS
<S> <C> <C>
Assets:
Investments $12,395.7 $12,343.5
Cash and cash equivalents 1,410.2 1,290.1
Accrued investment income 166.9 165.0
Deferred policy acquisition costs 236.5 232.0
Value of insurance in force 52.7 53.3
Deferred distribution costs 107.0 108.1
Intangible assets 197.8 199.0
Other assets 324.1 131.4
Separate account assets 1,469.5 1,329.2
---------- ----------
$16,360.4 $15,851.6
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policyholder balances $12,161.6 $12,086.1
Notes payable to affiliates 229.0 229.0
Payable for investments
purchased and loaned 971.1 722.1
Other liabilities 345.2 336.9
Separate account liabilities 1,401.4 1,264.0
---------- ----------
Total liabilities 15,108.3 14,638.1
---------- ----------
Series A redeemable convertible
preferred stock, par value $.01;
authorized, issued and outstanding
326,036 shares in 1998 and 327,006
shares in 1997 14.7 14.6
---------- ----------
Stockholders' Equity:
Common stock, par value $.01;
authorized 100,000,000 shares,
issued 45,064,950 shares in 1998 and
44,706,398 shares in 1997 0.5 0.4
Additional paid-in capital 873.1 866.5
Accumulated other comprehensive income 87.9 83.0
Retained earnings 278.1 251.5
Cost of common stock held in treasury
(9,465 shares at December 31, 1997) 0.0 (0.3)
Unearned compensation (2.2) (2.2)
---------- ----------
Total stockholders' equity 1,237.4 1,198.9
---------- ----------
$16,360.4 $15,851.6
========== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED INCOME STATEMENTS
(in millions, except per share data)
Unaudited
<CAPTION>
Three Months Ended
March 31
-----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Investment income $207.4 $208.0
Interest credited to policyholders (142.1) (147.3)
---------- ----------
Investment spread 65.3 60.7
---------- ----------
Net realized investment gains 2.2 12.9
---------- ----------
Fee income:
Investment advisory and administrative fees 56.8 53.1
Distribution and service fees 12.6 12.1
Transfer agency fees 12.2 11.8
Surrender charges and net commissions 8.4 8.5
Separate account fees 4.7 3.9
---------- ----------
Total fee income 94.7 89.4
---------- ----------
Expenses:
Operating expenses (79.9) (75.8)
Amortization of deferred policy
acquisition costs (19.0) (16.3)
Amortization of deferred distribution costs (9.0) (8.2)
Amortization of value of insurance in force (1.5) (3.2)
Amortization of intangible assets (3.5) (3.2)
Interest expense, net (3.9) (4.5)
---------- ----------
Total expenses (116.8) (111.2)
---------- ----------
Pretax income 45.4 51.8
Income tax expense (13.9) (16.8)
---------- ----------
Net income $31.5 $35.0
========== ==========
Net income per share - basic $0.70 $0.81
========== ==========
Net income per share - assuming dilution $0.67 $0.76
========== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Unaudited
<CAPTION>
Three Months Ended
March 31
-----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $31.5 $35.0
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 19.0 18.2
Interest credited to policyholders 142.1 147.3
Net realized investment gains (2.2) (12.9)
Net amortization (accretion) on investments 39.3 (8.1)
Change in deferred policy acquisition costs (0.2) (0.6)
Net change in other assets and liabilities (26.2) (18.0)
---------- ----------
Net cash provided by operating activities 203.3 160.9
---------- ----------
Cash flows from investing activities:
Investments purchased available for sale (1,145.3) (724.4)
Investments sold available for sale 1,034.0 243.6
Investments matured available for sale 287.5 450.5
Change in policy loans, net (9.0) (6.0)
Change in mortgage loans, net 1.4 1.7
---------- ----------
Net cash provided by (used in) investing
activities 168.6 (34.6)
---------- ----------
Cash flows from financing activities:
Withdrawals from policyholder accounts (393.1) (299.4)
Deposits to policyholder accounts 167.4 202.3
Securities lending (23.2) 223.7
Change in revolving credit facility (4.0) (5.5)
Exercise of stock options 2.5 1.3
Dividends paid (1.4) (1.0)
---------- ----------
Net cash provided by (used in)
financing activities (251.8) 121.4
---------- ----------
Increase in cash and cash equivalents 120.1 247.7
Cash and cash equivalents at beginning
of period 1,290.1 875.8
---------- ----------
Cash and cash equivalents at end of period $1,410.2 $1,123.5
========== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in millions)
Unaudited
<CAPTION>
Accum.
Add'l. Other Total
Common Paid-In Comp. Retained Treas. Unearned Stockholders'
Stock Capital Income Earnings Stock Comp. Equity
------- ------- ------- -------- ------ -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance,
December
31, 1997 $0.4 $866.5 $83.0 $251.5 $(0.3) $(2.2) $1,198.9
Effect of
stock-based
compensation
plans 0.1 3.3 0.3 3.7
Accretion to
face value of
preferred
stock (0.2) (0.2)
Common stock
dividends 3.3 (4.5) (1.2)
Preferred stock
dividends (0.2) (0.2)
Net income 31.5 31.5
Other
comprehensive
income, net
of tax 4.9 4.9
------- ------- ------- -------- ------ -------- ------------
Balance, March
31, 1998 $0.5 $873.1 $87.9 $278.1 $0.0 $(2.2) $1,237.4
======= ======= ======= ======== ====== ======== ============
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
LIBERTY FINANCIAL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
1. General
The accompanying unaudited consolidated financial statements include all
adjustments, consisting of normal recurring accruals, that management
considers necessary for a fair presentation of the Company's financial
position and results of operations as of and for the interim periods
presented. Certain footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. Therefore, these
consolidated financial statements should be read in conjunction with the
audited consolidated financial statements contained in the Company's 1997
Annual Report to Stockholders. The results of operations for the three months
ended March 31, 1998 are not necessarily indicative of the results to be
expected for the full year. Certain previously reported amounts have been
reclassified to conform with the current period presentation.
2. Industry Segment Information
The Company is an asset accumulation and management company which operates
in two industry segments: retirement-oriented insurance (principally
annuities) and asset management. The annuity insurance business is conducted
at Keyport Life Insurance Company ("Keyport"). Keyport generates investment
spread income from the investment portfolio which supports policyholder
balances associated with its fixed and indexed annuity business and its
closed block of single premium whole life insurance. The annuity insurance
business also derives fee income from the administration of fixed, indexed
and variable annuity contracts. The asset management business is conducted
principally at The Colonial Group, Inc. ("Colonial"), an investment advisor,
distributor and transfer agent to mutual funds, Stein Roe & Farnham
Incorporated ("Stein Roe"), a diversified investment advisor, Newport Pacific
Management, Inc. ("Newport"), an investment advisor to mutual funds and
institutional accounts specializing in Asian equity markets, and Liberty
Asset Management Company ("LAMCO"), an investment advisor to mutual funds.
The asset management business derives fee income from investment products and
services.
Approximately 63% of the Company's income before interest expense,
amortization of intangible assets, net realized gains and income taxes for
the three months ended March 31, 1998 was attributable to the Company's
annuity insurance business, with the remaining 37% attributable to the
Company's asset management activities. This compares to approximately 65% and
35%, respectively, during the year earlier period.
3. Investments
Investments, all of which pertain to the Company's annuity insurance
operations, were comprised of the following (in millions):
<TABLE>
<CAPTION>
March 31 December 31
1998 1997
----------- -----------
<S> <C> <C>
Fixed maturities $11,187.4 $11,246.5
Equity securities 41.5 40.8
Mortgage loans 59.2 60.7
Policy loans 563.7 554.7
Other invested assets 543.9 440.8
----------- -----------
Total $12,395.7 $12,343.5
=========== ===========
</TABLE>
The Company's general investment policy is to hold fixed maturity assets
for long-term investment and, accordingly, the Company does not have a
trading portfolio. To provide for maximum portfolio flexibility and enable
appropriate tax planning, the Company classifies its entire fixed maturities
investments as "available for sale" which are carried at fair value.
<PAGE>
4. Net Income Per Share
The following table sets forth the computation of net income per
share - basic and net income per share-assuming dilution (in millions, except
share and per share data):
<TABLE>
<CAPTION>
Three Months Ended
March 31
-------------------
1998 1997
------- ------
<S> <C> <C>
Numerator:
Net income $31.5 $35.0
Preferred stock dividends (0.2) (0.2)
------- ------
Numerator for net income per share -
basic - income available to common
stockholders 31.3 34.8
Effect of dilutive securities:
Preferred stock dividends 0.2 0.2
------- ------
0.2 0.2
------- ------
Numerator for net income per share
- assuming dilution - income
available to common stockholders
after assumed conversions 31.5 35.0
Denominator:
Denominator for net income per
share - basic - weighted-average shares 44,747,459 43,163,696
Effect of dilutive securities:
Employee stock options 1,828,980 2,571,529
Convertible preferred stock 517,474 518,457
----------- -----------
Dilutive potential common shares 2,346,454 3,089,986
----------- -----------
Denominator for net income per
share - assuming dilution -
adjusted weighted-average shares
and assumed conversions 47,093,913 46,253,682
============ ===========
Net income per share - basic $0.70 $0.81
============ ===========
Net income per share - assuming
dilution $0.67 $0.76
============ ===========
</TABLE>
5. Recent Accounting Change
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of SFAS 130 had no impact on
the Company's net income or stockholders' equity. SFAS 130 requires
unrealized gains or losses on the Company's available-for-sale securities,
which prior to adoption were reported separately in stockholders' equity, to
be included in accumulated other comprehensive income. Prior year financial
statements have been reclassified to conform to the requirements of SFAS 130.
During the first quarters of 1998 and 1997, comprehensive income (loss) was
comprised of the following (in millions):
<TABLE>
<CAPTION>
Three Months Ended
March 31
---------------------
1998 1997
------ ------
<S> <C> <C>
Net income $31.5 $35.0
Other comprehensive income (loss),
net of tax:
Change in net unrealized
investment gains 4.9 (43.7)
------ ------
Comprehensive income (loss) $36.4 $(8.7)
====== ======
</TABLE>
<PAGE>
6. Recent Accounting Pronouncement
In April 1998, the Financial Accounting Standards Board voted to proceed
with the drafting of an accounting statement entitled "Accounting for
Derivative Instruments and for Hedging Activities," which is expected to be
issued by mid-June. This statement will standardize the accounting for
derivative instruments and the derivative portion of certain other contracts
that have similar characteristics by requiring that an entity recognize those
instruments at fair value. This statement also requires a new method of
accounting for hedging transactions, prescribes the type of items and
transactions that may be hedged, and specifies detailed criteria to be met to
qualify for hedge accounting. This statement will become effective for fiscal
years beginning after June 15, 1999. Earlier adoption is permitted as of July
1, 1998. The Company is evaluating the impact of this statement.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
Results of Operations
Net Income was $31.5 million or $0.67 per share in the first quarter of 1998
compared to $35.0 million or $0.76 per share in the first quarter of 1997. The
decrease of $3.5 million in 1998 compared to 1997 resulted from lower net
realized investment gains and higher operating expenses and amortization
expense. Partially offsetting these items were higher investment spread and fee
income and lower income tax expense.
Pretax Income was $45.4 million in the first quarter of 1998 compared to
$51.8 million in the first quarter of 1997. The lower pretax income in 1998
compared to 1997 resulted from lower net realized investment gains and higher
operating expenses and amortization expense. Partially offsetting these items
were higher investment spread and fee income.
Investment Spread is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $65.3 million in the first quarter of 1998 compared to
$60.7 million in the first quarter of 1997. The amount by which the average
yield on investments exceeds the average interest credited rate on policyholder
balances is the investment spread percentage. Such investment spread percentage
in the first quarter of 1998 was 1.89% compared to 1.90% in the first quarter of
1997.
Investment income was $207.4 million in the first quarter of 1998 compared to
$208.0 million in the first quarter of 1997. The decrease of $0.6 million in
1998 compared to 1997 primarily relates to a $10.7 million decrease resulting
from a lower average investment yield, largely offset by a $10.1 million
increase as a result of the higher level of average invested assets. The 1998
investment income was net of $17.3 million of S&P 500 Index call option
amortization expense related to the Company's equity-indexed annuities compared
to $7.8 million in 1997. The average investment yield was 6.58% in the first
quarter of 1998 compared to 6.94% in the first quarter of 1997.
Interest credited to policyholders totaled $142.1 million in the first
quarter of 1998 compared to $147.3 million in the first quarter of 1997. The
decrease of $5.2 million in 1998 compared to 1997 primarily relates to a $10.2
million decrease resulting from a lower average interest credited rate,
partially offset by a $5.0 million increase as a result of a higher level of
average policyholder balances. Policyholder balances averaged $12.1 billion
(including $10.5 billion of fixed products, consisting of fixed annuities and
the closed block of single premium whole life insurance, and $1.6 billion of
equity-indexed annuities) in the first quarter of 1998 compared to $11.7 billion
(including $10.8 billion of fixed products and $0.9 billion of equity-indexed
annuities) in the first quarter of 1997. The average interest credited rate was
4.69% (5.31% on fixed products and 0.85% on equity-indexed annuities) in the
first quarter of 1998 compared to 5.04% (5.37% on fixed products and 0.85% on
equity-indexed annuities) in the first quarter of 1997. Keyport's equity-indexed
annuities credit interest to the policyholder at a "participation rate" equal to
a portion (ranging for existing policies from 55% 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.
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 $12.6 billion in the first quarter of 1998 compared to $12.0
billion in the first quarter of 1997. The increase of $0.6 billion in 1998
compared to 1997 primarily relates net insurance cash flows for the twelve
months ended March 31, 1998.
Net Realized Investment Gains were $2.2 million in the first quarter of 1998
compared to $12.9 million in the first quarter of 1997. Sales of fixed maturity
investments generally are made to maximize total return. The net realized
investment gains in 1998 included gains on the sales of fixed maturity
investments of $0.8 million and gains on sales of general corporate securities
of $1.4 million. The net realized investment gains in 1997 were attributable to
sales of the Company's 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 $56.8 million in the first
quarter of 1998 compared to $53.1 million in the first quarter of 1997. The
increase of $3.7 million in 1998 compared to 1997 primarily reflects a higher
level of average fee-based assets under management.
Average fee-based assets under management were $39.4 billion in the first
quarter of 1998 compared to $35.8 billion in the first quarter of 1997. The
increase of $3.6 billion during 1998 compared to 1997 resulted primarily from
market appreciation. Investment advisory and administrative fees were 0.58% of
average fee-based assets under management in the first quarter of 1998 and 0.59%
in the first quarter of 1997.
The amount of fee-based assets under management is 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).
<TABLE>
Fee-Based Assets Under Management
<CAPTION>
As of March 31
--------------------
1998 1997
------ ------
<S> <C> <C>
Mutual Funds:
Intermediary-distributed $16.8 $15.6
Direct-marketed 7.6 6.2
Closed-end 2.3 1.9
Variable annuity 1.4 1.1
------ ------
28.1 24.8
Wealth Management 7.2 5.5
Institutional 5.5 4.5
------ ------
Total Fee-Based
Assets Under Management* $40.8 $34.8
====== ======
- --------------
* As of March 31, 1998 and 1997, Keyport's insurance assets of $13.0 billion
and $12.2 billion, respectively, bring total assets under management to $53.8
billion and $47.0 billion, respectively.
</TABLE>
<TABLE>
Changes in Fee-Based Assets Under Management
<CAPTION>
Three Months Ended
March 31
--------------------
1998 1997
------ ------
<S> <C> <C>
Fee-based assets under management
- beginning $38.7 $35.9
Sales and reinvestments 1.9 1.8
Redemptions and withdrawals (1.7) (2.0)
Market appreciation (depreciation) 1.9 (0.9)
------ ------
Fee-based assets under management
- ending $40.8 $34.8
====== ======
</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 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 $12.6 million in the first quarter of 1998 compared to $12.1
million in the first quarter of 1997. The increase of $0.5 million in 1998
compared to 1997 was primarily attributable to the higher asset levels of mutual
funds with contingent deferred sales charges. As a percentage of weighted
average assets, distribution and service fees were approximately 0.71% in the
first quarters of 1998 and 1997.
Transfer Agency Fees are based on the market value of assets managed in the
Company's intermediary-distributed and direct-marketed mutual funds. Such fees
were $12.2 million on average assets of $25.0 billion in the first quarter of
1998 and $11.8 million on average assets of $23.6 billion in the first quarter
of 1997. As a percentage of total average mutual fund assets under management,
transfer agency fees were approximately 0.20% in the first quarters of 1998 and
1997.
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 such 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 $8.4 million in the first quarter of 1998 compared to $8.5 million in the
first quarter of 1997.
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 $5.3 million and $4.8 million
in the first quarters of 1998 and 1997, respectively. Total annuity withdrawals
represented 14.1% and 11.2% of the total average annuity policyholder and
separate account balances in the first quarters of 1998 and 1997, respectively.
The increase in annualized withdrawals in 1998 was primarily attributable to
surrenders of a certain block of single premium deferred annuities which came
out of their surrender charge period during the first quarter of 1998; excluding
these surrenders, the withdrawal percentage in 1998 was 11.6%. Net commissions
were $3.1 million in the first quarter of 1998 and $3.7 million in the first
quarter of 1997.
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 $4.7 million in the first quarter of 1998 compared to $3.9
million in the first quarter of 1997. Such fees represented 1.43% and 1.55% of
average variable annuity and variable life separate account balances in the
first quarters of 1998 and 1997, respectively.
Operating Expenses primarily represent compensation, marketing, and other
general and administrative expenses. These expenses were $79.9 million in the
first quarter of 1998 compared to $75.8 million in the first quarter of 1997.
The increase in 1998 compared to 1997 was primarily due to increases in
compensation and marketing expenses. Operating expenses expressed as a percent
of average total assets under management were 0.61% and 0.63% in the first
quarters of 1998 and 1997, respectively.
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 $19.0
million in the first quarter of 1998 compared to $16.3 million in the first
quarter of 1997. The increase in amortization in 1998 compared to 1997 was
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 29.10% and
26.85% of investment spread in the first quarters of 1998 and 1997,
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 $9.0 million in the first quarter of 1998 compared to $8.2
million in the first quarter of 1997. The increase in 1998 compared to 1997 was
primarily attributable to the continuing sales of such fund shares during 1998
and 1997.
Amortization of Value of Insurance in Force relates to the
actuarially-determined present value of projected future gross profits from
policies in force at the date of acquisition. Amortization totaled $1.5 million
in the first quarter of 1998 compared to $3.2 million in the first quarter of
1997. The decrease in amortization in 1998 compared to 1997 was primarily due to
reduced amortization related to a change in mortality assumptions.
Amortization of Intangible Assets relates to goodwill and certain
identifiable intangible assets arising from business combinations accounted for
as purchases. Amortization was $3.5 million in the first quarter of 1998
compared to $3.2 million in the first quarter of 1997.
Interest Expense, Net was $3.9 million in the first quarter of 1998 compared
to $4.5 million in the first quarter of 1997. The decrease of $0.6 million was
due to lower interest expense related to Colonial's credit facility which is
utilized to finance the sale of shares of mutual funds which have contingent
deferred sales charges and to higher interest income which is netted against
interest expense.
Income Tax Expense was $13.9 million or 30.6% of pretax income in the first
quarter of 1998 compared to $16.8 million, or 32.4% of pretax income in the
first quarter of 1997.
Financial Condition
Stockholders' Equity as of March 31, 1998 was $1.24 billion compared to $1.20
billion as of December 31, 1997. Net income in the first quarter of 1998 was
$31.5 million and cash dividends on the Company's preferred and common stock
totaled $1.4 million. Common stock totaling $2.5 million was issued in
connection with the exercise of stock options. In addition, the exercise of
certain stock options resulted in a federal income tax benefit to the Company of
$1.0 million which was credited to additional paid-in capital. An increase in
accumulated other comprehensive income, 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 $4.9 million.
Book Value Per Share amounted to $27.46 at March 31, 1998 compared to $26.82
at December 31, 1997. Excluding net unrealized gains on investments, book value
per share amounted to $25.51 at March 31, 1998 and $24.97 at December 31, 1997.
As of March 31, 1998, there were 45.1 million common shares outstanding compared
to 44.7 million shares as of December 31, 1997.
Investments not including cash and cash equivalents, totaled $12.4 billion at
March 31, 1998 compared to $12.3 billion at December 31, 1997.
The Company manages the substantial majority of its invested assets
internally. The Company's general investment policy is to hold fixed maturity
assets for long-term investment and, accordingly, the Company does not have a
trading portfolio. To provide for maximum portfolio flexibility and appropriate
tax planning, the Company classifies its entire fixed maturities investments as
"available for sale" and accordingly carries such investments at fair value. The
Company's total investments at March 31, 1998 and December 31, 1997 reflected
net unrealized gains of $276.1 million and $280.2 million, respectively,
relating to its fixed maturity and equity portfolios.
Approximately $11.0 billion, or 80.5%, of the Company's general account
investments at March 31, 1998, 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
March 31, 1998, the carrying value of investments in below investment grade
securities totaled $1.1 billion, or 8.0% of general account investments of $13.7
billion. Below investment grade securities generally provide higher yields and
involve greater risks than investment grade securities because their issuers
typically are more highly leveraged and more vulnerable to adverse economic
conditions than investment grade issuers. In addition, the trading market for
these securities may be more limited than for investment grade securities.
Management of the Company's Investments
Asset-liability duration management is utilized by the Company to minimize
the risks of interest rate fluctuations and 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 82.2% of the Company's
fixed annuity policyholder balances were subject to surrender charges at March
31, 1998.
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 March 31, 1998,
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 ("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 credited to
policyholders. The Company had 46 and 45 outstanding swap agreements as of March
31, 1998 and December 31, 1997, respectively, with an aggregate notional
principal amount of $2.6 billion.
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 as of March 31, 1998 and December 31, 1997.
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 $478.6
million and $323.3 million as of March 31, 1998 and December 31, 1997,
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. 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.
There were no non-income producing investments in the Company's fixed maturity
portfolio at March 31, 1998 or December 31, 1997.
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 be paid until it is approved by the Commissioner of Insurance of the State
of Rhode Island. As of March 31, 1998, 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 March 31, 1998, $10.6 billion, or 77.6% 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.
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
communication 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 issues 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 operation.
Effects of Inflation
Inflation has not had a material effect on the Company's consolidated results
of operations. The Company manages its investment portfolio in part to reduce
its exposure to interest rate fluctuations. In general, the market value of the
Company's fixed maturity portfolio increases or decreases in inverse
relationship with fluctuations in interest rates, and the Company's net
investment income increases or decreases in direct relationship with interest
rate changes. For instance, if interest rates decline, the Company's fixed
maturity investments generally will increase in market value, while net
investment income will decrease as fixed maturity investments mature or are sold
and the proceeds are reinvested at reduced rates. However, inflation may result
in increased operating expenses that may not be readily recoverable in the
prices of the services charged by the Company.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
12 Statement re Computation of Ratios
27 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended March 31,
1998.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LIBERTY FINANCIAL COMPANIES, INC.
/s/ J. Andy Hilbert
----------------------------
J. Andy Hilbert
(Duly Authorized Officer and
Chief Financial Officer)
Date: May 14, 1998
<PAGE>
Exhibit Index
Exhibit No. Description Page
- ----------- ----------- ----
12 Statement re Computation of Ratios
27 Financial Data Schedule
<TABLE>
LIBERTY FINANCIAL COMPANIES, INC.
EXHIBIT 12 - Statement re Computation of Ratios
($ in millions)
<CAPTION>
Three Months Ended
March 31
-------------------
1998 1997
------- -------
<S> <C> <C>
Earnings:
Pretax income $45.4 $51.8
Add fixed charges:
Interest on indebtedness 5.2 5.5
Portion of rent representing
the interest factor 1.0 1.1
Preferred stock dividends 0.2 0.2
Accretion to face
value of redeemable
convertible preferred stock 0.2 0.2
------- -------
Income as adjusted $52.0 $58.8
======= =======
Fixed charges:
Interest on indebtedness $5.2 $5.5
Portion of rent representing
the interest factor 1.0 1.1
Preferred stock dividends 0.2 0.2
Accretion to face
value of redeemable
convertible preferred stock 0.2 0.2
------- -------
Total fixed charges $6.6 $7.0
======= =======
Ratio of earnings to fixed charges 7.88x 8.40x
======= =======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 11,187
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 42
<MORTGAGE> 59
<REAL-ESTATE> 0
<TOTAL-INVEST> 12,396
<CASH> 1,410
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 237
<TOTAL-ASSETS> 16,360
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 12,162
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 229
0
15
<COMMON> 1
<OTHER-SE> 1,236
<TOTAL-LIABILITY-AND-EQUITY> 16,360
0
<INVESTMENT-INCOME> 207
<INVESTMENT-GAINS> 2
<OTHER-INCOME> 95
<BENEFITS> 0
<UNDERWRITING-AMORTIZATION> 19
<UNDERWRITING-OTHER> 80
<INCOME-PRETAX> 46
<INCOME-TAX> 14
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 32
<EPS-PRIMARY> 0.70
<EPS-DILUTED> 0.67
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
