-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HwhG567vaGdAA0k4LftvVR/RilOO1IqXaUsNJNj5vSkcsP9YJB1tQC77qczMX+MJ FcUL/hq1I5ca6YItMZyYJw== 0001029869-97-000762.txt : 19970617 0001029869-97-000762.hdr.sgml : 19970617 ACCESSION NUMBER: 0001029869-97-000762 CONFORMED SUBMISSION TYPE: S-3 PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19970616 SROS: NASD SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: LIBERTY FINANCIAL COMPANIES INC /MA/ CENTRAL INDEX KEY: 0000936372 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 043260640 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-3 SEC ACT: 1933 Act SEC FILE NUMBER: 333-29315 FILM NUMBER: 97624779 BUSINESS ADDRESS: STREET 1: 600 ATLANTIC AVE 24TH FLOOR STREET 2: 24TH FL CITY: BOSTON STATE: MA ZIP: 02110-2214 BUSINESS PHONE: 6177226000 MAIL ADDRESS: STREET 1: 600 ATLANTIC AVENUE 24TH FLOOR STREET 2: 600 ATLANTIC AVENUE 24TH FLOOR CITY: BOSTON STATE: MA ZIP: 02210-2214 FORMER COMPANY: FORMER CONFORMED NAME: NEW LFC INC DATE OF NAME CHANGE: 19950130 S-3 1 LIBERTY FINANCIAL COMPANIES, INC. As filed with the Securities and Exchange Commission on June 16, 1997 Registration No. 333- ------------------------------------------------------------------------ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM S-3 REGISTRATION STATEMENT Under THE SECURITIES ACT OF 1933 ---------------------- LIBERTY FINANCIAL COMPANIES, INC. (Exact name of registrant as specified in its charter) ---------------------- Massachusetts 04-3260640 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 600 Atlantic Avenue, Boston, Massachusetts 02210-2214 (617) 722-6000 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ---------------------- JOHN A. BENNING, ESQ. Senior Vice President and General Counsel Liberty Financial Companies, Inc. 600 Atlantic Avenue Boston, Massachusetts 02210-2214 (617) 722-6000 (Name, address, including zip code, and telephone number, including area code, of agent for service) ---------------------- Copies to: WILLIAM P. GELNAW, JR., ESQ. CHRISTOPHER C. MANSFIELD, ESQ. KENNETH T. COTE, ESQ. JAMES W. HACKETT, JR., ESQ. Liberty Mutual Insurance Company MICHAEL A. KING, ESQ. Choate, Hall & Stewart 175 Berkeley Street Brown & Wood LLP 53 State Street Boston, Massachusetts 02117 One World Trade Center Boston, Massachusetts 02109 (617) 357-9500 New York, New York 10048 (617) 248-5000 (212) 839-5300
Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement. If the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, check the following box. [BOX] If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [BOX] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of earlier effective registration statement for the same offering. [BOX] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [BOX] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [BOX]
CALCULATION OF REGISTRATION FEE - ---------------------------------------------------------------------------------------------------------------- Proposed Maximum Proposed Maximum Title of each Class of Amount to be Offering Price Aggregate Offering Amount of Securities to be Registered Registered (1) Per Share (2) Price (2) Registration Fee - ---------------------------------------------------------------------------------------------------------------- Common Stock, $.01 par value 2,875,000 shares $49.50 $142,312,500 $43,125 - ----------------------------------------------------------------------------------------------------------------
(1) Includes 375,000 shares subject to the Underwriters' over-allotment option. (2) Estimated solely for the purpose of calculating the registration fee, in accordance with Rule 457(c) under the Securities Act of 1933, on the basis of the last reported sale price of the registrant's Common Stock on June 11, 1997, as reported by the New York Stock Exchange, Inc. ---------------------- The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. SUBJECT TO COMPLETION PRELIMINARY PROSPECTUS DATED JUNE 16, 1997 PROSPECTUS - ---------- 2,500,000 Shares [LIBERTY FINANCIAL LOGO] Liberty Financial Companies, Inc. Common Stock ------------ All of the 2,500,000 shares of Common Stock offered hereby are being sold by LFC Holdings, Inc. and certain other shareholders (collectively, the "Selling Shareholders") of Liberty Financial Companies, Inc. (the "Company" or "Liberty Financial"). See "Principal and Selling Shareholders." LFC Holdings, Inc. is an indirect subsidiary of Liberty Mutual Insurance Company ("Liberty Mutual"). The Company will not receive any of the proceeds from the sale of the shares by the Selling Shareholders. The Common Stock is traded on the New York Stock Exchange under the symbol "L". The Common Stock is also listed on the Boston Stock Exchange. On June 11, 1997, the last reported sale price of the Common Stock on the New York Stock Exchange was $49.50 per share. See "PRICE RANGE OF COMMON STOCK AND DIVIDENDS." Investors should consider carefully the factors set forth under the caption "INVESTMENT CONSIDERATIONS" on page 8. ------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - ------------------------------------------------------------------------- Price to Underwriting Proceeds to Public Discount (1) Selling Shareholders (2) - ------------------------------------------------------------------------- Per Share ...... $ $ $ - ------------------------------------------------------------------------- Total (3) ...... $ $ $ - ------------------------------------------------------------------------- (1) The Company and LFC Holdings, Inc. have agreed to indemnify the several Underwriters and certain related persons against certain liabilities under the Securities Act of 1933, as amended. See "UNDERWRITING." (2) Before deducting expenses of the offering estimated at $425,000 payable by LFC Holdings, Inc. (3) LFC Holdings, Inc. has granted the Underwriters a 30-day option to purchase up to 375,000 additional shares of Common Stock, solely to cover over-allotments, if any. If the option is exercised in full, the total Price to Public, Underwriting Discount and Proceeds to Selling Shareholders will be $ , $ and $ , respectively. See "UNDERWRITING." ------------ The shares of Common Stock are offered by the several Underwriters, subject to prior sale, when, as and if delivered to and accepted by them, and subject to the approval of certain legal matters by counsel for the Underwriters and certain other conditions. The Underwriters reserve the right to withdraw, cancel or modify such offer and to reject any order in whole or in part. It is expected that delivery of the shares will be made in New York, New York, on or about , 1997. ------------ Merrill Lynch & Co. Goldman, Sachs & Co. PaineWebber Incorporated Fox-Pitt, Kelton Inc. ------------ The date of this Prospectus is , 1997. FOR NORTH CAROLINA INVESTORS: THE COMMISSIONER OF INSURANCE FOR THE STATE OF NORTH CAROLINA HAS NOT APPROVED OR DISAPPROVED THIS OFFERING, NOR HAS THE COMMISSIONER RULED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. Liberty Financial has insurance subsidiaries organized under the laws of the State of Rhode Island. Rhode Island law prohibits any person from directly or indirectly acquiring control of any domestic insurer unless such person has provided certain required information to the state insurance commission and such acquisition of control has been approved by the state's insurance commissioner. Under these insurance laws, any person acquiring 10% or more of the outstanding voting stock of a corporation is presumed to have acquired control of that corporation and its subsidiaries. Consequently, no person may acquire, directly or indirectly, 10% or more of the voting stock or voting power of the Company outstanding unless such person has provided such required information to the Rhode Island insurance commission and such acquisition is approved by the insurance commissioner of such state. Liberty Financial's Restated Articles of Organization (the "Restated Articles") include provisions limiting the voting power of shares of the Company's Voting Stock (as defined in the Restated Articles) held by holders of 20% or more of such Voting Stock (other than Liberty Mutual and its subsidiaries and affiliates) in certain circumstances. These provisions are designed to prevent, under certain circumstances, a deemed assignment under the Investment Advisers Act of 1940 or the Investment Company Act of 1940 of investment advisory contracts to which certain of the Company's subsidiaries are or may become parties. See "INVESTMENT CONSIDERATIONS-- Regulation," "BUSINESS--Regulation" and "DESCRIPTION OF CAPITAL STOCK." Certain persons participating in this offering may engage in transactions that stabilize, maintain or otherwise affect the price of the Common Stock. Such transactions may include stabilizing, the purchase of shares of Common Stock to cover syndicate short positions and the imposition of penalty bids. For a description of these activities, see "Underwriting." 2 AVAILABLE INFORMATION Liberty Financial is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files reports, proxy or information statements and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy or information statements and other information filed by the Company with the Commission can be inspected and copied at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices located at Seven World Trade Center, New York, New York 10048 and Northwest Atrium Center, Suite 1400, 500 West Madison Street, Chicago, Illinois 60661. Copies of such material can be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 upon payment of prescribed fees. The Commission maintains a site on the World Wide Web at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants, such as the Company, that file electronically with the Commission through the Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. This Prospectus constitutes a part of a Registration Statement on Form S-3 filed by the Company with the Commission under the Securities Act of 1933, as amended (the "Securities Act"). This Prospectus omits certain of the information contained in the Registration Statement and reference is hereby made to the Registration Statement and to the exhibits relating thereto for further information with respect to the Company and the Common Stock offered hereby. Any statements contained herein concerning the provisions of any documents are not necessarily complete, and, in each instance, reference is made to the copy of such document filed as an exhibit to the Registration Statement or otherwise filed with the Commission. Each such statement is qualified in its entirety by such reference. The Registration Statement and the exhibits thereto may be inspected at the public reference facilities maintained by the Commission discussed above, and copies thereof may be obtained from the Commission at prescribed rates. The Registration Statement and the exhibits thereto may also be accessed electronically at the Commission's site on the World Wide Web at http://www.sec.gov. INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents, previously filed by the Company with the Commission under the Exchange Act, are incorporated in this Prospectus by reference and made a part hereof: (1) Annual Report on Form 10-K for the fiscal year ended December 31, 1996, filed on March 28, 1997 (File No. 1-13654). (2) Quarterly Report on Form 10-Q for the period ended March 31, 1997 filed on May 14, 1997 (File No. 1-13654). All documents subsequently filed by the Company pursuant to sections 13(a), 13(c), 14 or 15(d) of the Exchange Act prior to the termination of any offering made hereby shall be deemed to be incorporated by reference in this Prospectus and to be a part of this Prospectus from the date of the filing of such documents. Any statements contained herein or in a document incorporated or deemed to be incorporated by reference herein shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement contained herein or in any other subsequently filed document that also is or is deemed to be incorporated by reference herein modifies or replaces such statement. Any such statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. The Company will provide without charge to each person to whom this Prospectus is delivered, on written or oral request of such person, a copy of any or all of the documents referred to above that have been or may be incorporated by reference in this Prospectus, other than exhibits to such documents. Such written or oral requests should be directed to the attention of Investor Relations, Liberty Financial Companies, Inc., 600 Atlantic Avenue, Boston, Massachusetts 02210-2214 (telephone: (617) 722-6000). 3 - -------------------------------------------------------------------------------- PROSPECTUS SUMMARY The following summary information is qualified in its entirety by, and should be read in conjunction with, the more detailed information and Consolidated Financial Statements and notes thereto included elsewhere in this Prospectus or incorporated herein by reference. Except as otherwise noted, all information in this Prospectus assumes no exercise of the Underwriters' over-allotment option. All financial information set forth herein is presented in accordance with generally accepted accounting principles ("GAAP"), unless otherwise noted, and includes data for acquired entities from and after the applicable acquisition date. All references herein to the Consolidated Financial Statements shall be deemed to refer to the audited Consolidated Financial Statements included herein. The Company Liberty Financial is a leading asset accumulation and management company. The Company is a leader in each of its two core product lines--retirement-oriented insurance products and investment management products. Retirement-oriented insurance products consist substantially of annuities, and 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 depositary 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 $26.7 million in the first quarter of 1997, and $94.8 million, $76.5 million and $56.2 million in 1996, 1995 and 1994, respectively. The following table sets forth the Company's assets under management as of March 31, 1997 and December 31, 1996, 1995 and 1994:
Assets Under Management ------------------------------------------- As of December 31, As of ---------------------- March 31, 1997 1996 1995 1994 -------------- ---- ---- ---- (dollars in billions) Retirement-Oriented Insurance Products ...... $12.2 $12.1 $10.6 $ 9.3 Mutual Funds ................................. 24.8 25.7 23.3 7.4 Wealth Management ........................... 5.5 5.3 4.5 4.1 Institutional Asset Management ............... 4.5 4.9 4.1 4.8 ----- ----- ----- ----- Total .................................... $47.0 $48.0 $42.5 $25.6 ===== ===== ===== =====
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 $8.6 billion of policyholder liabilities as of March 31, 1997. In addition to SPDAs, Keyport 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. An equity-indexed annuity credits 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 KeyIndex, the Standard & Poor's 500 Stock 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 the date of this Prospectus, the Company sponsored 67 open-end mutual funds, as well as seven closed-end funds. The open-end funds consist of 36 intermediary-distributed Colonial mutual funds, 20 direct-marketed Stein Roe funds and 11 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. - -------------------------------------------------------------------------------- 4 - -------------------------------------------------------------------------------- Forty-nine of the Company's 67 mutual funds are long-term open-end 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 49 funds (representing 68% of the total assets in those 49 funds as of May 31, 1997) were ranked by Lipper Analytical Services, Inc. in the top two quartiles of their respective peer groups for the three-year period ended that date. 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 brokerage firms, banks and other depository institutions, financial planners and insurance agents. To capitalize on the growing importance of banks and other depository institutions as intermediaries for its products, the Company also operates its own distribution unit which sells mutual funds and annuities 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 the three months ended March 31, 1997 and for the year ended December 31, 1996 were $2.1 billion and $8.6 billion, respectively (including $0.2 billion and $1.0 billion, respectively, of reinvested dividends). During the three months ended March 31, 1997 and during 1996, 53% and 61%, respectively, of sales were made through intermediary distributors, with the balance made directly to the investor. Over 35,000 individual brokers and other intermediaries sold Liberty Financial products in 1996. 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 $1.7 billion of assets under management as of March 31, 1997. The Stein Roe Young Investor 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 $330.3 million of assets under management and over 85,000 shareholders of record as of March 31, 1997. The Company introduced the first equity-indexed annuity product to the marketplace. At March 31, 1997 and December 31, 1996, the Company's equity-indexed annuity policyholder balances were $926.8 million and $787.8 million, respectively. The Company's equity-indexed annuity sales during the three months ended March 31, 1997 and during 1996 were $123.4 million and $655.2 million, respectively. 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, which was rebranded under the Colonial name. In conjunction with Colonial's sales efforts, the Colonial Newport Tiger Fund's assets have more than tripled from April, 1995 to March 31, 1997. The availability of the Colonial Newport Tiger Fund has facilitated new intermediary distribution relationships for Colonial, including approximately 6,000 new broker relationships. Stein Roe manages a substantial portion of Keyport's general account assets (approximately $9.3 billion at March 31, 1997) and together with Colonial and Newport manages certain - -------------------------------------------------------------------------------- 5 - -------------------------------------------------------------------------------- of the funds underlying Keyport's variable annuity products (approximately $1.1 billion at that date). Colonial's transfer agency operations perform these functions for the Stein Roe funds. The Company's bank distribution unit was the largest distributor of Keyport's annuities during both the three months ended March 31, 1997 and during 1996, and the second and third largest distributor, respectively, of the Colonial funds during such periods. [bullet] Acquisitions. Where appropriate, the Company seeks acquisitions that provide additional assets, new and 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 bank distribution unit (including Independent Financial Marketing Group, Inc. ("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 of this Prospectus the Company has not entered into any material definitive acquisition agreements. 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-provider 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. The Offering (1) Shares Offered by the Selling Shareholders ...... 2,500,000 shares Common Stock Outstanding after the Offering (2) ............... 29,082,511 shares Use of Proceeds .................. The Company will not receive any proceeds. All of the proceeds of this offering will be received by the Selling Shareholders. NYSE Symbol ..................... "L" - ---------------- (1) Assumes no exercise of the Underwriters' over-allotment option and is based on the number of shares of Common Stock outstanding at June 11, 1997. (2) Excludes (i) 3,225,984 shares of Common Stock issuable upon exercise of outstanding stock options having an average exercise price of $22.24 per share, (ii) 345,286 shares of Common Stock issuable upon conversion of the Company's Series A Convertible Preferred Stock and (iii) shares issuable in connection with the acquisition of Independent in four annual installments based upon attainment of certain performance objectives. Approximately 87,000 shares will be issued in June, 1997 representing the first installment. - -------------------------------------------------------------------------------- 6 - -------------------------------------------------------------------------------- Summary Consolidated Financial Data(1) (in millions, except per share data) As of or for the Three Months Ended March 31, ---------------- 1997 ----------- (unaudited) Income Statement Data: Investment income ........................... $ 208.0 Interest credited to policyholders ......... (147.3) --------- Investment spread ........................... 60.7 --------- Net realized investment gains (losses) ...... 12.9 --------- Fee income: Investment advisory and administrative fees ....................................... 53.1 Distribution and service fees ............... 12.1 Transfer agency fees ........................ 11.8 Surrender charges and net commissions ...... 8.5 Separate account fees ..................... 3.9 --------- Total fee income ........................... 89.4 --------- Expenses: Operating expenses(2) ...................... (75.8) Amortization of deferred policy acquisition costs ........................ (16.3) Amortization of deferred distribution costs ........................ (8.2) Amortization of value of insurance in force ................................. (3.2) Amortization of intangible assets(3) ....... (3.2) Interest expense ........................... (4.5) --------- Total expenses ........................... (111.2) --------- Pretax income (loss) ........................ 51.8 Income tax expense ........................... (16.8) --------- Net income (loss) ........................... $ 35.0 ========= Per Share Data: Net income (loss) ........................... $ 1.14 Dividends on common stock(4) ................ 0.15 Dividends on convertible preferred stock . 0.72 Book value ................................. 36.08 Other Operating Data: Net operating income (loss)(5) ............. $ 26.7 Net realized investment gains (losses), net of taxes ................................. 8.3 --------- Net income (loss) ........................... $ 35.0 ========= Balance Sheet Data: Total investments ........................... $11,541.5 Intangible assets ........................... 199.9 Total assets ................................. 14,758.7 Notes payable to affiliates .................. 229.0 Series A redeemable convertible preferred stock ........................... 14.0 Stockholders' equity ........................ 1,042.8 Shares of common stock outstanding ......... 28.9
As of or for the Three Months Ended As of or for the March 31, Year Ended December 31, ------------ --------------------------------------------------------------- 1996 1996 1995 1994 1993(2) 1992(3) ------------ ------------ ------------ ------------ ------------ ----------- (unaudited) Income Statement Data: Investment income ........................... $ 189.2 $ 796.4 $ 761.8 $ 695.1 $ 675.3 $ 710.0 Interest credited to policyholders ......... (138.1) (572.7) (555.8) (481.9) (504.2) (571.0) --------- --------- --------- --------- --------- -------- Investment spread ........................... 51.1 223.7 206.0 213.2 171.1 139.0 --------- --------- --------- --------- --------- -------- Net realized investment gains (losses) ...... 3.8 8.0 (4.0) (8.2) 11.4 3.1 --------- --------- --------- --------- --------- -------- Fee income: Investment advisory and administrative fees ....................................... 46.4 196.4 155.8 95.9 98.9 88.0 Distribution and service fees ............... 10.6 44.9 28.9 -- -- -- Transfer agency fees ........................ 10.4 43.9 30.8 4.0 5.4 5.0 Surrender charges and net commissions ...... 7.7 34.7 23.4 20.0 22.9 24.2 Separate account fees ..................... 3.5 16.0 13.2 12.5 8.0 5.0 --------- --------- --------- --------- --------- -------- Total fee income ........................... 78.6 335.9 252.1 132.4 135.2 122.2 --------- --------- --------- --------- --------- -------- Expenses: Operating expenses(2) ...................... (65.9) (277.9) (225.1) (174.9) (178.9) (175.8) Amortization of deferred policy acquisition costs ........................ (14.1) (60.2) (58.5) (52.2) (41.0) (17.0) Amortization of deferred distribution costs ........................ (6.8) (33.9) (18.8) -- -- -- Amortization of value of insurance in force ................................. (1.7) (10.2) (9.5) (17.0) (22.4) (32.4) Amortization of intangible assets(3) ....... (3.7) (15.4) (12.2) (5.8) (15.0) (42.3) Interest expense ........................... (5.0) (19.7) (16.2) (4.2) -- -- --------- --------- --------- --------- --------- -------- Total expenses ........................... (97.2) (417.3) (340.3) (254.1) (257.3) (267.5) --------- --------- --------- --------- --------- -------- Pretax income (loss) ........................ 36.3 150.3 113.8 83.3 60.4 (3.2) Income tax expense ........................... (12.5) (49.6) (39.9) (32.5) (29.1) (9.3) --------- --------- --------- --------- --------- -------- Net income (loss) ........................... $ 23.8 $ 100.7 $ 73.9 $ 50.8 $ 31.3 $ (12.5) ========= ========= ========= ========= ========= ======== Per Share Data: Net income (loss) ........................... $ 0.81 $ 3.36 $ 2.64 $ 2.15 $ 1.32 $ (0.55) Dividends on common stock(4) ................ 0.15 0.60 0.45 -- -- -- Dividends on convertible preferred stock . 0.72 2.88 2.21 -- -- -- Book value ................................. 33.78 36.63 34.55 27.38 28.00 26.87 Other Operating Data: Net operating income (loss)(5) ............. $ 20.9 $ 94.8 $ 76.5 $ 56.2 $ 23.9 $ (14.5) Net realized investment gains (losses), net of taxes ................................. 2.9 5.9 (2.6) (5.4) 7.4 2.0 --------- --------- --------- --------- --------- -------- Net income (loss) ........................... $ 23.8 $ 100.7 $ 73.9 $ 50.8 $ 31.3 $ (12.5) ========= ========= ========= ========= ========= ======== Balance Sheet Data: Total investments ........................... $10,178.6 $11,537.9 $10,144.7 $ 8,590.2 $ 8,411.7 $8,151.6 Intangible assets ........................... 207.4 205.4 192.3 29.3 35.2 50.2 Total assets ................................. 13,092.4 14,427.7 12,749.4 10,968.8 10,324.6 9,798.3 Notes payable to affiliates .................. 229.0 229.0 229.0 75.0 -- -- Series A redeemable convertible preferred stock ........................... 13.2 13.8 13.0 -- -- -- Stockholders' equity ........................ 947.9 1,051.4 956.4 624.7 638.8 612.7 Shares of common stock outstanding ......... 28.1 28.7 27.7 22.8 22.8 22.8
- ---------------- (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) In 1992, the Company changed its estimate of the carrying value of certain intangible assets in its asset management business, resulting in additional amortization expense of $21.0 million. In addition, in 1992 the Company accrued $28.2 million for anticipated guaranty fund assessments in its annuity insurance business in connection with the failure of certain unaffiliated insurance companies. (4) The amount for 1995 does not include a non-cash dividend of $30.0 million paid to an affiliate of Liberty Mutual. See Note 5 of Notes to the Consolidated Financial Statements. (5) Net operating income (loss) is defined as net income (loss), excluding net realized investment gains and losses, net of related income taxes. 7 INVESTMENT CONSIDERATIONS This Prospectus contains certain forward-looking statements within the meaning of Section 27A of the Securities Act. Actual results could differ materially from those projected in such forward-looking statements as a result of the investment considerations set forth below and the matters set forth in this Prospectus generally. The Company cautions the reader, however, that this list of factors may not be exhaustive. The following investment considerations should be considered carefully in addition to the other information contained in this Prospectus before purchasing the Common Stock offered hereby. Interest Rate Risk The Company's investment spread (i.e., the amount by which investment income exceeds interest credited to annuity and life insurance policyholders) is the most significant component of its results of operations. The Company's results of operations and financial condition are significantly dependent on the Company's ability to manage effectively its investment spread. The Company will experience a compression of its investment spread when it is unable or chooses not to maintain the same margin between its investment earnings and its crediting rates. When interest rates rise, the Company may not be able to reposition the assets in its investment portfolio into higher-yielding assets that will be necessary to fund the higher crediting rates necessary to keep its SPDAs competitive. As a result, the Company may experience either a decrease in SPDA sales and an increase in surrenders (as described below) if it chooses to maintain its spread by not raising its crediting rates, or spread compression if it does increase its crediting rates. Conversely, when interest rates fall, the Company would have to reinvest the cash received from its investments (i.e., interest and payments of principal upon maturity or redemption) in the lower-yielding instruments then available. If the Company were unable (e.g., because of guaranteed minimum crediting rates or delays or limitations on the frequency of crediting rate resets) or chose not to reduce the crediting rates on SPDAs or acquire relatively higher-risk securities yielding higher rates of return, spread compression would occur. If, as a result of interest rate increases, the Company were unable or chose not to raise its renewal crediting rates to keep them competitive, the Company may experience an increase in surrenders. If the Company lacked sufficient liquidity, the Company might have to sell investment securities to fund associated payments. Because the value of such securities would likely have decreased in response to the increase in interest rates, the Company would realize a loss on the sales. In addition, regardless of whether the Company realizes an investment loss, the surrenders would produce a decrease in invested assets, with an adverse effect on future earnings therefrom. Finally, premature surrenders may also cause the Company to accelerate amortization of expenses related to the policy acquisition (principally commissions), which would otherwise be amortized over the life of the policy. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION." Investment Portfolio Risks The Company's general account investments are subject to additional risks due to the nature of certain investment assets, including mortgage-backed securities ("MBSs"), certain securities which are not freely tradeable and below investment grade securities. MBSs, including collateralized mortgage obligations ("CMOs"), are subject to prepayment risks that vary with, among other things, interest rates. As of March 31, 1997, Keyport owned approximately $4.0 billion of MBSs and CMOs (31.9% of its general account investments). During periods of declining interest rates, MBSs generally prepay faster as the underlying mortgages are prepaid and refinanced by the borrowers in order to take advantage of the lower rates. MBSs that have an amortized cost that is greater than par (i.e., purchased at a premium) may incur a reduction in yield or a loss as a result of such prepayments. In addition, during such periods, the Company will generally be unable to reinvest the proceeds of any such prepayment at comparable yields, which may contribute to spread compression. Conversely, during periods of rising interest rates, prepayments generally slow. Significant delays in expected rates of prepayment could adversely affect the Company's liquidity. MBSs that have an amortized value that is less than par (i.e., purchased at a discount) may incur a decrease in yield or a loss as a result of slower prepayments. As of March 31, 1997, approximately $3.3 billion or 26.6% 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 to sell such securities, it might be 8 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. The Company's inability to dispose of illiquid and/or restricted securities at desired times and prices could have a material adverse effect on the Company's investment spread and liquidity. Approximately $10.3 billion, or 81.9%, of the Company's general account investments at March 31, 1997, was rated by Standard & Poor's Corporation, Moody's Investors Service, Inc. or under comparable statutory rating guidelines established by the National Association of Insurance Commissioners ("NAIC"). At March 31, 1997, the carrying value of investments in below investment grade securities totaled $991.5 million, or 7.9% of general account investments of $12.6 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. Defaults or the inability to liquidate these securities at their carrying value could adversely affect the Company's results of operations and financial condition. While the Company seeks to mitigate the potentially adverse effects of interest rate changes through asset/ liability management and through various hedging techniques, there can be no assurance that such portfolio management techniques will be effective in mitigating the potentially adverse effects of interest rate changes. The Company employs hedging strategies to manage interest rate risk, including interest rate swaps and caps. The primary risk associated with swaps and caps is counterparty nonperformance. In addition, swap agreements have interest rate risk. Such instruments are entered into for hedging (as opposed to investment or speculative) purposes in connection with the management of the Company's general account portfolio, and from time to time the Company incurs gains or losses on such instruments. The Company purchases S&P 500 call options to hedge the guarantees made to equity-indexed policyholders. The value of call options can be adversely affected by changes in the level of the S&P 500 index. Call options also have the risk of counterparty nonperformance. The Company believes that changes in the value of its S&P 500 call options will be substantially offset by changes in the value of its equity-indexed 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 impacting interest credited to equity-indexed policyholders. Keyport's profitability could be adversely affected if the value of its S&P 500 call options increase less than (or decrease more than) the value of the guarantees made to equity-indexed policyholders. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--Management of the Company's Investments" and "BUSINESS--Retirement-Oriented Insurance Products--General Account Investments." Other Factors Affecting Product Sales and Asset Retention The Company's product sales and asset levels are affected by certain general economic and market factors such as changes in interest rates and stock prices. These factors can influence, among other things, product sales and asset retention. In particular, significant growth in the retirement-oriented investment market and strong stock market appreciation have been material factors in the growth in the Company's assets and its ability to generate new sales in recent years. There can be no assurance, however, that these economic and market trends will continue. Adverse economic conditions and other factors, including a protracted or precipitous decline in stock market and other economic conditions that affect the popularity of the Company's products and services, may negatively affect the Company's results of operations and financial condition. Industry sales and surrenders of SPDAs tend to be sensitive to prevailing interest rates. Sales can be expected to decrease and surrenders to increase in interest rate environments when SPDA rates are lower than rates offered by competing conservative fixed-return investments, such as bank certificates of deposit. SPDA sales also can be adversely affected by low interest rates. Sales of mutual funds and other investment management products also are subject to market forces. 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. The competitiveness of the Company's investment management products (both in terms of new sales and asset retention) also is dependent, in part, on the relative attractiveness of their underlying investment philosophies and methods under prevailing market conditions. 9 All of the Company's annuities permit the policyholder at any time to withdraw all or any part of the accumulated policy value. Premature termination of an annuity policy results in the loss by the Company of anticipated future earnings related to the annuity premium deposit and the accelerated recognition of the sales expenses related to policy acquisition, as described above. Surrender charges provide a measure of protection against premature withdrawal of policy values. All of the Company's SPDAs currently are issued with surrender charges. At March 31, 1997, 85.0% of the Company's SPDAs remained in the surrender charge period. During the remaining nine months of 1997, and during 1998 and 1999, policies having aggregate balances of $697.6 million, $993.8 million and $1.2 billion, respectively, were scheduled as of March 31, 1997 to come off the surrender charge period. Substantially all of the Company's investment management assets are subject to client withdrawals. 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 a daily basis. In addition, the Company's other investment management clients generally may terminate their relationship on 30 to 60 days' notice. Significant levels of asset withdrawals could have a material adverse effect on the Company's results of operations. See "BUSINESS--Investment Management." Industry and Competitive Factors New product sales and asset retention are essential for the Company to maintain its growth in assets and earnings. The insurance and investment management businesses are highly competitive. Liberty Financial competes with a large number of insurance companies, investment management firms, mutual fund companies, banks and others, many of which are larger and have greater financial and other resources than Liberty Financial. Liberty Financial believes that the most important factors affecting competition to accumulate and retain assets are investor returns and relative performance, access to and maintenance of distribution relationships, pricing practices, and product and service features. The Company's ability to accumulate and retain assets under management could be adversely affected if investment results underperform the market or the competition. Such underperformance could result in reduced sales and asset withdrawals. No assurance can be given as to the Company's future investment results. The Company distributes the majority of its products (53.0% and 61.0%, respectively, during the three months ended March 31, 1997 and during 1996) through intermediaries. The proliferation of competing products requires the Company to compete to establish and maintain distribution relationships and to maintain "shelf space" with distributors. In response to the proliferation of available investment products, 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. An interruption in the Company's continuing relationship with certain of these distributors could materially adversely affect the Company's ability to market its products. There can be no assurance that the Company would be able to find alternative sources of distribution in a timely manner. Some distributors have begun to assess fee sharing payments or similar charges as compensation for fund sales. The Company can be confronted with the choice of absorbing these charges or limiting its access to certain distributors. National banks may become more significant competitors in the future as a result of certain recent court decisions and regulatory actions. Also, several proposals to repeal or modify the Glass-Steagall Act of 1933 (which restricts banks from engaging in securities-related businesses) and 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. None of these proposals has yet been enacted, and it is not possible to predict whether any of these proposals will be enacted or, if enacted, what their potential effect will be on the Company. See "BUSINESS--Competition." Control by Liberty Mutual; Potential Conflicts of Interest Upon completion of this offering, based upon shares outstanding as of June 11, 1997, Liberty Mutual will own, indirectly through a wholly-owned subsidiary, approximately 74.5% of the Company's outstanding Common Stock and approximately 73.6% of the combined voting power of the Company's outstanding Common Stock and Preferred Stock (approximately 73.2% and 72.4%, respectively, if the over-allotment option granted to the Underwriters is exercised in full). Liberty Mutual has and following this offering will continue to have the power to elect the entire Board of Directors and to approve any action requiring shareholder approval, including adopting amendments to the Company's Restated Articles, approving the issuance of additional Common Stock or other equity securities, authorizing the payment of dividends, and, subject to receipt of necessary government approvals, approving mergers or sales of all or substantially all of the assets of Liberty Financial or its subsidiaries. If Liberty 10 Financial's public stockholders become dissatisfied with management of Liberty Financial, they will be unable to effect a change in control as long as Liberty Mutual continues to own a majority of the Company's voting stock. Fifteen of the Company's 18 directors are also directors of Liberty Mutual. Liberty Financial is a party to various agreements with Liberty Mutual and certain of its affiliates. The existing agreements between Liberty Financial and Liberty Mutual may be modified in the future and additional agreements or transactions may be entered into between Liberty Financial and Liberty Mutual. From time to time Liberty Financial has received capital contributions, loans and other credit support and advances from Liberty Mutual. Liberty Mutual has no obligation to make further capital contributions or loans or advances or otherwise provide credit support to Liberty Financial. Conflicts of interest could arise between Liberty Financial and Liberty Mutual with respect to any of the foregoing, or any future agreements or arrangements between them. The members of Liberty Financial's Board of Directors who are affiliated with Liberty Mutual may consider both the short-term and long-term impact of operating decisions on Liberty Financial as well as the impact of decisions on the financial results of Liberty Mutual. Neither Liberty Mutual nor Liberty Financial has instituted, or has any current plans to institute, any formal plan or arrangement to address any possible conflicts of interest. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--Liquidity," "MANAGEMENT," "PRINCIPAL AND SELLING SHAREHOLDERS" and "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." Importance of Credit Ratings for Annuities Keyport competes with other insurance companies, financial intermediaries and other institutions on the basis of a number of factors, including the ratings assigned by A.M. Best and the claims-paying ability ratings assigned by nationally recognized statistical rating organizations. Keyport is currently rated "A+" (Superior) by A.M. Best. Ratings by A.M. Best for the industry currently range from "A++" (Superior) to "F" (in Liquidation) and some companies are not rated. At present, Keyport is rated "AA-" (excellent financial security) by Standard & Poor's Corporation ("S&P") and "A1" (good financial strength) by Moody's Investors Service, Inc. ("Moody's") and "AA-" (very high claims paying ability) by Duff & Phelps. The S&P and Duff & Phelps "-" modifier signifies that Keyport is at the lower end of the AA category. These ratings reflect the opinion of the rating company 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 Common Stock. 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. See "BUSINESS--Retirement- Oriented Insurance Products--Sales and Asset Retention." Reliance on Key Personnel Liberty Financial's ability to attract and retain clients is dependent, to a large extent, on its ability to attract and retain key employees, including senior officers at the Company and Keyport, Colonial, Stein Roe, Newport and the Company's other subsidiaries and experienced portfolio managers and sales executives. Competition for such persons is intense. Certain of these employees are responsible for significant client relationships. In general, Liberty Financial's employees are not subject to non-compete arrangements. Loss of key personnel could have a material adverse effect on Liberty Financial. The Company does not have, and is not contemplating securing, any significant amount of key-man life insurance for any of its employees. Holding Company Structure; Dividend Restrictions Liberty Financial is a holding company whose principal assets (and source of funds for the payment of operating expenses, principal and interest on debt, redemption of stock and dividends) consist of its equity interests in Keyport, Colonial, Stein Roe, Newport and its other subsidiaries. Current Rhode Island insurance law applicable to Keyport permits the payment of dividends or distributions which, together with dividends or distributions paid during the preceding 12 months, do not exceed the lesser of (i) 10% of Keyport's statutory surplus as of the preceding 11 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 has been approved by the Commissioner of Insurance of the State of Rhode Island. As of December 31, 1996, the amount of dividends that Keyport could pay without such approval was $42.5 million. However, Keyport has not paid any dividends since its acquisition in December, 1988. The terms of Colonial's loan agreement place certain restrictions on the payment of dividends by Colonial. Under the terms of the facility (as amended in April 1997), Colonial could pay dividends of up to $87.2 million as of March 31, 1997. No assurances can be given that future regulatory changes will not create additional restrictions on the ability of the Company's subsidiaries to pay dividends. See "PRICE RANGE OF COMMON STOCK AND DIVIDENDS" and "BUSINESS--Regulation." Recent Accounting Proposal In June 1996, the Financial Accounting Standards Board ("FASB") issued an exposure draft of an accounting standard entitled "Accounting for Derivative and Similar Financial Instruments and for Hedging Activities." This exposure draft, if adopted in the form in which it was issued, would require companies to report derivatives on the balance sheet at fair value with changes in fair value recorded in income or equity. The exposure draft also would change the accounting for derivatives used in hedging strategies from traditional deferral accounting to a current recognition approach which could impact a company's income statement and balance sheet and expand the definition of a derivative instrument. Management expects that this accounting standard, in whatever form, will not be effective until 1999. FASB's Rules of Procedure require that, prior to approving a new accounting standard, extensive "due process" be followed. FASB requests written comments from interested parties on an exposure draft and also may hold public hearings. This exposure draft has drawn widespread criticism primarily because the required accounting treatment would not match the perceived economic effect of such hedging strategies. As a result of, among other things, the concerns and criticisms in comment letters and at public hearings held on this exposure draft, the Company is unable to predict the form that the final accounting standard, if adopted, may take and believes it would be inappropriate to speculate on the effects of any such adoption at this time. Regulation The Company's business activities are extensively regulated. Keyport is subject to comprehensive state and federal laws and regulations throughout the United States. Such laws and regulations, in addition to limiting the amounts of dividends and other payments that can be paid by Keyport without prior approval, impose restrictions on the amount and type of investments Keyport may hold. These regulations also affect many other aspects of Keyport's business, including risk-based capital requirements, the type and amount of required asset valuation reserve accounts, the licensing of agents, the form and content of statutory financial statements and policy forms. These regulations are designed primarily to insure the financial stability of insurance companies and otherwise to protect policyholders, not stockholders. The insurance regulatory structure, including transactions between a holding company and its insurance subsidiaries, has been subjected to increased scrutiny in recent years by the NAIC, federal and state legislative bodies and state regulatory authorities. In addition, the insurance laws and regulations of Rhode Island also may impede or delay a business combination involving the Company or Keyport. Keyport prepares its statutory-basis financial statements in accordance with accounting practices prescribed or permitted by the Insurance Department of the State of Rhode Island. Prescribed statutory accounting practices generally include state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ between the states and companies within a state. 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, when completed, 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. The Company's investment management businesses are also subject to extensive regulation, including the Exchange Act, the Investment Advisers Act of 1940, as amended (the "Advisers Act"), and various other federal and state securities and banking laws and regulations. Such laws and regulations generally grant supervisory agencies and bodies broad administrative powers. Certain of the Company's subsidiaries are also subject to regulation by the National Association of Securities Dealers, Inc. The Company cannot predict, and no assurances can be given as to, the effect that any proposed or future regulations or changes in the interpretation of existing 12 regulations in any area in which the Company or its subsidiaries is regulated, may have on the financial condition or operations of Liberty Financial. See "BUSINESS--Regulation." 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 of 1940, as amended (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. Following the completion of this offering, additional 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 provide that no person or group deemed to be a beneficial owner (as defined therein) of the voting stock of Liberty Financial may vote more than 20% of the total voting shares outstanding. 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. Liberty Financial's Board of 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. See "BUSINESS--Regulation" and "DESCRIPTION OF CAPITAL STOCK-- Other Provisions Pertaining to a Change in Control." Tax Status of Insurance Products Under the Code, income tax payable by annuity and life insurance policy- holders on current investment earnings is deferred during the accumulation period. Taxes, if any, are payable by the policyholder on the accumulated tax- deferred earnings when the policy benefits are actually paid or to be paid, in accordance with the provisions of the Code. From time to time, legislation has been proposed, but not enacted, which would tax investment earnings currently as they are credited to the policyholder. No assurances can be given that these or other similar tax proposals will not be enacted in the future. If the Code were to be amended to eliminate or reduce the tax-deferred status of the Company's retirement-oriented insurance products, market demand for such products could be materially adversely affected. Other possible legislation, such as a reduction in the tax rate applicable to capital gains, could also adversely affect the Company's business. A reduction of the capital gains rate could make annuities a less attractive form of investment. It also could result in investors liquidating their positions in the Company's retirement-oriented insurance products to take advantage of such lower tax rate. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--Federal Income Taxes" and "BUSINESS--Retirement-Oriented Insurance Products--Products." Shares Eligible for Future Sale by Liberty Mutual The sale of a substantial number of shares of Common Stock held directly or indirectly by Liberty Mutual following this offering, or the perception that such sales could occur, could materially adversely affect the prevailing market price of the Common Stock. It could also make it more difficult for the Company to sell newly issued equity securities in the future at a time and price which it deems appropriate. On the date of this Prospectus, Liberty Mutual will hold indirectly 21,666,935 shares of Common Stock (giving effect to the sale pursuant to this Prospectus of 1,955,196 shares held indirectly by Liberty Mutual), all of which will be eligible for future sale in the public market in accordance with Rule 144 under the Securities Act. The Company has granted to Liberty Mutual certain rights to have all of its shares registered for sale under the Securities Act. These registration rights include multiple demand registrations, as well as so-called "piggy-back" registrations. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS--Registration Rights Agreement" for a more detailed description of the terms and conditions of these registration rights. These registration rights could result in additional secondary offerings of significant share amounts by Liberty Mutual. 13 PRICE RANGE OF COMMON STOCK AND DIVIDENDS The Company's Common Stock is listed on the New York Stock Exchange ("NYSE") under the symbol "L". The Common Stock began trading on the NYSE on March 27, 1995, following the Company's acquisition of Colonial. The Common Stock is also listed on the Boston Stock Exchange. Prior to March 27, 1995, there was no public market for the Company's Common Stock. The following table sets forth the high and low closing sales price for the Common Stock on the NYSE for each of the periods indicated below. 1995 High Low - ---- First Quarter (from March 27, 1995) ......... $29 $27 Second Quarter .............................. 27-1/2 23-7/8 Third Quarter ................................. 29-1/4 25-3/8 Fourth Quarter .............................. 30-1/4 27-1/8 1996 - ---- First Quarter ................................. $32-3/8 $30 Second Quarter .............................. 34 30-3/4 Third Quarter ................................. 33-7/8 29-1/8 Fourth Quarter .............................. 39 30-7/8 1997 - ---- First Quarter .............................. $45-5/8 $38-5/8 Second Quarter (through June 11, 1997) ...... 49-1/2 37-3/4 On June 11, 1997, the last reported sale price for the Common Stock, as reported on the NYSE, was $49-1/2. The approximate number of stockholders of record of the Company's Common Stock as of June 11, 1997 was 160. Since the second quarter of 1995, the Company has paid quarterly cash dividends of $0.15 per share. 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 assurance can be given, that dividends will be paid on the Common Stock. The Company's Board of Directors has established an optional dividend reinvestment plan ("DRIP") for holders of Common Stock and Preferred Stock. Liberty Mutual has participated in the DRIP since 1995 and, prior to January 1997, was the only participant. Liberty Mutual's 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 and Capital Resources" and "BUSINESS--Regulation--Annuity Insurance." As a holding company, the Company's ability to pay dividends depends largely upon the ability of its subsidiaries to make distributions to it. Payments by Keyport to the Company are restricted by the insurance laws of the State of Rhode Island, Keyport's state of domicile. See "INVESTMENT CONSIDERATIONS--Holding Company Structure; Dividend Restrictions." As of December 31, 1996, the amount of dividends that Keyport could pay under such restrictions without the approval of the Commissioner of Insurance of the State of Rhode Island was $42.5 million. However, Keyport has not paid any dividends since its acquisition in 1988. The terms of Colonial's existing senior credit facility place certain limitations on Colonial's ability to pay dividends. In April 1997, this facility was renewed and various terms were revised. Under the revised terms of the facility, Colonial could pay dividends of up to $87.2 million as of March 31, 1997. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--Liquidity and Capital Resources" and "BUSINESS--Regulation--Annuity Insurance." 14 SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA The following selected consolidated financial data as of and for the years ended December 31, 1996, 1995, 1994, 1993 and 1992 have been derived from the Company's Consolidated Financial Statements, which have been audited by the Company's independent auditors. The balance sheet data as of March 31, 1997 and 1996 and the income statement data for the three months ended March 31, 1997 and 1996 have been derived from unaudited financial statements of the Company also appearing herein and which, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the unaudited interim periods. The results of operations for the three months ended March 31, 1997 are not necessarily indicative of the results that may be expected for the full year or for any future period. The data presented below includes data for acquired entities from and after the applicable acquisition date (the most significant being Colonial, which was acquired on March 24, 1995). The data presented should be read in conjunction with the Consolidated Financial Statements of the Company and notes thereto and other financial information included herein. See the Consolidated Financial Statements and Notes thereto and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION." As of or for the Three Months Ended March 31, ----------- ----------- 1997 1996 ----------- ----------- (unaudited) Income Statement Data: Investment income ........................... $ 208.0 $ 189.2 Interest credited to policyholders ......... (147.3) (138.1) -------- -------- Investment spread ........................... 60.7 51.1 -------- -------- Net realized investment gains (losses) ...... 12.9 3.8 -------- -------- Fee income: Investment advisory and administrative fees ....................................... 53.1 46.4 Distribution and service fees ............... 12.1 10.6 Transfer agency fees ........................ 11.8 10.4 Surrender charges and net commissions ...... 8.5 7.7 Separate account fees ..................... 3.9 3.5 -------- -------- Total fee income ........................... 89.4 78.6 -------- -------- Expenses: Operating expenses(1) ...................... (75.8) (65.9) Amortization of deferred policy acquisition costs ........................ (16.3) (14.1) Amortization of deferred distribution costs ........................ (8.2) (6.8) Amortization of value of insurance in force ................................. (3.2) (1.7) Amortization of intangible assets(2) ....... (3.2) (3.7) Interest expense ........................... (4.5) (5.0) -------- -------- Total expenses ........................... (111.2) (97.2) -------- -------- Pretax income (loss) ........................ 51.8 36.3 Income tax expense ........................... (16.8) (12.5) -------- -------- Net income (loss) ........................... $ 35.0 $ 23.8 ======== ======== Per Share Data: Net income (loss) ........................... $ 1.14 $ 0.81 Dividends on common stock(3) ................ 0.15 0.15 Dividends on convertible preferred stock . 0.72 0.72 Book value ................................. 36.08 33.78
As of or for the Year Ended December 31, ----------------------------------------------------------- 1996 1995 1994 1993(1) 1992(2) ----------- ----------- ----------- ----------- ----------- (in millions, except per share data) Income Statement Data: Investment income ........................... $ 796.4 $ 761.8 $ 695.1 $ 675.3 $ 710.0 Interest credited to policyholders ......... (572.7) (555.8) (481.9) (504.2) (571.0) -------- -------- -------- -------- -------- Investment spread ........................... 223.7 206.0 213.2 171.1 139.0 -------- -------- -------- -------- -------- Net realized investment gains (losses) ...... 8.0 (4.0) (8.2) 11.4 3.1 -------- -------- -------- -------- -------- Fee income: Investment advisory and administrative fees ....................................... 196.4 155.8 95.9 98.9 88.0 Distribution and service fees ............... 44.9 28.9 -- -- -- Transfer agency fees ........................ 43.9 30.8 4.0 5.4 5.0 Surrender charges and net commissions ...... 34.7 23.4 20.0 22.9 24.2 Separate account fees ..................... 16.0 13.2 12.5 8.0 5.0 -------- -------- -------- -------- -------- Total fee income ........................... 335.9 252.1 132.4 135.2 122.2 -------- -------- -------- -------- -------- Expenses: Operating expenses(1) ...................... (277.9) (225.1) (174.9) (178.9) (175.8) Amortization of deferred policy acquisition costs ........................ (60.2) (58.5) (52.2) (41.0) (17.0) Amortization of deferred distribution costs ........................ (33.9) (18.8) -- -- -- Amortization of value of insurance in force ................................. (10.2) (9.5) (17.0) (22.4) (32.4) Amortization of intangible assets(2) ....... (15.4) (12.2) (5.8) (15.0) (42.3) Interest expense ........................... (19.7) (16.2) (4.2) -- -- -------- -------- -------- -------- -------- Total expenses ........................... (417.3) (340.3) (254.1) (257.3) (267.5) -------- -------- -------- -------- -------- Pretax income (loss) ........................ 150.3 113.8 83.3 60.4 (3.2) Income tax expense ........................... (49.6) (39.9) (32.5) (29.1) (9.3) -------- -------- -------- -------- -------- Net income (loss) ........................... $ 100.7 $ 73.9 $ 50.8 $ 31.3 $(12.5) ======= ======== ======== ======== ======== Per Share Data: Net income (loss) ........................... $ 3.36 $ 2.64 $ 2.15 $ 1.32 $ (0.55) Dividends on common stock(3) ................ 0.60 0.45 -- -- -- Dividends on convertible preferred stock ..... 2.88 2.21 -- -- -- Book value ................................. 36.63 34.55 27.38 28.00 26.87
15
As of or for the Three Months Ended As of or for the March 31, Year Ended December 31, ----------------------- ---------------------------------------------------------- 1997 1996 1996 1995 1994 1993(1) 1992(2) ----------- ----------- ----------- ----------- ----------- ---------- ----------- (unaudited) (in millions, except per share data) Other Operating Data: Net operating income (loss)(4) .......... $ 26.7 $ 20.9 $ 94.8 $ 76.5 $ 56.2 $ 23.9 $ (14.5) Net realized investment gains (losses), net of taxes ................................. 8.3 2.9 5.9 (2.6) (5.4) 7.4 2.0 ---------- ---------- ---------- --------- -------- --------- -------- Net income (loss) ........................ $ 35.0 $ 23.8 $ 100.7 $ 73.9 $ 50.8 $ 31.3 $ (12.5) ========== ========== ========== ========= ======== ========= ======== Balance Sheet Data: Total investments ........................ $11,541.5 $10,178.6 $11,537.9 $10,144.7 $8,590.2 $8,411.7 $8,151.6 Intangible assets ........................ 199.9 207.4 205.4 192.3 29.3 35.2 50.2 Total assets .............................. 14,758.7 13,092.4 14,427.7 12,749.4 10,968.8 10,324.6 9,798.3 Notes payable to affiliates ............... 229.0 229.0 229.0 229.0 75.0 -- -- Series A redeemable convertible preferred stock ........................... 14.0 13.2 13.8 13.0 -- -- -- Stockholders' equity ..................... 1,042.8 947.9 1,051.4 956.4 624.7 638.8 612.7 Shares of common stock outstanding ......... 28.9 28.1 28.7 27.7 22.8 22.8 22.8
- ---------------- (1) 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. (2) In 1992, the Company changed its estimate of the carrying value of certain intangible assets in its asset management business, resulting in additional amortization expense of $21.0 million. In addition, in 1992 the Company accrued $28.2 million for anticipated guaranty fund assessments in its annuity insurance business in connection with the failure of certain unaffiliated insurance companies. (3) The amount for 1995 does not include a non-cash dividend of $30.0 million paid to an affiliate of Liberty Mutual. See Note 5 of Notes to the December 31, 1996 Consolidated Financial Statements. (4) Net operating income (loss) is defined as net income (loss), excluding net realized investment gains and losses, net of related income taxes. 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Results of Operations Comparison of Three Months Ended March 31, 1997 and 1996 Net Income was $35.0 million or $1.14 per share in the first quarter of 1997 compared to $23.8 million or $0.81 per share in the first quarter of 1996. The improvement of $11.2 million in 1997 compared to 1996 resulted from higher investment spread, higher fee income and higher net realized investment gains. Partially offsetting these items were increased operating expenses, amortization expense and income tax expense. Pretax Income was $51.8 million in the first quarter of 1997 compared to $36.3 million in the first quarter of 1996. The higher pretax income in 1997 compared to 1996 resulted from higher investment spread, higher fee income and higher net realized investment gains. Partially offsetting these increases were the higher expenses referred to above. Investment Spread is the amount by which investment income earned on the Company's investments exceeds interest credited on policyholder balances. Investment spread was $60.7 million in the first quarter of 1997 compared to $51.1 million in the first quarter of 1996. The amount by which the average yield on investments exceeds the average interest credited rate on policyholder balances is the investment spread percentage. Such investment spread percentage in the first quarter of 1997 was 1.90% compared to 1.82% in the first quarter of 1996. Investment income was $208.0 million in the first quarter of 1997 compared to $189.2 million in the first quarter of 1996. The increase of $18.8 million in 1997 compared to 1996 primarily relates to a $27.4 million increase as a result of the higher level of average invested assets, partially offset by an $8.6 million decrease resulting from a lower average investment yield. The average investment yield was 6.94% in the first quarter of 1997 compared to 7.27% in the first quarter of 1996. Interest credited to policyholders totaled $147.3 million in the first quarter of 1997 compared to $138.1 million in the first quarter of 1996. The increase of $9.2 million in 1997 compared to 1996 primarily relates to a $19.5 million increase as a result of a higher level of average policyholder balances, partially offset by a $10.3 million decrease resulting from a lower average interest credited rate. Policyholder balances averaged $11.7 billion in the first quarter of 1997 compared to $10.2 billion in the first quarter of 1996. The average interest credited rate was 5.04% in the first quarter of 1997 compared to 5.45% in the first quarter of 1996. Average Investments (computed without giving effect to SFAS 115--see Note 1 of the Notes to the Consolidated Financial Statements), including a portion of the Company's cash and cash equivalents, were $12.0 billion in the first quarter of 1997 compared to $10.4 billion in the first quarter of 1996. The increase of $1.6 billion in 1997 compared to 1996 primarily relates to the 100 percent coinsurance agreement with respect to a $954.0 million block of single premium deferred annuities entered into with Fidelity & Guaranty Life Insurance Company ("F&G Life") during the third quarter of 1996 and the investment of portfolio earnings for the twelve months ended March 31, 1997 of $0.8 billion. Under the F&G Life transaction, the investment risk of the annuity policies was transferred to Keyport. However, F&G Life continues to administer the policies and remains contractually liable for the performance of all policy obligations. Net Realized Investment Gains were $12.9 million in the first quarter of 1997 compared to $3.8 million in the first quarter of 1996. Net realized investment gains are made to maximize total return. In 1997 net realized investment gains included gains on the sales of fixed maturity investments of $6.3 million and gains on redemption of seed money investments made by the Company in separate account mutual funds sponsored by the Company of $6.6 million. The net realized investment gains in 1996 were attributable to sales of the Company's fixed maturity investments which were made to maximize total return. 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 $53.1 million in the first quarter of 1997 compared to $46.4 million in the first quarter of 1996. The increase of $6.7 million in 1997 compared to 1996 primarily reflects a higher level of average fee-based assets under management. Average fee-based assets under management were $35.8 billion in the first quarter of 1997 compared to $32.5 billion in the first quarter of 1996. The increase of $3.3 billion during the first quarter of 1997 compared to the 17 first quarter of 1996 resulted primarily from market appreciation of $1.8 billion and net sales of $1.2 billion for the twelve months ended March 31, 1997. In addition, approximately $0.3 billion in fee-based assets under management were acquired during this twelve month period. Investment advisory and administrative fees were 0.59% of average fee-based assets under management in the first quarter of 1997 and 0.57% in the first quarter of 1996. This increase in the effective fee rate in the first quarter of 1997 was primarily due to the increased proportion of assets under management in mutual funds with higher fees. 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). Fee-Based Assets Under Management As of March 31, ---------------- 1997 1996 ------- ------ Mutual Funds: Intermediary-distributed ..................... $15.6 $15.7 Direct-marketed .............................. 6.2 5.4 Closed-end .................................... 1.9 1.8 Variable annuity .............................. 1.1 1.0 ------ ------ 24.8 23.9 Wealth Management .............................. 5.5 4.4 Institutional ................................. 4.5 4.4 ------ ------ Total Fee-Based Assets Under Management* ...... $34.8 $32.7 ====== ====== - ---------------- * As of March 31, 1997 and 1996, Keyport's insurance assets of $12.2 billion and $10.6 billion, respectively, bring total assets under management to $47.0 billion and $43.3 billion, respectively. Changes in Fee-Based Assets Under Management Three Months Ended March 31, ---------------------- 1997 1996 ---------- --------- Fee-based assets under management--beginning ..... $ 35.9 $ 31.9 Sales and reinvestments .......................... 1.9 1.9 Redemptions and withdrawals ....................... (2.1) (1.2) Market appreciation (depreciation) .............. (0.9) 0.1 ------ ------ Total Fee-Based Assets Under Management--ending .. $ 34.8 $ 32.7 ====== ====== Changes in the financial markets, including significant increases or decreases in interest rates or stock prices, can increase or decrease redemptions. The competitiveness of the Company's investment management products is also dependent on the relative attractiveness of their underlying investment philosophies and methods under prevailing market conditions. The increased redemptions in the first quarter of 1997 reflect weak performance of the securities markets relative to their performance in the comparable period of 1996. In addition, in the first quarter of 1997 the Company experienced the loss of a $0.3 billion institutional fixed income sub-advisory relationship. 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. Service fees of 0.25% (net of amounts passed on to selling brokers) are earned on average assets of all intermediary-distributed mutual funds. These fees totaled $12.1 million in the first quarter of 1997 compared to $10.6 million in the first quarter of 1996. The increase of $1.5 million in 1997 compared to 1996 was primarily attributable to the higher asset levels of mutual funds with contingent deferred sales charges. As a percentage of the corresponding weighted average assets, distribution and service fees approximated 0.71% in 1997 and 0.70% in 1996. 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 $11.8 million on average assets of $23.6 billion in 18 the first quarter of 1997 and $10.4 million on average assets of $21.8 billion in the first quarter of 1996. The increase of $1.4 million in 1997 compared to 1996 was primarily due to higher average assets in direct-marketed mutual funds. As a percentage of average mutual fund assets under management, transfer agency fees were approximately 0.20% and 0.19% in the first quarters of 1997 and 1996, 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 such commissions that is passed on to the selling brokers); and (c) the sales of non- proprietary investment products in the Company's bank marketing businesses (net of such commissions that are paid to the Company's client banks and brokers). Total surrender charges and net commissions were $8.5 million in the first quarter of 1997 compared to $7.7 million in the first quarter of 1996. 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 during the first six years. Such charges totaled $4.8 million and $4.9 million in the first quarters of 1997 and 1996, respectively. Annuity withdrawals represented 11.2% and 9.8% of the total average annuity policyholder and separate account balances in the first quarters of 1997 and 1996, respectively. The percentage increase in 1997 was primarily attributable to surrenders of annuities acquired in the F&G Life transaction; excluding these surrenders, the withdrawal percentage in 1997 would have been 9.4%. Net commissions were $3.7 million in the first quarter of 1997 and $2.8 million in the first quarter of 1996. The increase in 1997 compared to 1996 was primarily attributable to the acquisition in March 1996 of Independent. Separate Account Fees are primarily mortality and expense charges earned on variable annuity and variable life policyholder balances. These fees, which are based on the market values of the assets supporting the contracts in separate accounts, were $3.9 million in the first quarter of 1997 compared to $3.5 million in the first quarter of 1996. Such fees represented 1.55% and 1.52% of average variable annuity and variable life separate account balances in 1997 and 1996, respectively. Operating Expenses primarily represent compensation, marketing, and other general and administrative expenses. These expenses were $75.8 million in the first quarter of 1997 compared to $65.9 million in the first quarter of 1996. The increase in 1997 compared to 1996 was primarily due to increases in compensation of $6.3 million, in marketing expenses of $1.4 million relating to mutual fund sales and to the acquisition of Independent which increased operating expenses by $1.6 million, partially offset by a first quarter 1996 $1.9 million restructuring charge. Operating expenses expressed as a percent of average total assets under management were 0.63% and 0.60% in the first quarters of 1997 and 1996, 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 $16.3 million in the first quarter of 1997 compared to $14.1 million in the first quarter of 1996. The increase in amortization in the first quarter of 1997 compared to 1996 was primarily due to the growth of business in force associated with annuity sales. Amortization expense represented 0.62% and 0.64% of the total average policyholder and separate account balances in 1997 and 1996, respectively. Amortization of Deferred Distribution Costs relates to the deferred sales commissions acquired in connection with the Colonial acquisition in the first quarter of 1995 and the distribution of mutual fund shares sold with contingent deferred sales charges. Amortization was $8.2 million in the first quarter of 1997 compared to $6.8 million in the first quarter of 1996. The increase in 1997 was primarily attributable to the continuing sales of such fund shares during 1997 and 1996. 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 was $3.2 million in the first quarter of 1997 compared to $1.7 million in the first quarter of 1996. The increase in amortization in 1997 compared to 1996 was primarily due to $1.5 million of amortization relating to the F&G Life transaction. Amortization of Intangible Assets relates to goodwill and certain identifiable intangible assets arising from business combinations accounted for as purchases. Amortization was $3.2 million in the first quarter of 1997 19 compared to $3.7 million in the first quarter of 1996. The decrease in 1997 was primarily attributable to certain assets becoming fully amortized in the third quarter of 1996 which reduced amortization by $1.0 million, partially offset by an increase of $0.4 million in amortization relating to the acquisition of Independent. Interest Expense was $4.5 million in the first quarter of 1997 compared to $5.0 million in the first quarter of 1996. The decrease of $0.5 million is principally due to higher interest income which is netted against interest expense. Income Tax Expense was $16.8 million or 32.4% of pretax income in the first quarter of 1997 compared to $12.5 million, or 34.3% of pretax income in the first quarter of 1996. The low effective tax rates in 1997 and 1996 were attributable primarily to reductions in the deferred tax asset valuation reserve. There was no such reduction prior to the acquisition of Colonial in 1995. Substantially all the federal income tax expense related to the Company's annuity insurance business. Comparison of Years Ended December 31, 1996, 1995 and 1994 Net Income was $100.7 million or $3.36 per share in 1996 compared to $73.9 million or $2.64 per share in 1995 and $50.8 million or $2.15 per share in 1994. The improvement of $26.8 million in 1996 compared to 1995 resulted from higher investment spread, higher fee income and net realized investment gains in 1996 compared to net realized investment losses in 1995. Partially offsetting these items were increased operating expenses, amortization expense, interest expense and income tax expense. The full-period consolidation of the 1995 Colonial and Newport acquisitions resulted in an $8.9 million increase in 1996 net income compared to 1995. The improvement of $23.1 million in 1995 compared to 1994 resulted primarily from higher fee income associated with the Colonial and Newport acquisitions and lower net realized investment losses in 1995. Partially offsetting these items were decreased investment spread and increased operating expenses, amortization expense, interest expense and income tax expense. Pretax Income was $150.3 million in 1996 compared to $113.8 million in 1995 and $83.3 million in 1994. The higher pretax income in 1996 compared to 1995 resulted from higher investment spread, higher fee income, and net realized investment gains in 1996 compared to net realized investment losses in 1995. The full-period consolidation of the 1995 Colonial and Newport acquisitions resulted in an $11.9 million increase in 1996 pretax income compared to 1995. The higher pretax income in 1995 compared to 1994 was primarily due to the Colonial and Newport acquisitions, and to lower net realized investment gains. Partially offsetting these increases in both years were the higher expenses referred to above. Investment Spread was $223.7 million in 1996 compared to $206.0 million in 1995 and $213.2 million in 1994. Such investment spread percentage in 1996 was 1.89% compared to 1.90% for 1995 and 2.17% for 1994. Investment income was $796.4 million in 1996 compared to $761.8 million in 1995 and $695.1 million in 1994. Investment income increased in 1996 compared to 1995 primarily as a result of the higher level of average invested assets, partially offset by a decrease in the average investment yield. The average investment yield was 7.21% in 1996 compared to 7.57% in 1995. The decreased investment yield in 1996 reflects the lower interest rates prevailing during the latter half of 1995 and early 1996 and amortization of S&P 500 Index options, relating to equity-indexed annuities. Investment income increased in 1995 compared to 1994 primarily as a result of the higher level of average invested assets. The investment yield increased slightly during 1995. The average investment yield was 7.53% in 1994. Interest credited to policyholders totaled $572.7 million in 1996 compared to $555.8 million in 1995 and $481.9 million in 1994. Interest credited to policyholders increased in 1996 compared to 1995 primarily as a result of a higher level of average policyholder balances, partially offset by a decrease in the average interest credited rate. Policyholder balances averaged $10.8 billion in 1996 compared to $9.8 billion in 1995. The average interest credited rate was 5.32% in 1996 compared to 5.67% in 1995. Interest credited to policyholders increased in 1995 compared to 1994 primarily as a result of the higher level of average policyholder balances and to an increase in the average interest credited rate. Policyholder balances averaged $9.8 billion in 1995 compared to $9.0 billion in 1994. The average interest credited rate was 5.36% in 1994. Average Investments (computed without giving effect to SFAS 115--See Note 1 of the Notes to the Consolidated Financial Statements), including a portion of the Company's cash and cash equivalents, were $11.0 billion in 1996 compared to $10.1 billion in 1995 and $9.2 billion in 1994. The increase of $0.9 billion in 1996 compared to 1995 was primarily due to the F&G Life transaction and sales of the Company's fixed and indexed annuities offset, in part, by withdrawals of $1.1 billion. Fixed and indexed annuity premiums totaled $1.2 billion for 1996 compared to $1.1 billion for 1995 and $1.2 billion in 1994. The increase in premiums in 1996 compared to 1995 was primarily attributable to 20 the sales of indexed annuities which were introduced during 1995. Sales of indexed annuities in 1996 totaled $655.2 million compared to $83.9 million in 1995. The decrease in total premiums in 1995 compared to 1994 was primarily due to lower interest rates prevailing during the latter half of 1995, making fixed income products, such as the Company's SPDAs, less competitive. Net Realized Investment Gains were $8.0 million in 1996 compared to net realized investment losses of $4.0 million in 1995 and net realized investment losses of $8.2 million in 1994. The net realized investment gains in 1996 were primarily attributable to sales of Keyport fixed maturity investments and sales of investments received in the F&G Life transaction which were made to maximize total return. The net realized investment losses in 1995 were attributable to sales of Keyport fixed maturity investments which were made to maximize total return. The net realized investment losses in 1994 were primarily due to write-downs of investments whose declines in value were determined to be other than temporary. Investment Advisory and Administrative Fees were $196.4 million in 1996 compared to $155.8 million in 1995 and $95.9 million in 1994. The increase of $40.6 million in 1996 compared to 1995 primarily reflects a higher level of average fee-based assets under management due to the full year consolidation of Colonial and Newport. A substantial portion of the $59.9 million increase in 1995 compared to 1994 was related to the fee income attributable to the assets acquired in the Colonial acquisition in March 1995 and the Newport acquisition in April 1995. Average fee-based assets under management were $33.9 billion in 1996 compared to $27.2 billion in 1995 and $19.7 billion in 1994. The increase of $6.7 billion during 1996 compared to 1995 was primarily due to the full year inclusion of the assets acquired in the Colonial and Newport acquisitions, net mutual fund sales and market appreciation. The increase of $7.5 billion in 1995 compared to 1994 was due to the Colonial and Newport acquisitions and to market appreciation. Investment advisory and administrative fees were 0.58% of average fee- based assets under management in 1996, 0.57% in 1995 and 0.49% in 1994. These increases in the effective fee rate in 1996 and 1995 were primarily due to the increased proportion of assets under management in mutual funds with higher fees. Fee-based assets under management and changes in such assets are set forth in the tables below (in billions). Fee-Based Assets Under Management As of December 31, -------------------------- 1996 1995 1994 ------- ------- ------ Mutual Funds: Intermediary-distributed ................... $16.1 $15.7 $ 1.3 Direct-marketed ............................ 6.6 4.8 4.5 Closed-end .................................. 1.9 1.8 0.8 Variable annuity ............................ 1.1 1.0 0.8 ------ ------ ------ 25.7 23.3 7.4 Wealth Management ............................ 5.3 4.5 4.1 Institutional ............................... 4.9 4.1 4.8 ------ ------ ------ Total Fee-Based Assets Under Management* .... $35.9 $31.9 $16.3 ====== ====== ====== - ---------------- * As of December 31, 1996, 1995 and 1994, Keyport's insurance assets of $12.1 billion, $10.6 billion and $9.3 billion, respectively, bring total assets under management at those dates to $48.0 billion, $42.5 billion and $25.6 billion, respectively. Changes in Fee-Based Assets Under Management Year Ended December 31, ---------------------------- 1996 1995 1994 -------- -------- -------- Fee-based assets under management--beginning .. $ 31.9 $ 16.3 $ 21.7 Sales and reinvestments ....................... 7.5 4.8 2.6 Redemptions and withdrawals .................... (5.7) (8.5) (6.7) Acquisitions ................................... 0.3 14.9 -- Market appreciation (depreciation) ........... 1.9 4.4 (1.3) ------ ------ ------ Fee-Based Assets Under Management--ending ..... $ 35.9 $ 31.9 $ 16.3 ====== ====== ====== 21 Redemptions and withdrawals during 1996, 1995 and 1994 include $1.0 billion, $4.6 billion and $4.5 billion, respectively, of withdrawals of assets by wealth management and institutional asset management clients. In 1995, redemptions also increased due to the $14.9 billion increase in the total assets under management as a result of the acquisitions of Colonial and Newport. Distribution and Service Fees totaled $44.9 million in 1996 compared to $28.9 million in 1995. There were no such fees prior to the acquisition of Colonial. The increase of $16.0 million in 1996 compared to 1995 was primarily attributable to the higher asset levels of mutual funds with contingent deferred sales charges. As a percentage of weighted average assets, distribution and service fees approximated 0.69% in each of 1996 and 1995. Transfer Agency Fees were $43.9 million on average intermediary-distributed and direct-marketed mutual funds assets of $22.6 billion in 1996, $30.8 million on average assets of $17.4 billion in 1995 and $4.0 million on average assets of $5.6 billion in 1994. The increase of $13.1 million in 1996 compared to 1995 was primarily due to higher average assets in direct-marketed mutual funds. The revenue increase of $26.8 million in 1995 compared to 1994 was due to the acquisition of Colonial. As a percentage of average mutual fund assets under management, transfer agency fees were approximately 0.19%, 0.18% and 0.07% in 1996, 1995 and 1994, respectively. Surrender Charges and Net Commissions were $34.7 million in 1996 compared to $23.4 million in 1995 and $20.0 million in 1994. Contingent deferred sales charges totaled $19.8 million, $18.4 million and $11.5 million in 1996, 1995 and 1994, respectively. The increase in 1996 compared to 1995 was primarily attributable to the full-period consolidation of Colonial. The increase in 1995 compared to 1994 was attributable to the Colonial acquisition and higher earlier withdrawals subject to surrender charges for annuity policyholders. Total fixed, indexed and variable annuity withdrawals represented 11.6%, 9.9%, and 12.6% of the total average annuity policyholder and separate account balances in 1996, 1995 and 1994, respectively. Net commissions were $14.9 million in 1996, $5.0 million in 1995 and $8.5 million in 1994. The increase in 1996 compared to 1995 was primarily attributable to the acquisition of Independent in March 1996. The decrease in 1995 compared to 1994 was primarily attributable to lower sales of investment and insurance products in the Company's bank marketing business. Separate Account Fees were $16.0 million in 1996 compared to $13.2 million in 1995 and $12.5 million in 1994. Such fees represented 1.68%, 1.61%, and 1.63% of average variable annuity and variable life separate account balances in 1996, 1995 and 1994, respectively. Operating Expenses were $277.9 million in 1996 compared to $225.1 million in 1995 and $174.9 million in 1994. The increase in 1996 compared to 1995 was primarily due to increases in compensation and marketing expenses relating to mutual fund sales and to the acquisition of Independent. The increase in 1995 compared to 1994 includes $66.5 million of operating expenses related to Colonial and Newport, offset, in part, by decreases in guaranty fund association expense, stock option plan compensation expense and certain other operating expenses. Operating expenses expressed as a percent of average total assets under management were 0.61%, 0.59% and 0.59% in 1996, 1995, and 1994, respectively. Amortization of Deferred Policy Acquisition Costs was $60.2 million in 1996 compared to $58.5 million in 1995 and $52.2 million in 1994. The increase in amortization in 1996 compared to 1995 was primarily due to a decrease in estimated amortization periods determined in the last quarter of 1995 due to shorter average policy lives, and to the growth of business in force associated with fixed, indexed and variable annuity sales. The increase in 1995 compared to 1994 was primarily attributable to a decrease in the estimated amortization periods and lower projected fixed annuity surrender charges; in addition, this increase was attributable to the growth in business in force during 1995 and 1994. Amortization expense represented 0.51%, 0.55% and 0.53% of the total average policyholder and separate account balances in 1996, 1995 and 1994, respectively. Amortization of Deferred Distribution Costs was $33.9 million in 1996 compared to $18.8 million in 1995. There was no such expense prior to the acquisition of Colonial. The increase in 1996 was primarily attributable to the full period consolidation of Colonial, the continuing sales of mutual fund shares with contingent deferred sales charges during 1996 and 1995 and a $3.8 million charge in the fourth quarter of 1996 relating to a reduction in the amortization period. 22 Amortization of Value of Insurance in Force was $10.2 million in 1996 compared to $9.5 million in 1995 and $17.0 million in 1994. The increase in amortization in 1996 compared to 1995 was primarily due to $2.7 million of amortization recorded in 1996 relating to the F&G Life transaction, partially offset by lower amortization in 1996 due to an increase in estimated amortization periods in the last quarter of 1995 of the Company's closed block of single premium whole life insurance ("SPWLs"). The decrease in amortization in 1995 compared to 1994 of $7.5 million was primarily related to the actual persistency experience and higher expected future profits relating to the Company's closed block of SPWLs. Amortization of Intangible Assets was $15.4 million in 1996 compared to $12.2 million in 1995 and $5.8 million in 1994. These increases were attributable to the acquisitions of Independent, Colonial and Newport. Interest Expense was $19.7 million in 1996 compared to $16.2 million in 1995 and $4.2 million in 1994. These increases are primarily attributable to the $100.0 million note issued in connection with the Colonial acquisition, the $24.0 million note issued in connection with the Newport acquisition and the $30.0 million note issued in 1995 to an affiliate of Liberty Mutual. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." Income Tax Expense was $49.6 million or 33.0% of pretax income in 1996 compared to $39.9 million, or 35.1% of pretax income in 1995, and $32.5 million, or 39.0% of pretax income in 1994. The lower effective tax rates in 1996 and 1995 were attributable primarily to reductions in the deferred tax asset valuation reserve. For all periods, substantially all the federal income tax expense related to the Company's annuity insurance business. Financial Condition Stockholders' Equity as of March 31, 1997 was $1.04 billion compared to $1.05 billion and $0.96 billion, respectively, as of December 31, 1996 and December 31, 1995. Net income in the first quarter of 1997 and in 1996 was $35.0 million and $100.7 million, respectively, and cash dividends on the Company's preferred and common stock totaled $1.0 million and $3.9 million, respectively. During the first quarter of 1997, Common Stock totaling $1.3 million was issued in connection with the exercise of stock options. During 1996, Common Stock totaling $8.5 million and $2.4 million was issued in connection with the acquisition of Independent and upon the exercise of stock options, respectively. A decrease in net unrealized investment gains, net of taxes and adjustments to deferred policy acquisition costs and value of insurance in force, during the first quarter of 1997 decreased stockholders' equity by $43.7 million. A decrease in net unrealized investment gains, net of the same items referred to in the previous sentence, during 1996 decreased stockholders' equity by $12.7 million. Book Value Per Share amounted to $36.08 at March 31, 1997 compared to $36.63 and $34.55 at December 31, 1996 and December 31, 1995, respectively. Excluding net unrealized gains on investments, book value per share would have amounted to $35.01, $34.04 and $31.40 at March 31, 1997, December 31, 1996 and December 31, 1995, respectively. As of March 31, 1997, there were 28.9 million common shares outstanding compared to 28.7 and 27.7 million shares as of December 31, 1996 and December 31, 1995, respectively. Investments not including cash and cash equivalents totaled $11.5 billion at March 31, 1997 and December 31, 1996 compared to $10.1 billion at December 31, 1995. The increase from December 31, 1995 reflects the investments acquired in the F&G Life transaction, fixed and indexed annuity sales in 1996, withdrawals and a decrease in net unrealized investment gains. The Company manages the substantial majority of its invested assets internally. The Company's general investment policy is to hold fixed maturity assets for long-term investment and, accordingly, the Company does not have a trading portfolio. To provide for maximum portfolio flexibility and appropriate tax planning, the Company classifies its entire fixed maturities investments as "available for sale" and accordingly carries such investments at fair value. The Company's total investments at March 31, 1997 and December 31, 1996 reflected net unrealized gains of $78.3 million and $229.8 million, respectively, relating to its fixed maturity and equity portfolios. At December 31, 1995, such net unrealized investment gains were $308.5 million. The decrease in net unrealized gains in 1996 principally reflects the higher interest rates prevailing at the end of 1996. Approximately $10.3 billion, or 81.9%, of the Company's general account investments at March 31, 1997, was rated by Standard & Poor's Corporation, Moody's Investors Service or under comparable statutory rating 23 guidelines established by the NAIC. At March 31, 1997, the carrying value of investments in below investment grade securities totaled $991.5 million, or 7.9% of general account investments of $12.6 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. See "INVESTMENT CONSIDERATIONS--Investment Portfolio Risk." Management of the Company's Investments Asset-liability management is utilized by the Company to minimize the risks of interest rate fluctuations and policyholder withdrawals. The Company believes that its fixed and indexed policyholder balances should be backed by investments, principally comprised of fixed maturities, that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rates, the slope of the yield curve and the excess at which fixed maturities are priced over the yield curve. Its portfolio strategy is designed to achieve acceptable risk-adjusted returns by effectively managing portfolio liquidity and credit quality. The Company conducts its investment operations to closely match the duration of the assets in its investment portfolio to its policyholder balances. The Company seeks to achieve an acceptable spread between what it earns on its assets and interest credited on its policyholder balances by investing principally in fixed maturities. The Company's fixed-rate products incorporate surrender charges to encourage persistency and make the cost of its policyholder balances more predictable. Approximately 85.0% of the Company's fixed annuity policyholder balances were subject to surrender charges at March 31, 1997. During the remaining nine months of 1997, and during 1998 and 1999, policies having aggregate balances of $697.6 million, $993.8 million and $1.2 billion, respectively, were scheduled as of March 31, 1997 to come off the surrender charge period. 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, 1997, the effective duration of the Company's fixed maturities investments (including certain cash and cash equivalents) was approximately 2.8 years. As a component of its investment strategy and to reduce its exposure to interest rate risk in the event of an increasing interest rate environment, the Company utilizes interest rate swap agreements ("swap agreements") to match assets more closely to liabilities. Swap agreements are agreements to exchange with a counterparty interest rate payments of differing character (e.g., fixed-rate payments exchanged for variable-rate payments) based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company currently utilizes swap agreements to reduce asset duration and to better match interest rates earned on longer-term fixed rate assets with interest credited to policyholders. At March 31, 1997, the Company had 41 outstanding swap agreements with an aggregate notional principal amount of $2.3 billion. These agreements mature in various years through 2001. In addition, with respect to the Company's indexed annuity, the Company buys call options on the S&P 500 index to manage its obligation to provide returns based upon this index. At March 31, 1997, the Company had call options with a market value of $131.2 million. There are risks associated with some of the techniques the Company uses to match its assets and liabilities. The primary risk associated with swap and call option agreements is counterparty nonperformance. The Company believes that the counterparties to its swap and call option agreements are financially responsible and that the counterparty risk associated with these transactions is minimal. In addition, swap agreements have interest rate risk and call options have stock market risk. However, the swap agreements hedge fixed-rate assets; the Company expects that any interest rate movements that adversely affect the market value of swap agreements would be offset by changes in the market values of such fixed rate assets. Similarly, the call options hedge the Company's obligations to provide returns based upon the S&P 500 index, and the Company believes that any stock market movements that adversely affect the market value of S&P call options would be substantially offset by a reduction in policyholder liabilities. However, there can be no assurance that these hedges will be effective in offsetting the potentially adverse effects of changes in S&P 500 index levels impacting interest credited to equity-indexed 24 policyholders. Keyport's profitability could be adversely affected if the value of its S&P 500 call options increase less than (or decrease more than) the value of the guarantees made to equity-indexed policyholders. The Company routinely reviews its portfolio of investment securities. The Company identifies monthly any investments that require additional monitoring, and carefully reviews the carrying value of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. 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 and Capital Resources The Company is a holding company whose liquidity needs include the following: (i) operating expenses; (ii) debt service; (iii) dividends on the preferred stock and Common Stock; (iv) acquisitions; and (v) working capital where needed to fund 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). See "PRICE RANGE OF COMMON STOCK AND DIVIDENDS." Regulatory authorities permit dividend payments from Keyport to the Company up to the lesser of (i) 10% of statutory surplus as of the preceding December 31 or (ii) the net gain from operations for the preceding fiscal year. As of December 31, 1996, Keyport could pay dividends of up to $42.5 million without the approval of the Department of Business Regulation of the State of Rhode Island. However, Keyport has not paid any dividends since its acquisition in 1988. The terms of Colonial's existing senior credit facility place certain limitations on Colonial's ability to pay dividends. In April 1997, this facility was renewed and various terms were revised. Under the revised terms of the facility, Colonial could pay dividends of up to $87.2 million as of March 31, 1997. Based upon the historical cash flow of the Company, the Company's current financial condition and the Company's expectation that there will not be a material adverse change in the results of operations of the Company and its subsidiaries during the next twelve months, the Company believes that cash flow provided by operating activities over this period will provide sufficient liquidity for the Company to meet its working capital, capital investment and other operational cash needs, its debt service obligations, its obligations to pay dividends on the Preferred Stock, and its intentions to pay dividends on the Common Stock. See "PRICE RANGE OF COMMON STOCK AND DIVIDENDS." The Company anticipates that it would require external sources of liquidity in order to finance material acquisitions. 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, its operating subsidiaries will be able to meet their respective 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 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 designed 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, 1997, $9.3 billion, or 73.4%, of Keyport's investments, including short-term investments, are considered readily marketable. See "BUSINESS--Keyport--General Account Investments." 25 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 withdrawals would be available through incoming cash flow, the sale of short-term or floating-rate instruments or investment securities in its short duration portfolio, thereby precluding the sale of fixed maturity investments in a potentially unfavorable market. 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. Recent Accounting Pronouncement In February 1997, FASB issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), which is required to be adopted for periods ending after December 15, 1997. SFAS 128 replaces primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed similarly to fully diluted earnings per share. Assuming that SFAS 128 had been implemented, basic earnings per share would have been $1.21 and $0.85 for the first quarters of 1997 and 1996, respectively. The calculation of diluted earnings per share under SFAS 128 for these quarters would not materially differ from the calculation of fully diluted earnings per share. Recent Accounting Proposal In June 1996, FASB issued an exposure draft of an accounting standard entitled "Accounting for Derivative and Similar Financial Instruments and for Hedging Activities." This exposure draft, if adopted in the form in which it was issued, would require companies to report derivatives on the balance sheet at fair value with changes in fair value recorded in income or equity. The exposure draft also would change the accounting for derivatives used in hedging strategies from traditional deferral accounting to a current recognition approach which could impact a company's income statement and balance sheet and expand the definition of a derivative instrument. Management expects that this accounting standard, in whatever form will not be effective until 1999. FASB's Rules of Procedure require that, prior to approving a new accounting standard, extensive "due process" be followed. FASB requests written comments from interested parties on an exposure draft and also may hold public hearings. This exposure draft has drawn widespread criticism primarily because the required accounting treatment would not match the perceived economic effect of such hedging strategies. As a result of, among other things, the concerns and criticisms in comment letters and at public hearings held on this exposure draft, the Company is unable to predict the form that the final accounting standard, if adopted, may take and believes it would be inappropriate to speculate on the effects of any such adoption at this time. 26 BUSINESS Liberty Financial is a leading asset accumulation and management company. The Company is a leader in each of its two core product lines--retirement-oriented insurance products and investment management products. Retirement-oriented insurance products consist substantially of annuities, and 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 depositary 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 $26.7 million in the first quarter of 1997, and $94.8 million, $76.5 million and $56.2 million and in 1996, 1995 and 1994, respectively. The following table sets forth the Company's assets under management as of March 31, 1997 and December 31, 1996, 1995 and 1994: Assets Under Management ----------------------------------- As of December 31, As of -------------------------- March 31, 1997 1996 1995 1994 --------- ----- ---- ---- (dollars in billions) Retirement-Oriented Insurance Products $12.2 $12.1 $10.6 $ 9.3 Mutual Funds ........................... 24.8 25.7 23.3 7.4 Wealth Management ..................... 5.5 5.3 4.5 4.1 Institutional Asset Management ......... 4.5 4.9 4.1 4.8 ------ ------ ------ ------ Total .............................. $47.0 $48.0 $42.5 $25.6 ====== ====== ====== ====== 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 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 SPDAs, which represented $8.6 billion of policyholder liabilities as of March 31, 1997. In addition to SPDAs, Keyport 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. An equity-indexed annuity credits 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 KeyIndex, the Standard & Poor's 500 Stock Index). The Company has four operating units engaged in investment management: Colonial, Stein Roe, Newport and LAMCO, each of which carries strong brand name recognition in the markets it serves. As of the date of this Prospectus, the Company sponsored 67 open-end mutual funds, as well as seven closed-end funds. The open-end funds consist of 36 intermediary-distributed Colonial mutual funds, 20 direct-marketed Stein Roe funds and 11 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. Forty-nine of the Company's 67 mutual funds are long-term open-end 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 49 funds (representing 68% of the total assets in those 49 funds as of May 31, 1997), were ranked by Lipper Analytical Services, Inc. in the top two quartiles of their respective peer groups for the three-year period ended that date. 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 brokerage firms, banks and other depository institutions, financial planners and insurance agents. To capitalize on the growing importance of banks and other depository institutions as intermediaries for its products, the Company also operates its own distribution unit which sells mutual funds and annuities 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 the three months ended March 31, 1997 and for the years ended December 31, 1996 were $2.1 billion and $8.6 billion, respectively (including $0.2 billion and $1.0 billion, respectively, of reinvested dividends). During the three months ended March 31, 1997 and during 1996, 53% and 61%, respectively, of sales were made through intermediary distributors, 27 with the balance made directly to the investor. Over 35,000 individual brokers and other intermediaries sold Liberty Financial products in 1996. 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 $1.7 billion of assets under management as of March 31, 1997. The Stein Roe Young Investor 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 $330.3 million of assets under management and over 85,000 shareholders of record as of March 31, 1997. The Company introduced the first equity-indexed annuity product to the marketplace. At March 31, 1997 and December 31, 1996, the Company's equity-indexed annuity policyholder balances were $926.8 million and $787.8 million, respectively. The Company's equity-indexed annuity sales during the three months ended March 31, 1997 and during 1996 were $123.4 million and $655.2 million, respectively. 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 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, which was rebranded under the Colonial name. In conjunction with Colonial's sales efforts, the Colonial Newport Tiger Fund's assets have more than tripled from April, 1995 to March 31, 1997. The availability of the Colonial Newport Tiger Fund has facilitated new intermediary distribution relationships for Colonial, including approximately 6,000 new broker relationships. Stein Roe manages a substantial portion of Keyport's general account assets (approximately $9.3 billion at March 31, 1997) and together with Colonial and Newport manages certain of the funds underlying Keyport's variable annuity products (approximately $1.1 billion at that date). Colonial's transfer agency operations perform these functions for the Stein Roe funds. The Company's bank distribution unit was the largest distributor of Keyport's annuities during both the three months ended March 31, 1997 and during 1996, and the second and third largest distributor, respectively, of the Colonial funds during such periods. [bullet] Acquisitions. Where appropriate, the Company seeks acquisitions that provide additional assets, new and 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 bank distribution unit (including Independent, acquired in 1996). 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. Current areas of focus for the Company's acquisition efforts include the following: mutual funds, with particular focus on equities and foreign markets; other new or complementary investment skills; additional distribution capabilities; wealth management firms that can be integrated into Stein Roe and can leverage and expand Stein Roe's franchise in the wealth management market; and blocks of annuity assets that can be purchased or co-insured. While the Company is 28 constantly evaluating acquisition opportunities, as of the date of this Prospectus the Company has not entered into any material definitive acquisition agreements. 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-provider 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. 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 are insurance products designed to offer individuals protection against the risk of outliving their income during retirement. 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. 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. An 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. In August, 1996 the Company completed a coinsurance agreement with F&G Life under which the Company acquired a $954.0 million block of SPDAs. [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. An equity-indexed annuity credits 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 risk to the policyholder's principal. In late 1996, the Company introduced a market value adjusted ("MVA") annuity product, sales of which have not been material to date, which offers a choice between an equity-indexed account similar to KeyIndex and a fixed annuity-type interest account. The MVA product offers terms for each equity-indexed account of one, three, five, six and seven years, as well as a 10-year term for the fixed interest account. The MVA 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. [bullet] Variable Annuities. Variable annuities offer a selection of underlying investment alternatives which may satisfy a variety of policyholder risk/return objectives. In 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. Guaranteed fixed interest options also are available. The Company's Keyport Advisor variable annuity currently offers 17 separate account investment choices (substantially all of the assets of which are managed by the Company) and four guaranteed fixed-interest options. 29 While the Company currently does not offer traditional life insurance products, it manages a closed block of 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 March 31, 1997 and December 31, 1996. Under current law, 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. See "INVESTMENT CONSIDERATION--Tax Status of Insurance Products." 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 increase in interest rate environments when this differential in rates is not present. SPDA sales also can be adversely affected by low interest rates. The Company believes that the recent decline in the sale of the Company's SPDAs has resulted from this type of low interest rate environment. The sales trend of the Company's equity-indexed products declined during the first quarter of 1997 from the sales levels the Company experienced in 1996. The Company believes that the decline is due to an increase in the number of firms offering competing products and lower participation rates resulting from increased volatility in the S&P 500. The following table sets forth certain information regarding Keyport's retirement-oriented insurance products and its reserves for the periods indicated. As of or for the Three Months Ended As of or for the Year Ended March 31, December 31, -------------- ----------------------------- 1997 1996 1995 1994 -------------- --------- --------- --------- (dollars in millions, except policy data) Policy and Separate Account Liabilities: Fixed annuities ................. $ 8,564 $ 8,641 $ 7,772 $ 7,072 Indexed annuities .............. 927 788 84 -- Variable annuities .............. 1,101 1,083 950 812 Life insurance ................. 2,133 2,142 2,168 2,224 -------- -------- -------- -------- Total .......................... $12,725 $12,654 $10,974 $10,108 ======== ======== ======== ======== Number of In Force Policies: Fixed annuities ................. 232,255 236,574 224,238 212,390 Indexed annuities .............. 27,804 24,174 2,778 -- Variable annuities .............. 25,314 25,177 25,037 25,400 Life insurance ................. 26,413 26,850 28,489 30,465 -------- -------- -------- -------- Total .......................... 311,786 312,775 280,542 268,255 ======== ======== ======== ======== Average In Force Policy Amount: Fixed annuities ................. $36,808 $36,479 $34,611 $33,247 Indexed annuities .............. $33,335 $32,591 $30,207 -- Variable annuities .............. $43,502 $43,035 $37,941 $31,985 Life insurance ................. $79,917 $79,207 $75,728 $72,756 30 As of or for the Three As of or for Months Ended the Year Ended March 31, December 31, ----------- -------------------------------- 1997 1996 1995 1994 ----------- -------- --------- -------- (dollars in millions, except policy data) Premiums (statutory basis): Fixed annuities ................. $ 68 $ 493 $ 977 $1,156 Indexed annuities .............. 123 655 84 -- Variable annuities .............. 31 97 80 156 Life insurance (net of reinsurance) .......... -- -- (1) (1) ------ ------ ------- ------- Total .......................... $ 222 $1,245 $1,140 $1,311 ====== ====== ======= ======= New Contracts and Policies: Fixed annuities ................. 2,419 11,358 30,043 45,557 Indexed annuities .............. 3,620 21,396 2,778 -- Variable annuities .............. 631 1,814 1,789 4,117 ------ ------ ------- ------- Total .......................... 6,670 34,568 34,610 49,674 ====== ====== ======= ======= Aggregate Amount Subject to Surrender Charges and Similar Penalties: Fixed annuities ................. $7,323 $7,371 $6,904 $6,168 Indexed annuities .............. $ 927 $ 788 $ 84 -- Withdrawals and Terminations (statutory basis): Fixed Annuities: Death .......................... $ 11 $ 25 $ 15 $ 16 Maturity ....................... $ 26 $ 87 $ 76 $ 65 Surrender .................... $ 241 $ 966 $ 693 $ 826 Indexed Annuities: Death .......................... $ 0.3 $ 0.1 -- -- Maturity ....................... -- -- -- -- Surrender ....................... $ 3 $ 3 -- -- Variable Annuities: Death .......................... $ 2 $ 2 $ 0.4 $ 0.6 Maturity ....................... $ 6 $ 21 $ 14 $ 16 Surrender .................... $ 23 $ 77 $ 92 $ 76 Life Insurance: Death .......................... $ 18 $ 53 $ 54 $ 49 Surrender ....................... $ 25 $ 98 $ 95 $ 89 Surrender Rates: Fixed annuities ................. 11.19% 11.79% 9.34% 12.34% Indexed annuities .............. 1.52% 0.69% 0.12% -- Variable annuities .............. 8.48% 7.55% 10.46% 9.54% Life insurance ................. 4.60% 4.58% 4.36% 3.73% Sales and Asset Retention New 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 March 31, 1997, crediting rates 31 on 93.0% of the Company's in force SPDA policy liabilities 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 4.0% to 8.0% at March 31, 1997. Such policies had guaranteed minimum rates ranging from 3.0% to 4.5% as of such date. Initial interest crediting rates on new policies issued in 1996 and on new policies issued in the three months ended March 31, 1997 ranged from 4.65% to 7.15% and from 5.15% to 6.86%, respectively. Guaranteed minimum rates on new policies ranged from 3.0% to 4.5% issued during 1996 and the three months ended March 31, 1997. 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 March 31, 1997, 85.0% 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 10 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. See "INVESTMENT CONSIDERATIONS--Other Factors Affecting Product Sales and Asset Retention" and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION." 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. The S&P and Duff & Phelps "-" modifier signifies that Keyport is at the lower end of the AA category. These ratings are based upon information supplied to the rating agency by Keyport. These ratings merely 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; they are not directed toward investors. No assurances can be given that Keyport will be able to maintain its current financial ratings. 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. See "INVESTMENT CONSIDERATIONS--Importance of Credit 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 1996 were 0.44% of assets, making Keyport a low cost operator. General Account Investments Premium deposits on fixed and indexed annuities are credited to Keyport's general account investments (which at March 31, 1997 totaled $12.6 billion, including certain 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 32 management. Successful asset/liability 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. There can be no assurances that Keyport will continue to realize investment spreads at levels necessary for the Company to remain profitable. See "INVESTMENT CONSIDERATIONS--Interest Rate Risk" and "--Certain Investment Portfolio Risks." The bulk of the Company's general account is invested in fixed maturity securities (84.9% at March 31, 1997). The Company's principal strategy for managing interest rate risk is to closely match the duration of its investment portfolio and its policyholder balances. At March 31, 1997, the duration of its fixed income portfolio was approximately 2.8 years. 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 call options to hedge its obligations to provide participation rate returns. Credit risk is managed by careful credit analysis and monitoring. At March 31, 1997, the Company's fixed maturity portfolio had an overall average S&P rating of A+ and 92.1% of the Company's general account investments consisted of investment grade securities. The balance was invested in below investment grade 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, 1996 or March 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." Investments and certain cash and cash equivalents, all of which pertain to the Company's annuity insurance operations, were comprised of the following (in millions): As of As of March 31, December 31, ----------- ------------------------ 1997 1996 1995 ----------- ----------- ---------- Fixed maturities available for sale .. $10,683.7 $10,718.6 $ 9,536.0 Mortgage loans ....................... 65.3 67.0 74.5 Policy loans .......................... 538.8 532.8 498.3 Other invested assets ................. 216.3 183.6 10.7 Equity securities .................... 37.4 35.9 25.2 ---------- ---------- ---------- Investments ....................... 11,541.5 11,537.9 10,144.7 Cash and cash equivalents ........... 1,036.5 767.4 777.4 ---------- ---------- ---------- General account investments ........ $12,578.0 $12,305.3 $10,922.1 ========== ========== ========== The amortized cost, gross unrealized gains and losses and fair value of fixed maturity securities by types of securities were as follows as of the dates specified below (in millions):
Gross Gross Amortized Unrealized Unrealized Fair March 31, 1997 Cost Gains Losses Value ----------- ------------ ------------ --------- U.S. Treasury securities .............................. $ 35.3 $ 0.1 $ (0.7) $ 34.7 Mortgage backed securities of U.S. government corporations and agencies ........................... 1,641.5 28.0 (18.1) 1,651.4 Obligations of states and political subdivisions ...... 41.2 0.2 (0.3) 41.1 Debt securities issued by foreign governments ......... 177.1 5.8 (1.1) 181.8 Corporate securities ................................. 4,325.7 97.6 (42.1) 4,381.2 Other mortgage backed securities ..................... 2,350.3 43.9 (35.6) 2,358.6 Asset backed securities .............................. 1,776.3 7.2 (18.5) 1,765.0 Senior secured loans ................................. 269.9 --- --- 269.9 ---------- ------- ------- ---------- Total fixed maturities .............................. $10,617.3 $182.8 $(116.4) $10,683.7 ========== ======= ======== ==========
33
Gross Gross Amortized Unrealized Unrealized Fair December 31, 1996 Cost Gains Losses Value --------------- --------------- --------------- ----------- U.S. Treasury securities .............................. $ 35.3 $ 0.2 $ (0.1) $ 35.4 Mortgage backed securities of U.S. government corporations and agencies ........................... 1,666.1 41.4 (8.6) 1,698.9 Obligations of states and political subdivisions ...... 23.9 0.4 (0.1) 24.2 Debt securities issued by foreign governments ......... 246.3 11.7 (0.5) 257.5 Corporate securities ................................. 4,093.5 153.4 (12.3) 4,234.6 Other mortgage backed securities ..................... 2,413.0 47.6 (24.0) 2,436.6 Asset backed securities .............................. 1,736.0 15.5 (6.4) 1,745.1 Senior secured loans ................................. 286.3 -- -- 286.3 ---------- ----------- ---------- ---------- Total fixed maturies ................................. $10,500.4 $ 270.2 $ (52.0) $10,718.6 ========== =========== ========== ========== Gross Gross Amortized Unrealized Unrealized Fair December 31, 1995 Cost Gains Losses Value ---------- ----------- ---------- --------- U.S. Treasury securities .............................. $ 360.2 $ 9.0 $ (0.2) $ 369.0 Mortgage backed securities of U.S. government corporations and agencies ........................... 1,585.5 58.8 (5.2) 1,639.1 Obligations of states and political subdivision ...... 26.7 1.3 -- 28.0 Debt securities issued by foreign governments ......... 57.4 4.3 -- 61.7 Corporate securities ................................. 3,479.6 224.3 (7.3) 3,696.6 Other mortgage backed securities ..................... 1,951.5 66.6 (71.8) 1,946.3 Asset backed securities .............................. 1,543.9 29.8 (1.5) 1,572.2 Senior secured loans ................................. 223.1 -- -- 223.1 ---------- ----------- ---------- ---------- Total fixed maturies ................................. $ 9,227.9 $ 394.1 $ (86.0) $ 9,536.0 ========== =========== ========== ==========
The amortized cost and fair value of fixed maturities by contractual maturity as of March 31, 1997 are as follows (in millions): Amortized Fair March 31, 1997 Cost Value ----------- ---------- Due in one year or less ..................... $ 306.8 $ 307.4 Due after one year through five years ...... 1,606.0 1,624.8 Due after five years through ten years ...... 2,181.4 2,206.1 Due after ten years ........................... 755.0 770.4 ---------- ---------- 4,849.2 4,908.7 Mortgage and asset backed securities ......... 5,768.1 5,775.0 ---------- ---------- Total fixed maturities ..................... $10,617.3 $10,683.7 ========== ========== As of March 31, 1997, Keyport owned approximately $4.0 billion of MBSs (31.9% of its general account investments), 96.9% of which were investment grade. MBSs and CMOs are subject to significant prepayment and extension risks, since underlying mortgage may be repaid more or less rapidly than scheduled. See "INVESTMENT CONSIDERATIONS--Investment Portfolio Risk." As of March 31, 1997, approximately $3.3 billion (26.6% of the Company's general account investments) were invested in securities not freely tradeable under the Securities Act or which were otherwise illiquid. If the Company sought 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. See "INVESTMENT CONSIDERATIONS--Investment Portfolio Risk." 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. 34 Products and Services [bullet] Mutual Funds. The Company sponsors 67 open-end mutual funds, as well as seven closed-end funds. The open-end funds include the 36 intermediary-distributed Colonial mutual funds, 20 direct-marketed Stein Roe funds and 11 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 March 31, 1997 and December 31, 1996, total mutual fund assets were $24.8 billion and $25.7 billion, respectively. At March 31, 1997, 46.5 % of these assets were invested in equity funds, 27.4% in taxable fixed income funds and 26.1% in tax-exempt fixed income funds. The Company seeks to continue to increase equity mutual fund assets, which generally carry higher fees than funds that invest in fixed income securities. [bullet] Wealth Management. At March 31, 1997, the Company managed $5.5 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 March 31, 1997, the Company managed $4.5 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. At March 31, 1997, Stein Roe also managed $9.3 billion of Keyport's general account assets supporting Keyport's insurance products. 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 a daily basis. The Company's direct-market mutual funds are sold without a sales load. Most of the Company's intermediary-distributed mutual funds offer investors a choice of two pricing options: a traditional front-end load option, in which the investor pays a sales charge at the time of purchase, and 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 for eight years after purchase and a declining contingent deferred sales charge paid by the investor if shares are redeemed within six years after purchase. Certain funds also offer a level-load option, in which the investor pays a small initial sales 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 the three month period ended March 31, 1997 and as of or for each year in the three-year period ended December 31, 1996. Such information includes Keyport's assets (including its general account assets managed by Stein Roe, as well as loans to policyholders and Keyport's general account assets managed by unaffiliated investment managers). In addition, certain information is provided separately for mutual fund assets. 35 Total Assets Under Management -------------------------------------- As of December 31, As of ----------------------- March 31, 1997 1996 1995 1994 ------------ ------ ------ ------ (dollars in billions) Mutual Funds: Intermediary-distributed ............ $15.6 $16.1 $15.7 $ 1.3 Direct-marketed ..................... 6.2 6.6 4.8 4.5 Closed-end ........................... 1.9 1.9 1.8 0.8 Variable Annuity ..................... 1.1 1.1 1.0 0.8 ------ ------ ------ ------ Total Mutual Funds .................. 24.8 25.7 23.3 7.4 Wealth Management ..................... 5.5 5.3 4.5 4.1 Institutional ........................ 4.5 4.9 4.1 4.8 ------ ------ ------ ------ Retirement-Oriented Insurance Products 12.2 12.1 10.6 9.3 ------ ------ ------ ------ Total ........................... $47.0 $48.0 $42.5 $25.6 ====== ====== ====== ====== Total Assets Under Management By Asset Class (1) -------------------------------------- As of December 31, As of ----------------------- March 31, 1997 1996 1995 1994 ------------ ------ ------ ------ (dollars in billions) Fee-Based Assets: Equity .............................. $15.5 $16.1 $11.4 $ 7.2 Fixed Income ........................ 19.3 19.8 20.5 9.1 ------ ------ ------ ------ Total Fee-Based Assets ............... 34.8 35.9 31.9 16.3 Retirement-Oriented Insurance Products 12.2 12.1 10.6 9.3 ------ ------ ------ ------ Total .............................. $47.0 $48.0 $42.5 $25.6 ====== ====== ====== ====== - ---------------- (1) Balanced funds are classified as equity funds; all categories include cash and other short-term investments in applicable portfolios. Total Mutual Fund Assets Under Management By Asset Class (1) -------------------------------------------- As of December 31, ------------------------- As of March 31, 1997 1996 1995 1994 ---------------- ------- ------- ----- (dollars in billions) Equity Funds ...... $11.5 $12.1 $ 8.6 $3.6 Fixed Income Funds: Taxable ......... 6.8 7.0 7.4 2.5 Tax-Exempt ...... 6.5 6.6 7.3 1.3 ------ ------ ------ ----- Total ............ $24.8 $25.7 $23.3 $7.4 ====== ====== ====== ===== - ---------------- (1) Balanced funds are classified as equity funds; all categories include cash and other short-term investments in applicable portfolios. 36
Total Assets Under Management Asset Flow Summary ------------------------------------------------- For the For the Year Ended December 31, Three Months -------------------------------- Ended March 31, 1997 1996 1995 1994 ---------------- ---------- ---------- ---------- (dollars in billions) Beginning Assets Under Management ... $ 48.0 $ 42.5 $ 25.6 $ 30.6 Sales and Reinvestments ............... 2.1 8.6 5.8 3.7 Redemptions and Withdrawals ......... (2.4) (6.9) (9.4) (7.7) Asset Acquisitions .................. -- 1.2 14.9 -- General Account Investment Earnings ... 0.3 0.7 0.6 0.5 Market Action ........................ (1.0) 1.9 5.0 (1.5) ------ ------ ------ ------ Ending Assets Under Management ...... $ 47.0 $ 48.0 $ 42.5 $ 25.6 ====== ====== ====== ======
Sales and Asset Retention The Company's 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. As a result of its acquisitions of Colonial and Newport and subsequent integration steps, the Company generated annual cost savings of $13.5 million through the consolidation of various support and service functions in its mutual fund business. 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. Forty-nine of the Company's 67 mutual funds are long-term open-end 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 49 funds (representing 68% of the total assets in those 49 funds as of May 31, 1997) were ranked by Lipper Analytical Services, Inc. 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 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, 1996, 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. Sales of the Company's equity mutual funds benefited in 1996 from the continued strong performance of the U.S. stock market. Sales of the Company's fixed income mutual funds were more modest in 1996, given prevailing market conditions. Changes in the financial markets, including significant increases or decreases in interest rates or stock prices, can increase or decrease fund sales and redemptions, as well as the values of assets in such portfolios, all of which impact investment management fees. 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 37 asset management products. For information on these industry segments, see Note 11 of the Notes to the Consolidated Financial Statements. Distribution Liberty Financial sells its products through multiple distribution channels. Total product sales for the three months ended March 31, 1997 and during 1996 were $2.1 billion and $8.6 billion, respectively (including $0.2 billion and $1.0 billion, respectively, of reinvested dividends and similar reinvested returns). During the three months ended March 31, 1997 and during 1996, 53% and 61%, respectively, of these sales were made through intermediaries and the remaining 47% and 39%, respectively, of sales were made directly to the investor. Over 35,000 individual brokers and other intermediaries sold Liberty Financial products in 1996. Distribution Through Intermediaries The Company sells both annuities and mutual funds through various intermediaries, including national and regional brokerage firms, banks, financial planners and insurance agents. 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. In recent years banks and financial planners also have become significant distributors of these products. Fee-based financial planners also have emerged as an important distribution channel. 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 mutual funds and annuities products 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 March 31, 1997, Independent had over 150 bank relationships involving over 3,100 registered salespersons. The proliferation of competing products requires the Company to compete to establish and maintain distribution relationships and to maintain "shelf space" with distributors. In response to the proliferation of available investment products, 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. An interruption in the Company's continuing relationship with certain of these distributors could materially adversely affect the Company's ability to market its products. There can be no assurance that the Company would be able to find alternative sources of distribution in a timely manner. Some distributors have begun to assess fee sharing payments or similar charges as compensation for fund sales. The Company can be confronted with the choice of absorbing these charges or limiting its access to certain distributors. See "INVESTMENT CONSIDERATIONS--Industry and Competitive Factors." 38 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 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. The Company is developing innovative new technology-based service and support tools, such as interactive asset allocation models and on-line customer account management systems, designed to provide value-added services to intermediaries and their customers. Some distributors have begun to assess fee sharing payments or similar charges as additional compensation for fund sales. The Company may be confronted with the choice of absorbing these charges or limiting its access to certain distributors. Direct Distribution The Company's direct-marketed mutual funds, as well as its wealth management and institutional 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 to select their own funds and who wish to avoid paying sales loads and similar fees. Wealth management clients typically are high net worth individuals and families and smaller institutional investors. Institutional 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 of the technology-based customer service and support tools it is developing, such as 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, have become an important source of customers for direct-marketed mutual funds. During the three months ended March 31, 1997 and during 1996, 59% and 63%, respectively, of the total new sales of the Stein Roe mutual funds were through mutual fund supermarkets and similar arrangements. To gain access to 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. 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"), a Keyport subsidiary, also issues certain policies. Keyport and Independence Life 39 are each chartered in the state of Rhode Island, and the Rhode Island Department of Business Regulation is their primary oversight regulator. 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 subsidiaries. Keyport prepares its statutory-basis financial statements in accordance with accounting practices prescribed or permitted by the Insurance Department of the State of Rhode Island. Prescribed statutory accounting practices generally include state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ between the states and companies within a state. 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 1997 or 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, 1996, Keyport's capital 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 15 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. 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, 1996, such restriction would limit dividends without such approval to $42.5 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% 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. See "PRICE RANGE OF COMMON STOCK AND DIVIDENDS." 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 40 from engaging in the insurance and mutual fund business. In particular, several proposals to repeal or modify the Glass-Steagall Act of 1933 (which restricts banks from engaging in securities-related businesses) and 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 on January 18, 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 on March 26, 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 also 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's business, financial condition and results of operations. 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 ("SEC") as investment advisers under the Advisers Act. They are subject to the Investment Company Act insofar as it relates to investment advisers to registered investment companies. These securities laws and the 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. The Advisers Act and the Investment Company Act provide, in substance, that if a change in control of the Company were to occur, each client investment management agreement would terminate, unless the client consents to the continuation of the agreement. In the case of mutual fund clients, this would require approval of the fund's Board of Trustees (including a majority of the independent Trustees) and shareholders. A person holding more than 25% of the Company's voting stock is presumed to control the Company. Sales by Liberty Mutual or other stockholders or new issuances of equity securities by Liberty Financial, among other things, may raise issues relating to a deemed assignment of the Company's investment advisory agreements. The Restated Articles provide that no person or group deemed to be a beneficial owner (as defined therein) of Liberty Financial's Voting Stock (as defined therein) may vote more than 20% of the total voting power of such Voting Stock outstanding. These provisions of the Restated Articles do not apply to Liberty Mutual, subsidiaries or affiliates of Liberty Mutual, direct or indirect subsidiaries of the Company and certain employee plans maintained by the Company. The Company's Board of Directors also may approve the exemption of other persons or groups from these provisions. There can be no assurance that this limitation would have the desired legal effect. 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 Securities 41 Exchange Act of 1934 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 annuity sales are processed. 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. 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 SEC 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, however, on the courts and no assurance can be given that the SEC 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 generating new sales and maintaining distribution relationships. The Company believes that, aside from excellent investment performance, new products with compelling innovations are the best devices for generating new sales. Sales of particular products may be affected by conditions in the financial markets, such as increases or decreases in interest rates or stock prices. See "INVESTMENT CONSIDERATIONS--Industry and Competitive Factors." Product features of particular relevance to annuities include interest crediting and participation rates, surrender charges and innovation in product design. Maintenance of Keyport's strong 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 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 March 31, 1997, the Company had 1,986 full-time employees summarized by activity as follows: 366 in annuity insurance operations; 1,138 in asset management activities; 429 employees in marketing and distribution operations; and 53 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. 42 Properties As of March 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 pursuant to a lease which expires in 2002. Keyport leases approximately 76,000 square feet in a single facility in downtown Boston pursuant to a lease which expires in 2002. 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 November, 2000. Stein Roe leases 142,000 square feet in downtown Chicago pursuant to a lease which expires in 2009. Independent leases approximately 23,200 square feet in Purchase, New York under a lease which expires in 2007. Legal Proceedings On April 24, 1997, eight unitholders of Liberty High Income Plus Limited Partnership ("LHIP") filed a lawsuit seeking certification as a class action in the Superior Court for the State of California for the County of Los Angeles against LHIP, certain other limited partnerships and certain other defendants, including Liberty Securities Corporation, which is an indirect wholly-owned subsidiary of the Company, Liberty Mutual and a former subsidiary of the Company (Liberty Real Estate Corporation) sold to Liberty Mutual in 1996. Liberty Real Estate Corporation had sponsored the public offerings of LHIP and such other limited partnerships. Liberty Securities Corporation had acted as dealer manager in connection with the public offerings of LHIP and certain of the other limited partnerships. The Company itself is not named as a defendant. The plaintiffs allege, among other things, securities fraud, breach of fiduciary duties and violations of the partnership agreements governing the partnerships and seek damages in an amount to be proved at trial and various other remedies. The Company is in the early stages of evaluating this litigation's potential impact, if any, on the Company and, accordingly, cannot predict the outcome with any degree of certainty. However, based upon all of the facts presently under consideration by management, the Company does not believe that any likely outcome will have a material adverse effect on the Company's financial condition or results of operations. The Company is from time to time involved in other litigation incidental to its businesses. In the opinion of Liberty Financial's management, the resolution of such other litigation is not expected to have a material adverse effect on the Company's financial condition or results of operations. 43 MANAGEMENT Executive Officers of the Registrant The following table sets forth certain information regarding the executive officers of Liberty Financial. Name Age Position - --------------------- ---- -------------------------------------------------- Gary L. Countryman 57 Chairman and Director Kenneth R. Leibler 47 Chief Executive Officer, President and Director John A. Benning 62 Senior Vice President, General Counsel and Clerk Harold W. Cogger 61 Executive Vice President Lindsay Cook 45 Executive Vice President Stephen E. Gibson 43 President, The Colonial Group, Inc. J. Scott Hansen 43 Senior Vice President, Corporate Development J. Andy Hilbert 39 Senior Vice President and Chief Financial Officer Denis Kaplan 53 Chief Executive Officer of Independent C. Allen Merritt, Jr. 57 Executive Vice President and Treasurer Porter P. Morgan 57 Senior Vice President, Marketing John W. Rosensteel 57 President and Chief Executive Officer of Keyport Hans P. Ziegler 56 Chief Executive Officer of Stein Roe The following table sets forth certain information regarding the directors of Liberty Financial. Expiration of Name Age Term of Office - ------------------------- --- --------------- Gregory H. Adamian (2) 70 1998 Gerald E. Anderson 65 1998 Michael J. Babcock (2) 55 2000 Harold W. Cogger (1) 61 2000 Gary L. Countryman (1)(2) 57 2000 Paul J. Darling, II (2) 59 1999 David F. Figgins (3) 68 1999 John B. Gray (3) 69 1999 John P. Hamill (2) 57 2000 Marian L. Heard 56 2000 Raymond H. Hefner, Jr. 69 1999 Edmund F. Kelly (1) 51 1998 Kenneth R. Leibler (1) 47 1998 Sabino Marinella(1) 67 1998 Ray B. Mundt (2) 68 1998 Glenn P. Strehle (1)(3) 61 1998 Stephen J. Sweeney (3) 68 1999 Michael von Clemm 61 1998 - ---------------- (1) Member of the Executive Committee (2) Member of the Compensation and Stock Option Committee (3) Member of the Audit Committee Mr. Countryman has been Chief Executive Officer of Liberty Mutual and Liberty Mutual Fire Insurance Company (an affiliate of Liberty Mutual) ("Liberty Fire") 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, The First National Bank of Boston, Boston Edison Company and Harcourt General, Inc. 44 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. Cogger became an 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 an 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. Gibson joined Colonial in July, 1996 as Executive Vice President, becoming President and Chief Executive Officer in December, 1996. Prior to joining Colonial, Mr. Gibson held various senior marketing positions at Putnam Investments. 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. From October 1995 until that time, he was Senior Vice President and Chief Financial Officer of Paul Revere Corporation, a life insurance company. Prior to joining Paul Revere, Mr. Hilbert was a partner at Price Waterhouse, LLP. Mr. Kaplan has been Chief Executive Officer of Independent since 1990. Mr. Merritt became an Executive Vice President of Liberty Financial in February, 1997. From March, 1993 until that time, he was Senior Vice President of Liberty Financial. Prior to that time, he served as Senior Vice President of its subsidiary, Liberty Financial Services, Inc. Mr. Morgan has been Senior Vice President, Marketing of Liberty Financial since 1991. Mr. Rosensteel joined Keyport in 1992 as Chief Operating Officer. He was appointed President and Chief Executive Officer of Keyport effective January 1, 1993. Mr. Ziegler has been Chief Executive Officer of Stein Roe since June, 1994. Mr. Ziegler was President of Stein Roe's Investment Counsel division from July, 1993 to July, 1994. Prior to joining Stein Roe, Mr. Ziegler was President and Chief Executive Officer of the Pitcairn Trust Company. Dr. Adamian was elected to the Board of Directors in May, 1991. Dr. Adamian has been the Chancellor of Bentley College since 1991 and prior thereto, from 1970 to 1991, served as President thereof. He currently serves as a director of Liberty Mutual and Liberty Fire. Mr. Anderson was elected to the Board of Directors in May, 1991. From 1974 until his retirement in 1992, Mr. Anderson served as President, Chief Executive Officer and Trustee of Commonwealth Energy System, a public utility holding company. He currently serves as a director of Liberty Mutual and Liberty Fire. Mr. Babcock is a private investor. He was President and Chief Operating Officer of Leslie Fay Companies, Inc., an apparel manufacturer, from January, 1993 to January, 1995. He currently serves as a director of Liberty Mutual and Liberty Fire. In April 5, 1993, Leslie Fay Companies, Inc. filed for protection from creditors under Chapter 11 of the federal Bankruptcy Code. Mr. Darling was elected to the Board of Directors in May, 1991. Since 1983 Mr. Darling has served as President and Chief Executive Officer of Corey Steel Company, a manufacturer of cold finished steel bars and a metal service center. He currently serves as a director of Liberty Mutual, Liberty Fire and Unisource World Wide, Inc. Mr. Figgins was elected to the Board of Directors in May, 1991. From 1993 until his retirement in 1994, Mr. Figgins served as Chairman, and from 1991 to 1993 was President of Trafalgar House Construction, Inc., a 45 construction company. Mr. Figgins currently serves as a director of Liberty Mutual, Liberty Fire, and First Bell Bancorp, Inc. Mr. Gray was elected to the Board of Directors in May, 1991. From 1986 until his retirement in 1990, Mr. Gray served as President of Dennison Manufacturing Company, a manufacturer of self-adhesive materials and office supplies. He currently serves as a director of Liberty Mutual, Liberty Fire, EG&G Inc. and Stackpole Corporation. Mr. Hamill was elected to the Board of Directors in May, 1991. He has been President of Fleet Bank of Massachusetts, N.A. since October, 1992. Mr. Hamill currently serves as a director of Liberty Mutual and Liberty Fire. Mrs. Heard was elected to the Board of Directors in November, 1994. She has been President and Chief Executive Officer of the United Way of Massachusetts Bay since February 1992. She currently serves as a director of Liberty Mutual, and Liberty Fire and numerous national and local non-profit organizations. Mr. Hefner was elected to the Board of Directors in May, 1991. He has served as President of Bonray, Inc., an oil and gas exploration company since 1992. He currently serves as a director of Liberty Mutual, Liberty Fire, Gulf Canada Resources Limited and Liberty Bancorp, Inc. (which is not an affiliate of Liberty Financial or Liberty Mutual). Mr. Kelly was elected to the Board of Directors in May, 1992. In April, 1992 he was elected President and Chief Operating Officer of Liberty Mutual and Liberty Fire. Mr. Kelly is a director of Liberty Mutual and certain of its affiliates. Mr. Marinella has been Vice Chairman of Liberty Financial since January, 1995. From October, 1989 to December, 1994, he was Chief Executive Officer of Liberty Financial. He was elected to the Board of Directors in May, 1990. Mr. Mundt was elected to the Board of Directors in May, 1991. Since August, 1996, Mr. Mundt has been Chairman and Chief Executive Officer of Unisource World Wide, Inc., a paper supply and systems company. From 1985 until September, 1993, Mr. Mundt served as Chairman and Chief Executive Officer and, from September, 1993 until August, 1996, served as Chairman of Alco Standard Corporation, a distributor of paper packaging products and office equipment. He currently serves as a director of Liberty Mutual, Liberty Fire, Corestates Bank, Alco Standard Corporation and Nocopi International Technologies, Inc. Mr. Strehle was elected to the Board of Directors in May, 1991. Since 1975 Mr. Strehle has been Treasurer of the Massachusetts Institute of Technology and Vice President since 1986 (becoming Vice President for Finance and Treasurer in June, 1994). He currently serves as a director of Liberty Mutual, Liberty Fire, and SofTech, Inc., and a Trustee of Property Capital Trust. Mr. Sweeney was elected to the Board of Directors in May, 1991. Mr. Sweeney has held various management positions with Boston Edison Company, an electric utility company, serving as President and Chief Executive Officer from 1984 to 1986, as Chairman and Chief Executive Officer from 1987 to 1990, and as Chairman from 1990 until his retirement in 1992. Mr. Sweeney currently serves as a director of Liberty Mutual, Liberty Fire, Boston Edison Company, the Boston Stock Exchange, Uno Restaurants, Inc. and Microscript, Inc. Dr. von Clemm was elected to the Board of Directors in February, 1993. Currently Dr. von Clemm is a financier and consultant and has been the President of Templeton College, Oxford University since 1996. He was Executive Vice President of Merrill Lynch & Co. from March, 1986 until his retirement at the end of 1992. He currently serves as a director of Liberty Mutual, Liberty Fire, Mycomed AS and Eastman Chemical Company. 46 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information with respect to the beneficial ownership of Common Stock by LFC Holdings (the only person or entity known to Liberty Financial to be the beneficial owner of 5% or more of Common Stock), certain other selling shareholders, each of the five most highly compensated executive officers of Liberty Financial for 1996, each Director of Liberty Financial who owns beneficially any shares of Common Stock, and all Directors and executive officers as a group, in each case as of June 11, 1997. Except as noted in the footnotes to such table, based on information provided by such persons, each holder of Common Stock has or will have sole voting and investment power with respect to the shares of Common Stock set forth below. Unless otherwise indicated below, the address of each such person is: c/o Liberty Financial Companies, Inc., 600 Atlantic Avenue, Boston, Massachusetts 02210.
Shares Beneficially Shares to be Owned Beneficially Prior to Offering(1) Owned After Offering ------------------------ (1)(2) Number of ----------------------- Number of Shares Number of Name Shares Percent Offered Shares Percent - ------------------------------------- ------------ --------- ----------- ---------- -------- LFC Holdings, Inc. c/o Liberty Mutual 175 Berkeley Street Boston, MA 02117 .................. 23,622,131 81.2% 1,955,196 21,666,935 74.5% John A. McNeice, Jr. c/o One Financial Center 12th Floor Boston, MA 02110(3) ............... 1,118,077 3.8% 300,000 818,077 2.8% C. Herbert Emilson 236 Corn Hill Lane P.O. Box 128 North Marshfield, MA 02059(4) 208,831 * 50,000 158,831 * Sage Group Limited 11th Floor -- Sage Centre 10 Fraser Street Johannesburg 2000 South Africa ..................... 94,804 * 94,804 -- -- Kenneth R. Leibler (5) ............ 350,916 1.1% -- 350,916 1.1% Harold W. Cogger (6)(7) ............ 135,077 * -- 135,077 * John W. Rosensteel (5) ............ 67,488 * -- 67,488 * C. Allen Merritt (5) ............... 91,372 * -- 91,372 * John A. Benning (5) ............... 104,089 * -- 104,089 * Dr. Gregory H. Adamian ............ 1,000 * -- 1,000 * Gerald E. Anderson .................. 500 * -- 500 * Paul J. Darling II .................. 1,000 * -- 1,000 * John B. Gray ........................ 200 * -- 200 * Sabino Marinella (5) ............... 459,214 1.5% 100,000 359,214 1.1% Glenn P. Strehle .................. 500 * -- 500 * Stephen J. Sweeney .................. 100 * -- 100 * All executive officers and director as a group (28 persons) (7) ...... 1,479,479 4.9% 100,000 1,379,479 4.6%
- ---------------- *Less than 1% (1) Percentage calculations assume, for each person and group, that all shares which may be acquired by such person or group (i) pursuant to options presently exercisable or which become exercisable within 60 days following June 11, 1997 or (ii) upon conversion of shares of Preferred Stock are outstanding for the purpose of computing the percentage of Common Stock owned by such person or group. Percentages are calculated pursuant to Rule 13d-3 under the Exchange Act. However, those unissued shares of Common Stock described above are not deemed to be outstanding for the purpose of calculating the percentage of Common Stock owned by any other person. (2) Assumes no exercise of the Underwriters' over-allotment option. (3) Includes 155,761 shares of Common Stock issuable upon conversion of 147,515 shares of Preferred Stock held in trust under the Irrevocable Trust Agreement for Children dated September 24, 1985 (of C. Herbert 47 Emilson), 536 shares of Common Stock held in trust under the C. Herbert Emilson and Pauline V. Emilson Charitable Remainder Unitrust and 3,779 shares of Common Stock held in trust under the C. Herbert Emilson and Pauline V. Emilson Charitable Annuity Trust, as to which Mr. McNeice, as a co-trustee of each such trust, shares voting and investment power and disclaims any beneficial ownership. (4) Includes 95,692 shares of Common Stock owned of record by Pauline V. Emilson (Mr. Emilson's spouse), as to which Mr. Emilson disclaims any beneficial ownership. Also includes 536 shares of Common Stock held in trust under the C. Herbert and Pauline V. Emilson Charitable Remainder Unitrust and 3,779 shares of Common Stock held in trust under the C. Herbert Emilson and Pauline V. Emilson Charitable Annuity Trust, as to which Mrs. Emilson (as a co-trustee of each such trust) shares voting and investment power, and as to which Mr. Emilson disclaims beneficial ownership. (5) Except as indicated below, consists of options to purchase shares of Common Stock which are presently exercisable or which become exercisable within 60 days following June 11, 1997. Also includes 19,100 shares owned by Mr. Leibler, 9,800 shares owned by Mr. Rosensteel, 10,000 shares owned by Mr. Merritt, 10,585 shares owned by Mr. Benning and 24,910 shares owned by Mr. Marinella. (6) Includes options to purchase 66,300 shares all of which are fully vested and exercisable. (7) Includes 66,263 shares of Common Stock issuable upon conversion of 62,755 shares of Preferred Stock owned by Mr. Cogger. (8) Includes (without duplication), (i) the option shares referenced in notes 4 and 5 above and (ii) Mr. Cogger's shares referenced in note 7 above. Also includes options to purchase an additional 181,501 shares of Common Stock held by unnamed executive officers which are presently exercisable or which become exercisable within 60 days following June 11, 1997. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Matters Pertaining to Liberty Mutual General Prior to the acquisition of Colonial in March, 1995, Liberty Financial was an indirect wholly owned subsidiary of Liberty Mutual. Upon completion of this offering, based upon shares outstanding as of June 11, 1997, Liberty Mutual will own (indirectly through LFC Holdings, Inc.) approximately 74.5% of the outstanding shares of Common Stock and approximately 73.6% of the combined voting power of the outstanding Common Stock and Preferred Stock (approximately 73.2% and 72.4%, respectively, if the overallotment option granted to the Underwriters is exercised in full). Liberty Mutual is a Massachusetts-chartered property and casualty mutual insurance company with more than $22.7 billion in assets and $5.6 billion in surplus at December 31, 1996. The principal business activities of Liberty Mutual's subsidiaries and affiliates (other than Liberty Financial) are property-casualty insurance, insurance services and life insurance (including group life and health insurance products) marketed through its own sales force. Although at present 15 of Liberty Financial's directors are also directors of Liberty Mutual, Liberty Financial's operations are separate from, and generally have been conducted independently of, Liberty Mutual and its other business activities. Liberty Financial and its operating subsidiaries have their own personnel responsible for operations, strategic planning, marketing, finance, administration, human resources, accounting, legal and other management functions. Reimbursement of Certain Direct Costs and Intercompany Agreement Liberty Mutual from time to time has provided management, legal, internal audit and treasury services to Liberty Financial, as well as to other Liberty Mutual subsidiaries, which services are of the type normally performed by a parent company's corporate staff. In connection with the Colonial acquisition, Liberty Financial and Liberty Mutual entered into an Intercompany Agreement (the "Intercompany Agreement") governing ongoing services provided by Liberty Mutual to Liberty Financial. Under the Intercompany Agreement, such services are provided only as requested by Liberty Financial and may include legal, tax, treasury and certain other services. Liberty Financial pays Liberty Mutual a fee based upon Liberty Mutual's direct costs allocable to the services provided, 48 and reimburses Liberty Mutual for all associated out of pocket fees and expenses incurred by it. The Intercompany Agreement provides for estimated quarterly payments and subsequent adjustments thereto based upon actual experience. For 1996, 1995 and 1994, Liberty Financial paid Liberty Mutual $624,000, $864,000 and $865,000, respectively, for services under the Intercompany Agreement. The Intercompany Agreement also provides that, during any period in which Liberty Mutual owns at least 20% of the voting power of the outstanding capital stock of Liberty Financial, Liberty Financial will provide Liberty Mutual with certain financial and other information. During any period in which Liberty Mutual owns at least 50% of the voting power of the outstanding capital stock of Liberty Financial or in which Liberty Mutual is required or elects to consolidate Liberty Financial's financial results in its own financial statements, Liberty Financial must obtain Liberty Mutual's prior written consent to any significant changes in accounting principles of Liberty Financial. In addition, the Intercompany Agreement provides that the Company will indemnify Liberty Mutual, its subsidiaries (other than the Company and its subsidiaries), and each of their respective officers, directors, employees, and agents against losses from third-party claims based on, arising out of or resulting from (i) the activities of the Company or its subsidiaries (including without limitation liabilities under the Securities Act, the Exchange Act and other securities laws) and (ii) any other acts or omissions arising out of performance of the Intercompany Agreement. Tax Sharing Agreement Liberty Financial and its subsidiaries (except for Keyport and its subsidiaries, each of which filed a separate federal income tax return through 1993) have been included in the consolidated federal income tax return filed by Liberty Mutual. With respect to all periods through the date of this Prospectus (during which time Liberty Mutual owned at least 80% of the outstanding stock of Liberty Financial), Liberty Mutual, in accordance with the Code, included Liberty Financial and its subsidiaries in its consolidated federal income tax return. Prior to 1994, when Keyport and its subsidiaries became eligible for inclusion in Liberty Mutual's consolidated tax return, each of Keyport and its subsidiaries determined separately its liability for federal income taxes. Liberty Financial and Liberty Mutual have entered into a formal Tax Sharing Agreement (the "Tax Sharing Agreement"). The Tax Sharing Agreement, effective for taxable years beginning on or after January 1, 1990, provides for the allocation between Liberty Financial and Liberty Mutual, during periods when Liberty Mutual files consolidated returns, of the liability for federal income taxes and foreign, state, and local income, franchise, or excise taxes, and details the methodology and procedures for determining the payments or reimbursements to be made by or to Liberty Financial with respect to such taxes. The Tax Sharing Agreement generally provides, among other things, that Liberty Financial will pay to Liberty Mutual an amount for federal income tax purposes determined as if Liberty Financial filed a separate consolidated federal income tax return for Liberty Financial and its subsidiaries (i.e., as if Liberty Financial were the common parent of an affiliated group including its subsidiaries but not including Liberty Mutual and its other subsidiaries [in each case excluding Keyport and its subsidiaries for periods prior to 1994]), regardless of the amount of federal income tax shown on the actual consolidated federal income tax return filed by Liberty Mutual on behalf of its entire affiliated group (including Liberty Financial and its subsidiaries). The determination of the amounts to be paid by Liberty Financial pursuant to the Tax Sharing Agreement generally take into account carryovers and carrybacks of net operating losses and other attributes, again as if Liberty Financial and its subsidiaries (other than Keyport and its subsidiaries for periods prior to 1994) independently filed a consolidated federal income tax return. The Tax Sharing Agreement further provides that Liberty Financial will pay to Liberty Mutual amounts for foreign, state, or local income, franchise, or excise taxes on a basis consistent with the methodology for determining federal income tax payments, except that Liberty Financial generally will not be required to pay for a taxable year an amount that exceeds the total liability shown on the combined, joint, consolidated, or similar return actually filed on behalf of Liberty Mutual and/or any of its other subsidiaries together with Liberty Financial and/or any of its subsidiaries (with subsequent adjustments as appropriate, however, to be taken into account where tax payments have been so limited in a prior year). The Tax Sharing Agreement also provides for procedures with respect to adjustments to tax payments or reimbursements resulting from audits or other proceedings with respect to taxable years for which Liberty Financial and/or its subsidiaries have been included with Liberty Mutual and/or its other subsidiaries in any consolidated 49 federal income tax return or any combined, joint, consolidated, or similar foreign, state, or local income, franchise, or excise tax return. In addition, while the Tax Sharing Agreement generally applies to taxable years in which Liberty Financial has been or will be included in a consolidated federal income tax return filed by Liberty Mutual, it also contains provisions that may affect carryovers or carrybacks of net operating losses or other tax attributes from or to taxable years prior or subsequent to such consolidation. For 1996 and 1995, Liberty Financial paid Liberty Mutual $39.9 million and $38.7 million, respectively, pursuant to the Tax Sharing Agreement. As the common parent of an affiliated group filing a consolidated federal income tax return and under the terms of the Tax Sharing Agreement, Liberty Mutual has various rights. Among other things, it is the sole and exclusive agent for Liberty Financial in any and all matters relating to the U.S. income tax liability of Liberty Financial, it has sole and exclusive responsibility for the preparation and filing of the U.S. consolidated federal income tax return for such affiliated group, and it has the power, in its sole discretion, to contest or compromise any asserted tax adjustment or deficiency and to file, litigate, or compromise any claim for refund on behalf of Liberty Financial. Upon the consummation of this offering, if not sooner, Liberty Mutual's ownership of the outstanding capital stock of the Company will fall below 80% (the "Deconsolidation Date"), as a result of which the Company will no longer be included in the consolidated federal and certain other income tax returns filed by Liberty Mutual and the Tax Sharing Agreement will no longer be in effect except for certain provisions that may affect carryovers and carrybacks of net operating losses or other tax attributes and subsequent examination adjustments by taxing authorities. Liberty Mutual's 1997 consolidated federal income tax return will include Liberty Financial and its subsidiaries until the Deconsolidation Date. Subsequently, the Company and its subsidiaries will file consolidated federal income tax returns, exclusive of Keyport and Keyport's subsidiaries. For the remainder of 1997 and the five full tax years subsequent, Keyport and its subsidiaries will file separately from the Company, after which period Keyport and its subsidiaries can be included in the Company's consolidated federal income tax returns. Registration Rights Agreement In connection with the Colonial acquisition, Liberty Financial and Liberty Mutual entered into a Registration Rights Agreement (the "Liberty Mutual Registration Rights Agreement") which, among other things, provides that Liberty Financial will, upon Liberty Mutual's request, register under the Securities Act any of the shares of Common Stock at any time held directly or indirectly by Liberty Mutual (including, therefore, all shares held by LFC Holdings) for sale in accordance with Liberty Mutual's intended method of disposition thereof, and will take such other actions necessary to permit the sale thereof in other jurisdictions. Liberty Mutual has the right to request up to three such registrations per year, subject to certain minimum share requirements. This offering is being made upon the request of Liberty Mutual for purposes of the Liberty Mutual Registration Rights Agreement. Liberty Mutual has agreed to pay the costs and expenses in connection with each such registration of its shares. Liberty Financial has the right (exercisable not more than once in any 12-month period) to require Liberty Mutual to delay any exercise by Liberty Mutual of such rights to require registration and other actions under the agreement for a period of up to 120 days if Liberty Financial determines, and the underwriters selected by Liberty Financial concur, that any other offerings by Liberty Financial then being conducted or about to be conducted would be adversely affected, or if Liberty Financial determines that it would be required to disclose publicly material business information which would cause a material disruption of a major corporate development then pending or in progress or that such registration would have other material adverse consequences. Liberty Mutual also has the right, which it may exercise at any time and from time to time in the future, to include the shares of Common Stock held directly or indirectly by it in certain other registrations of common equity securities of Liberty Financial initiated by Liberty Financial on its own behalf. Liberty Mutual has agreed to pay its pro rata share of all costs and expenses in connection with each such registration. Liberty Financial will indemnify Liberty Mutual, and its officers, directors and controlling persons against certain liabilities arising in respect of any registration or other offering covered by the registration rights under the Liberty Mutual Registration Rights Agreement, including this offering. Certain Other Transactions Involving Liberty Mutual Immediately prior to the Colonial acquisition, Liberty Mutual and two of its affiliates loaned an aggregate of $100.0 million (collectively, the "Colonial Acquisition Loan") to Liberty Financial, the proceeds of which were used to fund the cash portion of the purchase price in the acquisition. The Colonial Acquisition Loan is evidenced 50 by notes in the aggregate principal amount of $100.0 million bearing interest at 8.5% per annum, payable semiannually. The entire principal amount of such notes is payable on the tenth anniversary of issuance. Liberty Mutual and its affiliates have the right to accelerate Liberty Financial's obligations under the Colonial Acquisition Loan if Liberty Mutual ceases, for any reason, to own a majority of the outstanding Common Stock. The Colonial Acquisition Loan is subject to a prepayment penalty in the form of a "make whole" provision. Under the "make whole" provision, the prepayment penalty would be an amount equal to the present value, as of the prepayment date, of the loss of investment income resulting from the interest rate differential on the principal amount prepaid between 8.5% and the yield to maturity, as of such date, on U.S. Government Securities maturing on the due date of the Colonial Acquisition Loan notes. In January, 1995, a wholly owned subsidiary of Liberty Financial issued a $30.0 million principal amount promissory note to LFC Holdings in the payment of a dividend. This note bears interest, payable semi-annually, at 8.0% per annum, with the entire principal amount being payable (without scheduled mandatory prepayments) on March 31, 2000. Such note may be prepaid without penalty or premium at any time. In December, 1993, an affiliate of Liberty Mutual made a loan in the principal amount of $75.0 million to Liberty Financial, the proceeds of which were used in connection with a capital contribution to Keyport. In connection with the financing for Liberty Financial's acquisition in April, 1995 of Newport Pacific Management, Inc. ("Newport Pacific"), an affiliate of Liberty Mutual loaned approximately $24.0 million to Liberty Financial. At that time, both of these loans were combined into a single note in the principal amount of $99.0 million which bears interest at 8.0% per annum. This note is due and payable on March 31, 2000, and may be prepaid, without penalty or premium, at any time. Liberty Financial has made all required interest payments on the above-described indebtedness to Liberty Mutual and its affiliates to date. Colonial is a party to a revolving credit agreement with The First National Bank of Boston and certain other lenders pursuant to which the lenders have agreed to lend up to $60.0 million to Colonial. The proceeds of the loans made under this credit agreement are used to finance the sale of shares of the mutual funds sponsored by Colonial which have contingent deferred sales charges. Liberty Mutual has guaranteed such loans. As consideration for this guarantee, Liberty Mutual receives a fee from Colonial equal to the sum of (i) a percentage of any interest rate and other savings which Colonial receives as a result of the guarantee, determined by subtracting the percentage equal to Liberty Mutual's direct or indirect equity interest from time to time in Liberty Financial, calculated on a fully diluted basis, from 100%, and (ii) 0.15% of the average outstanding borrowings under the credit agreement. The aggregate guarantee fee paid in 1996 and 1995 by Colonial to Liberty Mutual was $151,000 and $210,750, respectively. Keyport has a sales arrangement with Liberty Life Assurance Company of Boston ("Liberty Life"), a subsidiary of Liberty Mutual which is licensed to sell variable annuity contracts in the State of New York. Liberty Life issues variable annuity contracts in New York with substantially the same policy terms and underlying investment options as Keyport's variable annuity products, the premiums for which are deposited in a separate account of Liberty Life. Keyport provides administrative services to Liberty Life with respect to such annuities. All contractual obligations in respect of such annuities are those of Liberty Life rather than of Keyport. Liberty Life charges the fees payable under the annuities, pays Keyport a fee designed to cover Keyport's expenses in administering these annuities, and retains the balance. During 1996, 1995 and 1994, Liberty Life paid Keyport fees of $71,800, $60,000 and $81,000, respectively, under these arrangements. In October, 1996, the Company sold to a wholly owned subsidiary of Liberty Mutual a wholly owned subsidiary of the Company, which had provided real estate management services to certain affiliates of Liberty Mutual and certain third parties. The sales price was $2.1 million, the net book value of the transferred subsidiary. The Company provides investment management services to Liberty Mutual. Liberty Mutual paid the Company $841,000 and $63,000 for these services in 1996 and 1995, respectively. In addition, Liberty Financial provides investment advisory services to oil and gas investment subsidiaries of Liberty Mutual. These subsidiaries reimburse Liberty Financial for all direct out-of-pocket costs for these services. These cost reimbursements totaled $727,200, $599,000 and $581,000, respectively, in 1996, 1995 and 1994. As of December 31, 1996, Liberty Mutual and Liberty Mutual Fire Insurance Company, an affiliate of Liberty Mutual, owned approximately 9.4% and 1.0%, respectively, of the outstanding shares of beneficial interest of 51 Liberty ALL-STAR Equity Fund, a closed-end fund listed on the New York Stock Exchange. All of such shares were purchased in open market transactions. Liberty Asset Management Company, a Liberty Financial subsidiary, is the investment adviser to this fund. The Company provided asset management services to real estate limited partnerships for which an affiliate of Liberty Mutual serves as the general partner. An affiliate of Liberty Mutual paid the Company fees for such services which totaled approximately $6.7 million and $5.7 million in 1995 and 1994, respectively. Keyport has mortgage notes in the original principal amount of $100.0 million on properties owned by certain indirect subsidiaries of Liberty Mutual. The notes were purchased for a price equal to their face value. Liberty Mutual has agreed to provide credit support to the obligors under these notes with respect to certain payments of principal and interest thereon. As of December 31, 1996, the amount outstanding was $39.5 million. The existing and proposed agreements between Liberty Financial and Liberty Mutual may be modified in the future and additional transactions or agreements may be entered into between Liberty Financial and Liberty Mutual. Conflicts of interest could arise between Liberty Financial and Liberty Mutual with respect to any of the foregoing, or any future agreements or arrangements between them. Neither Liberty Mutual nor Liberty Financial has instituted, or has any current plans to institute, any formula plan or arrangement to address any possible conflicts of interest. Certain Other Transactions In connection with the Colonial acquisition, Liberty Financial and C. Herbert Emilson and John A. McNeice, Jr. entered into a Registration Rights Agreement with respect to Common Stock of Liberty Financial obtained by Messrs. Emilson and McNeice in the Colonial acquisition. Mr. Emilson is a Director of Liberty Financial. Mr. McNeice was a Director of Liberty Financial prior to December 31, 1996. The agreement provides that Messrs. Emilson and McNeice will have the right, which they may exercise at any time and from time to time, to include the shares of Common Stock held directly or indirectly by them in certain registrations of common equity securities of Liberty Financial initiated by Liberty Financial on its own behalf. Liberty Financial will be required to pay substantially all of the costs and expenses in connection with each such registration. Each of Liberty Financial and Messrs. Emilson and McNeice will indemnify the other, and the affiliates of the other, against certain liabilities arising in respect of any registration or other offering covered by the registration rights under such Registration Rights Agreement. Hans P. Ziegler, who is Chief Executive Officer of Stein Roe and an executive officer of Liberty Financial, obtained interest-free loans from Liberty Financial during 1995 in the aggregate principal amount of $583,411. The loans were made on a limited recourse basis, with Mr. Ziegler's repayment obligation limited to the sales proceeds to be received from certain residential real estate owned by him. The loans were secured by mortgages on this real estate. Liberty Financial extended these loans in fulfillment of a commitment made to Mr. Ziegler at the time he was hired by Stein Roe to finance his relocation and protect him on the sale of his former principal residence. In 1996, the real estate securing these loans was sold for aggregate proceeds of $353,634. This amount was credited to reduce the balance of these loans. Pursuant to such commitment, the remaining balance of $229,777 was forgiven and Liberty Financial paid a bonus in the amount of $212,111 to Mr. Ziegler in respect of his estimated tax liabilities arising from imputed interest in respect of such loans, such debt forgiveness and the payment of the bonus. DESCRIPTION OF CAPITAL STOCK Voting Rights The Restated Articles provide that the holders of shares of Common Stock have a right to vote on all matters submitted to a vote of Liberty Financial stockholders, except that no person or group other than Liberty Mutual, certain affiliates of Liberty Mutual, certain savings, profit sharing, stock bonus and employee stock ownership plans established by Liberty Financial or certain subsidiaries of Liberty Financial and other persons approved in advance by the Board of Directors of Liberty Financial shall have the right to vote more than 20% of the combined voting power of Liberty Financial's Voting Stock (as defined in the Restated Articles and below). Accordingly, assuming such 20% voting restriction does not apply, holders of a majority of the shares of Common Stock entitled to vote in any election of directors may elect all of the directors standing for election. Following the offering of Common Stock pursuant to this Prospectus, based upon shares outstanding as of June 11, 1997, Liberty Mutual (indirectly 52 through LFC Holdings, Inc.) will own approximately 74.5% of the outstanding Common Stock (73.2% if over-allotment option granted to the Underwriters is exercised in full). The provisions in the Restated Articles regarding the 20% voting restriction are designed to prevent a deemed assignment under the Advisers Act or the Investment Company Act of investment contracts that Liberty Financial's subsidiaries have with their clients. 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 25% of the voting stock of Liberty Financial "controls" Liberty Financial. The Restated Articles provide that a person or "group" (which includes affiliates and associates of a person, as defined in the Restated Articles) that owns (as defined in the Restated Articles) more than 20% of the voting shares of Liberty Financial's issued and outstanding capital stock ("Voting Stock") shall have the right to vote not more than 20% of the outstanding shares of Voting Stock entitled to vote. The remaining shares of Voting Stock owned by such person or group ("Excludable Shares") shall have no voting rights and shall not be counted for quorum or stockholder approval purposes. These provisions do not apply to Liberty Mutual, affiliates of Liberty Mutual, direct or indirect subsidiaries of Liberty Financial and certain employee plans established or to be established by Liberty Financial. The Board of Directors of Liberty Financial may approve the exemption of other persons or groups from the provisions described above. The foregoing limitation is intended to have the effect of decreasing the chance of any assignment occurring for purposes of the Advisers Act and the Investment Company Act, including in connection with future issuances on sales of Common Stock. However, no assurances can be given that such an "assignment" will not occur under these or other circumstances. See "INVESTMENT CONSIDERATIONS--Regulation." The 20% voting restriction may be viewed as having the effect of making more difficult or of discouraging, absent the support of Liberty Mutual, a proxy contest, a merger or other combination involving Liberty Financial, a tender offer, an open-market purchase program or other purchase of Common Stock that could give Liberty Financial stockholders an opportunity to realize a premium over the then-prevailing market price for their shares. However, given the fact that Liberty Mutual owns, and will continue to own following the offering contemplated in this Prospectus, more than 67% of the outstanding Voting Stock, this effect is not considered significant. Other Provisions Pertaining to a Change in Control The Restated Articles and Restated By-Laws of Liberty Financial (the "Restated By-Laws") also contain certain provisions that are intended to enhance the likelihood of continuity and stability in the composition of the Board of Directors of Liberty Financial and in the policies formulated by the Board. These provisions may serve to delay, defer or prevent a change in control of Liberty Financial if the Board of Directors determines that such a change in control is not in the Company's best interests. These provisions, which are summarized below, could have the effect of discouraging certain attempts to acquire Liberty Financial or remove incumbent management even if some or a majority of Liberty Financial's stockholders deemed such an attempt to be in their best interest. Although the Company has elected to be exempt from the statutory staggered board provisions of Massachusetts General Laws, Chapter 156B ("Chapter 156B"), [sec]50A, the Restated Articles provide that, except for Liberty Financial directors elected by holders of shares of any outstanding series of Preferred Stock having the right to elect directors, the Liberty Financial directors shall be elected on a staggered basis. This means that Liberty Financial's Board of Directors is divided into three classes whose members each serve for staggered three-year terms, with one class being elected each year. The Restated Articles and Restated By-Laws contain provisions concerning the removal of directors and the filling of vacancies. Directors may be removed only for cause (as defined in the Restated Articles) and only upon the affirmative vote of the holders of at least 67% of the outstanding shares of Voting Stock entitled to vote thereon, voting as a single class. The number of directors may be increased to a maximum of 30 or decreased to a minimum of three (but only to eliminate vacancies) by a majority of the directors. No decrease in the number of directors may reduce the term of any incumbent director. A majority of the remaining directors then in office are empowered to fill any vacancy on the Board of Directors. The Restated Articles and Restated By-Laws establish procedures with regard to the nomination of candidates for election as directors who have not been nominated by the Company's Board of Directors. In general, notice must be received by the Company not less than 60 days and no more than 90 days prior to the applicable stockholder meeting and must contain certain specified information concerning the persons to be nominated and the stockholder 53 submitting the proposal. In addition, any such nomination of candidates for election as a director must be accompanied by a petition signed by at least 100 record holders of capital stock entitled to vote in the election of the Company's directors, representing in the aggregate at least 1% of the outstanding Liberty Financial capital stock entitled to vote thereon. The Restated Articles and Restated By-Laws also establish procedures with regard to stockholder proposals for bringing business for consideration at stockholder meetings, which procedures apply to proposals that Liberty Financial stockholders are entitled to make under applicable law. In general, notice must be received by the Company not less than 60 days and no more than 90 days prior to the applicable stockholder meeting and must contain certain specified information concerning the business desired to be brought before the meeting and the stockholder submitting the proposal. The Restated By-Laws provide that a special meeting of stockholders shall be called at the request of stockholders only upon the application of the holders of shares of Voting Stock representing at least 67% of the outstanding shares of Voting Stock entitled to vote generally in the election of directors. The Board of Directors is permitted pursuant to Massachusetts law and the Restated Articles to consider special factors when evaluating proposed tender or exchange offers or certain consolidations, mergers or other fundamental transactions. These special factors may include, but are not limited to, social, legal and economic effects upon employees, suppliers, customers and others having similar relationships with Liberty Financial, the communities in which the Company conducts its business, and its future prospects. The affirmative vote of stockholders representing a majority of the combined voting power of the outstanding shares of Voting Stock, voting as a single class, is required to amend certain provisions of the Restated Articles and Restated By-Laws, including the provisions concerning the inability to vote certain shares of Voting Stock defined as Excludable Shares, the staggered term of the Board of Directors, the removal of directors, the filling of vacancies on the Board of Directors and increasing and decreasing the size of the Board of Directors, the regulation of stockholder nominations of candidates for election as directors and of stockholder proposals, and the special factors which may be considered by the Board of Directors of in evaluating tender or exchange offers or certain mergers or fundamental transactions. In addition, the Restated Articles require the affirmative vote of stockholders representing a majority of the combined voting power of the outstanding shares of Voting Stock for adoption, amendment or repeal of the Restated By-laws by the stockholders. Exculpation and Indemnification for Officers and Directors As permitted by Chapter 156B, the Restated Articles contain a provision which limits the personal liability of directors of the Company for monetary damages for breach of their fiduciary duty of care as a director. Under current Massachusetts law and the Restated Articles, liability is not eliminated for (i) any breach of the director's duty of loyalty to the Company or its stockholders, (ii) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) unlawful payment of dividends or stock purchases or redemptions pursuant to Section 61 and Section 62 of Chapter 156B, or (iv) any transaction from which the director derived an improper personal benefit. The provision does not eliminate a stockholder's right to seek non-monetary remedies, such as an injunction or rescission, which are equitable, to redress action taken by directors. However, equitable remedies may not be available in all situations, and there may be instances in which no effective equitable remedy is available. The Restated Articles provide that the Company shall, to the maximum extent permitted from time to time under Massachusetts law, indemnify any person who is or was a party or is threatened to be made a party to any threatened, pending or completed action, suit, proceeding or claim, by reason of the fact that such person is or was a director, officer, employee or other agent of the Company and any person who at the request of Liberty Financial is or was serving as a director, officer, employee or other agent of another organization, including service in any capacity with respect to employee benefit plans, against expenses (including attorneys' fees and expenses), judgments, fines, penalties and amounts paid in settlement incurred in connection with the investigation, preparation to defend or defense of such action, suit, proceeding or claim. Such indemnification is not exclusive of other indemnification rights arising under any by-law, agreement, vote of directors or stockholders or otherwise. Currently applicable Massachusetts law provides that officers and directors may receive indemnification from their corporations for actual or threatened lawsuits, except that indemnification may not be provided for any person with respect to any matter to which such person has been adjudicated not to have acted in good faith in the reasonable belief that such person's action was in the best interest of the corporation or, to the extent that such matter relates 54 to service with respect to any employee benefit plan, in the best interest of the participants or beneficiaries of such employee benefit plan. Massachusetts law further provides that a corporation may purchase indemnification insurance, such insurance providing indemnification for the officers and directors whether or not the corporation would have the power to indemnify them against such liability under the provisions of the Massachusetts law. Liberty Financial currently maintains such insurance. Certain Other Massachusetts Law Provisions The Restated By-Laws include a provision that will exclude Liberty Financial from the applicability of Chapter 110D of the Massachusetts General Laws, entitled "Regulation of Control Share Acquisitions." In general, Chapter 110D provides that any stockholder of a corporation subject to this statute who acquires 20% or more of the outstanding voting stock of a corporation may not vote such stock unless the stockholders of the corporation so authorize. The Board of Directors of Liberty Financial, by majority vote, and the stockholders by vote of stockholders representing a majority of the combined voting power of the outstanding shares of Voting Stock entitled to vote thereon, voting as a single class, may amend the Restated By-laws at any time to make the Company subject to this statute prospectively. The Restated By-Laws also include a provision that excludes Liberty Financial from the applicability of Chapter 110F of the Massachusetts General Laws, entitled "Business Combinations with Interested Shareholders." Chapter 110F prohibits Massachusetts corporations from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person becomes an interested stockholder, unless: (a) the interested stockholder obtains the approval of the board of directors prior to becoming an interested stockholder, or (b) the interested stockholder acquires 90% of the outstanding voting stock of the corporation (excluding shares held by certain affiliates of the corporation) at the time that he becomes an interested stockholder, or (c) the business combination is approved by both the board of directors and two-thirds of the outstanding voting stock of the corporation (excluding shares held by the interested stockholder). Under Chapter 110F, an "interested stockholder" is a person who, together with affiliates and associates, owns (or at any time within the prior three years did own) 5% or more of a corporation's voting stock. A "business combination" includes mergers, stock and asset sales and other transactions resulting in a financial benefit to the stockholders. Under Chapter 110F, the stockholders of the Company may, by amendment to the Restated Articles or Restated By-Laws, provide that the provisions of Chapter 110F apply to LFC. Massachusetts law explicitly permits directors to adopt stockholder rights plans (so-called "poison pills"). At present, Liberty Financial has no plans to adopt any such plan, but may do so in the future. General Provisions Regarding Common Stock and Preferred Stock; Description of Series A Convertible Preferred Stock The authorized capital stock of Liberty Financial consists of 100,000,000 shares of Common Stock, $.01 par value per share, and 10,000,000 shares of Preferred Stock, $.01 par value per share, of which 1,040,000 shares have been designated as Series A Convertible Preferred Stock. The Restated Articles and Restated By-Laws do not grant the holders of Common Stock any preemptive, subscription, redemption or conversion rights or the right to accumulate votes for the election of directors. Subject to prior dividend rights and preferences of holders of shares of Preferred Stock, if any, holders of Common Stock are entitled to receive such dividends as may be declared by the Board of Directors of Liberty Financial from funds legally available therefor. Holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors of the Company out of funds legally available therefor, subject to any preferential dividend rights of then outstanding Preferred Stock. Upon the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to receive ratably the net assets of the Company available after the payment of all debts and other liabilities and subject to the prior rights of any outstanding Preferred Stock. The rights, preferences and privileges of holders of Common Stock are subject to and may be adversely affected by, the rights of the holders of shares of any series of Preferred Stock which Liberty Financial may designate and issue in the future. Under the Restated Articles, the Board of Directors of the Company has the authority, subject to any limitations prescribed by law, without further action by or notice to the stockholders, to issue from time to time shares of Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, conversion rights, voting rights, rights and terms of redemption (including sinking fund provisions), liquidation preferences and the number of shares constituting any series or designation of such series. The ability 55 of the Board of Directors to issue additional Preferred Stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to remove current Liberty Financial management, even if such removal may be in the stockholders' best interest, and may have the effect of delaying, deterring or preventing a change in control of Liberty Financial, or of discouraging a third party from acquiring a majority of its outstanding voting stock. Other than the Preferred Stock described below issued in connection with the Company's acquisition of Colonial, there are no outstanding shares of Preferred Stock and the Company has no present plans to issue any of the Preferred Stock. Summary of Terms of Series A Convertible Preferred Stock In connection with the Colonial acquisition, the Company issued an aggregate of 328,209 shares of Series A Convertible Preferred Stock (the "Series A Preferred Stock"), of which 327,006 remain outstanding on the date hereof. The Series A Preferred Stock has the following preferences, voting powers, qualifications, and special or relative rights and privileges (the following summary is qualified in its entirety by reference to the Certificate of Designation filed by the Company with the Massachusetts Secretary of State and filed as an Exhibit to the Registration Statement of which this Prospectus is a part (the "Certificate")). Dividends. The face amount of each share of Series A Preferred Stock is $50.00. The holders of shares of the Series A Preferred Stock are entitled to receive cumulative cash dividends at the rate of $2.875 per annum per share, payable in equal quarterly installments. Such dividends shall be cumulative from the date of original issue to and including the date provision for the payment of liquidation value, or redemption price, as the case may be, plus all then accrued and unpaid dividends, has been made whether or not such dividends are declared and whether or not there are profits, surplus or other funds of Liberty Financial legally available for the payment of dividends. No dividends may be paid on the Common Stock and no Common Stock may be redeemed, repurchased, or otherwise acquired by the Company or any of its subsidiaries unless full cumulative dividends on the shares of Series A Preferred Stock have been paid or declared in full and sums set aside for the payment thereof. Redemption. The shares of the Series A Preferred Stock are redeemable at the option of Liberty Financial and at the price set forth in the Certificate by resolution of the Board of Directors, in whole or from time to time in part, at any time on or after March 27, 1998; provided, however, that prior to March 27, 2000 a condition to any such redemption shall be that the Trading Price (as defined in the Certificate) of the Common Stock shall have exceeded $59.20 (adjusted from time to time for any stock split, stock dividend, combination of shares, recapitalization or similar event pertaining to the Common Stock) for 20 Trading Days out of the 30 consecutive Trading Days immediately preceding the date notice of such Redemption is mailed by the Liberty Financial. Pursuant to a Stockholders Agreement entered into in connection with the Colonial transaction, at any time during the first sixty days after March 24, 2000, the holder of any shares of Series A Preferred Stock subject to the Stockholders Agreement may elect to sell to Liberty Mutual, and Liberty Mutual shall be obligated to purchase, all, but not less than all, of the Series A Preferred Stock then owned by such stockholder at a price of $50 per share plus accrued but unpaid dividends on such shares through the date of purchase. Liberty Mutual may designate Liberty Financial (without any further action or approval by Liberty Financial), or any other person, as the purchaser of such shares, in which event such person shall be required to pay the full purchase price. Voting Rights. Each share of Series A Preferred Stock is entitled to such number of votes as equals the number of shares of Common Stock into which such share is then convertible. Except as otherwise provided in the Certificate, or by the Restated Articles, as amended from time to time, or by law, the shares of Series A Preferred Stock, the shares of Common Stock and any other shares of Preferred Stock at the time entitled to vote generally shall vote together as one class on all matters submitted to a vote of stockholders. Liquidation Rights. In the event of any liquidation, dissolution or winding up of the affairs of the Company, whether voluntary or otherwise, after payment or provision for payment of its debts and other liabilities, the holders of shares of the Series A Preferred Stock shall be entitled to receive, in cash, out of the remaining net assets of Liberty Financial, the amount of Fifty Dollars ($50.00) for each share of the Series A Preferred Stock held, plus an amount equal to all dividends accrued and unpaid on each such share up to and including the date fixed for distribution, before any distribution shall be made to the holders of shares of the Common Stock or before the Company shall redeem, repurchase or otherwise acquire any shares of Common Stock. After the payment of the full preferential amounts to the holders of shares of the Series A Preferred Stock or funds necessary for such payment 56 have been set aside in trust for the holders thereof, such holders shall be entitled to no other or further participation in the distribution of the assets of Liberty Financial. Conversion. Holders of shares of the Series A Preferred Stock have the right, exercisable at any time and from time to time to convert all or any such shares of the Series A Preferred Stock into shares of Common Stock at a rate of 1.0559 shares of Common Stock for each share of the Series A Preferred Stock so converted, subject to anti-dilution adjustment from time to time as described in detail in Section 6 of the Certificate. Limitations. The Certificate provides that, in addition to any other rights provided by applicable law, so long as any shares of the Series A Preferred Stock are outstanding, the Company shall not, without the affirmative vote of the holders of at least two-thirds of the outstanding shares of the Series A Preferred Stock, voting separately, create, authorize or issue any class or series of capital stock ranking either as to payment of dividends or distribution of assets upon liquidation prior to or on a parity with the Series A Preferred Stock; provided, however, that no such vote of the holders of the Series A Preferred Stock shall be required if, at or prior to the time when the issuance of any such shares ranking prior to the Series A Preferred Stock is to be made or any such change is to take effect, as the case may be, provision is made for the redemption of all the then outstanding shares of the Series A Preferred Stock in accordance with the provisions of the Certificate. Transfer Agent and Registrar The transfer agent and the registrar for the Common Stock is Boston EquiServe. 57 UNDERWRITING Subject to the terms and conditions set forth in the purchase agreement (the "Purchase Agreement"), the Selling Shareholders have agreed to sell to each of the underwriters named below (the "Underwriters"), and each of the Underwriters, for whom Merrill Lynch, Pierce, Fenner & Smith Incorporated, Goldman, Sachs & Co., PaineWebber Incorporated and Fox-Pitt, Kelton Inc. are acting as representatives (the "Representatives"), severally has agreed to purchase from the Selling Shareholders, the number of shares of Common Stock set forth opposite its name below. Number of Underwriter Shares - ----------------------------------------------------- ---------- Merrill Lynch, Pierce, Fenner & Smith ...... Incorporated ........................... Goldman, Sachs & Co. ........................ PaineWebber Incorporated .................. Fox-Pitt, Kelton Inc. ..................... ---------- Total ................................. 2,500,000 ========== The Underwriters have agreed, subject to the terms and conditions set forth in the Purchase Agreement, to purchase all of the shares of Common Stock being sold pursuant to such Purchase Agreement if any of the shares of Common Stock being sold pursuant to such Purchase Agreement are purchased. Under certain circumstances, under the Purchase Agreement, the commitments of non-defaulting Underwriters may be increased. The Purchase Agreement provides that the Selling Shareholders are not obligated to sell, and the Underwriters named therein are not obligated to purchase, the shares of Common Stock under the terms of the Purchase Agreement unless all of the shares of Common Stock to be sold pursuant to the Purchase Agreement are contemporaneously sold. The Underwriters propose to offer the shares of Common Stock to the public at the initial public offering price set forth on the cover page of this Prospectus and to certain dealers at such price less a concession not in excess of $ per share. The Underwriters may allow, and such dealers may re-allow, a concession not in excess of $ per share on sales to other dealers. After the initial public offering, the public offering price and the concessions may be changed by the Representatives. LFC Holdings, Inc. has granted to the Underwriters an option exercisable for 30 days from the date of this Prospectus to purchase up to an additional 375,000 shares of Common Stock solely to cover over-allotments, if any, at the initial public offering price less the underwriting discount set forth on the cover page of this Prospectus. If the Underwriters exercise this option, each Underwriter will have a firm commitment, subject to certain conditions, to purchase approximately the same percentage thereof which the number of shares of Common Stock to be purchased by it shown in the foregoing table bears to the 2,500,000 shares of Common Stock initially offered hereby. The Company, the Selling Shareholders and certain officers and directors of the Company have agreed not to sell or otherwise dispose of any Common Stock or securities convertible into or exchangeable or exercisable for Common Stock for a period of ___ days after the date of this Prospectus, without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"). Upon the consummation of this offering, it is expected that such lock-up agreements will cover an aggregate of approximately ______ shares of Common Stock. There are no known formal or informal plans, arrangements, agreements or understandings regarding any intention to seek the consent of Merrill Lynch to release any of the foregoing restrictions at this time. It is generally the policy of Merrill Lynch to review any such requested consent on a case by case basis in light of the applicable circumstances. Until the distribution of the Common Stock is completed, rules of the Securities and Exchange Commission may limit the ability of the Underwriters and certain selling group members to bid for and purchase the Common Stock. As an exception to these rules, the Representatives are permitted to engage in certain transactions that stabilize the price of the Common Stock. Such transactions consist of bids or purchases for the purpose of pegging, fixing or maintaining the price of the Common Stock. If the Underwriters create a short position in the Common Stock in connection with the offering (i.e., if they sell more shares of Common Stock than are set forth on the cover page of this Prospectus), the Representatives may reduce that short position by purchasing Common Stock in the open market. The Representatiaves may also elect to reduce any short position through the exercise of all or part of the over-allotment options described above. 58 The Representatives may also impose a penalty bid on certain Underwriters and selling group members. This means that if the Representatives purchase shares of Common Stock in the open market to reduce the Underwriters' short position or to stabilize the price of the Common Stock, they may reclaim the amount of the selling concession from the Underwriters and selling group members who sold those shares as part of the offering. In general, purchases of a security for the purpose of stabilization or to reduce a short position could cause the price of the security to be higher than it might be in the absence of such purchases. The imposition of a penalty bid might also have an effect on the price of a security to the extent that it were to discourage resales of the security. Neither the Company nor any of the Underwriters makes any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the Common Stock. In addition, neither the Company nor any of the Underwriters makes any representation that the Representatives will engage in such transactions or that such transactions, once commenced, will not be discontinued without notice. In the Purchase Agreement, the Company and LFC Holdings, Inc. have agreed to indemnify the several Underwriters against certain civil liabilities, including liabilities under the Securities Act. LEGAL OPINIONS The validity of the Common Stock offered by this Prospectus will be passed upon for the Company and the Selling Shareholders by Choate, Hall & Stewart (a partnership including professional corporations), Boston, Massachusetts, and for the Underwriters by Brown & Wood LLP, New York, New York. EXPERTS The consolidated financial statements of Liberty Financial Companies, Inc. at December 31, 1996 and for the year then ended, appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors and at December 31, 1995 and for each of the two years in the period ended December 31, 1995, appearing in this Prospectus and Registration Statement have been audited by KPMG Peat Marwick LLP, independent auditors, as set forth in their respective reports thereon appearing elsewhere herein and are included in reliance upon such reports given upon the authority of such firms as experts in accounting and auditing. 59 LIBERTY FINANCIAL COMPANIES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Independent Auditors ......................................................... F-2 Independent Auditors' Report ............................................................ F-3 Consolidated Balance Sheets as of December 31, 1996 and 1995 ........................... F-4 Consolidated Income Statements for the years ended December 31, 1996, 1995 and 1994 ... F-5 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994 .......................................................................... F-6 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 ................................................................................... F-7 Notes to Consolidated Financial Statements ............................................. F-8 Consolidated Balance Sheets as of March 31, 1997 and 1996 (unaudited) .................. F-24 Consolidated Income Statements for the three months ended March 31, 1997 and 1996 (unaudited) ............................................................................ F-25 Consolidated Statements of Cash Flows for the three months ended March 31, 1997 and 1996 (unaudited)............................................................................. F-26 Consolidated Statements of Stockholders' Equity for the three months ended March 31, 1997 (unaudited) ............................................................................ F-27 Notes to Unaudited Consolidated Financial Statements ................................... F-28
F-1 REPORT OF INDEPENDENT AUDITORS [LOGO] Ernst & Young LLP Shareholders and Board of Directors Liberty Financial Companies, Inc. We have audited the accompanying consolidated balance sheet of Liberty Financial Companies, Inc. as of December 31, 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Liberty Financial Companies, Inc. at December 31, 1996, and the consolidated results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Boston, Massachusetts February 5, 1997 F-2 INDEPENDENT AUDITORS' REPORT The Board of Directors Liberty Financial Companies, Inc. We have audited the accompanying consolidated balance sheet of Liberty Financial Companies, Inc. as of December 31, 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the two year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Liberty Financial Companies, Inc. as of December 31, 1995, and the results of their operations and their cash flows for each of the years in the two year period ended December 31, 1995 in conformity with generally accepted accounting principles. KPMG Peat Marwick, LLP Boston, Massachusetts February 16, 1996 F-3 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED BALANCE SHEETS ($ in millions)
December 31, ----------------------- 1996 1995 --------- ---------- ASSETS: Investments ........................................................................ $11,537.9 $ 10,144.7 Cash and cash equivalents ............................................................ 875.8 875.3 Accrued investment income ............................................................ 146.8 132.9 Deferred policy acquisition costs ................................................... 250.4 179.7 Value of insurance in force ......................................................... 70.8 44.0 Deferred distribution costs ......................................................... 114.4 114.6 Intangible assets .................................................................. 205.4 192.3 Other assets ........................................................................ 134.7 106.7 Separate account assets ............................................................ 1,091.5 959.2 --------- ---------- $14,427.7 $ 12,749.4 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Policy liabilities .................................................................. $11,637.5 $ 10,084.4 Notes payable to affiliates ......................................................... 229.0 229.0 Revolving credit facility ............................................................ 52.5 61.0 Payable for investments loaned ...................................................... 211.2 317.7 Other liabilities .................................................................. 172.1 149.2 Net deferred tax liability ......................................................... 42.5 49.6 Separate account liabilities ......................................................... 1,017.7 889.1 --------- ---------- Total liabilities ............................................................... 13,362.5 11,780.0 --------- ---------- Series A redeemable convertible preferred stock, par value $.01; authorized, issued and outstanding 327,340 shares in 1996 and 327,741 shares in 1995 ........................ 13.8 13.0 --------- ---------- Stockholders' Equity: Common stock, par value $.01, authorized 100,000,000 shares, issued and outstanding 28,705,015 shares in 1996 and 27,682,536 shares in 1995 ............... 0.3 0.3 Additional paid-in capital ......................................................... 835.3 810.5 Net unrealized investment gains ...................................................... 74.4 87.1 Retained earnings .................................................................. 141.4 59.4 Unearned compensation ............................................................... -- (0.9) --------- ---------- Total stockholders' equity ...................................................... 1,051.4 956.4 --------- ---------- $14,427.7 $ 12,749.4 ========= ==========
See accompanying notes to consolidated financial statements. F-4 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED INCOME STATEMENTS (in millions, except per share data)
Year Ended December 31, ----------------------------------- 1996 1995 1994 ------- ------- ------- Investment income ....................................... $ 796.4 $ 761.8 $ 695.1 Interest credited to policyholders ..................... (572.7) (555.8) (481.9) ------- ------- ------- Investment spread ....................................... 223.7 206.0 213.2 ------- ------- ------- Net realized investment gains (losses) .................. 8.0 (4.0) (8.2) ------- ------- ------- Fee income: Investment advisory and administrative fees ............ 196.4 155.8 95.9 Distribution and service fees ........................... 44.9 28.9 -- Transfer agency fees .................................... 43.9 30.8 4.0 Surrender charges and net commissions .................. 34.7 23.4 20.0 Separate account fees ................................. 16.0 13.2 12.5 ------- ------- ------- Total fee income .................................... 335.9 252.1 132.4 ------- ------- ------- Expenses: Operating expenses .................................... (277.9) (225.1) (174.9) Amortization of deferred policy acquisition costs ...... (60.2) (58.5) (52.2) Amortization of deferred distribution costs ............ (33.9) (18.8) -- Amortization of value of insurance in force ............ (10.2) (9.5) (17.0) Amortization of intangible assets ..................... (15.4) (12.2) (5.8) Interest expense ....................................... (19.7) (16.2) (4.2) ------- ------- ------- Total expenses ....................................... (417.3) (340.3) (254.1) ------- ------- ------- Pretax income .......................................... 150.3 113.8 83.3 Income tax expense ....................................... (49.6) (39.9) (32.5) ------- ------- ------- Net income ............................................. $ 100.7 $ 73.9 $ 50.8 ======= ======= ======= Net income per share .................................... $ 3.36 $ 2.64 $ 2.15 ======= ======= =======
See accompanying notes to consolidated financial statements. F-5 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in millions)
Net Additional Unrealized Total Common Paid-In Investment Retained Treasury Unearned Stockholders' Stock Capital Gains Earnings Stock Compensation Equity ------ ---------- ---------- -------- -------- ------------ ------------- Balance, December 31, 1993 ......... $0.2 $659.8 $ 0.5 $ (21.7) $ 638.8 Adjustment to beginning balance for change in accounting principle, net of taxes ............ 41.6 41.6 Proceeds from exercise of stock options ........................... 0.1 0.1 Change in net unrealized investment gains .................. (106.6) (106.6) Net income ........................... 50.8 50.8 ---- ------ ------- ------- -------- Balance, December 31, 1994 ......... 0.2 659.9 (64.5) 29.1 624.7 Common stock issued in Colonial merger ..................... 0.1 117.3 117.4 Proceeds from exercise of stock options ........................... 0.7 0.7 Reclassification of accrued option compensation liability . 22.4 $ (2.1) 20.3 Contribution of treasury stock ...... 7.1 $(7.1) Unearned compensation ............... 1.2 1.2 Accretion to face value of preferred stock ..................... (0.6) (0.6) Common stock dividends ............... 3.1 (12.3) 7.1 (2.1) Note issued in connection with common stock dividend ............... (30.0) (30.0) Preferred stock dividends ............ (0.7) (0.7) Change in net unrealized investment gains .................. 151.6 151.6 Net income ........................... 73.9 73.9 ---- ------ ------- ------- ----- ------ -------- Balance, December 31, 1995 ......... 0.3 810.5 87.1 59.4 (0.9) 956.4 Common stock issued in Independent acquisition ............ 8.5 8.5 Proceeds from exercise of stock options ........................... 2.4 2.4 Unearned compensation ............... 0.9 0.9 Accretion to face value of preferred stock ..................... (0.9) (0.9) Common stock dividends ............... 13.9 (16.9) (3.0) Preferred stock dividends ............ (0.9) (0.9) Change in net unrealized investment gains .................. (12.7) (12.7) Net income ........................... 100.7 100.7 ---- ------ ------- ------- ----- ------ -------- Balance, December 31, 1996 ......... $0.3 $835.3 $ 74.4 $ 141.4 $ -- $ -- $1,051.4 ==== ====== ======= ======= ===== ====== ========
See accompanying notes to consolidated financial statements. F-6 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions)
Year Ended December 31, ---------------------------------------- 1996 1995 1994 --------- --------- --------- Cash flows from operating activities: Net income ................................................... $ 100.7 $ 73.9 $ 50.8 Adjustments to reconcile net income to net cash provided by operating activities: ........................... Depreciation and amortization .............................. 74.3 51.6 30.9 Interest credited to policyholders ........................ 572.7 555.8 481.9 Net realized investment (gains) losses ..................... (8.0) 4.0 8.2 Net amortization (accretion) on investments ............... (29.1) 9.7 12.2 Change in deferred policy acquisition costs ............... (24.4) (24.6) (38.8) Change in current and deferred income taxes ............... 4.9 13.3 7.7 Net change in other assets and liabilities, net of effects of acquisitions ............................................. (81.8) (59.7) (16.1) --------- --------- --------- Net cash provided by operating activities .................. 609.3 624.0 536.8 --------- --------- --------- Cash flows from investing activities: Investments purchased held to maturity ........................ -- -- (277.6) Investments purchased available for sale ..................... (4,493.2) (2,851.0) (2,625.4) Investments sold held to maturity ........................... -- 14.9 10.6 Investments sold available for sale ........................... 1,714.0 605.2 950.9 Investments matured held to maturity ........................ -- 317.8 576.0 Investments matured available for sale ........................ 1,387.7 906.5 854.4 Increase in policy loans, net ................................. (34.5) (21.0) (35.1) Decrease in mortgage loans, net .............................. 7.5 55.0 26.5 Acquisitions, net of cash acquired ........................... (41.5) (106.0) -- --------- --------- --------- Net cash used in investing activities ..................... (1,460.0) (1,078.6) (519.7) --------- --------- --------- Cash flows from financing activities: Withdrawals from policyholder accounts ........................ (1,154.1) (933.8) (1,034.5) Deposits to policyholder accounts ........................... 2,134.5 1,116.9 1,202.1 Securities lending .......................................... (119.2) 317.7 -- Borrowings from affiliates .................................... -- 124.0 -- Repayments under revolving credit ........................... (8.5) (19.5) -- Exercise of stock options .................................... 2.4 0.7 -- Dividends paid ................................................ (3.9) (2.8) -- --------- --------- --------- Net cash provided by financing activities .................. 851.2 603.2 167.6 --------- --------- --------- Increase in cash and cash equivalents ........................ 0.5 148.6 184.7 Cash and cash equivalents at beginning of year ............... 875.3 726.7 542.0 --------- --------- --------- Cash and cash equivalents at end of year ..................... $ 875.8 $ 875.3 $ 726.7 ========= ========= =========
Noncash Investing Activities: The Company made several acquisitions during 1995 using $106.0 million of cash, net of cash acquired. The fair value of assets acquired was $352.6 million; total liabilities assumed were $108.8 million. Noncash Financing Activities: Noncash financing activities relate to dividends paid to an affiliate of Liberty Mutual in the amount of $13.9 million and $10.2 million in 1996 and 1995, respectively, pursuant to the Company's dividend reinvestment plan with Liberty Mutual and, in 1995, $30.0 million in the form of an 8.0% note due in 2000. See accompanying notes to consolidated financial statements. F-7 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 indirect subsidiary of Liberty Mutual Insurance Company ("Liberty Mutual"). Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries, including Keyport Life Insurance Company ("Keyport"), Stein Roe & Farnham Incorporated ("Stein Roe"), and, from the date of acquisition: The Colonial Group, Inc. ("Colonial"), Newport Pacific Management, Inc. ("Newport") and Independent Holdings, Inc. ("Independent"). All significant intercompany balances and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year's presentation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Investments Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities." Investments in debt and equity securities classified as available for sale are carried at fair value, and after-tax unrealized gains and losses (net of adjustments to deferred policy acquisition costs and value of insurance in force) are reported as a separate component of stockholders' equity. Realized investment gains and losses are calculated on a first-in, first-out basis. On December 31, 1995, pursuant to the "Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities," the Company made a one-time reclassification of certain fixed maturity securities from held to maturity to available for sale. The amortized cost of those securities at the time of transfer was $1.4 billion, and the unrealized gain of $13.9 million was recorded net of taxes in stockholders' equity. For the mortgage-backed bond portion of the fixed maturity investment portfolio, the Company recognizes income using a constant effective yield based on anticipated prepayments over the estimated economic life of the security. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments; and any resulting adjustment is included in investment income. Mortgage loans are carried at amortized cost. Policy loans are carried at the unpaid principal balances plus accrued interest. Fee Income Fees from asset management and investment advisory services and from transfer agent, bookkeeping, distribution and service fees are recognized as revenues when services are provided. Revenues from single premium deferred annuities and single premium whole life policies include mortality charges, surrender charges, policy fees and contract fees and are recognized when earned under the respective contracts. Net commission revenue is recognized on the trade date. F-8 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued Deferred Policy Acquisition Costs Policy acquisition costs are the costs of acquiring new business which vary with, and are primarily related to, the production of new annuity business. Such costs include commissions, costs of policy issuance and underwriting and selling expenses. These costs are deferred and amortized in relation to the present value of estimated gross profits from mortality, investment and expense margins. Deferred policy acquisition costs are adjusted for amounts relating to unrealized gains and losses on fixed maturity and equity securities the Company has designated as available for sale. This adjustment, net of tax, is included with the change in net unrealized gains or losses that is credited or charged directly to stockholders' equity. Deferred policy acquisition costs were decreased by $103.7 million at December 31, 1996 and $151.4 million at December 31, 1995, respectively, relating to this adjustment. Value of Insurance in Force Value of insurance in force represents the actuarially-determined present value of projected future gross profits from policies in force at the date of their acquisition. This amount is amortized in proportion to the projected emergence of profits over periods not exceeding 15 years for annuities and 25 years for life insurance. The value of insurance in force is adjusted for amounts relating to the recognition of unrealized investment gains and losses. This adjustment, net of tax, is included with the change in net unrealized gains or losses that is credited or charged directly to stockholders' equity. Value of insurance in force was decreased by $26.0 million and $32.5 million at December 31, 1996 and 1995, respectively, relating to this adjustment. Deferred Distribution Costs Sales commissions and other direct costs related to the sale of Company-sponsored broker-distributed funds which do not charge front-end sales commissions are recorded as deferred distribution costs. Amortization is provided on a straight-line basis over periods up to six years to match the estimated period in which distribution fees will be earned. Contingent deferred sales charges (back-end loads) received are applied to deferred distribution costs to the extent of the estimated unamortized portion of such costs, with the remainder recognized as additional distribution fee income. Intangible Assets Intangible assets consist of goodwill and certain identifiable intangible assets arising from business combinations accounted for as a purchase. Amortization is provided on a straight-line basis over estimated lives of the acquired intangibles which range from 5 to 25 years. The carrying value of intangible assets is adjusted when the expected present value of future gross profits attributable to such assets is less than their carrying value. Separate Account Assets and Liabilities The assets and liabilities resulting from variable annuity and variable life policies are segregated in separate accounts. Separate account assets, which are carried at fair value, consist principally of investments in mutual funds. Investment income and changes in asset values are allocated to the policyholders, and therefore, do not affect the operating results of the Company. The Company provides administrative services and bears the mortality risk related to these contracts. Keyport also classified as separate account assets investments in Company-sponsored mutual funds of $73.8 million and $72.5 million at December 31, 1996 and 1995, respectively. Policy Liabilities Policy liabilities consist of deposits received plus interest credited, less accumulated policyholder charges, assessments, and withdrawals related to deferred annuities and single premium whole life policies. Policy benefits that are charged to expense include benefit claims incurred in the period in excess of related policy account balances. F-9 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued Stock Options The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Income Taxes The Company is included in the consolidated federal income tax return filed by Liberty Mutual. Income taxes have been provided using the liability method in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," and are calculated as if the Company filed its own consolidated income tax return. Earnings Per Share The calculation of earnings per share is based on the weighted average number of shares of common stock and common stock equivalents outstanding during each period as follows: 29.65 million in 1996, 27.70 million in 1995, and 23.63 million in 1994. Cash Equivalents Short-term investments having an original maturity of three months or less are classified as cash equivalents. Recent Accounting Pronouncement In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"). The relevant provisions of SFAS 125 relating to securities lending, dollar rolls and other similar secured transactions become effective after December 31, 1997. It is not expected that the adoption of SFAS 125 will have a material effect on the Company's consolidated financial position or results of operations. 2. Acquisitions In March 1996, the Company acquired all the outstanding common stock of Independent, a distributor of annuity and investment products through banks. In April 1996, the Company acquired all the outstanding capital stock of KJMM Investment Management Company, Inc., a registered investment advisor primarily in the wealth management business. The purchase price for these two transactions has totaled $18.7 million in cash and common stock, and the Company may be obligated to make additional cash or stock payments through approximately 2000 based upon the attainment of certain performance objectives. These acquisitions are not material to the financial condition or results of operation of the Company. In March 1995, the Company completed the acquisition of Colonial, an investment advisor, distributor and transfer agent to mutual funds. The purchase price was $264.8 million, consisting of $100.0 million in cash, 328,209 shares of redeemable convertible preferred stock and 4,677,808 shares of common stock. In April 1995 and September 1995, respectively, the Company acquired Newport and American Asset Management Company, each a registered investment advisor. The purchase price for these two transactions has totaled $27.8 million in cash. In addition, at the time of the Newport acquisition the Company made a capital contribution to Newport in the amount of $3.5 million. The Company may be obligated in each transaction to make F-10 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued contingent additional cash payments through approximately 1999 based upon the attainment of certain performance objectives. The above transactions were recorded using the purchase method of accounting and resulted in the recording of intangible assets of $190.7 million, including goodwill of $92.1 million. Each company's results of operations are included in the Company's consolidated financial statements from the dates of their acquisition. The following table discloses 1995 pro forma results of operations (in millions) for the Company had the 1995 acquisition occurred as of January 1, 1995. These pro forma results of operations are not necessarily indicative of actual results which might have occurred had the Company owned these companies since those dates.
Year Ended December 31, 1995 ----------------- Revenues .................. $ 1,044.5 Net income ............... 79.0 Net income per share ...... 2.72
In addition to the above acquisitions, in August 1996, Keyport entered into a 100 percent coinsurance agreement for a $954.0 million block of single premium deferred annuities issued by Fidelity & Guaranty Life Insurance Company ("F&G Life"). Under this transaction, the investment risk of the annuity policies was transferred to Keyport. However, F&G Life will continue to administer the policies and will remain contractually liable for the performance of all policy obligations. This transaction increased investments by $923.1 million and value of insurance in force by $30.9 million. 3. Investments Investments, all of which pertain to the Company's annuity insurance operations, were comprised of the following (in millions):
December 31, ----------------------- 1996 1995 --------- --------- Fixed maturities ............ $10,718.6 $ 9,536.0 Mortgage loans ............ 67.0 74.5 Policy loans ............... 532.8 498.3 Other invested assets ...... 183.6 10.7 Equity securities ......... 35.9 25.2 --------- --------- $11,537.9 $10,144.7 ========= =========
As of December 31, 1996, the Company did not have a material concentration of financial instruments in a single investee, industry or geographic location and no investment in any person or its affiliates (other than bonds issued by agencies of the United States government) exceeded ten percent of stockholders' equity. As of December 31, 1996, $987.0 million of fixed maturities were below investment grade. These securities represented 8.0% of the Company's total investments, including certain cash and cash equivalents. Fixed Maturities As of December 31, 1996 and 1995, the Company did not hold any investments in fixed maturities that were classified as held to maturity or as trading securities. The amortized cost, gross unrealized gains and losses and fair value of fixed maturity securities are as follows (in millions): F-11 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
December 31, 1996 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value --------- ---------- ---------- ---------- U.S. Treasury securities ..................... $ 35.3 $ 0.2 $ (0.1) $ 35.4 Mortgage backed securities of U.S. government corporations and agencies ......... 1,666.1 41.4 (8.6) 1,698.9 Obligations of states and political subdivisions 23.9 0.4 (0.1) 24.2 Debt securities issued by foreign governments 246.3 11.7 (0.5) 257.5 Corporate securities ........................... 4,093.5 153.4 (12.3) 4,234.6 Other mortgage backed securities ............... 2,413.0 47.6 (24.0) 2,436.6 Asset backed securities ........................ 1,736.0 15.5 (6.4) 1,745.1 Senior secured loans ........................... 286.3 -- -- 286.3 --------- ------ ------- --------- Total fixed maturities ..................... $10,500.4 $270.2 $ (52.0) $10,718.6 ========= ====== ======= =========
December 31, 1995 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value --------- ---------- ---------- ---------- U.S. Treasury securities ..................... $ 360.2 $ 9.0 $ (0.2) $ 369.0 Mortgage backed securities of U.S. government corporations and agencies ......... 1,585.5 58.8 (5.2) 1,639.1 Obligations of states and political subdivisions 26.7 1.3 -- 28.0 Debt securities issued by foreign governments 57.4 4.3 -- 61.7 Corporate securities ........................... 3,479.6 224.3 (7.3) 3,696.6 Other mortgage backed securities ............... 1,951.5 66.6 (71.8) 1,946.3 Asset backed securities ........................ 1,543.9 29.8 (1.5) 1,572.2 Senior secured loans ........................... 223.1 -- -- 223.1 --------- ------ ------- --------- Total fixed maturities ..................... $9,227.9 $394.1 $ (86.0) $9,536.0 ========= ====== ======= =========
At December 31, 1996, gross unrealized gains on equity securities, interest rate cap agreements and investments in separate accounts aggregated $29.9 million, and gross unrealized losses aggregated $5.3 million, respectively. At December 31, 1995, gross unrealized gains on equity securities, interest rate cap agreements and investments in separate accounts aggregated $16.9 million, and gross unrealized losses aggregated $9.3 million, respectively. Contractual Maturities The amortized cost and estimated fair value of fixed maturities by contractual maturity as of December 31, 1996 are as follows (in millions):
December 31, 1996 ------------------------ Amortized Fair Cost Value --------- --------- Due in one year or less ..................... $ 487.4 $ 489.1 Due after one year through five years ...... 1,522.4 1,559.8 Due after five years through ten years ...... 2,013.4 2,084.9 Due after ten years ........................ 662.1 704.1 --------- --------- 4,685.3 4,837.9 Mortgage and asset backed securities ......... 5,815.1 5,880.7 --------- --------- $10,500.4 $10,718.6 ========= =========
F-12 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued 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):
Year Ended December 31, ----------------------------------- 1996 1995 1994 ------- ------- ------- Fixed maturities .................................... $ 737.4 $ 682.0 $ 636.0 Policy loans ....................................... 30.2 28.5 26.3 Equity securities .................................... 4.5 4.8 2.1 Mortgage loans and other invested assets ............ 11.4 12.9 15.4 Cash and cash equivalents ........................... 36.1 41.6 20.7 ------- ------- ------- Gross investment income ........................... 819.6 769.8 700.5 Investment expenses ................................. (6.7) (5.0) (4.6) Amortization of options and interest rate caps ...... (16.5) (3.0) (0.8) ------- ------- ------- Net investment income .............................. $ 796.4 $ 761.8 $ 695.1 ======= ======= =======
There were no non-income producing fixed maturity investments as of December 31, 1996 or 1995. Net Realized Investment Gains (Losses) Net realized investment gains (losses) on the investments in the Company's annuity insurance operations are summarized as follows (in millions):
Year Ended December 31, ----------------------------------- 1996 1995 1994 ------- ------- ------- Fixed maturities held to maturity: Gross gains ......................................................... $ -- $ 1.3 $ 3.5 Gross losses ......................................................... -- (0.1) (0.8) Fixed maturities available for sale: Gross gains ......................................................... 24.3 8.2 26.0 Gross losses ......................................................... (17.8) (16.0) (26.8) Equity securities ................................................... 0.9 1.3 (0.8) Interest rate swaps ................................................... -- (0.9) -- Other ............................................................... (0.2) -- (0.8) Impairment writedowns ................................................ -- -- (11.5) ------ ------ ------ Gross realized investment gains (losses) .............................. 7.2 (6.2) (11.2) ------ ------ ------ Amortization adjustments of deferred policy acquisition costs and value of insurance in force ................................................ (1.7) 2.2 3.0 ------ ------ ------ Net realized investment gains (losses) .............................. $ 5.5 $ (4.0) $ (8.2) ====== ====== ======
Proceeds from sales of fixed maturities available for sale were $1.7 billion, $565.4 million and $927.8 million in 1996, 1995 and 1994, respectively. In addition to the net realized investment gains (losses) shown above, additional gains of $2.5 million were realized in 1996 relating to sales of general corporate securities in the Company's asset management operations. F-13 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued 4. Off Balance Sheet Financial Instruments The Company's primary objective in acquiring off balance sheet financial instruments is the management of interest rate risk. Interest rate risk results from a mismatch in the timing and amount of invested asset and policyholder liability cash flows. The Company seeks to manage this risk through various asset/liability management strategies such as the setting of renewal rates and by investment portfolio actions designed to address the interest rate sensitivity of asset cash flows in relation to liability cash flows. Portfolio actions used to manage interest rate risk primarily include managing the effective duration of portfolio securities and utilizing interest rate swaps and caps. Outstanding off balance sheet financial instruments, shown in notional amounts along with their carrying value and estimated fair values, are as follows (in millions):
Assets (Liabilities) Notional Amounts --------------------------------------------- ------------------- 1996 1995 December 31, --------------------- -------------------- ------------------- Carrying Fair Carrying Fair 1996 1995 Value Value Value Value ------- ------- -------- ------ --------- ------- Interest rate cap agreements ...... $ 450.0 $ 450.0 $ 6.2 $ 1.4 $ 8.8 $ 1.5 Interest rate swaps ............... 2,275.0 1,975.0 (8.8) (8.8) (64.1) (64.1) Indexed call options ............... -- -- 109.6 109.6 7.8 7.8
The interest rate cap agreements, which expire in 1997 through 2000, entitle the Company to receive payments from the counterparties on specified future dates, contingent on future interest rates. For each cap, the amount of such payment, if any, is determined by the excess of a market interest rate over a specified cap rate times the notional amount. The premium paid for the interest rate caps is included in other invested assets and is being amortized over the terms of the agreements and is included in net investment income. Interest rate contracts relating to investments designated as available for sale are adjusted to fair value with the resulting unrealized gains and losses included in stockholders' equity. Fair values for these contracts are based on current settlement values. The current settlement values are based on quoted market prices and brokerage quotes, which utilize pricing models or formulas using current assumptions. The Company uses indexed call options for purposes of hedging its equity-indexed products. The call options hedge the interest credited on these 1 and 5 year term products, which is based on the changes in the Standard & Poor's 500 Composite Stock Price Index ("S&P Index"). Premiums paid on the call options are amortized to interest expense over the terms of the underlying equity-indexed products using the straight line method. Gains and losses, if any, resulting from the early termination of the call options are deferred and amortized to interest credited over the remaining term of the underlying equity-indexed products. At December 31, 1996 the Company had approximately $73.1 million of unamortized premium in call option contracts. The call options' maturities range from 1997 to 2001. The Company carries its S&P Index call options at market value. Deferred losses of $7.9 million and $10.6 million as of December 31, 1996 and 1995, respectively, resulting from terminated interest rate swap agreements are included with the related fixed maturity securities to which the hedge applied and are being amortized over the life of such securities. The Company is exposed to potential credit loss in the event of nonperformance by counterparties on interest rate cap agreements and interest rate swaps. Nonperformance is not anticipated and, therefore, no collateral is held or pledged. The credit risk associated with these agreements is minimized by purchasing such agreements from investment-grade counterparties. F-14 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued 5. Indebtedness The Company has notes payable to affiliates as follows (in millions):
December 31, --------------- 1996 1995 ------ ------ 8.0% promissory note due April 3, 2000 ................................... $ 99.0 $ 99.0 8.0% promissory note due March 31, 2000 ................................... 30.0 30.0 8.5% promissory note due March 24, 2005 ................................... 100.0 100.0 ------ ------ $229.0 $229.0 ====== ======
The $100 million 8.5% promissory note becomes due and payable in the event Liberty Mutual ceases to own more than a 50% interest in the Company. The $30 million 8.0% promissory note was issued in connection with the payment of a dividend to an affiliate of Liberty Mutual. The Company has available an $80.0 million revolving credit facility (the "Facility") which is utilized to finance deferred sales commissions paid in connection with the distribution of mutual fund shares sold with no up-front sales charges. The Facility is subject to annual renewal. If not renewed, effective April 11, 1997, the Facility converts to a term loan which matures on April 11, 2002. As of December 31, 1996 and 1995, balances of $52.5 million and $61.0 million were outstanding under the Facility. Upon conversion to a term loan, minimum quarterly payments of principal equal to 5% of outstanding borrowings as of the conversion date are required. Interest accrues on the outstanding borrowings of the Facility at floating rates based upon LIBOR options plus 0.225%. The Facility contains certain covenants. The Company was in compliance with these covenants at December 31, 1996. Interest paid was $22.9 million, $19.2 million and $4.6 million in 1996, 1995 and 1994, respectively. 6. Income Taxes Income tax expense is summarized as follows (in millions):
Year Ended December 31, -------------------------- 1996 1995 1994 ------ ----- ----- Current ......................................................... $ 54.8 $39.3 $18.5 Deferred ......................................................... (5.2) 0.6 14.0 ------ ----- ----- $ 49.6 $39.9 $32.5 ====== ===== =====
A reconciliation of income tax expense with expected federal income tax expense computed at the applicable federal income tax rate of 35% is as follows (in millions):
Year Ended December 31, --------------------------- 1996 1995 1994 ------ ------ ------ Expected income tax expense ................................. $ 52.6 $ 39.9 $ 29.1 Increase (decrease) in income taxes resulting from: Nontaxable investment income .............................. (1.2) (1.7) (2.2) Change in deferred tax asset valuation allowance ......... (6.7) (8.3) 1.0 Amortization of goodwill and other intangible assets ...... 2.0 2.0 4.0 State taxes, net of federal tax benefit .................. 2.5 1.0 0.3 Stock option plan compensation ........................... 0.8 6.0 -- Other, net ................................................ (0.4) 1.0 0.3 ------ ------ ------ Income tax expense .......................................... $ 49.6 $ 39.9 $ 32.5 ====== ====== ======
F-15 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued The components of deferred federal income taxes are as follows (in millions):
December 31, --------------------- 1996 1995 ------- ------- Deferred tax assets: Policy liabilities ................................................ $ 171.3 $ 141.0 Guaranty fund expense ............................................. 6.3 7.7 Stock option plan compensation .................................... 3.8 4.9 Deferred compensation and other benefit plans ..................... 6.4 6.3 Excess of book over tax basis depreciation and amortization ...... 1.6 1.6 Deferred gain on interest rate swaps .............................. -- 0.3 Net operating loss carryforwards ................................. 27.6 26.0 Distribution fees ................................................ 14.8 10.9 Other ............................................................ 7.8 6.4 ------- ------- Total deferred tax assets ....................................... 239.6 205.1 Less: valuation allowance ....................................... (17.0) (23.7) ------- ------- Net deferred tax assets .......................................... 222.6 181.4 ------- ------- Deferred tax liabilities: Deferred policy acquisition costs ................................. (63.1) (44.5) Value of insurance in force and intangible assets ............... (20.5) (7.2) Excess of book over tax basis of investments ..................... (125.7) (130.5) Deferred loss on interest rate swaps .............................. -- (3.7) Deferred revenue ................................................ (2.0) (1.5) Amortization of deferred distribution costs ..................... (49.8) (41.9) Other ............................................................ (4.0) (1.7) ------- ------- Total deferred tax liabilities ................................. (265.1) (231.0) ------- ------- Net deferred tax liability .................................... $ (42.5) $ (49.6) ======= =======
As of December 31, 1996, the Company had net operating loss carryforwards relating to certain of the Company's non-insurance operations of $71.1 million. Utilization of these net operating losses is limited to use against future taxable profits in these non-insurance operations. As of December 31, 1996, the Company had approximately $7.6 million of purchased net operating loss carryforwards (relating to an acquisition in its insurance operations). Utilization of these net operating loss carryforwards, which expire through 2006, is limited to use against future profits in a component of the Company's insurance operations. The Company believes that it is more likely than not that it will realize the benefits of its net deferred tax asset. Income taxes paid were $45.7 million, $43.2 million and $29.4 million in 1996, 1995 and 1994, respectively. 7. Redeemable Convertible Preferred Stock The Series A Redeemable Convertible Preferred Stock (the "Preferred Stock"), with a $50 face value, has an annual cumulative cash dividend rate of $2.875 per share and is convertible into shares of Company Common Stock at a rate of 1.0559 for each share of such Preferred Stock. The Preferred Stock is redeemable at the option of the Company anytime after March 24, 1998 provided that the market value of the Company's Common Stock exceeds a specified amount. The Preferred Stock may also be put to the Company by the holders of such Preferred Stock after March 24, 2000, for a period of sixty days, at face value plus cumulative unpaid dividends. Each share of Preferred Stock is entitled to that number of votes equal the number of common shares into which it is convertible. The difference between the face value of the Preferred Stock and its fair value F-16 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued at the time of its issuance is being added to the carrying value of the Preferred Stock ratably over a five year period by a direct charge to retained earnings. 8. Retirement Plans The Company maintains a noncontributory defined benefit pension plan (the "Plan") covering its employees (except employees of Stein Roe and Colonial, who participate in separate profit sharing plans, and except employees of Independent). It is the Company's practice to fund amounts for the Plan sufficient to meet the minimum requirements of the Employee Retirement Income Security Act of 1974. Additional amounts are contributed from time to time when deemed appropriate by the Company. Under the Plan, all employees are vested after five years of service. Benefits are based on years of service, the employee's average pay for the highest five consecutive years during the last ten years of employment and the employee's estimated social security retirement benefit. The Company also has an unfunded nonqualified Supplemental Pension Plan ("Supplemental Plan"), collectively with the Plan (the "Plans"), to replace benefits lost due to limits imposed on Plan benefits under the Internal Revenue Code. Plan assets consist of investments in certain Company-sponsored mutual funds. The following table sets forth the Plans' funded status (in millions) as of December 31, 1996 and 1995.
December 31, ------------------- 1996 1995 ------ ------ Actuarial present value of benefit obligations: Vested benefit obligations .......................................... $ 16.5 $ 13.7 Accumulated benefit obligation ....................................... 1.8 1.9 ------ ------ $ 18.3 $ 15.6 ====== ====== Projected benefit obligation .......................................... $ 23.4 $ 20.7 Plan assets at fair value ............................................. (11.7) (10.2) ------ ------ Projected benefit obligation in excess of the Plans' assets ......... 11.7 10.5 Unrecognized net actuarial loss ....................................... (2.0) (2.8) Prior service cost not yet recognized in net periodic pension cost ... (3.1) (3.6) Adjustment for minimum liability .................................... -- 1.3 ------ ------ Accrued pension cost ................................................ $ 6.6 $ 5.4 ====== ======
Pension cost includes the following components (in millions):
Year Ended December 31, ----------------------------- 1996 1995 1994 ----- ----- ----- Service cost benefits earned during the period ............. $ 1.6 $ 1.3 $ 1.6 Interest cost on projected benefit obligation ............. 1.6 1.3 1.2 Actual return on Plan assets ............................... (1.3) (1.7) 0.1 Net amortization and deferred amounts ..................... 1.1 1.5 (0.1) ----- ----- ----- Total net periodic pension cost ........................... $ 3.0 $ 2.4 $ 2.8 ===== ===== =====
F-17 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued The assumptions used to develop the actuarial present value of the projected benefit obligation, and the expected long-term rate of return on plan assets are as follows:
Year Ended December 31, ----------------------------- 1996 1995 1994 ----- ----- ----- Discount rate ............................................... 7.50% 7.25% 8.25% Rate of increase in compensation level ....................... 5.25% 5.25% 5.25% Expected long-term rate of return on assets ................. 8.50% 8.50% 8.50%
The Company provides various other funded and unfunded defined contribution plans, which include savings and investment plans, supplemental savings plans, profit sharing plans, and supplemental profit sharing plans. Expenses related to these defined contribution plans totaled $7.6 million, $5.4 million and $3.8 million in 1996, 1995 and 1994, respectively. 9. Stock Option Plans The Company has two stock-based compensation plans, the 1990 Stock Option Plan (the "1990 Plan") and the 1995 Stock Incentive Plan (the "1995 Plan"). The 1990 Plan provided for grants of incentive and nonqualified stock options, which were issued from 1990 through 1994. The 1995 Plan provides for grants of incentive and nonqualified stock options, stock appreciation rights, restricted stock, unrestricted stock and performance shares, as well as cash and other awards. To date, only stock options have been granted under the 1995 Plan. A maximum of 3,145,558 shares of the Company's common stock may be issued under the 1990 and 1995 Plans. This amount does not include 607,800 nonqualified options at prices ranging from $1.00 to $31.50 that were assumed by the Company in connection with the Colonial acquisition. All options granted under the 1990 Plan were granted at a price not less than the fair market value of the Company's common stock (determined by the valuation provisions of the 1990 Plan). All options granted under the 1995 Plan have been granted at the market price of the Company's common stock on the grant date. All granted options provide for vesting in four equal annual installments, beginning one year after the date of grant, and expire 10 years after the grant date. Compensation expense associated with these plans was $0.9 million, $1.3 million and $6.9 million in 1996, 1995 and 1994, respectively. Pro forma information regarding net income and earnings per share is required by SFAS 123, which also requires that the information be determined as if the Company accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. As provided for under SFAS 123, the fair value for these options was estimated using a Black-Scholes option pricing model with the following assumptions for 1996 and 1995: risk free interest rate--6.26%; dividend yield--1.99%; expected volatility of the market price of the Company's common stock--15%; and the weighted average life of the options--6 years. For pro forma disclosure purposes, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in millions, except for earnings per share information):
1996 1995 ------ ------ Pro forma net income ................................................. $ 99.3 $ 73.6 Pro forma net income per share ...................................... 3.33 2.63
Because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1998. F-18 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued A summary of the stock option activity, and related information for the years ended December 31 follows (in thousands, except price data):
1996 1995 1994 ----------------------- ----------------------- ----------------------- Weighted- Weighted- Weighted- Average Average Average Exercise- Exercise- Exercise- Options Price Options Price Options Price ------- --------- ------- --------- ------- --------- Outstanding--beginning of year ...... 2,755 $ 14.37 2,121 $ 11.96 2,282 $ 10.24 Granted .............................. 612 33.00 481 25.75 306 22.96 Assumed .............................. -- -- 607 10.24 -- -- Exercised for shares ............... (326) (7.21) (100) (6.80) (4) (10.09) Forfeited or cashed out ............ (52) (26.92) (354) (10.66) (463) (10.30) ----- ------- ----- ------- ----- ------- Outstanding--end of year ............ 2,989 $ 18.74 2,755 $ 14.37 2,121 $ 11.96 ===== ======= ===== ======= ===== ======= Exercisable--end of year ............ 1,806 $ 12.90 1,727 $ 10.88 1,254 $ 10.19 ===== ======= ===== ======= ===== ======= Available for grant .................. 349 891 ===== ===== Weighted-average fair value of options granted during year ......... $7.97 $6.24 ===== =====
Exercise prices for options outstanding as of December 31, 1996 ranged from $1.00 to $33.00. The weighted-average remaining contractual life of these options is 6.75 years. 10. Fair Value of Financial Instruments The following discussion outlines the methodologies and assumptions used to determine the estimated fair value of the Company's financial instruments. The aggregate fair value amounts presented herein do not necessarily represent the underlying value of the Company, and accordingly, care should be exercised in deriving conclusions about the Company's business or financial condition based on the fair value information presented herein. The following methods and assumptions were used by the Company in determining estimated fair values of financial instruments: Fixed maturities and equity securities: Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturities not actively traded, the estimated fair values are determined using values from independent pricing services, or, in the case of private placements, are determined by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the securities. The estimated fair values for equity securities are based on quoted market prices. Mortgage loans: The estimated fair value of mortgage loans are determined by discounting future cash flows to the present at current market rates, using expected prepayment rates. Policy loans: The carrying value of policy loans approximates fair value. Policy liabilities: Deferred annuity contracts are assigned fair value equal to current net surrender value. Annuitized contracts are valued based on the present value of the future cash flows at current pricing rates. Other invested assets, Cash: The carrying value for assets classified as other invested assets and cash in the accompanying balance sheets approximates their fair value. F-19 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued Notes payable to affiliates, Revolving credit facility: Fair values for debt are estimated using discounted cash flow analyses based on the Company's incremental borrowing rate for similar types of borrowing arrangements. The estimated fair values and carrying values of the Company's financial instruments are as follows (in millions):
December 31, ------------------------------------------------- 1996 1995 ----------------------- --------------------- Carrying Fair Carrying Fair Value Value Value Value --------- --------- -------- -------- Assets: Fixed maturity securities ............... $10,718.6 $10,718.6 $9,536.0 $9,536.0 Equity securities ........................ 35.9 35.9 25.2 25.2 Mortgage loans ........................... 67.0 73.4 74.5 79.7 Policy loans .............................. 532.8 532.8 498.3 498.3 Other invested assets ..................... 183.6 183.6 10.7 10.7 Cash and cash equivalents ............... 875.8 875.8 875.3 875.3 Liabilities: Policy liabilities ........................ 11,637.5 11,127.4 10,084.4 9,650.1 Note payable to affiliates ............... 229.0 229.0 229.0 229.0 Revolving credit facility ............... 52.5 52.5 61.0 61.0
11. Industry Segment Information The Company's operations are classified in two business segments: annuity and asset management. Annuity operations relate principally to the issuance of fixed, indexed and variable annuity products and a closed block of investment-oriented life insurance products. Asset management includes mutual funds, wealth management, and institutional asset management. Information by industry segment for 1996, 1995 and 1994 is shown below (in millions).
Year Ended December 31, ----------------------------------- 1996 1995 1994 -------- -------- ------- Statement of Operations Data Revenues: Annuity: Unaffiliated .......................................... $ 840.8 $ 790.1 $ 719.0 Intersegment .......................................... (8.6) (7.7) (6.7) -------- -------- ------- Total annuity ....................................... 832.2 782.4 712.3 -------- -------- ------- Asset management: Unaffiliated .......................................... 299.5 219.8 100.3 Intersegment .......................................... 8.6 7.7 6.7 -------- -------- ------- Total asset management .............................. 308.1 227.5 107.0 -------- -------- ------- Total revenues ....................................... $1,140.3 $1,009.9 $ 819.3 ======== ======== ======= Income before income taxes: Annuity: Income before amortization of intangible assets ...... $ 132.6 $ 101.6 $ 91.4 Amortization of intangible assets ..................... (1.1) (1.2) (1.3) -------- -------- ------- Subtotal annuity .................................... 131.5 100.4 90.1 -------- -------- -------
F-20 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
Year Ended December 31, -------------------------------- 1996 1995 1994 ------ ------ ------ Asset management: Income before amortization of intangible assets ...... 71.5 55.4 19.3 Amortization of intangible assets ..................... (14.1) (10.8) (4.3) ------ ------ ------ Subtotal asset management ........................... 57.4 44.6 15.0 ------ ------ ------ Corporate: Income before amortization of intangible assets ...... (38.4) (31.0) (21.6) Amortization of intangible assets ..................... (0.2) (0.2) (0.2) ------ ------ ------ Subtotal corporate ................................. (38.6) (31.2) (21.8) ------ ------ ------ Total income before income taxes ..................... $150.3 $113.8 $ 83.3 ====== ====== ======
December 31, -------------------------------------------- 1996 1995 1994 ---------- ---------- ---------- Balance Sheet Data Identifiable Assets: Annuity ...................................... $ 13,924.6 $ 12,279.2 $ 10,873.6 Asset management ............................. 484.0 469.3 74.3 Corporate ................................... 22.0 17.2 28.2 Intercompany eliminations ................... (2.9) (16.3) (7.3) ---------- ---------- ---------- Total ...................................... $ 14,427.7 $ 12,749.4 $ 10,968.8 ========== ========== ==========
12. Quarterly Financial Data, in Millions, Except Per Share Amounts (unaudited)
Quarter Ended 1996 ------------------------------------------------- March June September December 31 30 30 31 ------- ------- --------- -------- Investment income ........................... $ 189.2 $ 189.8 $ 201.7 $ 215.7 Interest credited to policyholders ......... (138.1) (136.2) (146.0) (152.4) ------- ------- ------- ------- Investment spread ........................... 51.1 53.6 55.7 63.3 Net realized investment gains (losses) ...... 3.8 (1.7) 0.7 5.2 Fee income ................................. 78.6 83.7 85.9 87.7 Pretax income .............................. 36.3 34.0 36.4 43.6 Net income ................................. 23.8 23.1 24.7 29.1 Net income per share ........................ 0.81 0.77 0.82 0.96
Quarter Ended 1995 (1) ------------------------------------------------- March June September December 31 30 30 31 ------- ------- --------- -------- Investment income ........................... $ 185.2 $ 190.9 $ 191.2 $ 194.5 Interest credited to policyholders ......... (130.9) (139.2) (143.3) (142.4) ------- ------- ------- ------- Investment spread ........................... 54.3 51.7 47.9 52.1 Net realized investment gains (losses) ...... (5.7) (0.7) 1.4 1.0 Fee income ................................. 33.3 70.0 72.6 76.2 Pretax income .............................. 18.2 32.3 32.7 30.6 Net income ................................. 10.1 21.1 21.9 20.8 Net income per share ........................ 0.42 0.72 0.76 0.71
- ------------ (1) Includes the results of operations of Colonial since its acquisition date in March 1995. F-21 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued 13. Statutory Information Keyport is domiciled in Rhode Island and prepares its statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the Department of Business Regulation of the State of Rhode Island. Statutory surplus differs from shareholders' equity reported in accordance with GAAP primarily because policy acquisition costs are expensed when incurred, investment reserves and policy liabilities are based on different assumptions, and income tax expense reflects only taxes paid or currently payable. Keyport's statutory net income and surplus are as follows:
Year Ended December 31, -------------------------- 1996 1995 1994 ------ ------ ------ Statutory surplus ......... $567.7 $535.2 $546.4 Statutory net income ...... 40.2 38.3 23.4
14. Transactions with Affiliated Companies Liberty Mutual from time to time provides management, legal, audit and financial services to the Company. Reimbursements to Liberty Mutual for these services totaled $0.6 million in 1996 and $0.9 million in each of 1995 and 1994. These reimbursements are based on direct and indirect costs incurred by Liberty Mutual and are allocated to the Company primarily based upon the amount of time spent by Liberty Mutual's employees on the Company's behalf. The Company believes that this allocation methodology is reasonable. The Company provided asset management services to real estate limited partnerships for which an affiliate of Liberty Mutual served as the general partner. The affiliate paid the Company fees for such services which totaled $6.7 million and $5.7 million in 1995 and 1994, respectively. These limited partnerships were liquidated in 1995. During 1996, the Company sold to a wholly owned subsidiary of Liberty Mutual a wholly owned subsidiary which had provided real estate management services to certain affiliates of Liberty Mutual. The sales price was $2.1 million, the net book value of the transferred subsidiary. Regulatory authorities permit dividend payments from Keyport to the Company up to the lesser of (i) 10% of statutory surplus as of the preceding December 31 or (ii) the net gain from operations for the preceding fiscal year. As of December 31, 1996, Keyport could pay dividends of up to $42.5 million without the approval of the Department of Business Regulation of the State of Rhode Island. As of December 31, 1996 under its credit facility, Colonial could pay dividends of up to $44.7 million. 15. Commitments and Contingencies Leases: The Company leases data processing equipment, furniture and certain office facilities from others under operating leases expiring in various years through 2009. Rental expense (in millions) amounted to $16.0 million, $14.7 million and $10.6 million for the years ended December 31, 1996, 1995 and 1994, respectively. For each of the next five years, and in the aggregate, as of December 31, 1996, the following are the minimum future rental payments under noncancelable operating leases having remaining terms in excess of one year (in millions):
Year Payments ---- --------- 1997 ................... $13.4 1998 ................... 12.8 1999 ................... 12.7 2000 ................... 12.7 2001 ................... 13.0 Thereafter ............. 37.3
F-22 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued Legal Matters: The Company is involved at various times in litigation common to its business. In the opinion of management, the resolution of any such litigation is not expected to have a material adverse effect on the Company's financial condition or its results of operations. Regulatory Matters: Under existing guaranty fund laws in all states, insurers licensed to do business in those states can be assessed for certain obligations of insolvent insurance companies to policyholders and claimants. The actual amount of such assessments will depend upon the final outcome of rehabilitation proceedings and will be paid over several years. In 1996, 1995 and 1994, Keyport was assessed $10.0 million, $8.1 million, and $7.7 million, respectively. During 1996, 1995 and 1994, Keyport recorded $1.0 million, $2.0 million, and $7.2 million respectively, of provisions for state guaranty fund association expense. At December 31, 1996 and 1995, the reserve for such assessments was $12.9 million and $21.9 million, respectively. F-23 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED BALANCE SHEETS ($ in millions)
March 31, December 31, 1997 1996 ------------ ------------ (Unaudited) ASSETS Assets: Investments ........................................................................ $11,541.5 $11,537.9 Cash and cash equivalents ............................................................ 1,123.5 875.8 Accrued investment income ............................................................ 156.7 146.8 Deferred policy acquisition costs ................................................... 321.9 250.4 Value of insurance in force ......................................................... 85.9 70.8 Deferred distribution costs ......................................................... 113.2 114.4 Intangible assets .................................................................. 199.9 205.4 Other assets ........................................................................ 127.2 134.7 Separate account assets ............................................................ 1,088.9 1,091.5 --------- --------- $14,758.7 $14,427.7 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Policyholder balances ............................................................... $11,687.7 $11,637.5 Notes payable to affiliates ......................................................... 229.0 229.0 Payable for investments purchased and loaned ....................................... 517.5 211.2 Other liabilities .................................................................. 230.2 267.1 Separate account liabilities ......................................................... 1,037.5 1,017.7 --------- --------- Total liabilities ............................................................... 13,701.9 13,362.5 ========= ========= Series A redeemable convertible preferred stock, par value $.01; authorized, issued and outstanding 327,340 shares in 1997 and 1996 .......................................... 14.0 13.8 --------- --------- Stockholders' Equity: Common stock, par value $.01; authorized 100,000,000 shares, issued and outstanding 28,904,131 shares in 1997 and 28,705,015 shares in 1996 ............... 0.3 0.3 Additional paid-in capital ......................................................... 840.1 835.3 Net unrealized investment gains ...................................................... 30.7 74.4 Retained earnings .................................................................. 171.7 141.4 --------- --------- Total stockholders' equity ...................................................... 1,042.8 1,051.4 --------- --------- $14,758.7 $14,427.7 ========= =========
See accompanying notes to unaudited consolidated financial statements. F-24 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED INCOME STATEMENTS (Unaudited) (in millions, except share and per share data)
Three Months Ended March 31, ------------------------- 1997 1996 --------- ---------- Investment income ....................................... $ 208.0 $ 189.2 Interest credited to policyholders ..................... (147.3) (138.1) ---------- ---------- Investment spread ....................................... 60.7 51.1 ---------- ---------- Net realized investment gains ........................... 12.9 3.8 ---------- ---------- Fee income: Investment advisory and administrative fees ............ 53.1 46.4 Distribution and service fees ........................... 12.1 10.6 Transfer agency fees .................................... 11.8 10.4 Surrender charges and net commissions .................. 8.5 7.7 Separate account fees ................................. 3.9 3.5 ---------- ---------- Total fee income .................................... 89.4 78.6 ---------- ---------- Expenses: Operating expenses .................................... (75.8) (65.9) Amortization of deferred policy acquisition costs ...... (16.3) (14.1) Amortization of deferred distribution costs ............ (8.2) (6.8) Amortization of value of insurance in force ............ (3.2) (1.7) Amortization of intangible assets ..................... (3.2) (3.7) Interest expense, net ................................. (4.5) (5.0) ---------- ---------- Total expenses ....................................... (111.2) (97.2) ---------- ---------- Pretax income .......................................... 51.8 36.3 Income tax expense ....................................... (16.8) (12.5) ---------- ---------- Net income ............................................. $ 35.0 $ 23.8 ========== ========== Net income per share .................................... $ 1.14 $ 0.81 ========== ========== Common stock and common stock equivalents ............... 30,490,150 29,262,329 ========== ==========
See accompanying notes to unaudited consolidated financial statements. F-25 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in millions)
Three Months Ended March 31, --------------------- 1997 1996 -------- -------- Cash flows from operating activities: Net income .................................................................. $ 35.0 $ 23.8 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ............................................. 18.2 14.8 Interest credited to policyholders ....................................... 147.3 138.1 Net realized investment gains ............................................. (12.9) (3.8) Net amortization (accretion) on investments .............................. (8.1) 1.5 Change in deferred policy acquisition costs .............................. (0.6) (1.6) Net change in other assets and liabilities, net of effect of acquisitions (18.0) (42.7) -------- -------- Net cash provided by operating activities .............................. 160.9 130.1 -------- -------- Cash flows from investing activities: Investments purchased available for sale .................................... (717.6) (544.0) Investments sold available for sale ....................................... 45.0 92.7 Investments matured available for sale .................................... 671.1 300.6 Change in policy loans, net ................................................ (6.0) (4.2) Change in mortgage loans, net ............................................. 1.7 1.7 Acquisitions, net of cash acquired .......................................... -- (7.1) -------- -------- Net cash used in investing activities .................................... (5.8) (160.3) -------- -------- Cash flows from financing activities: Withdrawals from policyholder accounts .................................... (299.4) (252.6) Deposits to policyholder accounts .......................................... 202.3 218.9 Securities lending ......................................................... 194.9 198.0 Change in revolving credit facility ....................................... (5.5) 3.0 Exercise of stock options ................................................... 1.3 0.2 Dividends paid ............................................................ (1.0) (0.9) -------- -------- Net cash provided by financing activities .............................. 92.6 166.6 -------- -------- Increase in cash and cash equivalents ....................................... 247.7 136.4 Cash and cash equivalents at beginning of period ........................... 875.8 875.3 -------- -------- Cash and cash equivalents at end of period ................................. $1,123.5 $1,011.7 ======== ========
See accompanying notes to unaudited consolidated financial statements. F-26 LIBERTY FINANCIAL COMPANIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) (in millions)
Net Unrealized Additional Investment Total Common Paid-In Gains Retained Stockholders' Stock Capital (Losses) Earnings Equity ------ ---------- ----------- -------- ------------- Balance, December 31, 1996 ...... $0.3 $835.3 $ 74.4 $ 141.4 $ 1,051.4 Proceeds from exercise of stock options ............... 1.3 1.3 Accretion to face value of preferred stock ............ (0.2) (0.2) Common stock dividends ......... 3.5 (4.3) (0.8) Preferred stock dividends ...... (0.2) (0.2) Change in net unrealized investment gains ............... (43.7) (43.7) Net income ..................... 35.0 35.0 ---- ------ ------ ------- --------- Balance, March 31, 1997 ......... $0.3 $840.1 $ 30.7 $ 171.7 $ 1,042.8 ==== ====== ====== ======= =========
See accompanying notes to unaudited consolidated financial statements. F-27 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. General The accompanying unaudited consolidated financial statements include all adjustments, consisting of normal recurring accruals, that management considers necessary for a fair presentation of the Company's financial position and results of operations as of and for the interim periods presented. Certain footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although the Company believes the disclosures in these consolidated financial statements are adequate to present fairly the information contained herein. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in this Prospectus. The results of operations for the three months ended March 31, 1997 are not necessarily indicative of the results to be expected for the full year. Certain prior period amounts in the accompanying unaudited consolidated income statements have been reclassified to conform to the current period presentation. The principal reclassifications relate to the presentation of investment spread (the amount by which net investment income exceeds interest credited to policyholder balances) and the components of the Company's fee income. These reclassifications were made to provide additional information with respect to the Company's major sources of revenue. 2. Industry Segment Information The Company is an asset accumulation and management company which operates in two industry segments: retirement-oriented insurance (principally annuities) and asset management. The annuity insurance business is conducted at Keyport Life Insurance Company ("Keyport"). Keyport generates investment spread income from the investment portfolio which supports policyholder balances associated with its fixed and indexed annuity business and its closed block of single premium whole life insurance. The annuity insurance business also derives fee income from the administration of fixed, indexed and variable annuity contracts. The asset management business is conducted principally at The Colonial Group, Inc. ("Colonial"), an investment advisor, distributor and transfer agent to mutual funds, Stein Roe & Farnham Incorporated ("Stein Roe"), a diversified investment advisor, and Newport Pacific Management, Inc. ("Newport"), an investment advisor to mutual funds and institutional accounts specializing in Asian equity markets. The asset management business derives fee income from investment products and services. Approximately 65% of the Company's income before amortization of intangible assets, net realized investment gains and income taxes for the three months ended March 31, 1997 was attributable to the Company's annuity insurance business, with the remaining 35% attributable to the Company's asset management activities. This compares to approximately 59% and 41%, 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):
March 31, December 31, 1997 1996 --------- ------------ Fixed maturities ............ $10,683.7 $10,718.6 Mortgage loans ............ 65.3 67.0 Policy loans ............... 538.8 532.8 Other invested assets ...... 216.3 183.6 Equity securities ......... 37.4 35.9 --------- --------- Total ..................... $11,541.5 $11,537.9 ========= =========
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 F-28 LIBERTY FINANCIAL COMPANIES, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--Continued appropriate tax planning, the Company classifies its entire fixed maturities investments as "available for sale" which are carried at estimated fair value. 4. Net Income Per Share Net income per share is calculated by dividing applicable net income by the weighted average number of shares of common stock outstanding during each period, adjusted for the incremental shares attributable to common stock equivalents. Common stock equivalents consist primarily of outstanding employee stock options. In calculating net income per share, net income is reduced by convertible preferred stock dividend requirements. Such preferred stock earns cumulative dividends at the annual rate of $2.875 per share and is redeemable at the option of the Company, subject to certain conditions, anytime after March 24, 1998. At the time of issuance, the convertible preferred stock was determined not to be a common stock equivalent. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), which is required to be adopted for periods ending after December 15, 1997. SFAS 128 replaces primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed similarly to fully diluted earnings per share. Assuming that SFAS 128 had been implemented, basic earnings per share would have been $1.21 and $0.85 for the first quarters of 1997 and 1996, respectively. The calculation of diluted earnings per share under SFAS 128 for these quarters would not materially differ from the calculation of fully diluted earnings per share. F-29 ================================================================================ - -------------------------------------------------------------------------------- No dealer, salesperson or any other person has been authorized to give any information or to make any representations other than those contained in this Prospectus in connection with the offering covered by this Prospectus. If given or made, such information or representations must not be relied upon as having been authorized by the Company, the Selling Shareholders or the Underwriters. This Prospectus does not constitute an offer to sell, or the solicitation of an offer to buy, the Common Stock in any jurisdiction where, or to any person to whom, it is unlawful to make such offer or solicitation. Neither the delivery of the Prospectus nor any sale made hereunder or thereunder shall, under any circumstances, create an implication that there has not been any change in the facts set forth in this Prospectus or in the affairs of the Company since the date hereof. ------------------------------ TABLE OF CONTENTS Page ------ Available Information ................................................ 3 Incorporation of Certain Documents by Reference ....................................................... 3 Prospectus Summary ................................................... 4 Investment Considerations ............................................ 8 Price Range of Common Stock and Dividends ...................................................... 14 Selected Historical Consolidated Financial and Operating Data ...................................... 15 Management's Discussion and Analysis of Results of Operations and Financial Condition ............................................ 17 Business ............................................................. 27 Management ........................................................... 44 Principal and Selling Stockholders ................................... 47 Certain Relationships and Related Transactions ...................................................... 48 Description of the Capital Stock ..................................... 52 Underwriting ......................................................... 58 Legal Opinions ....................................................... 59 Experts .............................................................. 59 Index to Consolidated Financial Statements ........................... F-1 2,500,000 Shares [Liberty Financial Logo] Liberty Financial Companies, Inc. Common Stock -------------------------------------- P R O S P E C T U S -------------------------------------- Merrill Lynch & Co. Goldman, Sachs & Co. PaineWebber Incorporated Fox-Pitt, Kelton Inc. June , 1997 ================================================================================ - -------------------------------------------------------------------------------- PART II Item 14. Other Expenses of Issuance and Distribution. Expenses payable in connection with the sale of the Common Stock offered hereby, all of which will be paid by the Liberty Mutual, are as follows: SEC Registration Fee .................................... $ 43,125 Blue sky fees and expenses (including legal fees) ...... 5,000 Legal fees and expenses .............................. 150,000 NASD filing fee ....................................... 14,732 Accounting fees and expenses ........................... 100,000 Printing and engraving expenses ........................ 100,000 Miscellaneous .......................................... 12,143 --------- Total Expenses ....................................... $425,000 ========= - ---------------- * Estimated Item 15. Indemnification of Directors and Officers. Section 67 of Chapter 156B of the Massachusetts General Laws provides that a corporation may indemnify its directors and officers to the extent specified in or authorized by (i) the articles of organization, (ii) a by-law adopted by the stockholders, or (iii) a vote adopted by the holders of a majority of the shares of stock entitled to vote on the election of director. In all instances, the extent to which a corporation provides indemnification to its directors and officers under Section 67 is optional. In its Restated Articles of Organization, the Registrant has elected to commit to provide indemnification to its directors and officers in specified circumstances. Generally, the Restated Articles of Organization provide that the Registrant shall indemnify directors and officers of Registrant against liabilities and expenses arising out of legal proceedings brought against them by reason of their status as directors or officers or by reason of their agreeing to serve, at the request of the Registrant, as a director or officer with another organization. Under this provision, a director or officer of the Registrant shall be indemnified by the Registrant for all costs and expenses (including attorneys' fees), judgments, liabilities and amounts paid in settlement of such proceedings, even if he is not successful on the merits, if he acted in good faith in the reasonable belief that his action was in the best interest of the Registrant. The Board of Directors may authorize advancing litigation expenses to a director or officer at his request upon receipt of an undertaking by any such director or officer to repay such expenses if it is ultimately determined that he is not entitled to indemnification for such expense. Article 6 of the Registrant's Restated Articles of Organization eliminates the personal liability of the Registrant's directors to the Registrant or its stockholders for monetary damages for breach of a director's fiduciary duty, except to the extent that Chapter 156B of the Massachusetts General Laws prohibits the elimination or limitation of such liability. Section of the Purchase Agreement provides that the Underwriters are obligated, under certain circumstances, to indemnify the Registrant and the Selling Shareholders, and their directors, officers and controlling persons against certain liabilities, including liabilities under the Securities Act. Reference is made to the form of Purchase Agreement filed as Exhibit 1.1 hereto. Each of the Registrant and Liberty Mutual has agreed to indemnify the other, and the officers, directors and controlling persons of the other, against certain liabilities arising in respect of a registration covered by a registration rights agreement between the parties. In addition, pursuant to an Intercompany Agreement (the "Intercompany Agreement") between the Registrant and Liberty Mutual, the Registrant will indemnify Liberty Mutual, its subsidiaries (other than the Registrant and its subsidiaries), and each of their respective officers, directors, employees, and agents, against losses from third-party claims based on, arising out of or resulting from (i) the activities of the Registrant or its subsidiaries (including without limitation liabilities under the Securities Act, the Exchange Act and other securities laws) and (ii) any other acts or omissions arising out of performance of the Intercompany Agreement. II-1 The Registrant maintains directors' and officers' liability insurance for the benefit of its directors and certain of its officers. Item 16. Exhibits. See Index to Exhibits immediately preceding the Exhibits included as part of this Registration Statement. Item 17. Undertakings. The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement; Provided, however, that paragraphs (1)(i) and (1)(ii) do not apply if the Registration Statement is on Form S-3, Form S-8 or Form F-3, and the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed with or furnished to the Commission by the registrant pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the Registration Statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report pursuant to section 13(a) or section 15(d) of the Securities Exchange Act of 1934 that is incorporated by reference in the Registration Statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described under Item 15 above, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. II-2 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-3 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Boston in The Commonwealth of Massachusetts on June 13, 1997. LIBERTY FINANCIAL COMPANIES, INC. By: /s/ Kenneth R. Leibler ------------------------------ Kenneth R. Leibler Chief Executive Officer, President and Director POWER OF ATTORNEY AND SIGNATURES We, the undersigned officers and directors of Liberty Financial Companies, Inc., hereby severally constitute and appoint Kenneth R. Leibler, John A. Benning and C. Allen Merritt, Jr., and each of them singly, our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below, all pre-effective and post-effective amendments to this Registration Statement, and generally to do all things in our names and on our behalf in such capacities to enable Liberty Financial Companies, Inc. to comply with the provisions of the Securities Act of 1933, as amended, and all requirements of the Securities and Exchange Commission. Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and as of the dates indicated. Signature Title Date - -------------------------- ---------------------------------- -------------- /s/ Kenneth R. Leibler Chief Executive Officer, President June 13, 1997 - -------------------------- and Director Kenneth R. Leibler /s/ C. Allen Merritt, Jr. Executive Vice President and June 13, 1997 - -------------------------- Treasurer C. Allen Merritt, Jr. /s/ J. Andrew Hilbert Senior Vice President and Chief June 13, 1997 - -------------------------- Financial Officer J. Andrew Hilbert /s/ Gary L. Countryman Chairman and Director June 13, 1997 - -------------------------- Gary L. Countryman /s/ Gregory H. Adamian Director June 13, 1997 - -------------------------- Gregory H. Adamian /s/ Gerald E. Anderson Director June 13, 1997 - -------------------------- Gerald E. Anderson /s/ Michael J. Babcock Director June 13, 1997 - -------------------------- Michael J. Babcock /s/ Harold W. Cogger Director June 13, 1997 - -------------------------- Harold W. Cogger II-3 Signature Title Date - --------------------------- ---------- -------------- /s/ Paul J. Darling, II Director June 13, 1997 - --------------------------- Paul J. Darling, II /s/ David F. Figgins Director June 13, 1997 - --------------------------- David F. Figgins /s/ John B. Gray Director June 13, 1997 - --------------------------- John B. Gray /s/ John P. Hamill Director June 13, 1997 - --------------------------- John P. Hamill /s/ Marian L. Heard Director June 13, 1997 - --------------------------- Marian L. Heard /s/ Raymond H. Hefner, Jr. Director June 13, 1997 - --------------------------- Raymond H. Hefner, Jr. /s/ Edmund F. Kelly Director June 13, 1997 - --------------------------- Edmund F. Kelly /s/ Sabino Marinella Director June 13, 1997 - --------------------------- Sabino Marinella /s/ Ray B. Mundt Director June 13, 1997 - --------------------------- Ray B. Mundt /s/ Glenn P. Strehle Director June 13, 1997 - --------------------------- Glenn P. Strehle /s/ Stephen J. Sweeney Director June 13, 1997 - --------------------------- Stephen J. Sweeney /s/ Michael von Clemm Director June 13, 1997 - --------------------------- Michael von Clemm II-4 Exhibit Index
Exhibit Number Description - ------------ --------------------------------------------------------------------------------- 1.1 * Form of Purchase Agreement 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 (2) 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 5.1 * Opinion of Choate, Hall & Stewart with respect to the legality of the securities of the Company being registered 10.1 (1) Form of Intercompany Agreement between Liberty Mutual and the Company 10.2 (3) Form of Registration Rights Agreement between Liberty Mutual and the Company 10.3 (3) 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 (4) 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 (4) Amendment No. 1 to Pension Plan 10.9 (1) Form of Amended and Restated Supplemental Pension Plan of the Company 10.10 Form of Amended and Restated 1995 Stock Incentive Plan of the Company 10.11 (3) 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 (2) 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 (2) 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 (3) 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
II-5
Exhibit Number Description - ------------ --------------------------------------------------------------------------- 10.24 (1) Form of Promissory Note dated January 29, 1995 of SteinRoe Services, Inc. in the principal amount of $30.0 million 10.25 (3) Form of Registration Rights Agreement among John A. McNeice, Jr., C. Herbert Emilson and the Company 10.26 (3) Form of Employment Agreement among the Company, Colonial and Harold W. Cogger 10.27 (3) 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) 10.27.1(4) Amendment No. 3 to Credit Agreement 10.27.2(2) Amendment No. 4 to Credit Agreement 10.28 (4) Colonial Profit Sharing Plan (and Amendment Nos. 1-3 thereto) 10.29 (4) Colonial Split-Dollar Insurance Coverage description 10.30 (2) Coinsurance Agreement between Fidelity and Guaranty Life Insurance Company and Keyport Life Insurance Company, and first and second amendments thereto 21(2) Subsidiaries of the Company 23.1 Consent of Ernst & Young LLP 23.2 Consent of KPMG Peat Marwick LLP 23.3 * Consent of Choate, Hall & Stewart (included in Exhibit 5.1) 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
- ------------ * To be filed by amendment. (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 1996 Annual Report on Form 10-K filed March 28, 1997. (3) Incorporated by reference to the same Exhibit Number in the Company's 1994 Annual Report on Form 10-K filed March 30, 1995. (4) Incorporated by reference to the same Exhibit Number in the Company's 1995 Annual Report on Form 10-K filed March 29, 1996. II-6 EX-10.10 2 1995 STOCK INCENTIVE PLAN Exhibit 10.10 LIBERTY FINANCIAL COMPANIES, INC. AMENDED AND RESTATED 1995 STOCK INCENTIVE PLAN -------------- 1. Purpose. The purpose of the Liberty Financial Companies, Inc. 1995 Stock Incentive Plan (the "Plan") is to advance the interests of Liberty Financial Companies, Inc. (the "Company"), and its present and future Affiliates by strengthening the ability of the Company and its Affiliates to attract, retain and motivate key employees, directors, and consultants to the Company by providing incentives, opportunities and favorable terms for them to acquire stock of the Company and to receive other Awards. The Plan shall be administered by the Board of Directors of the Company (the "Board") and the Compensation and Stock Option Committee of the Board, or another committee or persons designated by the Board, as provided in Section 15 (the "Committee"). 2. Participation. The Committee shall have exclusive power (except as may be delegated by the Committee as provided in Section 15 herein) to select the key employees, directors and other individuals performing services for the Company and its Affiliates who shall be eligible individuals who may participate in the Plan and be granted Awards under the Plan. Eligible individuals may be selected individually or by groups or categories, as determined by the Committee in its discretion. As used herein the term "Participant" means each eligible individual to whom an Award has been made under any provision of the Plan. 3. Awards Under the Plan. 3.1. Types of Awards. Awards under the Plan ("Awards") may include, but need not be limited to, one or more of the following types, either alone or in any combination thereof: (i) "Stock Options"; (ii) "Stock Appreciation Rights"; (iii) "Restricted Stock"; (iv) "Unrestricted Stock"; (v) "Performance Shares"; (vi) "Loans"; (vii) "Supplemental Cash Grants"; and (viii) any other type of Award deemed by the Board in its discretion to be consistent with the purposes of the Plan. Stock Options, which include "Nonqualified Stock Options" and "Incentive Stock Options" or combinations thereof, are rights to purchase common stock, $0.01 par value, of the Company ("Shares" or "Stock"). Nonqualified Stock Options and Incentive Stock Options are subject to the terms, conditions and restrictions specified in Section 4. Stock Appreciation Rights are rights to receive (without payment to the Company) cash, Shares, other securities of the Company (which may include, without limitation, preferred stock, debentures, warrants, securities convertible into common stock or other property, and any other securities including those of the Company or an Affiliate, or any combination thereof ("Other Securities")), or other forms of payment, or any combination thereof, as determined by the Committee, based on the increase in the value of the number of Shares specified in the Stock Appreciation Right. Stock Appreciation Rights are subject to the terms, conditions and restrictions specified in Section 5. Restricted Stock are Shares which are issued subject to terms, conditions and restrictions specified in Section 6. Unrestricted Stock are Shares issued without restrictions as described in Section 6. Performance Shares are contingent awards, subject to the terms, conditions and restrictions described in Section 7, under which the Participant may become entitled to receive cash, Shares, Other Securities, or other forms of payment, or any combination thereof, as determined by the Committee. Loans and Supplemental Cash Grants are other Awards which may be made subject to the terms described in Section 8. 3.2. Maximum Number of Shares That May be Issued. (a) There may be issued under the Plan any and all shares as shall be issuable under Stock Options issued and outstanding as of May 12, 1997 (the date prior to the Company's 1997 Annual Stockholders' Meeting, at which certain amendments to the Plan were approved) in accordance with the respective 1 terms of such Stock Options (including, without limitation, any adjustments pursuant to Section 13). In addition, from and after May 13, 1997, there may be issued under the Plan (as Restricted Stock or Unrestricted Stock, in payment of Performance Shares, pursuant to the exercise of Stock Options or Stock Appreciation Rights, or in payment of or pursuant to the exercise of other Awards) in any calendar year ("Award Year") Awards providing for the issuance of an amount of Shares not exceeding two percent (2.0%) of the total number of Shares outstanding as of the December 31 next preceding the applicable Award Year. At any time during an Award Year such two percent (2.0%) limit shall be calculated (i) first, after giving effect to the issuance of Awards during such Award Year and (ii) second, after taking into account whether any Awards previously issued during such Award Year shall have been forfeited or otherwise shall have expired or terminated, in whole or in part, without having been exercised or paid in Shares. (b) In addition, there shall be available for Awards under the Plan in any Award Year, in addition to Shares available for grant during such Award Year pursuant to paragraph (a) above, (i) shares in respect of Awards granted from and after May 13, 1997 which shall have been canceled, forfeited, terminated or which expire unexercised (with the exceptions of the termination of a Stock Appreciation Right granted in tandem with a Stock Option upon the exercise of the related Stock Option, and the termination of a related Stock Option upon the exercise of such a corresponding Stock Appreciation Right) and (ii) the excess amount of variable Awards granted from and after May 13, 1997 which become fixed at less than their maximum limitations. In each case the amounts provided by this paragraph (b) shall be subject to adjustment as provided in Section 13. (c) For purposes of the foregoing provisions of this Section 3.2, (i) at any time during an Award Year, Shares subject to an Award first shall be charged against the limitation created by paragraph (a) above until such limitation for such Award Year shall have been exhausted and thereafter shall be charged against the amount available under paragraph (b) above, (ii) the grant of a Performance Share shall be deemed to be equal to the maximum number of Shares which may be issued upon payment of the Performance Share and (iii) where the value of an Award is variable on the date it is granted, the value shall be deemed to be the maximum limitation of the Award. Awards payable solely in cash shall be excluded in calculating the limitations established above in this Section 3.2. (d) Notwithstanding the foregoing provisions of this Section 3.2, the maximum number of Shares that may be issued under Incentive Stock Options awarded under the Plan from and after May 13, 1997, subject to adjustment in accordance with Section 13, shall be 10,000,000 Shares. (e) In addition, without regard to the foregoing limit, the Company may issue Awards under the Plan in connection with the acquisition of other entities or businesses in replacement of awards held by employees or other persons associated with the acquired entity or business. Such replacement Awards shall be subject to adjustment as provided in Section 13. (f) Shares issued pursuant to the Plan may be either authorized but unissued Shares, treasury Shares, reacquired Shares, or any combination thereof. 3.3. Rights With Respect to Shares and Other Securities. (a) Unless otherwise determined by the Committee in its discretion, a Participant to whom an Award of Restricted Stock has been made (and any person succeeding to such a Participant's rights pursuant to the Plan) shall have, after issuance of a certificate for the number of Shares awarded (or after such Shares otherwise shall actually have been issued to or for the account of the Participant) and prior to the expiration of the Restricted Period (as defined in Section 6) or the earlier forfeiture of such Shares as herein provided, ownership of such Shares, including the right to vote the same and to receive dividends (including Shares issued upon reinvestment of cash dividends) or other distributions made or paid with respect to such Shares (provided that such Shares of Restricted Stock, and any new, additional or different Shares, or Other Securities, or other forms of consideration which the Participant may be entitled to receive with respect to such Shares of Restricted Stock as a result of a stock split, stock dividend or any other change in the capital structure of the Company, shall be subject to the restrictions hereinafter described as determined by the Committee in its discretion), subject, however, to the options, restrictions and limitations imposed thereon pursuant to the Plan. 2 Notwithstanding the foregoing, a Participant with whom any agreement is made to issue Shares or Other Securities in the future shall have no rights as a shareholder with respect to Shares or Other Securities related to such agreement until issuance of a certificate to the Participant (or until such Shares or such Other Securities otherwise shall actually have been issued to or for the account of the Participant). (b) Unless otherwise determined by the Committee in its discretion, a Participant to whom a grant of Stock Options, Stock Appreciation Rights, Performance Shares or any other Award is made (and any person succeeding to such a Participant's rights pursuant to the Plan) shall have no rights as a shareholder with respect to any Shares or as a holder with respect to Other Securities, if any, issuable pursuant to any such Award until the date of the issuance of a certificate to the Participant for such Shares or such Other Securities (or until such Shares or such Other Securities otherwise shall actually have been issued to or for the account of the Participant). Except as provided in Section 13, no adjustment shall be made for dividends, distributions or other rights for which the record date is prior to the date such certificate is issued (or such other issuance shall have occurred). 3.4. Definitions of Certain Terms. Whenever the "Fair Market Value" of Shares or Other Securities or any other property must be determined pursuant to any provisions of the Plan, "Fair Market Value" shall be the amount determined by the Committee as follows: (i) if the Shares or Other Securities or other property are then traded on a securities exchange, the closing sale price on the principal market on which the Shares or Other Securities or other property are traded on the date in question (or if such price is not available on such date, on the business day closest to such date for which such price is available); or (ii) if the Shares or Other Securities or other property are then traded in the over-the-counter market, the mean between the closing bid and asked price of the Shares or Other Securities or other property on the date in question (or if such prices are not available on such date, on the business day closest to such date for which such prices are available), as such price is reported in a publication of general circulation selected by the Committee; or (iii) if the Shares or Other Securities or other property are not then actively traded on an exchange or in the over-the-counter market, the amount determined in good faith by the Committee. As used herein, a "parent corporation" is any corporation which is the owner of at least 50% of the total combined voting power of all classes of stock of the Company, and a "subsidiary corporation" is any corporation of which the Company is the owner of at least 50% of the total combined voting power of all classes of stock of such corporation. "Affiliate" means any entity in which the Company or any parent or subsidiary corporation has a substantial direct or indirect equity interest. An "eligible individual" shall be deemed to refer to any person eligible to receive an Award under the Plan and shall include (i) key employees, (ii) non-employee directors, and (iii) individuals performing services as non- employee independent contractors. "Section 162(m) employee" means a Participant who is one of the group of "covered employees," as defined in regulations promulgated under Section 162(m) of the Code. For purposes of this Plan, a Participant shall be deemed to have terminated his employment or performance of services for the Company and its Affiliates by reason of "Disability" if the Participant has incurred total and permanent disability as determined under the provisions of a Company or subsidiary corporation long-term disability program which is applicable to the Participant. "Cause" means a felony conviction of a Participant or the failure of a Participant to contest prosecution for a felony, or a Participant's misconduct or dishonesty, any of which is directly and materially harmful to the business or reputation of the Company or any Affiliate. "Retirement" means the Participant's retirement from active employment with the Company or an Affiliate (or ceasing to provide services as an independent contractor) within or after the calendar year the Participant attains age sixty (60). 3 4. Stock Options. The Committee may grant Stock Options either alone, or in conjunction with Stock Appreciation Rights or other Awards, either at the time of grant or by amendment thereafter, provided that an Incentive Stock Option may be granted only to an eligible individual who is an employee of the Company or its parent or subsidiary corporation. Incentive Stock Options are Stock Options which are intended to meet the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). Each Stock Option granted under the Plan shall be evidenced by an instrument ("Option Agreement") in such form as the Committee shall prescribe from time to time in accordance with the Plan which shall comply with the terms and conditions specified in this Section 4 and with such other terms and conditions, including, but not limited to, restrictions upon the Stock Option or the Shares issuable upon exercise thereof, as the Committee, in its discretion, shall establish. 4.1. Option Price. The option price may be less than, equal to, or greater than, the Fair Market Value of the Shares subject to the option at the time the Stock Option is granted, as determined by the Committee, but in no event will the option price be less than 50% of the Fair Market Value of the underlying Shares at the time the Stock Option is granted; provided, however, that in the case of an Incentive Stock Option, the option price shall not be less than the Fair Market Value of the Shares at the time the Incentive Stock Option is granted, or if granted to an employee who owns stock representing more than ten percent of the voting power of all classes of stock of the Company or of its parent or subsidiary corporation (a "10% Employee"), such option price shall not be less than 110% of such Fair Market Value at the time the Incentive Stock Option is granted; and provided, further, that in the case of any Stock Option intended to satisfy the "performance-based" exemption under Section 162(m) of the Code, the option price shall not be less than the Fair Market Value of the Shares at the time the Stock Option is granted. However, in no event will the option price be less than the par value of such Shares. 4.2. Number of Option Shares. The Committee shall determine the number of Shares to be subject to each Stock Option; provided, however, that if the Committee determines that a Stock Option should satisfy the "performance-based" exemption under Section 162(m) of the Code, the maximum number of Shares subject to Stock Options which may be granted to any single Participant during any calendar year is three hundred thousand (300,000). The number of Shares subject to an outstanding Stock Option may be reduced on a share-for-share or other appropriate basis, as determined by the Committee, to the extent that Shares under the Stock Option are used to calculate the cash, Shares, Other Securities, or other forms of payment, or any combination thereof, received pursuant to exercise of a Stock Appreciation Right attached to such Stock Option, or to the extent that any other Award granted in conjunction with such Stock Option is paid. 4.3. Exercisability of Stock Options. A Stock Option shall not be exercisable, as follows: (a) in the case of any Incentive Stock Option granted to a 10% Employee, after the expiration of five (5) years from the date it is granted, and, in the case of any other Incentive Stock Option or any Nonqualified Stock Option, after the expiration of ten (10) years from the date it is granted; any Stock Option may be exercised during such period only at such time or times and in such installments as the Committee may establish in the Option Agreement; (b) unless payment in full is made for the Shares at the time of exercise and such payment shall be made in such form (including, but not limited to, cash, check, or if permitted by the Committee in the Option Agreement, by delivery to the Company of Shares, or a promissory note, or an irrevocable undertaking by a broker to deliver to the Company sufficient funds to pay the exercise price, or the surrender of another outstanding Award under the Plan, or any combination thereof) as the Committee may determine in its discretion; (c) unless the Participant has been, at all times during the period beginning with the date of the grant of the Stock Option and ending on the date of such exercise, employed by or otherwise performing services for the Company or an Affiliate, or a corporation substituting or assuming the Stock Option in a transaction to which Section 424(a) of the Code is applicable, except that: (i) unless otherwise provided in the Option Agreement, if the Participant ceases to perform services for the Company or an Affiliate because of Retirement or Disability, any unvested Stock Option or portion thereof shall fully vest, and following such Retirement or Disability the Participant may at any time within a period of three (3) years from the date of such Retirement or Disability exercise the Stock Option; (ii) unless otherwise provided in the Option Agreement, if the Participant ceases to perform services for the Company or an Affiliate because of the Participant's death, any unvested Stock Option or 4 portion thereof shall fully vest, and the Participant's estate, personal representative or Beneficiary to whom it has been transferred pursuant to Section 14 (or any other permitted transferee in accordance with Section 16.3) may at any time within a period of three (3) years from the date of the Participant's death exercise the Stock Option; (iii) if the Participant ceases to perform services for the Company or an Affiliate for Cause, all Stock Options shall immediately expire and cease to be vested or exercisable, and the Participant shall have no further rights or claims with respect thereto; (iv) unless otherwise provided in the Option Agreement, if the Participant ceases to perform services for the Company or an Affiliate for any reason other than death, Disability or Retirement, or for Cause, any Stock Option or portion thereof which was not vested and exercisable shall immediately terminate and the optionee shall have no further rights or claims with respect thereto, and the Participant may at any time within a period of ninety (90) days from the date of such termination exercise the Stock Option to the extent that the Stock Option was exercisable by the Participant on the date the Participant ceased to perform services; provided, however, that the Committee may provide specifically in the Option Agreement or otherwise for such other period of time during which a Participant may exercise a Stock Option after termination of the Participant's services, subject to the overriding limitation that no Stock Option may be exercised to any extent by anyone after the date of expiration of the Stock Option. In the event that an Incentive Stock Option is exercised by a Participant after the exercise period that applies for purposes of treatment as an incentive stock option under Section 422 of the Code, such Stock Option shall thereafter be treated as a Nonqualified Stock Option. 4.4. Restrictions on Incentive Stock Options. In the case of an Incentive Stock Option, the amount of aggregate Fair Market Value of Shares (determined at the time of grant of the Stock Option pursuant to Section 4.1) with respect to which incentive stock options are exercisable for the first time by an employee during any period shall not exceed any applicable limitations imposed by Section 422 of the Code or any successor provision (as of May 13, 1997, $100,000 per calendar year under all plans of the employer corporation and its parent and subsidiary corporations). To the extent the limitation in the preceding sentence would be exceeded with respect to any portion of a Stock Option otherwise first becoming exercisable for any year in accordance with the vesting schedule established for an optionee, the Committee may determine at the time of grant that vesting with respect to such excess amount shall be deferred until the first subsequent year that such excess amount (or any part thereof) can become exercisable within the limitation of the preceding sentence; absent such a determination, such excess amount shall become vested as a Nonqualified Stock Option. An Incentive Stock Option shall be transferable only as permitted under the rules prescribed in or under the Code for incentive stock options. 4.5. Restrictions on Shares. Shares purchased by a Participant upon exercise of a Stock Option may be subject to such transfer and forfeiture restrictions (including without limitation transfer and forfeiture restrictions like those which may be applicable to Restricted Stock under the provisions of Section 6) as the Committee in its sole discretion shall establish in the Option Agreement. 5. Stock Appreciation Rights. The Committee may grant Stock Appreciation Rights either alone, or in conjunction with Stock Options or other Awards, either at the time of grant or by amendment thereafter, except that a Stock Appreciation Right granted in conjunction with an Incentive Stock Option shall be granted only at the time the Stock Option is granted. Each Award of Stock Appreciation Rights ("SAR Award") granted under the Plan shall be evidenced by an instrument ("SAR Agreement") in such form as the Committee shall prescribe from time to time in accordance with the Plan which shall comply with the terms and conditions specified in this Section 5, and with such other terms and conditions, including, but not limited to, restrictions upon the SAR Award or the Shares issuable upon exercise thereof, as the Committee, in its discretion, shall establish. 5.1. Description of Stock Appreciation Rights. An SAR Award shall entitle the holder to exercise such Award or to surrender unexercised the Stock Option (or other Award) to which the Stock Appreciation Right is attached (or any portion of such Stock Option or other Award) to the Company and to receive from the Company in exchange therefor, without payment to the Company, that number of Shares having an aggregate value equal 5 to the excess of the Fair Market Value of one Share, at the time of such exercise, over the exercise price (or option price, as the case may be) per Share, times the number of Shares subject to the SAR Award or the Stock Option (or other Award), or portion thereof, which is so exercised or surrendered, as the case may be. Unless otherwise provided in the SAR Agreement, the Committee shall be entitled in its discretion to elect to settle the obligation arising out of the exercise of a Stock Appreciation Right by the payment of cash, Shares, Other Securities, or other forms of payment, or any combination thereof, as determined by the Committee, equal to the aggregate value of the Shares it would otherwise be obligated to deliver. Any such election by the Committee shall be made as soon as practicable after the receipt by the Committee of written notice of the exercise of the Stock Appreciation Right. 5.2. Number of Shares Subject to SAR Award. The Committee shall determine the number of Shares to be subject to each SAR Award; provided, however, that if the Committee determines that an SAR Award should satisfy the "performance-based" exemption under Section 162(m) of the Code, the maximum number of Stock Appreciation Rights which may be granted to any single Participant during any calendar year is three hundred thousand (300,000). The number of Shares subject to an outstanding SAR Award may be reduced on a share-for-share or other appropriate basis, as determined by the Committee, to the extent that Shares under such SAR Award are used to calculate the cash, Shares, Other Securities, or other forms of payment, or any combination thereof, received pursuant to exercise of an Stock Option attached to such SAR Award, or to the extent that any other Award granted in conjunction with such SAR Award is paid. 5.3. Exercisability of SAR Award. The SAR Award shall not be exercisable: (a) in the case of any SAR Award of that is attached to an Incentive Stock Option granted to a 10% Employee, after the expiration of five (5) years from the date it is granted, and, in the case of any other SAR Award, after the expiration of ten (10) years from the date it is granted. Any SAR Award may be exercised during such period only at such time or times and in such installments as the Committee may establish in the SAR Agreement; (b) unless the Stock Option or other Award (if any) to which the SAR Award is attached is at the time exercisable; (c) in the case of any SAR Award that is attached to an Incentive Stock Option, only when the Fair Market Value of the Shares subject to the Stock Option exceeds the option price of the Stock Option; (d) unless the Participant has been, at all times during the period beginning with the date of the grant thereof and ending on the date of such exercise, employed by or otherwise performing services for the Company or an Affiliate, except that: (i) unless otherwise provided in the SAR Agreement, if the Participant ceases to perform services for the Company or an Affiliate because of Retirement or Disability, any unvested Stock Appreciation Right or portion thereof shall fully vest, and following such Retirement or Disability the Participant may at any time within a period of three (3) years from the date of such Retirement or Disability exercise the Stock Appreciation Right; (ii) unless otherwise provided in the SAR Agreement, if the Participant ceases to perform services for the Company or an Affiliate because of the Participant's death, any unvested Stock Appreciation Right or portion thereof shall fully vest, and the Participant's estate, personal representative or Beneficiary to whom it has been transferred pursuant to Section 14 (or any other permitted transferee in accordance with Section 16.3) may at any time within a period of three (3) years from the date of the Participant's death exercise the Stock Appreciation Right; (iii) if the Participant ceases to perform services for the Company or an Affiliate for Cause, all Stock Appreciation Rights shall immediately expire and cease to be vested or exercisable, and the Participant shall have no further rights or claims with respect thereto; (iv) unless otherwise provided in the SAR Agreement, if the Participant ceases to perform services for the Company or an Affiliate for any reason other than death, Disability or Retirement, or for Cause, any Stock Appreciation Right or portion thereof which was not vested and exercisable shall immediately terminate and the Participant shall have no further rights or claims with respect thereto, and the Participant may at any time within a period of ninety (90) days from the date 6 of such termination exercise the Stock Appreciation Right to the extent that the Stock Appreciation Right was exercisable by the Participant on the date the Participant ceased to perform services; provided, however, that the Committee may provide specifically in the SAR Agreement or otherwise for such other period of time during which the Participant may exercise the SAR Award after termination of the Participant's services, subject to the overriding limitation that no SAR Award may be exercised to any extent by anyone after the date of expiration of the SAR Award. 5.4. Deemed Exercise of SAR Award. An SAR Award may provide that it shall be deemed to have been exercised at the close of business on the business day preceding the expiration date of the Stock Appreciation Right or of the related Stock Option (or other Award), or such other date as specified by the Committee, if at such time such Stock Appreciation Right has a positive value. Such deemed exercise shall be settled or paid in the same manner as a regular exercise thereof as provided in Section 5.1. 6. Restricted Stock and Unrestricted Stock. Each Award of Restricted Stock under the Plan shall be evidenced by an instrument ("Restricted Stock Agreement") in such form as the Committee shall prescribe from time to time in accordance with the Plan which shall comply with the terms and conditions specified in this Section 6, and with such other terms and conditions as the Committee, in its discretion, shall establish. 6.1. Number of Shares of Restricted Stock. The Committee shall determine the number of Shares to be issued to a Participant pursuant to the Award of Restricted Stock, and the extent, if any, to which they shall be issued in exchange for cash, other consideration, or both; provided, however, that if the Committee determines that an Award of Restricted Stock should satisfy the "performance-based" exemption under Section 162(m) of the Code, the maximum number of Shares of Restricted Stock which may be granted to any single Participant during any calendar is three hundred thousand (300,000). 6.2. Restriction on Transfer; Forfeiture. Shares issued to a Participant in accordance with the Award of Restricted Stock may not be sold, assigned, transferred, pledged or otherwise disposed of, except by will or the laws of descent and distribution (or as otherwise permitted pursuant to Section 16.3), or as otherwise determined by the Committee in the Restricted Stock Agreement, for such period as the Committee shall determine from the date on which the Award is granted (the "Restricted Period"). Without limiting the generality of the foregoing, the Restricted Period may terminate (in whole or in part) upon the lapse of a specified time period, the attainment of performance goals, or both. The Shares issued to a Participant in accordance with the Award of Restricted Stock shall be forfeited by the Participant and returned to the Company in the following circumstances: (i) if the Participant's continuous employment or performance of services for the Company and its Affiliates shall terminate for any reason (except as otherwise provided in Section 6.3) prior to the expiration of the Restricted Period; or (ii) if, on or prior to the expiration of the Restricted Period the Participant has not paid to the Company an amount equal to any federal, state, local or foreign income or other taxes which the Company determines is required to be withheld in respect of such Shares and such failure shall continue for 10 business days following notice thereof to the Participant (or such lesser period as is imposed by applicable law); or (iii) under such other circumstances as determined by the Committee in its discretion, as shall be specified in the Restricted Stock Agreement. Each certificate for Shares issued pursuant to an Award of Restricted Stock shall bear an appropriate legend referring to the foregoing forfeiture provisions and other restrictions; shall be deposited by the Participant with the Company, together with a stock power endorsed in blank; or shall be evidenced in such other manner permitted by applicable law as determined by the Committee in its discretion. Any attempt to dispose of any such Shares in contravention of the foregoing forfeiture provisions and other restrictions shall be null and void and without effect. If Shares issued pursuant to an Award of Restricted Stock shall be forfeited pursuant to the foregoing provisions, the Participant, or in the event of his or her death, his or her personal representative, shall forthwith deliver to the Clerk of the Company instruments of transfer as may reasonably be required by the Clerk of the Company. 7 6.3. Termination of Services Under Certain Circumstances. Notwithstanding Section 6.2, if a Participant who has been in continuous employment or performance of services for the Company or an Affiliate since the date on which an Award of Restricted Stock was granted to the Participant shall, while in such employment or performance of services, die, or terminate such employment or performance of services by reason of Disability or Retirement, and any of such events shall occur prior to the end of the Restricted Period of such Award, the Committee may determine to waive the application of the forfeiture provisions (and any and all other restrictions) on any or all of the Shares subject to such Award. The Committee also may in its discretion provide for such a result in the Restricted Stock Agreement. 6.4 Other Restrictions. The Committee shall impose such other conditions and/or restrictions on Restricted Stock as it may deem advisable including, without limitation, a requirement that Participants pay a stipulated purchase price therefor and/or restrictions designed to satisfy requirements of applicable federal or state securities laws. Unless and until the Committee proposes for stockholder vote a change in the general performance measures set forth below, the attainment of which shall determine the number of Shares of Restricted Stock that become vested under the Plan, the performance measure(s) to be used for purposes of grants to Section 162(m) employees shall be selected by the Committee from among the following alternatives: (i) earnings per Share, (ii) Share price, (iii) pre-tax operating profits, (iv) net income, (v) return on equity or assets, (vi) revenues or expenses, (vii) product sales, (viii) market share, or (ix) any combination of the foregoing. Performance measures may be in respect of the performance of the Company and its subsidiary corporations (which may be on a consolidated basis), a subsidiary corporation or a business unit or units. Performance measures may be absolute or relative and may be expressed in terms of a progression within a specified range. In the event that applicable tax and/or securities laws change to permit Committee discretion to alter the governing performance measures without obtaining stockholder approval of such changes, the Committee shall have sole discretion to make such changes without obtaining stockholder approval. The Committee retains the absolute discretion to grant Restricted Stock that shall not qualify for the "performance-based" exemption under Section 162(m) of the Code. 6.5. Notice of Election Under Section 83(b). A Participant making an election under Section 83(b) of the Code with respect to Restricted Stock must provide a copy thereof to the Company within ten (10) days of the filing of such election with the Internal Revenue Service. 6.6. Unrestricted Stock. The Committee may, in its discretion, approve the sale and transfer to a Participant of Shares of Unrestricted Stock free of any vesting requirements or transfer restriction for a price which is not less than the par value of the Shares. 7. Performance Shares. The Award of Performance Shares ("Performance Share Grant") to a Participant will entitle the Participant to receive a specified amount determined by the Committee (the "Value"), if the terms and conditions specified herein and in the Award are satisfied. Each Performance Share Grant shall be subject to the terms and conditions specified in this Section 7, and to such other terms and conditions, including but not limited to, restrictions upon any cash, Shares, Other Securities, or other forms of payment, or any combination thereof, issued in respect of the Performance Share Grant, as the Committee, in its discretion, shall establish, and shall be embodied in an instrument (a "Performance Share Agreement") in such form and substance as is determined by the Committee. 7.1. Description of Performance Shares. The Committee shall determine the Value or range of Values of a Performance Share Grant to be awarded to each Participant selected for such an Award and whether or not such a Performance Share Grant is granted in conjunction with an Award of Stock Options, Stock Appreciation Rights, Restricted Stock or other Award, or any combination thereof, under the Plan (which may include, but need not be limited to, deferred Awards) concurrently or subsequently granted to the Participant (the "Associated Award"). If the Committee determines that a grant of Performance Shares should satisfy the "performance-based" exemption under Section 162(m) of the Code, the maximum payout to any Section 162(m) employee with respect to Performance Shares granted in any one calendar year shall be one million dollars ($1,000,000). As determined by the Committee in the Performance Share Agreement, the maximum value of each Performance Share Grant (the "Maximum Value") shall be: (i) an amount fixed by the Committee at the time the 8 Award is made or amended thereafter; (ii) an amount which varies from time to time based in whole or in part on the then current value of a Share, Other Securities, other forms of payment, or any combination thereof; or (iii) an amount that is determinable from criteria specified by the Committee. Performance Share Grants may be issued in different classes or series having different names, terms and conditions. In the case of a Performance Share Grant awarded in conjunction with an Associated Award, the Performance Share Grant may be reduced on an appropriate basis to the extent that the Associated Award has been exercised, paid to or otherwise received by the Participant, as determined by the Committee. 7.2. Performance Objectives. The award period in respect of any Performance Share Grant shall be a period determined by the Committee. At the time each Award is made, the Committee shall establish performance objectives to be attained within the award period as the means of determining the Value of such a Performance Share Grant. The performance objectives shall be based on such measure or measures of performance, which may include, but need not be limited to, the performance of the Participant, the Company, one or more of its parent or subsidiary or corporations one or more of their business units, or any combination of the foregoing, as the Committee shall determine, and may be applied on an absolute basis or be relative to industry or other indices, or any combination thereof. The Value of a Performance Share Grant shall be equal to its Maximum Value only if the performance objectives are attained in full, but the Committee shall specify the manner in which the Value of Performance Share Grants shall be determined if the performance objectives are met in part. Such performance measures, the Value or the Maximum Value, or any combination thereof, may be adjusted in any manner by the Committee in its discretion at any time and from time to time during or as soon as practicable after the award period, if it determines that such performance measures, the Value or the Maximum Value, or any combination thereof, are not appropriate under the circumstances. Notwithstanding the foregoing, unless and until the Committee proposes for stockholder vote a change in the general performance measures referenced below, the attainment of which shall serve as a basis for the determination of the number and/or value of Performance Shares granted under the Plan, the performance measure(s) to be used for purposes of grants to Section 162(m) employees shall be selected from the alternatives set forth in Section 6.4 and shall be determined in the manner provided therein. In the event that applicable tax and/or securities laws change to permit Committee discretion to alter the governing performance measures without obtaining stockholder approval of such changes, the Committee shall have sole discretion to make such changes without obtaining stockholder approval. In addition, in the event that the Committee determines that it is advisable to grant Performance Shares that shall not qualify for the "performance-based" exemption under Section 162(m) of the Code, the Committee may make grants which do not qualify for such exemption. 7.3. Effect of Termination of Services. The rights of a Participant in Performance Shares awarded to him shall be provisional and may be canceled or paid in whole or in part, all as determined by the Committee, if the Participant's employment or performance of services for the Company and its Affiliates shall terminate for any reason prior to the end of the award period. 7.4. Payment of Performance Shares. The Committee shall determine whether the conditions of Section 7.1 or 7.2 have been met and, if so, shall ascertain the Value of the Performance Share Grants. If the Performance Share Grants have no Value, the Award and such Performance Share Grants shall be deemed to have been canceled and the Associated Award, if any, may be canceled or permitted to continue in effect in accordance with its terms. If the Performance Share Grants have any Value and: (i) were not awarded in conjunction with an Associated Award, the Committee shall cause an amount equal to the Value of the Performance Share Grants earned by the Participant to be paid to the Participant or the Participant's Beneficiary as provided below; or (ii) were awarded in conjunction with an Associated Award, the Committee shall determine, in accordance with criteria specified by the Board, (A) to cancel the Performance Share Grants, in which event no amount in respect thereof shall be paid to the Participant or the Participant's Beneficiary, and the Associated Award may be permitted to continue in effect in accordance with its terms, (B) to pay the Value of the Performance Share Grants to the Participant or the Participant's Beneficiary as provided below, in which event the Associated Award may be canceled or (C) to pay to the Participant or the Participant's Beneficiary (or 9 other permitted transferee in accordance with Section 16.3) as provided below, the Value of only a portion of the Performance Share Grants, in which event all or a portion of the Associated Award may be permitted to continue in effect in accordance with its terms or be canceled, as determined by the Committee. Such determination by the Committee shall be made as promptly as practicable following the end of the award period or upon the earlier termination of employment or performance of services, or at such other time or times as the Committee shall determine, and shall be made pursuant to criteria specified by the Committee. Payment of any amount in respect of the Performance Shares which the Committee determines to pay as provided above shall be made by the Company as promptly as practicable after the end of the award period or at such other time or times as the Committee shall determine, and may be made in cash, Shares, Other Securities, or other forms of payment, or any combination thereof, or in such other manner, as determined by the Committee in its discretion. Notwithstanding anything in this Section 7 to the contrary, the Committee may, in its discretion, determine and pay out the Value of the Performance Shares at any time during the award period. 8. Loans; Supplemental Cash Grants; Other Awards. 8.1. Loans. The Company may make a loan to a Participant ("Loan"), either on the date of or after the grant of any Award to the Participant. A Loan may be made either in connection with the purchase of Shares, Other Securities or other property under the Award or with the payment of any federal, state and local income tax with respect to income recognized as a result of the Award. The Committee will have full authority to decide whether to make a Loan and to determine the amount, terms and conditions of the Loan, including the interest rate, whether the Loan is to be secured or unsecured or with or without recourse against the borrower, the terms on which the Loan is to be repaid and the conditions, if any, under which it may be forgiven. However, no Loan may have a term (including extensions) exceeding ten (10) years in duration. 8.2. Supplemental Cash Grants. In connection with any Award, the Committee may at the time such Award is made or at a later date, provide for and grant a cash award to the Participant ("Supplemental Cash Grant") not to exceed an amount equal to (i) the amount of any federal, state and local income tax on ordinary income for which the Participant may be liable with respect to the Award, determined by assuming taxation at the highest marginal rate, plus (ii) an additional amount on a grossed-up basis intended to make the Participant whole on an after-tax basis after discharging all the Participant's income tax liabilities arising from all payments under this Section 8.2. Any payments under this Section 8.2 will be made at the time the Participant incurs such income tax liability with respect to the Award. 8.3. Other Awards. In addition to the types of Awards specifically described in the foregoing provisions of the Plan, the Committee may in its discretion determine, describe and award or grant any other type of Award which is consistent with the terms and purposes of the Plan. Such Awards may include special Awards relating to a single eligible individual and Awards made pursuant to special or recurring plans or programs covering groups of eligible individuals. 9. Deferral of Compensation. The Committee shall determine whether or not an Award shall be made in conjunction with deferral of the Participant's salary, bonus or other compensation, or any combination thereof, and whether or not such deferred amounts may be (i) forfeited to the Company or to other Participants, or any combination thereof, under certain circumstances (which may include, but need not be limited to, certain types of termination of employment or performance of services for the Company and its Affiliates), (ii) subject to increase or decrease in value based upon the attainment of or failure to attain, respectively, certain performance measures, and/or (iii) credited with investment equivalents (which may include, but need not be limited to, interest, dividends or other rates of return) until the date or dates of payment of the Award, if any. 10. Deferred Payment of Awards. The Committee may specify that the payment of all or any portion of cash, Shares, Other Securities, or any other form of payment, or any combination thereof, under an Award shall be deferred until a later date. Deferrals shall be for such periods or until the occurrence of such events, and upon such terms, as the Committee shall determine in its discretion. Deferred payments of Awards may be made by undertaking to make payment in the future based upon the performance of certain investment equivalents (which may include, but need not be limited to, government securities, Shares, Other Securities, other forms of payment, or any combination thereof), together with such additional amounts of investment equivalents as may be determined by the Committee in its discretion. 10 11. Amendment or Substitution of Awards Under the Plan. The terms of any outstanding Award under the Plan as provided in any instrument may be amended from time to time by the Committee in its discretion in any manner that it deems appropriate (including, but not limited to, acceleration of the date of exercise of any Award and/or payments thereunder); provided that no such amendment shall adversely affect in a material manner any right of a Participant under the Award without the Participant's written consent, unless the Committee determines in its discretion that there have occurred or are about to occur significant changes in the economic, legislative, regulatory, tax, accounting or cost/benefit conditions which are determined by the Committee in its discretion to have or to be expected to have a substantial effect on the performance of the Company, or any subsidiary corporation, Affiliate, division or business unit thereof, on the Plan, or on any Award under the Plan. The Committee may, in its discretion, permit holders of Awards under the Plan to surrender outstanding Awards in order to exercise or realize the rights under other Awards, or in exchange for the grant of new Awards, or require holders of Awards to surrender outstanding Awards as a condition precedent to the grant of new Awards under the Plan. 12. Termination of Services by a Participant. For all purposes under the Plan, the Committee shall determine whether a Participant has terminated employment by or the performance of services for the Company and its Affiliates; provided, however, that transfers between the Company and an Affiliate or between Affiliates and approved leaves of absence shall not be deemed such a termination. 13. Changes in the Company's Capital Structure. The existence of outstanding Awards shall not affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company's capital structure or its business, or any merger or consolidation of the Company, or any issue of capital stock, bonds, debentures, or Other Securities ahead of or affecting the Shares, Other Securities or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise. The number of Shares (or Other Securities) covered by any outstanding Award, the price per share thereof, and the limits on the amount of Incentive Stock Options issuable under the Plan and the amounts of Shares issuable pursuant to Section 162(m) employees upon exercise of Stock Options or Stock Appreciation Rights or as Restricted Stock each shall be appropriately adjusted for any increase or decrease in the number of issued Shares resulting from the subdivision or consolidation of Shares (or Other Securities) or any other capital adjustment, the payment of a stock dividend or any other increase in such Shares (or Other Securities) effected without receipt of consideration by the Company or any other decrease therein effected without a distribution of cash or property in connection therewith, or any other extraordinary or unusual event similarly affecting the Shares (or Other Securities). Any such adjustment shall be made by the Committee, in its discretion, and such adjustment shall be final, conclusive and binding for all purposes of the Plan. In the event the Company merges or consolidates with one or more corporations and the Company is the surviving corporation, thereafter upon any exercise of an Award, the holder thereof shall be entitled to purchase or receive in lieu of the number of Shares (or Other Securities) as to which the Award relates, the number and class of shares of stock or securities to which the holder would have been entitled pursuant to the terms of the agreement of merger or consolidation if immediately prior to such merger or consolidation, the holder had been the holder of record of Shares (or Other Securities) as to which the Award related. If the Company is merged into or consolidated with another corporation under circumstances where the Company is not the surviving corporation, or if the Company is liquidated or sells or otherwise disposes of substantially all of its assets to another corporation while unexercised Stock Options or other Awards remain outstanding under the Plan: (i) subject to the provisions of clauses (iii), (iv) and (v) below, after the effective date of such merger, consolidation or sale, as the case may be, each holder of an outstanding Stock Option or other Award shall be entitled, upon exercise of such Stock Option or other Award, to receive in lieu of Shares (or Other Securities) of the Company, shares of such stock or other securities as the holders of Shares (or Other Securities) received pursuant to the terms of the merger, consolidation or sale; or (ii) the Committee may waive any discretionary limitations imposed with respect to the exercise of the Stock Option or other Award so that all Stock Options or other Awards from and after a date prior to the effective date of such merger, consolidation, liquidation or sale, as the case may be, specified by the Committee, shall become fully vested or be exercisable in full; or 11 (iii) any or all outstanding Stock Options or other Awards may be canceled by the Committee as of the effective date of any such merger, consolidation, liquidation or sale provided that notice of such cancellation shall be given to each holder of a Stock Option or other Award, and each such holder thereof shall have the right to exercise such Stock Option or other Award in full (without regard to any discretionary limitations imposed with respect to the Stock Option or other Award) during a 30-day period preceding the effective date of such merger, consolidation, liquidation or sale; or (iv) any or all outstanding Stock Options or other Awards may be canceled by the Committee as of the date of any such merger, consolidation, liquidation or sale provided that notice of such cancellation shall be given to each holder of a Stock Option or other Award, and each such holder thereof shall have the right to exercise such Stock Option or other Award but only to the extent exercisable in accordance with any discretionary limitations imposed with respect to the Stock Option or other Award prior to the effective date of such merger, consolidation, liquidation or sale; or (v) the Committee may provide for the cancellation of any or all outstanding Stock Options or other Awards and for the payment to the holders thereof of some part or all of the amount by which the value thereof exceeds the payment, if any, which the holder would have been required to make to exercise such Stock Option or other Award. Except as hereinbefore expressly provided, the issue by the Company of shares of capital stock of any class or securities convertible into shares of capital stock of any class for cash or property or for labor or services either upon direct sale or upon the exercise of rights or warrants to subscribe therefor, or upon conversion of shares or obligations of the Company convertible into such shares or other securities, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number, class or price of Shares then subject to outstanding Stock Options or other Awards. 14. Designation of Beneficiary by Participant. A Participant may name a Beneficiary to receive any benefit or payment to which the Participant may be entitled in respect of any Award under the Plan in the event of the Participant's death, on a written form to be provided by and filed with the Company, and in a manner determined by the Committee. A Participant may change the Participant's Beneficiary from time to time in the same manner, unless such Participant has made an irrevocable designation. Any designation of Beneficiary under the Plan (to the extent it is valid and enforceable under applicable law) shall be controlling over any other disposition, testamentary or otherwise, as determined by the Committee in its discretion. If no designated Beneficiary survives the Participant or is otherwise in existence on the date on which any amount becomes payable to such Participant's Beneficiary, such payment will be made to the legal representatives of the Participant's estate, and the term "Beneficiary" as used in the Plan shall be deemed to include such person or persons. 15. Administration. The Plan shall be administered by the Compensation and Stock Option Committee of the Board, or by any other committee appointed by the Board (the Compensation and Stock Option Committee or other such committee appointed by the Board is herein referred to as the "Committee"). The members of the Committee shall be appointed from time to time by, and shall serve at the discretion of, the Board. The Committee shall have full power, except as limited by law, the Articles of Organization and By-Laws of the Company, subject to such other restricting limitations or directions as may be imposed by the Board from time to time, to exercise all of the powers vested in it by the terms of the Plan set forth herein, such powers to include authority (except as may be delegated as permitted herein) to select the key employees and other key individuals to be granted Awards under the Plan, to determine the type, size and terms of the Award to be made to each individual selected, to modify the terms of any Award that has been granted, to determine the time when Awards will be granted, to establish performance objectives, and to prescribe the form of the instruments embodying Awards made under the Plan. The Committee is authorized to interpret the Plan and the Awards granted under the Plan, to establish, amend and rescind any rules and regulations relating to the Plan, and to make any other determinations which it deems necessary or desirable for the administration of the Plan. The Committee may correct any defect or supply any omission or reconcile any inconsistency in the Plan or in any Award in the manner and to the extent the Committee deems necessary or desirable to carry it into effect. Any decision of the Committee (or its delegate as permitted herein) in the interpretation and administration of the Plan, as described herein, shall lie within its sole and absolute discretion and shall be final, conclusive and binding on all parties concerned. 12 The Committee may establish a sub-committee consisting of at least two members of the Committee to whom some or all of the authority of the Committee with respect to the Plan may be delegated. The Committee (and any sub-committee) may act only by a majority of its members in office, except that the members of the Committee (and any sub-committee) may authorize any one or more of their members or any officer of the Company (i) to designate additional Participants with respect to an authorized reserve of Awards approved by the Committee (or sub-committee) and (ii) to execute and deliver documents or to take any other ministerial action on behalf of the Committee (or such sub-committee) with respect to Awards made or to be made to Participants. No member of the Committee (or such sub-committee) and no officer of the Company shall be liable for anything done or omitted to be done by him, by any other member of the Committee (or such sub-committee) or by any other officer of the Company in connection with the performance of duties under the Plan, except for his or her own willful misconduct or as expressly provided by statute. If any such sub-committee or other authorized designee(s) shall have authority to grant, or to take any other action with respect to, any Awards intended to comply with Rule 16b-3 or to qualify as "performanced-based" compensation under Section 162(m) of the Code, then such sub-committee or such authorized designee(s) shall be constituted in a manner which shall comply at all relevant time(s) with the applicable requirements of Rule 16b-3 or Section 162(m), as the case may be. Notwithstanding the foregoing provisions of this Section 15, but subject to the provisions of Section 16.5, the Board of Directors may in any instance exercise authority with respect to the Plan that it has delegated hereunder to the Committee. 16. Miscellaneous Provisions. 16.1. No Rights to Awards or Employment. No employee or other person shall have any claim or right to be granted an Award under the Plan. Determinations made by the Committee under the Plan need not be uniform and may be made selectively among eligible individuals under the Plan, whether or not such eligible individuals are similarly situated. Neither the Plan nor any action taken hereunder shall be construed as giving any employee or other person any right to continue to be employed by or perform services for the Company or any Affiliate, and the right to terminate the employment of or performance of services by any Participant at any time and for any reason is specifically reserved. 16.2. Delivery of Written Instruments. No Participant or other person shall have any right with respect to the Plan, the Shares reserved for issuance under the Plan or in any Award, contingent or otherwise, until written evidence of the Award shall have been delivered to the recipient and all the terms, conditions and provisions of the Plan and the Award applicable to such recipient (and each person claiming under or through such recipient) have been met. 16.3. Assignment Prohibition. Subject to the provisions of this Section 16.3, (a) no Award under the Plan shall be transferable otherwise than by will, by the laws of descent and distribution, or by operation of a "qualified domestic relations order," as that term is defined in the Code, and (b) during the lifetime of the Participant to whom an Award has been granted, rights under the Award may be exercised only by the Participant, the Participant's guardian or legal representative, or by the assignee of the Award under such a "qualified domestic relations order." Notwithstanding the foregoing, the Committee may provide for greater transferability in the case of any Award, including, without limitation, transfer to one or more members of the Participant's family or to a partnership or trust established for the benefit of one or more members of the Participant's family. Unless otherwise provided by the Committee, the conditions and criteria governing the exercise or payment of such an Award (by way of example accelerated vesting upon death or Disability or the attainment of performance goals applicable to the Participant) shall following any permitted transfer continue to be determined by reference to the Participant and not the transferee. In no event shall Incentive Stock Options awarded under the Plan be transferable other than as permitted under the rules prescribed in or under the Code for incentive stock options. An award that is intended to be exempt under Rule 16b-3 under the Exchange Act or any successor rule, or that is intended to qualify for the performance- based exception under Section 162(m) of the Code, shall be transferable only to the extent consistent with such exemption or qualification. Nothing in this Section shall be construed as restricting the transfer of Shares that have become free of other transfer restrictions under the Plan or that were awarded free of any such restrictions. 16.4. Compliance With Applicable Laws. No Shares, Other Securities, or other forms of payment shall be issued hereunder with respect to any Award unless counsel for the Company shall be satisfied that such issuance will be in compliance with applicable federal, state, local and foreign legal, securities exchange and other applicable requirements. 13 16.5. Rule 16b-3 and Section 162(m). It is the intent of the Company that the Plan comply in all respects with Rule 16b-3, that any ambiguities or inconsistencies in construction of the Plan be interpreted to give effect to such intention and that if any provision of the Plan is found not to be in compliance with Rule 16b-3, such provision shall be deemed null and void to the extent required to permit the Plan to comply with Rule 16b-3. It is the intent of the Company that Awards to Section 162(m) employees may satisfy for "performance-based" compensation under Section 162(m) of the Code to the extent that the Committee shall make Awards which the Committee intends to satisfy such exemption; any ambiguities or inconsistencies in the Plan shall be interpreted to give effect to such intention. 16.6. Tax Withholding. The Company and its Affiliates shall have the right to deduct from any payment made under the Plan any federal, state, local or foreign income or other taxes required by law to be withheld with respect to such payment. It shall be a condition to the obligation of the Company to issue Shares, Other Securities, or other forms of payment, or any combination thereof, upon exercise, settlement or payment of any Award under the Plan, that the Participant (or any Beneficiary or person entitled to act) pay to the Company, upon its demand, such amount as may be requested by the Company for the purpose of satisfying any liability to withhold federal, state, local or foreign income or other taxes. If the amount requested is not paid, the Company may refuse to issue Shares, Other Securities, or other forms of payment, or any combination thereof. Notwithstanding anything in the Plan to the contrary the Committee may, in its discretion, permit an eligible Participant (or any Beneficiary or person entitled to act) to elect to pay a portion or all of the amount requested by the Company for such taxes with respect to such Award, at such time and in such manner as the Committee shall deem to be appropriate including, but not limited to, by authorizing the Company to withhold, or agreeing to surrender to the Company on or about the date such tax liability is determinable, Shares, Other Securities, or other forms of payment, or any combination thereof, owned by such person or a portion of such forms of payment that would otherwise be distributed, or have been distributed, as the case may be, pursuant to such Award to such person, having a Fair Market Value equal to the amount of such taxes. 16.7. Plan Not Funded. The Plan shall be unfunded. The Company shall not be required to establish any special or separate fund or to make any other segregation of assets to assure the payment of any Award under the Plan, and rights to the payment of Awards shall be no greater than the rights of the Company's general creditors. 16.8. Consent of Participant. By accepting any Award or other benefit under the Plan, each Participant and each person claiming under or through him shall be conclusively deemed to have indicated his acceptance and ratification of, and consent to, any action taken under the Plan by the Company, the Committee, or the delegates of the Committee. 16.9. Rules of Construction. The masculine pronoun includes the feminine and the singular includes the plural wherever appropriate. The validity, construction, interpretation, administration and effect of the Plan, and of its rules and regulations, and rights relating to the Plan and to Awards granted under the Plan, shall be governed by and construed in accordance with the domestic substantive laws of The Commonwealth of Massachusetts without giving effect to any choice or conflicts of laws rule or provision that would result in the application of the domestic substantive laws of any other jurisdiction. 17. Plan Amendment or Suspension. The Plan may be amended or suspended in whole or in part at any time and from time to time by the Board or by the Committee. No amendment of the Plan shall adversely affect in a material manner any right of any Participant with respect to any Award theretofore granted without such Participant's written consent, except as permitted under Section 11. 18. Plan Termination. This Plan shall terminate upon the earlier of the following dates or events to occur: (a) upon the adoption of a resolution of the Board terminating the Plan; or (b) May 13, 2007. No Award of an Incentive Stock Option may be granted under the Plan after May 13, 2007. No termination of the Plan shall materially alter or impair any of the rights or obligations of any person, without such person's consent, under any Award theretofore granted under the Plan, except that subsequent to termination of the Plan, the Committee may make amendments permitted under Section 11. 14 EX-23.1 3 CONSENT OF ERNST & YOUNG LLP Exhibit 23.1 Consent of Independent Auditors We consent to the reference to our firm under the caption "Experts" in the Registration Statement (Form S-3 No. 333-0000) and related Prospectus of Liberty Financial Companies, Inc. for the registration of 2,875,000 shares of its common stock and to the inclusion and incorporation by reference therein of our report dated February 5, 1997, with respect to the consolidated financial statements of Liberty Financial Companies, Inc. incorporated by reference in its Annual Report (Form 10-K) for the year ended December 31, 1996 and included in the Registration Statement, and to the incorporation by reference of our report dated February 5, 1997, with respect to the related financial statement schedules included in its Annual Report (Form 10-K), and incorporated by reference in the Registration Statement, filed with the Securities and Exchange Commission. ERNST & YOUNG LLP Boston, Massachusetts June 11, 1997 EX-23.2 4 REPORT AND CONSENT OF KPMG PEAT MARWICK LLP Exhibit 23.2 Consent of Independent Auditors The Board of Directors Liberty Financial Companies, Inc.: We consent to the use of our reports included herein and incorporated by reference and to the reference to our firm under the heading "Experts" in the prospectus. KPMG Peat Marwick LLP Boston, Massachusetts June 11, 1997 -----END PRIVACY-ENHANCED MESSAGE-----