(1) Includes data for acquired entities from and after the applicable acquisition date. 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 FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
On November 1, 2000, the Company announced that it has retained the investment banking firm of Credit Suisse First Boston Corporation to review its strategic alternatives, including a possible sale of the Company.
NET INCOME was $127.6 million or $2.61 per share in 2000 compared to $99.3 million or $2.07 per share in 1999 and $114.8 million or $2.42 per share in 1998. The increase in 2000 compared to 1999 resulted from higher fee income, investment spread, net change in unrealized and undistributed gains in private equity limited partnerships, and gain on sale of Private Capital Management. Partially offsetting these items were higher operating expenses, amortization expense, restructuring charges, special compensation plan expense, net realized investment losses, and income tax expense. The decrease in 1999 compared to 1998 resulted primarily from net realized investment losses in 1999 compared to net realized investment gains in 1998. Operating expenses, amortization expense and interest expense, net also increased, largely offset by higher fee and investment spread income. Although pretax income decreased in 1999 compared to 1998, income tax expense increased as the effective tax rate was significantly higher in 1999 compared to 1998. In addition, net income for 1998 included an extraordinary loss on extinguishment of debt, net of tax, of $9.7 million.
GAIN ON SALE OF PRIVATE CAPITAL MANAGEMENT relates to the sale, completed on December 29, 2000, of the Company's Private Capital Management ("PCM") division of Stein Roe & Farnham Incorporated, to the current PCM management team and an outside investor group. The sale price of $40.0 million consisted of $10.0 million in cash and a $30.0 million 12% note receivable due over five years. The Company recognized a gain of approximately $27.6 million, $13.2 million after tax, for the year-ended December 31, 2000.
INVESTMENT ADVISORY AND ADMINISTRATIVE FEES are based primarily on the market value of assets managed for mutual funds, private capital management and institutional investors. Investment advisory and administrative fees were $300.2 million in 2000 compared to $268.5 million in 1999 and $237.7 million in 1998. These increases primarily reflect a higher level of average fee-based assets under management.
* As of December 31, 2000, 1999 and 1998, Keyport's insurance assets of $14.8 billion, $13.7 billion and $13.1 billion, respectively, bring total assets under management to $66.6 billion, $65.1 billion and $61.0 billion, respectively.
TRANSFER AGENCY FEES for 2000 for the Company's intermediary-distributed mutual funds are based on a three-tier structure, which includes an account fee, a transaction fee and a fee based on the market value of the assets managed. Transfer agency fees for the Company's direct-marketed mutual funds are based on the market value of the assets in the funds and variable annuity mutual funds are charged a flat fee. For 1999 and 1998, transfer agency fees were based on the market value of the assets managed in the Company's intermediary-distributed, direct-marketed and variable annuity mutual funds. Such fees were $49.0 million on average assets of $28.8 billion in 2000, $51.7 million on average assets of $26.1 billion in 1999 and $49.0 million on average assets of $24.9 billion in 1998. As a percentage of total average assets under management, transfer agency fees were approximately 0.17% in 2000 and 0.20% in 1999 and 1998.
SEPARATE ACCOUNT FEES include mortality and expense charges earned on variable annuity and variable life policyholder balances. In addition, for certain separate institutional accounts, the difference between investment income and interest credited on these institutional accounts is included in separate account fees. These fees, which are primarily based on the market values of the assets in separate accounts supporting the contracts, were $43.5 million in 2000 compared to $33.5 million in 1999 and $20.6 million in 1998. Such fees represented 1.19%, 1.32% and 1.44% of average variable annuity, variable life and institutional separate account balances in 2000, 1999 and 1998, respectively.
SPECIAL COMPENSATION PLAN expense in 2000 of $11.1 million relates to the Company's announcement on November 1, 2000 that it has retained the investment banking firm of Credit Suisse First Boston Corporation to review its strategic initiatives, including a possible sale of the Company. To help retain its employees during the strategic review, the Company implemented a special compensation plan that provides cash retention bonuses to substantially all employees. The retention bonuses are generally based on employees' base salary and/or target incentive compensation amounts, except for sales personnel where retention bonuses are based on sales. The estimated maximum cost of the retention bonuses, assuming all covered employees remain with the Company, is approximately $158.0 million with fifty percent payable on November 1, 2001 and the remainder payable on April 1, 2002. In the event of a change of control of the Company that occurs prior to November 1, 2001, the payments would be accelerated and the retention bonus amount would be reduced, subject to a minimum. The estimated minimum retention bonus is approximately $91.0 million and would be recognized if a change of control occurs prior to May 14, 2001. The amount of the retention bonus increases from the minimum on May 14, 2001 to the maximum on October 31, 2001. In calculating the 2000 expense of $11.1 million, a turnover rate of 15% was assumed.
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 $116.0 million in 2000 compared to $97.4 million in 1999 and $77.4 million in 1998. These increases in amortization were due to the increased profit realized on the in-force business. Amortization expense represented 31.7%, 30.7% and 27.7% of investment spread and separate account fees in 2000, 1999 and 1998, respectively.
AMORTIZATION OF INTANGIBLE ASSETS relates to goodwill and certain identifiable intangible assets arising from business combinations accounted for as purchases. Amortization was $24.3 million in 2000 compared to $20.3 million in 1999 and $15.3 million in 1998. These increases in amortization in 2000 and 1999 were primarily attributable to acquisitions during 2000 and 1998, respectively. The Company has experienced higher than anticipated redemptions of assets under management at an acquired company, which at December 31, 2000 had goodwill and other intangible assets of $79.0 million. Although the Company has determined that there is no impairment of goodwill and other intangible assets at this time, if the higher level of redemptions were to continue and sales were not to increase, the Company's estimate of related future cash flows may change, resulting in the need to record an impairment loss.
BOOK VALUE PER SHARE amounted to $29.68 at December 31, 2000 compared to $24.99 at December 31, 1999. Excluding net unrealized losses on investments (computed pursuant to Statement of Financial Accounting Standards No. 115), book value per share amounted to $30.30 at December 31, 2000 and $28.32 at December 31, 1999. As of December 31, 2000, there were 48.8 million common shares outstanding compared to 47.5 million common shares outstanding as of December 31, 1999.
INVESTMENTS not including cash and cash equivalents, totaled $12.2 billion at December 31, 2000 and 1999.
Approximately $11.6 billion or 76.5% of the Company's general account and certain separate account investments at December 31, 2000 were rated by Standard & Poor's Corporation, Moody's Investors Service or under comparable statutory rating guidelines established by the National Association of Insurance Commissioners ("NAIC"). At December 31, 2000, the carrying value of investments in below investment grade securities totaled $1.3 billion or 8.3% of general account investments, including cash and cash equivalents in the Company's annuity operations, and certain separate account investments of $15.1 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.
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. The Company's primary market risk exposures are to changes in interest rates and to changes in equity prices.
The Company generates substantial investable funds from its annuity operations. The Company believes that its fixed and indexed policyholder balances should be backed by investments, principally comprised of fixed maturities, which 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.
The Company administers and oversees the investment risk management processes primarily through its Investment Committee and its Board of Directors. The Investment Committee and Board of Directors provide executive oversight of investment activities. The Investment Committee is a committee consisting of the Chief Executive Officer and other members of senior management of the Company. The Investment Committee meets monthly to provide detailed oversight of investment risk, including market risk.
The day-to-day management of market risk within defined tolerance ranges occurs as portfolio managers buy and sell within their respective markets based upon the acceptable boundaries established by asset allocation, duration and other limits, including but not limited to credit and liquidity.
Interest rate risk is the risk that the Company will incur economic losses due to adverse changes in interest rates. This risk arises from the Company's primary activities, as the Company invests substantial funds in interest-sensitive assets and also has interest-sensitive liabilities. The Company's asset/liability management emphasizes a conservative approach, which is oriented toward reducing downside risk in adverse markets, as opposed to maximizing spread in favorable markets.
The Company seeks to invest premiums and deposits to create future cash flows that will fund future benefits, claims, and expenses, and earn stable margins across a wide variety of interest rate and economic scenarios. In order to achieve this objective and limit its exposure to interest rate risk, the Company adheres to a philosophy of managing the effective duration of assets and related liabilities. The Company uses interest rate and total return swaps, futures and caps to reduce the interest rate risk resulting from effective duration mismatches between assets and liabilities. To the extent that actual results differ from the assumptions utilized, the Company's effective duration could be significantly impacted. Important assumptions include the timing of cash flows on mortgage-related assets and
The Company's potential exposure due to a 10% increase in prevailing interest rates from their December 31, 2000 and 1999 levels was a loss of $79.2 million and $146.3 million, respectively, in fair value of its fixed-rate assets that were not offset by a decrease in the fair value of its fixed-rate liabilities. The decrease in potential exposure is primarily due to lower prevailing market interest rates and the decrease in positive duration gap. The Company expects that its exposure to loss as interest rate changes occur will be minimized and that actual losses will be less than the estimated potential loss due to the combination of asset/liability management strategies and flexibility in adjusting crediting rate levels.
The Company manages the equity risk inherent in its assets relative to the equity risk inherent in its liabilities by conducting detailed computer simulations that model its S&P 500 Index derivatives and its equity-indexed annuity liabilities under stress-test scenarios in which both the index level and the index option implied volatility are varied through a wide range. Implied volatility is a value derived from standard option valuation models representing an implicit forecast of the standard deviation of the returns on the underlying asset over the life of the option or future. The fair values of S&P 500 Index linked securities, derivatives, and annuities are produced using standard derivative valuation techniques. The derivatives portfolio is constructed to maintain acceptable interest margins under a variety of possible future S&P 500 Index levels and option and futures cost environments. In order to achieve this objective and limit its exposure to equity price risk, the Company measures and manages these exposures using methods based on the fair value of assets and the price appreciation component of related liabilities. The Company uses derivatives, including futures, options and total return swaps to modify its net exposure to fluctuations in the S&P 500 Index.
Interest rate cap agreements are agreements with a counterparty which require the payment of a premium for the right to receive payments for the difference between the cap interest rate and a market interest rate on specified future dates based on an underlying principal balance (notional principal) to hedge against rising interest rates. The Company had no outstanding interest rate cap agreements as of December 31, 2000. The Company had interest rate cap agreements with an aggregate notional amount of $50.0 million as of December 31, 1999.
With respect to the Company's equity-indexed annuities and certain separate account liabilities, the Company buys call options, futures and certain total return swap agreements on the S&P 500 Index to hedge its obligations to provide returns based upon this index. The Company had call options with a carrying value of $337.7 million and $701.1 million as of December 31, 2000 and 1999, respectively. The Company had total return swap agreements with a carrying value of $23.9 million and $37.8 million as of December 31, 2000 and 1999, respectively.
On September 29, 2000, the Company completed the acquisition of Wanger Asset Management, L.P. ("Wanger"), a registered investment advisor with approximately $9.4 billion in assets under management as of that date. The purchase price for this transaction was approximately $277.4 million in cash, including transaction costs. In addition, the Company has agreed to make additional payments over the next five years of up to $178.0 million in cash, with $170.0 million contingent upon the attainment of certain earnings objectives and an $8.0 million 3-year note payable to WAM Rights Partnership bearing interest at the rate of 7.00%. This transaction was accounted for as a purchase and resulted in the recording of $133.0 million of intangible assets which will be amortized over 13 years and $145.9 million of goodwill which will be amortized over 25 years. The Company funded the acquisition of Wanger with cash and investments and $200.0 million of debt issued to Liberty Mutual Insurance Company and its affiliates. Such debt consists of a $180.0 million 12-year note with interest payable semi-annually at 8.85% and a $20.0 million 20-year note with interest payable semi-annually at 9.35%.
Current Rhode Island insurance law applicable to Keyport permits the payment of dividends or distributions, which, together with dividends and distributions paid during the preceding 12 months, do not exceed the lesser of (i) 10% of Keyport's statutory surplus as of the preceding December 31 or (ii) Keyport's statutory net gain from operations for the preceding fiscal year. Any proposed dividend in excess of this amount is called an "extraordinary dividend" and may not be paid until it is approved by the Commissioner of Insurance of the State of Rhode Island. The amount of dividends that Keyport could pay in 2001 without such approval is $38.4 million. Keyport paid dividends totaling $10.0 million during 2000. Future regulatory changes and credit agreements may create additional limitations on the ability of the Company's subsidiaries to pay dividends.
Keyport uses cash for the payment of annuity and life insurance benefits, operating expenses and policy acquisition costs, and the purchase of investments. Keyport generates cash from annuity premiums and deposits, net investment income, and from the sales and maturities of fixed investments. Annuity premiums, maturing investments and net investment income have historically been sufficient to meet Keyport's cash requirements. Keyport monitors cash and cash equivalents in an effort to maintain sufficient liquidity and has strategies in place to maintain sufficient liquidity in changing interest rate environments. Consistent with the nature of its obligations, Keyport has invested a substantial amount of its general account assets in readily marketable securities. As of December 31, 2000, $11.0 billion, or 79.2%, of Keyport's general account investments are considered readily marketable.