Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[ X ] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2002 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
For the transition period from to
---------- ----------
Commission file number: 1-9250
Conseco, Inc.
(Debtor-In-Possession as of December 17, 2002)
Indiana No. 35-1468632
---------------------- -------------------------------------
State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
- -------------------------------------- --------------
Address of principal executive offices Telephone
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
-------------------
Common Stock, No Par Value (a)
8-1/8% Senior Notes due 2003 (a)
10-1/2% Senior Notes due 2004 (a)
9.16% Trust Originated Preferred Securities (a)
8.70% Trust Originated Preferred Securities (a)
9% Trust Originated Preferred Securities (a)
9.44% Trust Originated Preferred Securities (a)
- ----------------------
(a) Prior to August 9, 2002, these securities were listed on the New York Stock
Exchange ("NYSE"). On August 9, 2002, the NYSE suspended trading of these
securities and the securities were subsequently removed from listing and
registration on the NYSE on September 25, 2002.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No[ ]
At June 28, 2002, the last business day of the Registrant's most recently
completed second fiscal quarter, the aggregate market value of the Registrant's
common equity held by nonaffiliates was approximately $668,600,000. This
calculation of market value has been made for the purposes of this report only
and should not be considered as an admission or conclusion by the Registrant
that any person is in fact an affiliate of the Registrant.
Shares of common stock outstanding as of March 28, 2003: 346,007,133
DOCUMENTS INCORPORATED BY REFERENCE: None.
PART I
------
ITEM 1. BUSINESS OF CONSECO.
Conseco, Inc. ("CNC") is the top tier holding company for our two operating
businesses: insurance and finance. Our insurance business is operated through
subsidiaries owned directly and indirectly by CIHC, Incorporated ("CIHC"), an
intermediate holding company that is controlled by CNC. Our finance business has
been historically operated through Conseco Finance Corp. ("CFC"), a wholly-owned
subsidiary of CIHC, and its subsidiaries. Effective December 17, 2002 (the date
CFC filed a petition for relief under the Bankruptcy Code as further described
below), we began to account for our finance business as a discontinued
operation. Our subsidiaries operate throughout the United States. We sometimes
collectively refer to CNC, together with its consolidated subsidiaries, as "we,"
"Conseco" or the "Company."
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. Our finance business has historically provided a variety of finance
products including manufactured housing and floor plan loans, home equity
mortgages, home improvement and consumer product loans and private label credit
cards.
PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On December 17, 2002 (the "Petition Date"), CNC, CIHC, CTIHC, Inc. and
Partners Health Group, Inc. (collectively, the "Debtors") filed voluntary
petitions for reorganization under Chapter 11 of Title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
(the "Bankruptcy Court") for the Northern District of Illinois. The following
discussion provides general background information regarding the Debtors'
Chapter 11 cases, but is not intended to be a comprehensive summary. For
additional information regarding the effect of these cases on the Debtors,
readers of this report should refer to the Bankruptcy Code, the Second Amended
Joint Plan of Reorganization (the "Plan"), and the Second Amended Disclosure
Statement approved by the Bankruptcy Court on March 18, 2003 (the "Disclosure
Statement"). The Plan and Disclosure Statement were filed with the Securities
and Exchange Commission (the "SEC") on March 21, 2003 as exhibits to CNC's
Current Report on Form 8-K dated March 18, 2003. The Debtors are currently
operating their business as debtors-in-possession pursuant to the Bankruptcy
Code. As debtors-in-possession, the Debtors are authorized to continue to
operate as ongoing businesses, but may not engage in transactions outside the
ordinary course of business without approval of the Bankruptcy Court, after
notice and an opportunity for a hearing. The Company's insurance subsidiaries
are separate legal entities and are not included in the petitions filed by the
Debtors.
CFC and Conseco Finance Servicing Corp. also filed petitions under the
Bankruptcy Code with the Bankruptcy Court on the Petition Date. In addition, on
February 3, 2003, the following subsidiaries of CFC filed petitions under the
Bankruptcy Code with the Bankruptcy Court: Conseco Finance Corp. - Alabama,
Conseco Finance Credit Corp., Conseco Finance Consumer Discount Company, Conseco
Finance Canada Holding Company, Conseco Finance Canada Company, Conseco Finance
Loan Company, Rice Park Properties Corporation, Landmark Manufactured Housing,
Inc., Conseco Finance Net Interest Margin Finance Corp. I, Conseco Finance Net
Interest Margin Finance Corp. II, Green Tree Finance Corp. - Two, Green Tree
Floorplan Funding Corp., Conseco Agency of Nevada, Inc., Conseco Agency of New
York, Inc., Conseco Agency, Inc., Conseco Agency of Alabama, Inc., Conseco
Agency of Kentucky, Inc., Crum-Reed General Agency, Inc. The foregoing entities
are referred to as the "Finance Company Debtors." The Finance Company Debtors
filed a separate plan in connection with their bankruptcy proceedings. The
bankruptcy proceedings of the Debtors and the Finance Company Debtors are
referred to as the "Chapter 11 Cases".
Since commencing operations in 1982, CNC pursued a strategy of growth
through acquisitions. Primarily as a result of these acquisitions and the
funding requirements necessary to operate and expand the acquired businesses,
CNC amassed outstanding indebtedness of approximately $6.0 billion as of June
30, 2002. In 2001 and early 2002, we undertook a series of steps designed to
reduce and extend the maturities of our parent company debt. Notwithstanding
these efforts, the Company's financial position continued to deteriorate,
principally due to our leveraged condition, losses experienced by our finance
business and losses in the value of our investment portfolio.
As a result of these developments, on August 9, 2002, we announced that we
would seek to fundamentally restructure the Company's capital, and announced
that we had retained legal and financial advisors to assist us in these efforts.
We ultimately decided to seek to reorganize under Chapter 11 of the Bankruptcy
Code.
Under the Bankruptcy Code, actions to collect prepetition indebtedness, as
well as most pending litigation, are stayed and other contractual obligations
against the Debtors generally may not be enforced. Absent an order of the
Bankruptcy Court, substantially all prepetition liabilities are subject to
settlement under a plan of reorganization to be voted upon by creditors and
other stakeholders and approved by the Bankruptcy Court. On March 18, 2003, the
Bankruptcy Court approved the Debtors' Plan, as summarized in the Disclosure
Statement, as containing adequate information, as such term is defined in
Section 1125 of the Bankruptcy Code, to permit the solicitation of votes from
creditors on whether or not to accept the Plan. The Debtors commenced
solicitation on April 4, 2003.
2
The voting record date has been set as March 19, 2003 and the deadline for
returning completed ballots is May 14, 2003. A hearing to consider confirmation
of the Plan is scheduled to begin on May 28, 2003. The Debtors will emerge from
bankruptcy if and when the Plan receives the requisite stakeholder approval and
is approved by the Bankruptcy Court, and all conditions to the consummation of
the Plan, have been satisfied or waived.
The United States Trustee has appointed a creditors committee representing
the unsecured creditors of the Debtors and a TOPrS committee representing the
claims of the holders of the Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts ("Trust Preferred Securities"). Before the
Petition Date, the Company met with and provided materials to certain
prepetition committees and entered into extensive arms-length negotiations with
committees representing the holders of bank debt and publicly held notes of CNC.
Shortly before the Petition Date, the Company reached a non-binding agreement in
principle with respect to the general terms of a restructuring with certain
prepetition committees. However, there can be no assurance that the appointed
committees will support the Debtors' positions in the bankruptcy proceedings or
approve the Plan. The TOPrS committee has raised certain objections to the Plan
which are summarized in the Disclosure Statement. Disagreements between the
Debtors and the appointed committees could protract the bankruptcy proceedings,
could negatively impact the Company's ability to operate and the results of
those operations during bankruptcy, and could delay the Debtors' emergence from
bankruptcy.
The Debtors previously filed with the Bankruptcy Court schedules of assets
and liabilities of the Debtors as reflected on our books and records. Subject to
certain limited exceptions, the Bankruptcy Court established a bar date of
February 21, 2003, for all prepetition claims against the Debtors. A bar date is
the date by which claims against the Debtors must be filed if the claimants wish
to receive any distribution in the bankruptcy proceedings. The Debtors notified
all known or potential claimants subject to the February 21, 2003 bar date of
their need to file a proof of claim with the Bankruptcy Court. Approximately
9,000 proofs of claim were filed on or before the February 21, 2003 bar date and
the Company has begun objecting to claims and otherwise reconciling claims that
differ from the Debtors' records. Any differences that cannot be resolved
through negotiations between the Debtors and the claimant will be resolved by
the Bankruptcy Court. Certain creditors have filed claims substantially in
excess of amounts reflected in the Debtors' records. Accordingly, the ultimate
number and amount of allowed claims is not presently known. Similarly, the
ultimate distribution with respect to allowed claims is not presently known.
We have filed several motions in the Chapter 11 Cases pursuant to which the
Bankruptcy Court has granted us authority or approval with respect to various
items required by the Bankruptcy Code and/or necessary for our reorganization
efforts. We have obtained orders providing for, among other things: (i) payment
of prepetition and postpetition employee compensation and benefits; (ii)
continuing a key-employee retention plan; (iii) obtaining debtor-in-possession
financing for the Finance Company Debtors; and (iv) increasing the amount of the
servicing fee paid to the Finance Company Debtors as servicers of various
manufactured housing securitization trusts.
Under the priority schedule established by the Bankruptcy Code, certain
postpetition and prepetition liabilities need to be satisfied before unsecured
creditors and holders of CNC's common and preferred stock and Trust Preferred
Securities are entitled to receive any distribution. The Plan (as summarized in
the Disclosure Statement) sets forth the Debtors' proposed treatment of claims
and equity interests. No assurance can be given as to what values, if any, will
be ascribed in the bankruptcy proceedings to each of these constituencies. Our
Plan would result in holders of CNC's common stock and preferred stock (other
than Series F Common-Linked Convertible Preferred Stock ("Series F Preferred
Stock")) receiving no value and the holders of CNC's Trust Preferred Securities
and Series F Preferred Stock receiving little value on account of the
cancellation of their interests. In addition, holders of unsecured claims
against the Debtors would, in most cases, receive less than full recovery for
the cancellation of their interests.
At this time, it is not possible to predict with certainty the effect of
the Chapter 11 Cases on our business or various creditors, or when we will
emerge from Chapter 11. Our future results depend upon our confirming and
successfully implementing, on a timely basis, a plan of reorganization.
The consolidated financial statements included in Item 8. "Financial
Statements and Supplementary Data" have been prepared on a going concern basis
which assumes continuity of operations and realization of assets and
satisfaction of liabilities in the ordinary course of business. Our Plan will
materially change amounts reported in the financial statements, which do not
give effect to all adjustments of the carrying value of assets and liabilities
that will be necessary as a consequence of a reorganization under Chapter 11 of
the Bankruptcy Code. The ability of Conseco to continue as a going concern is
predicated upon many issues, including various bankruptcy considerations and
risks related to our business and financial condition. Please refer to Item 7.
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" and Item 8. "Financial Statements and Supplementary Data" for
additional information.
DISCONTINUED FINANCE BUSINESS - PLANNED SALE OF CFC
In October 2002, we announced that we had engaged financial advisors to
pursue various alternatives with respect to our finance business and that CNC's
board of directors had approved a plan to sell or seek new investors for our
finance business. On
3
December 19, 2002, CFC entered into an Asset Purchase Agreement (the "Asset
Purchase Agreement") with CFN Investment Holdings LLC ("CFN"), an affiliate of
Fortress Investment Group LLC, J.C. Flowers & Co. LLC and Cerberus Capital
Management, L.P., pursuant to which CFC would, subject to the satisfaction of
certain conditions, sell all or substantially all of its assets (the "CFC
Assets") in a sale pursuant to Section 363 of the Bankruptcy Code as part of
CFC's Chapter 11 proceedings, subject to the right of CFN to exclude certain
assets from its purchase. In accordance with Section 363 of the Bankruptcy Code
and the terms of the Asset Purchase Agreement, CFC continued to seek alternative
transactions that would provide greater value to CFC and its creditors than the
transactions contemplated by the Asset Purchase Agreement.
As a result of the formalization of the plans to sell the finance business
and the filing of petitions under the Bankruptcy Code by CFC and certain of its
subsidiaries, the finance business is being accounted for as a discontinued
operation.
As part of CFC's efforts to seek alternative transactions that would
provide greater value to CFC, and in accordance with the bidding procedures
order approved by the Bankruptcy Court, CFC conducted an auction for the sale of
its businesses and assets. Potential bidders that submitted bids for the
purchase of the CFC Assets that, by their own terms or aggregated with other
bids, were for more than the purchase price payable under the Asset Purchase
Agreement, plus the amount of the break-up fee of $30 million, plus $5 million
in expense reimbursements, plus the profit sharing rights relating to the
manufactured housing business, were allowed to participate in the auction. The
auction, which commenced on February 28, 2003, promptly adjourned, and was
continued to March 4, 2003, ultimately concluding the morning of March 5, 2003.
At the auction, CFC, with the assistance of its advisors, analyzed each of
the bids presented and determined that CFN's bid of $970 million in cash, plus
the assumption of certain liabilities, represented the highest and best bid. The
terms of the sale included an option for CFC to sell the assets of Mill Creek
Bank, Inc. ("Mill Creek Bank", formerly known as Conseco Bank, Inc.) to General
Electric Capital Corporation ("GE") for approximately $310 million in cash, plus
certain assumed liabilities, which option, if exercised, would provide CFN with
a credit of $270 million to its $970 million bid.
On March 6, 2003, CFC received an offer from Berkadia Equity Holdings,
L.L.C. ("Berkadia") that purported to be a bid in the recently concluded
auction. Concurrently therewith, Berkadia filed an objection to the sale that
the Bankruptcy Court heard, and summarily dismissed, on March 7, 2003. After
further negotiations during the March 7-14, 2003 period, CFN and GE
significantly increased the amount of cash to be paid for the CFC Assets.
Ultimately, each of the major constituencies, including the CFC Committee, the
Ad Hoc Securitization Holders' Committee, U.S. Bank as securitization trustee
for the certificate holders of certain lower-rated securities that are senior in
payment priority to the interest-only securities (the "B-2 securities"), and
Federal National Mortgage Association, as a major B-2 securities certificate
holder, agreed to support the sale of CFC Assets to CFN and GE. The total value
to be received as part of the transactions with CFN and GE upon closing is
expected to be approximately $1.3 billion, representing approximately $1.1
billion in cash and approximately $200 million in assumed liabilities, subject
to certain purchase price adjustments. On March 14, 2003, the Bankruptcy Court
entered orders approving the terms of the sale of the CFC Assets free and clear
of all liens to each of CFN and GE. The closing of the sale of the CFC Assets is
subject to various closing conditions, but is currently expected to occur in the
second quarter of 2003.
Overall, CFC is seeking to maximize the value obtainable from all
restructuring transactions it contemplates as part of its Chapter 11 filing.
However, there can be no assurance that any such transaction will be completed.
Moreover, if such a transaction is completed, no proceeds will be available to
satisfy any creditors, other than creditors of the Finance Company Debtors or
parties with a security interest in the Finance Company Debtors' assets.
OTHER INFORMATION
During the third quarter of 2002, Conseco entered into an agreement to sell
Conseco Variable Insurance Company ("CVIC"), one of its wholly-owned
subsidiaries and the primary writer of its variable annuity products. The sale
was completed in October 2002. The operating results of CVIC have been reported
as a discontinued operation in all periods presented in the accompanying
consolidated statement of operations. See the note to the consolidated financial
statements entitled "Financial Information Regarding CVIC."
During 2001, we stopped renewing a large portion of our major medical lines
of business. These lines of business are in what we refer to as "run-off."
Unless otherwise noted, the collected premium information provided in Item 1
excludes amounts related to the business of CVIC that was sold and the major
medical lines of business that are no longer being sold and are not being
renewed when the contractual terms of the existing insurance policies expire.
CNC was organized in 1979 as an Indiana corporation and commenced
operations in 1982. Our executive offices are located at 11825 N. Pennsylvania
Street, Carmel, Indiana 46032, and our telephone number is (317) 817-6100. Our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act are available free of charge on
our web site at www.conseco.com as soon as
4
reasonably practicable after they are electronically filed with, or furnished
to, the SEC. These filings are also available to the public on the SEC's website
at www.sec.gov. In addition, the public may read and copy any document we file
at the SEC's Public Reference Room located at 450 Fifth Street, NW, Washington,
D.C. 20549. The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330.
Data in Item 1 are provided as of December 31, 2002, or for the year then
ended (as the context implies), unless otherwise indicated.
MARKETING AND DISTRIBUTION
Insurance
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. We sell these products through three primary distribution channels:
career agents, professional independent producers (many of whom sell one or more
of our product lines exclusively) and direct marketing. We had over $4.8 billion
of annual premium and asset accumulation product collections during 2002 and
$5.0 billion of collections during 2001.
Our insurance subsidiaries collectively hold licenses to market our
insurance products in all fifty states, the District of Columbia, and certain
protectorates of the United States. Sales to residents of the following states
accounted for at least 5 percent of our 2002 collected premiums: Florida (8.5
percent), California (7.5 percent), Illinois (7.3 percent), Texas (7.1 percent)
and Michigan (5.3 percent).
We believe that people purchase most types of life insurance, accident and
health insurance and annuity products only after being contacted and solicited
by an insurance agent. Accordingly, the success of our distribution system is
largely dependent on our ability to attract and retain agents who are
experienced and highly motivated. A description of the primary distribution
channels is as follows:
Professional Independent Producers. This distribution channel consists of a
general agency and insurance brokerage distribution system comprised of
independent licensed agents doing business in all fifty states, the District of
Columbia, and certain protectorates of the United States. In 2002, this channel
accounted for $2,430.2 million, or 51 percent, of our total collected premiums.
If a significant number of agents changed to other providers, it would have a
material adverse effect on our business.
Professional independent producers are a diverse network of independent
agents, insurance brokers and marketing organizations. Marketing companies
typically recruit agents for Conseco by advertising our products and commission
structure through direct mail advertising or through seminars for insurance
agents and brokers. These organizations bear most of the costs incurred in
marketing our products. We compensate the marketing organizations by paying them
a percentage of the commissions earned on new sales generated by the agents
recruited by such organizations. Certain of these marketing organizations are
specialty organizations that have a marketing expertise or a distribution system
relating to a particular product, such as flexible-premium annuities for
educators. During 1999 and 2000, Conseco purchased four organizations that
specialize in marketing and distributing supplemental health products. In 2002,
these four organizations accounted for $244.9 million, or 5.1 percent, of our
total collected premiums.
We have recently chosen to emphasize the sale of specified disease and
Medicare supplement insurance policies through this distribution channel. We are
de-emphasizing annuity and life insurance sales and eliminating long-term care
insurance sales through this channel of distribution.
Career Agents. This agency force of approximately 3,800 agents working from
149 branch offices, permits one-on-one contacts with potential policyholders and
promotes strong personal relationships with existing policyholders. The career
agents sell primarily Medicare supplement and long-term care insurance policies,
senior life insurance and annuities. In 2002, this distribution channel
accounted for $1,939.1 million, or 41 percent, of our total collected premiums.
These agents sell only Conseco policies and typically visit the prospective
policyholder's home to conduct personalized "kitchen-table" sales presentations.
After the sale of an insurance policy, the agent serves as a contact person for
policyholder questions, claims assistance and additional insurance needs.
Direct Marketing. This distribution channel is engaged primarily in the
sale of "graded benefit life" insurance policies. In 2002, this channel
accounted for $100.3 million, or 2 percent, of our total collected premiums.
During 2000, we reacquired the name "Colonial Penn" (the former brand name these
products were sold under prior to our acquisition of this business), which we
now use to market these products.
5
Finance
As a result of the formalization of the plans to sell the finance business
and the filing of petitions under the Bankruptcy Code for CFC and certain of its
subsidiaries, the finance business is being accounted for as a discontinued
operation.
CFC's finance business has historically provided a variety of finance
products to borrowers throughout the United States. These products included
manufactured housing and floor plan loans, home equity mortgages, home
improvement and consumer product loans and private label credit cards. At
December 31, 2002, CFC had managed receivables of $35.3 billion. Originations to
customers in the following states accounted for at least 5 percent of our 2002
originations: California (8.1 percent), Texas (6.9 percent), Minnesota (6.5
percent), Illinois (5.7 percent), Florida (5.5 percent) and North Carolina (5.0
percent). Unless otherwise noted, references to loans CFC has made may include
the purchase by CFC of credit contracts between dealers and buyers.
During 2002, 26 percent of CFC's finance products came indirectly from
customers through intermediary channels such as dealers, contractors, retailers
and correspondents. The remaining products were marketed directly to CFC's
customers through its regional offices and service centers. A description of the
primary distribution channels is as follows:
Dealers, Contractors, Retailers and Correspondents. Manufactured housing,
home improvement and home equity receivables are purchased from and originated
by selected dealers and contractors after being underwritten and analyzed via
one of CFC's automated credit scoring systems at one of its regional service
centers. During 2002, these marketing channels accounted for the following
percentages of total loan originations: 90 percent of manufactured housing, 97
percent of home improvement and 8 percent of home equity.
Regional Service Centers, Retail Satellite Offices and Telemarketing
Center. CFC has historically marketed and originated manufactured housing loans
through 33 regional offices and 3 origination and processing centers. CFC
originated home equity loans through a system of 88 retail satellite offices and
3 regional centers. In March 2003, CFC discontinued the origination of home
equity loans and closed or will be closing all of its facilities that were
dedicated to the home equity business. CFC also marketed private label retail
credit products through selected retailers and processed the contracts through
Mill Creek Bank, a Utah industrial loan company, and through Green Tree Retail
Services Bank, Inc. ("Retail Bank"), a South Dakota limited purpose credit card
bank, both of which are subsidiaries of CFC. CFC also utilized direct mail to
originate home improvement loans and home equity loans. During 2002, these
marketing channels accounted for the following percentages of total loan
originations: 10 percent of manufactured housing, 3 percent of home improvement,
92 percent of home equity and 100 percent of retail credit contracts.
Insurance Products
Supplemental Health
Supplemental health products include Medicare supplement, long-term care
and specified-disease insurance products distributed through our career agency
force and professional independent producers. During 2002, we collected Medicare
supplement premiums of $1,033.8 million, long-term care premiums of $917.4
million, specified-disease premiums of $368.7 million and other supplemental
health premiums of $104.3 million. Medicare supplement, long-term care,
specified disease and other supplemental health premiums represented 22 percent,
19 percent, 8 percent and 2 percent, respectively, of our total premiums
collected from continuing lines of business in 2002. Sales of certain
supplemental health products are affected by the financial strength ratings
assigned to our insurance subsidiaries by independent rating agencies. See
"Competition" below.
The following describes the major supplemental health products:
Medicare supplement. Medicare is a two-part federal health insurance
program for disabled persons and senior citizens (age 65 and older). Part A of
the program provides protection against the costs of hospitalization and related
hospital and skilled nursing home care, subject to an initial deductible,
related coinsurance amounts and specified maximum benefit levels. The deductible
and coinsurance amounts are subject to change each year by the federal
government. Part B of Medicare covers doctor's bills and a number of other
medical costs not covered by Part A, subject to deductible and coinsurance
amounts for "approved" charges.
Medicare supplement policies provide coverage for many of the medical
expenses which the Medicare program does not cover, such as deductibles,
coinsurance costs (in which the insured and Medicare share the costs of medical
expenses) and specified losses which exceed the federal program's maximum
benefits. Our Medicare supplement plans automatically adjust coverage to reflect
changes in Medicare benefits. In marketing these products, we concentrate on
individuals who have recently become eligible for Medicare by reaching the age
of 65. We offer a higher first-year commission for sales to these policyholders
and competitive premium pricing. Approximately 26 percent of new sales of
Medicare supplement policies are to individuals who are reaching the age of 65.
6
Long-term care. Long-term care products provide coverage, within prescribed
limits, for nursing home, home healthcare, or a combination of both nursing home
and home healthcare expenses. The long-term care plans are sold primarily to
retirees and, to a lesser degree, to older self-employed individuals and others
in middle-income levels.
Current nursing home care policies cover incurred and daily fixed-dollar
benefits available with an elimination period (which, similar to a deductible,
requires the insured to pay for a certain number of days of nursing home care
before the insurance coverage begins), subject to a maximum benefit. Home
healthcare policies cover the usual and customary charges after a deductible and
are subject to a daily or weekly maximum dollar amount, and an overall benefit
maximum. We monitor the loss experience on our long-term care products and, when
necessary, apply for rate increases in the jurisdictions in which we sell such
products. We depend on regulatory approval to increase our premiums on these
products. If we are unable to raise premiums, it would have a material adverse
effect on our business.
We have decided to eliminate the sale of new long-term care insurance
products through our professional independent producer distribution channel. We
will continue to sell these products through Bankers Life and Casualty Company.
Specified-disease products. These policies generally provide fixed or
limited benefits. Cancer insurance and heart/stroke products are guaranteed
renewable individual accident and health insurance policies. Payments under
cancer insurance policies are generally made directly to, or at the direction
of, the policyholder following diagnosis of, or treatment for, a covered type of
cancer. Heart/stroke policies provide for payments directly to the policyholder
for treatment of a covered heart disease, heart attack or stroke. The benefits
provided under the specified-disease policies do not necessarily reflect the
actual cost incurred by the insured as a result of the illness; benefits are not
reduced by any other medical insurance payments made to or on behalf of the
insured.
Approximately 75 percent of our specified-disease policies inforce (based
on a count of policies) are sold with return of premium or cash value riders.
The return of premium rider generally provides that after a policy has been
inforce for a specified number of years or upon the policyholder reaching a
specified age, the Company will pay to the policyholder, or a beneficiary under
the policy, the aggregate amount of all premiums paid under the policy, without
interest, less the aggregate amount of all claims incurred under the policy.
Annuities
Annuity products include equity-indexed annuity, traditional fixed rate
annuity and market value-adjusted annuity products sold through both career
agents and professional independent producers. During 2002, we collected annuity
premiums of $1,092.8 million, or 23 percent of our total premiums collected from
continuing lines of business. We are taking actions to de-emphasize the sale of
annuity products through the professional independent producer distribution
channel. Sales of annuities are affected by the financial strength ratings
assigned to our insurance subsidiaries by independent rating agencies. See
"Competition" below.
The following describes the major annuity products:
Equity-indexed annuity products. These products accounted for $220.1
million, or 5 percent, of our total premiums collected in 2002. The accumulation
value of these annuities is credited with interest at an annual minimum
guaranteed average rate over the term of the contract of 3 percent (or,
including the effect of applicable sales loads, a 1.7 percent compound average
interest rate over the term of the contracts), but the annuities provide for
potentially higher returns based on a percentage (the "participation rate") of
the change in the Standard & Poor's Corporation ("S&P") 500 Index during each
year of their term. The Company has the discretionary ability to annually change
the participation rate which currently ranges from 50 percent to 100 percent and
may include a first-year "bonus", similar to the bonus interest described below
for traditional fixed rate annuity products, which generally ranges from 10
percent to 30 percent. The minimum guaranteed values are equal to: (i) 90
percent of premiums collected for annuities for which premiums are received in a
single payment (single premium deferred annuities "SPDAs"), or 75 percent of
first year and 87.5 percent of renewal premiums collected for annuities which
allow for more than one payment (flexible premium deferred annuities "FPDAs");
plus (ii) interest credited on such percentage of the premiums collected at an
annual rate of 3 percent. The annuity provides for penalty-free withdrawals of
up to 10 percent of premium in each year after the first year of the annuity's
term. Other withdrawals from SPDA products are generally subject to a surrender
charge of 9 percent over the eight year contract term at which time the contract
must be renewed or withdrawn. Other withdrawals from FPDA products are subject
to a surrender charge of 12 percent to 20 percent in the first year, declining
1.2 percent to 1.3 percent each year, to zero over a 10 to 15 year period,
depending on issue age. We purchase S&P 500 Index Call Options ("S&P 500 Call
Options") in an effort to hedge potential increases to policyholder benefits
resulting from increases in the S&P 500 Index to which the product's return is
linked.
Other fixed rate annuity products. These products include SPDAs, FPDAs
(excluding the equity-indexed products) and single-premium immediate annuities
("SPIAs"). These products accounted for $872.7 million, or 18 percent, of our
total collected premiums in 2002. Our SPDAs and FPDAs typically have an interest
rate (the "crediting rate") that is guaranteed by the Company for the first
7
policy year, after which we have the discretionary ability to change the
crediting rate to any rate not below a guaranteed minimum rate. The guaranteed
rate on annuities written recently ranges from 3 percent to 4 percent, and the
rate on all policies inforce ranges from 3 percent to 6 percent. The initial
crediting rate is largely a function of: (i) the interest rate we can earn on
invested assets acquired with the new annuity fund deposits; (ii) the costs
related to marketing and maintaining the annuity products; and (iii) the rates
offered on similar products by our competitors. For subsequent adjustments to
crediting rates, we take into account the yield on our investment portfolio,
annuity surrender assumptions, competitive industry pricing and the crediting
rate history for particular groups of annuity policies with similar
characteristics.
Approximately 77 percent of our new annuity sales have been "bonus"
products. The initial crediting rate on these products specifies a bonus
crediting rate ranging from 1 percent to 6 percent of the annuity deposit for
the first policy year only. After the first year, the bonus interest portion of
the initial crediting rate is automatically discontinued, and the renewal
crediting rate is established. As of December 31, 2002, crediting rates on our
outstanding traditional annuities were at an average rate, excluding bonuses, of
4.3 percent.
The policyholder is typically permitted to withdraw all or part of the
premium paid plus the accumulated interest credited to his or her account (the
"accumulation value"), subject in virtually all cases to the assessment of a
surrender charge for withdrawals in excess of specified limits. Most of our
traditional annuities provide for penalty-free withdrawals of up to 10 percent
of the accumulation value each year, subject to limitations. Withdrawals in
excess of allowable penalty-free amounts are assessed a surrender charge during
a penalty period which generally ranges from five to 12 years after the date a
policy is issued. The initial surrender charge is generally 6 percent to 12
percent of the accumulation value and generally decreases by approximately 1 to
2 percentage points per year during the penalty period. Surrender charges are
set at levels to protect the Company from loss on early terminations and to
reduce the likelihood of policyholders terminating their policies during periods
of increasing interest rates. This practice is intended to lengthen the
effective duration of policy liabilities and enable the Company to maintain
profitability on such policies.
SPIAs accounted for $28.4 million, or .6 percent, of our total collected
premiums in 2002. SPIAs are designed to provide a series of periodic payments
for a fixed period of time or for life, according to the policyholder's choice
at the time of issue. Once the payments begin, the amount, frequency and length
of time for which they are payable are fixed. SPIAs often are purchased by
persons at or near retirement age who desire a steady stream of payments over a
future period of years. The single premium is often the payout from a terminated
annuity contract. The implicit interest rate on SPIAs is based on market
conditions when the policy is issued. The implicit interest rate on the
Company's outstanding SPIAs averaged 6.9 percent at December 31, 2002.
The Company also offers its multibucket annuity product which provides for
different rates of cash value growth based on the experience of a particular
market strategy. Earnings are credited to this product based on the market
activity of a given strategy, less management fees, and funds may be moved
between cash value strategies. Portfolios available include high-yield bond,
investment-grade bond, convertible bond and guaranteed-rate portfolios. During
2002, this product accounted for $40.0 million, or .8 percent, of our total
collected premiums.
As described above in "Other Information", in October 2002, we sold CVIC, a
company engaged in the variable annuity business. We no longer offer variable
annuity products.
Life
Life products include traditional, universal life and other life insurance
products. These products are currently sold through career agents, professional
independent producers and direct response marketing. During 2002, we collected
life insurance premiums of $637.0 million, or 13 percent, of our total collected
premiums from continuing lines of business. We have decided to take actions that
will de-emphasize new sales of life insurance products through professional
independent producers. These actions include eliminating certain products from
those offered by our insurance company subsidiaries. Sales of certain life
products are affected by the financial strength ratings assigned to our
insurance subsidiaries by independent rating agencies. See "Competition" below.
Interest-sensitive life products. These products include universal life
products that provide whole life insurance with adjustable rates of return
related to current interest rates. They accounted for $373.3 million, or 7.8
percent, of our total collected premiums in 2002 and are marketed through
professional independent producers and, to a lesser extent, career agents. The
principal differences between universal life products and other
interest-sensitive life insurance products are policy provisions affecting the
amount and timing of premium payments. Universal life policyholders may vary the
frequency and size of their premium payments, and policy benefits may also
fluctuate according to such payments. Premium payments under other
interest-sensitive policies may not be varied by the policyholders, and as a
result, are designed to reduce the administrative costs typically associated
with monitoring universal life premium payments and policy benefits.
8
Traditional life. These products accounted for $263.7 million, or 5.5
percent, of our total collected premiums in 2002. Traditional life policies,
including whole life, graded benefit life and term life products, are marketed
through professional independent producers, career agents and direct response
marketing. Under whole life policies, the policyholder generally pays a level
premium over an agreed period or the policyholder's lifetime. The annual premium
in a whole life policy is generally higher than the premium for comparable term
insurance coverage in the early years of the policy's life, but is generally
lower than the premium for comparable term insurance coverage in the later years
of the policy's life. These policies, which continue to be marketed by the
Company on a limited basis, combine insurance protection with a savings
component that gradually increases in amount over the life of the policy. The
policyholder may borrow against the savings generally at a rate of interest
lower than that available from other lending sources. The policyholder may also
choose to surrender the policy and receive the accumulated cash value rather
than continuing the insurance protection. Term life products offer pure
insurance protection for a specified period of time - typically 5, 10 or 20
years.
Traditional life products also include graded benefit life insurance
products. Graded benefit life products accounted for $152.4 million, or 3.2
percent, of our total collected premiums in 2002. Graded benefit life insurance
products are offered on an individual basis primarily to persons age 50 to 80,
principally in face amounts of $350 to $10,000, without medical examination or
evidence of insurability. Premiums are paid as frequently as monthly. Benefits
paid are less than the face amount of the policy during the first two years,
except in cases of accidental death. Graded benefit life policies are marketed
using direct response marketing techniques. New policyholder leads are generated
primarily from television and print advertisements.
Group Major Medical
Sales of our group major medical health insurance products are targeted to
self-employed individuals, small business owners, large employers and early
retirees. Various deductible and coinsurance options are available, and most
policies require certain utilization review procedures. The profitability of
this business depends largely on the overall persistency of the business
inforce, claim experience and expense management. During 2001, we decided to
discontinue a large block of major medical business by not renewing these
policies because this business was not profitable. During 2002, we collected
group major medical premiums of $315.6 million.
Finance Products
As described in Item 1. "Business of Conseco," we have agreed to sell our
finance business and it is being accounted for as a discontinued operation.
Manufactured Housing. CFC has historically provided financing for consumer
purchases of manufactured housing. During 2002, CFC originated $1.0 billion of
contracts for manufactured housing purchases, or 14 percent of its total
originations. A manufactured home is a structure, transportable in one or more
sections, designed to be a dwelling with or without a permanent foundation.
Manufactured housing does not include either modular housing (which typically
involves more sections, greater assembly and a separate means of transporting
the sections) or recreational vehicles. At December 31, 2002, CFC's managed
receivables included $23.0 billion of contracts for manufactured housing
purchases, or 65 percent of total managed receivables. On November 25, 2002, CFC
discontinued the origination of manufactured housing loans as a result of
funding constraints and the unprofitable nature of these loans in light of its
financial condition and prevailing market conditions at that time.
CFC had previously purchased manufactured housing contracts from dealers
located throughout the United States through its regional service centers.
Regional service center personnel solicited dealers in their region. If the
dealer wished to utilize CFC's financing, the dealer completed an application.
Upon approval, a dealer agreement was executed. CFC also originated manufactured
housing installment loan agreements directly with customers. For the year ended
December 31, 2002, 90 percent of CFC's manufactured housing loan originations
were purchased from dealers and 10 percent were originated directly by CFC.
CFC's manufactured housing contracts are secured by either the manufactured
home or, in the case of land-and-home contracts, by a lien on the manufactured
home and a lien on the real estate where the manufactured home is permanently
affixed. In 2002, approximately 25 percent of CFC's manufactured housing
originations were for land-and-home contracts. Customers who financed their
homes with CFC were required to make a minimum down payment of 5 percent. For
manufactured housing originations, the average loan-to-value ratio was
approximately 90 percent in 2002.
Customers' credit applications for new manufactured homes were reviewed in
CFC's service centers. If the application met CFC's guidelines, CFC generally
purchased the contract after the customer had moved into the manufactured home.
CFC used a proprietary automated credit scoring system to evaluate manufactured
housing credit applications. The scoring system is statistically based,
quantifying information using variables obtained from customer credit
applications and credit reports. CFC performed monthly audits on samples of new
loan originations to measure adherence to its underwriting policies and
procedures.
9
Mortgage Services. Products within this category include home equity and
home improvement loans. During 2002, CFC originated $2.5 billion of contracts
for these products, or 35 percent of its total originations. At December 31,
2002, CFC's managed receivables included $8.8 billion of contracts for home
equity and home improvement loans, or 25 percent of total managed receivables.
CFC originates home equity loans through 88 retail satellite offices and 3
regional centers, and through a network of correspondent and broker originators
throughout the United States. The retail offices are responsible for
originating, processing and funding the loan transaction. Underwriting of the
application is handled through central locations. Subsequently, loans are
re-underwritten on a test basis by a third party to ensure compliance with CFC's
credit policy. After the loan has closed, the loan documents are forwarded to
CFC's loan servicing center. The servicing center is responsible for handling
customer service and performing document handling, custodial, quality control,
collection and other servicing functions.
During 2002, approximately 92 percent of CFC's home equity finance loans
were originated directly with the borrower. The remaining finance volume was
originated through a few correspondent lenders. CFC has decreased the volume of
loans originated through the correspondent channel in recent years.
Typically, home equity loans are secured by first or second liens. Homes
used for collateral in securing home equity loans may be either residential or
investor owned, one-to-four-family properties. During 2002, approximately 83
percent of the loans originated were secured by first liens. The average loan to
value for loans originated in 2002 was approximately 88 percent. Approximately
70 percent of CFC's home equity loan originations during 2002 were fixed rate
closed-end loans. In March 2003, CFC discontinued the origination of home equity
loans and closed or will be closing all of its facilities that were dedicated to
the home equity business.
CFC originates the majority of its home improvement loan contracts
indirectly through a network of home improvement contractors located throughout
the United States. CFC reviews the financial condition, business experience and
qualifications of all contractors through which it obtains loans.
CFC finances conventional home improvement contracts generally secured by
first, second or, to a lesser extent, third liens on the improved real estate.
On a limited basis, CFC has also financed unsecured conventional home
improvement loans (generally from $2,500 to $15,000).
Typically, an approved contractor submits the customer's credit application
and construction contract to CFC's centralized service center where an analysis
of the creditworthiness of the customer is made using a proprietary credit
scoring system. If it is determined that the application meets CFC's
underwriting guidelines, CFC typically purchases the contract from the
contractor when the customer verifies satisfactory completion of the work.
CFC also originates home improvement loans directly with borrowers. After
receiving a mail solicitation, the customer calls CFC's telemarketing center and
a CFC sales representative explains the available financing plans, terms and
rates depending on the customer's needs. The majority of the loans are secured
by a second or third lien on the real estate of the customer. Direct
distribution accounted for approximately 3 percent of the home improvement loan
originations during 2002.
The types of home improvements CFC finances include exterior renovations
(such as windows, siding and roofing); pools and spas; kitchen and bath
remodeling; and room additions and garages. CFC may also extend additional
credit beyond the purchase price of the home improvement for the purpose of debt
consolidation.
Private Label Credit Card. During 2002, CFC originated $3.2 billion of
private label credit card receivables primarily through its bank subsidiaries,
or 44 percent of its total originations. At December 31, 2002, CFC's managed
receivables included $2.3 billion of contracts for credit card loans, or 6.4
percent of total managed receivables.
CFC originates private label credit card receivables through contractual
relationships with selected retailer and dealer partners. CFC's core
relationships are with retailers and dealers of home improvement products,
powersport vehicles (motorcycles, all-terrain-vehicles, snowmobiles and personal
watercraft) and outdoor power equipment.
CFC performs an initial review on all retailer and dealer partners as well
as periodic monitoring of their financial condition. Credit card applications
are generated primarily through retail and dealer outlets and the internet. CFC
utilizes a proprietary automated credit scoring system to review the credit of
individual customers seeking credit cards. CFC periodically monitors payment
behavior trends within its credit card portfolio through the use of automated
portfolio management tools. If CFC makes poor credit decisions with respect to
its partners and borrowers, it could have a material adverse effect on its
business.
10
ACQUISITIONS
Since 1982, Conseco has acquired 19 insurance groups and related businesses
and Green Tree Financial Corporation (renamed "Conseco Finance Corp.") These
acquisitions were responsible for the Company's growth in recent years. The
Company does not anticipate making additional acquisitions in the foreseeable
future, and is currently prohibited from doing so.
INVESTMENTS
Conseco Capital Management, Inc. ("CCM"), a registered investment adviser
and wholly-owned subsidiary of CNC, manages the investment portfolios of our
insurance subsidiaries. CCM had approximately $27.7 billion of assets (at fair
value) under management at December 31, 2002, of which $22.0 billion were assets
of CNC's subsidiaries, $3.8 billion were assets held by registered and
structured products and $1.9 billion were assets owned by other parties. Our
investment philosophy is to maintain a largely investment-grade fixed-income
portfolio, provide adequate liquidity for expected liability durations and other
requirements and maximize total return through active investment management. We
are subject to the risk that our investments will decline in value. This has
occurred in the past and may occur again. During 2002, we recognized net
realized investment losses of $597.0 million, compared to net realized
investment losses of $379.4 million during 2001. The net realized investment
losses during 2002 included: (i) $556.8 million of writedowns of fixed maturity
investments, equity securities and other invested assets as a result of
conditions which caused us to conclude a decline in fair value of the investment
was other than temporary; and (ii) $40.2 million of net losses from the sales of
investments (primarily fixed maturities) which generated proceeds of $19.5
billion. During 2002, we recognized other-than-temporary declines in value of
several of our investments including K-Mart Corp., Amerco, Inc., Global
Crossing, MCI Communications, Mississippi Chemical, United Airlines and
Worldcom, Inc.
Investment activities are an integral part of our business; investment
income is a significant component of our total revenues. Profitability of many
of our insurance products is significantly affected by spreads between interest
yields on investments and rates credited on insurance liabilities. Although
substantially all credited rates on SPDAs and FPDAs may be changed annually
(subject to minimum guaranteed rates), changes in crediting rates may not be
sufficient to maintain targeted investment spreads in all economic and market
environments. In addition, competition and other factors, including the impact
of the level of surrenders and withdrawals, may limit our ability to adjust or
to maintain crediting rates at levels necessary to avoid narrowing of spreads
under certain market conditions. As of December 31, 2002, the average yield,
computed on the cost basis of our investment portfolio, was 6.7 percent, and the
average interest rate credited or accruing to our total insurance liabilities
(excluding interest rate bonuses for the first policy year only and excluding
the effect of credited rates attributable to multi-bucket or equity-indexed
products) was 5.1 percent.
We manage the equity-based risk component of our equity-indexed annuity
products by: (i) purchasing S&P 500 Call Options in an effort to hedge such
risk; and (ii) adjusting the participation rate to reflect the change in the
cost of such options (such cost varies based on market conditions). Accordingly,
we are able to focus on managing the interest rate spread component of these
products.
We seek to balance the duration of our invested assets with the expected
duration of benefit payments arising from our insurance liabilities. At December
31, 2002, the adjusted modified duration of fixed maturities and short-term
investments was approximately 6.6 years and the duration of our insurance
liabilities was approximately 6.0 years.
For information regarding the composition and diversification of the
investment portfolio of our subsidiaries, see "Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations -
Investments" and the notes to our consolidated financial statements.
COMPETITION
Each of the markets in which we operate is highly competitive, and our
highly leveraged position and our recent bankruptcy filings have had a material
adverse impact on our ability to compete in these markets. The financial
services industry consists of a large number of companies, some of which are
larger and have greater capital, technological and marketing resources, access
to capital and other sources of liquidity at a lower cost, broader and more
diversified product lines and larger staffs than those of Conseco. An expanding
number of banks, securities brokerage firms and other financial intermediaries
also market insurance products or offer competing products, such as mutual fund
products, traditional bank investments and other investment and retirement
funding alternatives. We also compete with many of these companies and others in
providing services for fees. In most areas, competition is based on a number of
factors, including pricing, service provided to distributors and policyholders
and ratings. Conseco's subsidiaries must also compete with their competitors to
attract and retain the allegiance of dealers, vendors, contractors,
manufacturers, retailers and agents.
In the finance industry, operations are affected by consumer demand which
is influenced by regional trends, economic conditions and personal preferences.
Competition in the finance industry is primarily among finance companies,
commercial banks,
11
thrifts, other financial institutions, mortgage brokers, credit unions and
manufacturers and vendors. Competition is based on a number of factors,
including service, the credit review process, the integration of financing
programs and the ability to manage the servicing portfolio in changing economic
environments.
In the individual health insurance business, insurance companies compete
primarily on the basis of marketing, service and price. Pursuant to federal
regulations, the Medicare supplement products offered by all companies have
standardized policy features. This increases the comparability of such policies
and has intensified competition based on factors other than product features.
See "Insurance Underwriting" and "Governmental Regulation." In addition to the
products of other insurance companies, commercial banks, thrifts, mutual funds
and broker dealers, our insurance products compete with health maintenance
organizations, preferred provider organizations and other health care-related
institutions which provide medical benefits based on contractual agreements.
An important competitive factor for life insurance companies is the ratings
they receive from nationally recognized rating organizations. Agents, insurance
brokers and marketing companies who market our products and prospective
purchasers of our products use the ratings of our insurance subsidiaries as one
factor in determining which insurer's products to market or purchase. Ratings
have the most impact on our annuity and interest-sensitive life insurance
products. Insurance financial strength ratings are opinions regarding an
insurance company's financial capacity to meet the obligations of its insurance
policies in accordance with their terms. They are not directed toward the
protection of investors, and such ratings are not recommendations to buy, sell
or hold securities.
In July 2002, A.M. Best Company, a nationally recognized insurance company
ratings organization, lowered the financial strength ratings of our primary
insurance subsidiaries from "A- (Excellent)" to "B++ (Very good)" and placed the
ratings "under review with negative implications." In August 2002, A.M. Best
further downgraded the financial strength ratings of our primary insurance
subsidiaries to "B (Fair)". A.M. Best ratings for the industry currently range
from "A++ (Superior)" to "F (In Liquidation)" and some companies are not rated.
S&P has given our principal insurance subsidiaries a claims-paying ability
rating of "BB+ (Marginal)." These ratings have caused sales of our insurance
products to decline and policyholder redemptions and lapses to increase, which
has had a material adverse impact on our financial results. In some cases, the
ratings downgrades also caused defections among our sales force of agents and/or
increases in the commissions we had to pay to retain them. The effect of these
ratings downgrades is further discussed in the section of Management's
Discussion and Analysis of Financial Condition and Results of Operations
entitled "Consolidated Financial Condition."
A.M. Best and S&P each reviews its ratings from time to time. We cannot
provide any assurance that the ratings of our insurance subsidiaries will remain
at their current levels or predict the impact additional downgrades could have
on our business.
Conseco's leveraged condition and liquidity difficulties also severely
impacted the operations of CFC, which we have agreed to sell. For a more
complete discussion of the effect of our leveraged condition and liquidity
difficulties on CFC, see the section of Management's Discussion and Analysis of
Financial Condition and Results of Operations entitled "Results of the
Discontinued Finance Operations."
INSURANCE UNDERWRITING
Under regulations promulgated by the National Association of Insurance
Commissioners ("NAIC") (an association of state regulators and their staffs) and
adopted as a result of the Omnibus Budget Reconciliation Act of 1990, we are
prohibited from underwriting our Medicare supplement policies for certain
first-time purchasers. If a person applies for insurance within six months after
becoming eligible by reason of age, or disability in certain limited
circumstances, the application may not be rejected due to medical conditions.
Some states prohibit underwriting of all Medicare supplement policies. For other
prospective Medicare supplement policyholders, such as senior citizens who are
transferring to Conseco's products, the underwriting procedures are relatively
limited, except for policies providing prescription drug coverage.
Before issuing long-term care or comprehensive major medical products to
individuals and groups, we generally apply detailed underwriting procedures
designed to assess and quantify the insurance risks. We require medical
examinations of applicants (including blood and urine tests, where permitted)
for certain health insurance products and for life insurance products which
exceed prescribed policy amounts. These requirements are graduated according to
the applicant's age and may vary by type of policy or product. We also rely on
medical records and the potential policyholder's written application. In recent
years, there have been significant regulatory changes with respect to
underwriting individual and group major medical plans. An increasing number of
states prohibit underwriting and/or charging higher premiums for substandard
risks. We monitor changes in state regulation that affect our products, and
consider these regulatory developments in determining where we market our
products.
Most of our life insurance policies are underwritten individually, although
standardized underwriting procedures have been adopted for certain low
face-amount life insurance coverages. After initial processing, insurance
underwriters review each file and obtain the information needed to make an
underwriting decision (such as medical examinations, doctors' statements and
special
12
medical tests). After collecting and reviewing the information, the underwriter
either: (i) approves the policy as applied for, or with an extra premium charge
because of unfavorable factors; or (ii) rejects the application. We underwrite
group insurance policies based on the characteristics of the group and its past
claim experience. Graded benefit life insurance policies are issued without
medical examination or evidence of insurability. There is minimal underwriting
on annuities.
REINSURANCE
Consistent with the general practice of the life insurance industry, our
subsidiaries enter into both facultative and treaty agreements of indemnity
reinsurance with other insurance companies in order to reinsure portions of the
coverage provided by our insurance products. Indemnity reinsurance agreements
are intended to limit a life insurer's maximum loss on a large or unusually
hazardous risk or to diversify its risk. Indemnity reinsurance does not
discharge the original insurer's primary liability to the insured. The Company's
reinsured business is ceded to numerous reinsurers. We believe the assuming
companies are able to honor all contractual commitments, based on our periodic
review of their financial statements, insurance industry reports and reports
filed with state insurance departments.
As of December 31, 2002, the policy risk retention limit was generally $.8
million or less on the policies of our subsidiaries. Reinsurance ceded by
Conseco represented 27 percent of gross combined life insurance inforce and
reinsurance assumed represented 4.8 percent of net combined life insurance
inforce. At December 31, 2002, the total ceded business inforce of $26.4 billion
was primarily ceded to insurance companies rated "A- (Excellent)" or better by
A.M. Best. Our principal reinsurers at December 31, 2002 were American Founders
Life Insurance Company, General & Cologne Life Re of America, Lincoln National
Life Insurance Company, Munich American Reassurance Company, Reassure America
Life Insurance Company, RGA Reinsurance Company, Security Life of Denver Life
Insurance Company and Swiss Re Life and Health America Inc. No other single
reinsurer assumes greater than 4 percent of the total ceded business inforce.
In the first quarter of 2002, we completed a reinsurance agreement pursuant
to which we ceded 80 percent of the inforce traditional life business of our
subsidiary, Bankers Life & Casualty Company, to Reassure America Life Insurance
Company (rated A++ by A.M. Best). The total insurance liabilities ceded pursuant
to the contract were approximately $400 million. The reinsurance agreement and
the related dividends of $110.5 million were approved by the appropriate state
insurance departments and were paid to CNC. The ceding commission approximated
the amount of the cost of policies purchased and cost of policies produced
related to the ceded business.
On June 28, 2002, we completed a reinsurance transaction pursuant to which
we ceded 100 percent of the traditional life and interest-sensitive life
insurance business of our former subsidiary, CVIC, to Protective Life Insurance
Company (rated A+ by A.M. Best). The total insurance liabilities ceded pursuant
to the contract were approximately $470 million. CVIC, which was sold in the
fourth quarter of 2002, received a ceding commission of $49.5 million.
During the second quarter of 2002, one of our subsidiaries, Colonial Penn
Life Insurance Company (formerly known as Conseco Direct Life Insurance
Company), ceded a block of graded benefit life insurance policies to an
unaffiliated company pursuant to a modified coinsurance agreement. Our
subsidiary received a ceding commission of $83.0 million. The cost of policies
purchased and the cost of policies produced were reduced by $123.0 million and
we recognized a loss of $39.0 million related to the transaction.
EMPLOYEES
At December 31, 2002, Conseco, Inc. and its subsidiaries had approximately
10,400 employees, of which 10,100 are full time employees, including: (i) 4,300
employees supporting our insurance operations; (ii) 5,400 employees of CFC (a
discontinued operation we are in the process of selling); and (iii) 400
employees supporting our holding company and shared services. None of our
employees is covered by a collective bargaining agreement. We believe that we
have satisfactory relations with our employees.
GOVERNMENTAL REGULATION
Our insurance businesses and CFC's finance business are subject to
extensive regulation and supervision in the jurisdictions in which they operate.
This regulation and supervision is primarily for the benefit and protection of
customers, and not for the benefit of investors or creditors.
13
Insurance
Our insurance subsidiaries are subject to regulation and supervision by the
insurance regulatory agencies of the jurisdictions in which they transact
business. State laws generally establish supervisory agencies with broad
regulatory authority, including the power to: (i) grant and revoke business
licenses; (ii) regulate and supervise trade practices and market conduct; (iii)
establish guaranty associations; (iv) license agents; (v) approve policy forms;
(vi) approve premium rates for some lines of business; (vii) establish reserve
requirements; (viii) prescribe the form and content of required financial
statements and reports; (ix) determine the reasonableness and adequacy of
statutory capital and surplus; (x) perform financial, market conduct and other
examinations; (xi) define acceptable accounting principles; (xii) regulate the
type and amount of permitted investments; and (xiii) limit the amount of
dividends and of surplus debenture payments that can be paid without obtaining
regulatory approval. Because of limits on the payment of dividends and surplus
debenture payments from our insurance subsidiaries, not all of our consolidated
cash flows from operations are available to the parent company to service our
debt. Our insurance subsidiaries are subject to periodic examinations by state
regulatory authorities.
Since the announcement of our restructuring efforts on August 9, 2002, we
have been working closely with insurance regulators in each of the states in
which our insurance subsidiaries are domiciled (Arizona, Illinois, Indiana, New
York, Pennsylvania and Texas) in connection with their monitoring of the
operations and financial position of our insurance subsidiaries. The
Commissioner of Insurance for the State of Texas has acted as the lead regulator
among these states and has principally coordinated the oversight and monitoring
efforts associated with our financial restructuring.
On October 30, 2002, Bankers National Life Insurance Company and Conseco
Life Insurance Company of Texas (on behalf of itself and its subsidiaries), our
two insurance subsidiaries domiciled in Texas, each entered into consent orders
with the Commissioner of Insurance for the State of Texas whereby they agreed:
(i) not to request any dividends or other distributions before January 1, 2003
and, thereafter, not to pay any dividends or other distributions to parent
companies outside of the insurance system without the prior approval of the
Texas Insurance Commissioner; (ii) to continue to maintain sufficient
capitalization and reserves as required by the Texas Insurance Code; (iii) to
request approval from the Texas Insurance Commissioner before making any
disbursements not in the ordinary course of business; (iv) to complete any
pending transactions previously reported to the proper insurance regulatory
officials prior to and during Conseco's restructuring, unless not approved by
the Texas Insurance Commissioner; (v) to obtain a commitment from CNC and CIHC
to maintain their infrastructure, employees, systems and physical facilities
prior to and during Conseco's restructuring; and (vi) to continue to permit the
Texas Insurance Commissioner to examine its books, papers, accounts, records and
affairs. The consent orders do not prohibit the payment of fees in the ordinary
course of business pursuant to existing administrative, investment management
and marketing agreements with our non-insurance subsidiaries.
In addition to the limitations imposed by the laws described above and the
Texas consent orders, most states have also enacted laws or regulations with
respect to the activities of insurance holding company systems, including
acquisitions, the payment of ordinary and extraordinary dividends by insurance
companies, the terms of surplus debentures, the terms of transactions between
insurance companies and their affiliates and other related matters. Various
notice and reporting requirements generally apply to transactions between
insurance companies and their affiliates within an insurance holding company
system, depending on the size and nature of the transactions. These requirements
may include prior regulatory approval or prior notice for certain material
transactions. Currently, the Company and its insurance subsidiaries have
registered as holding company systems pursuant to such laws and regulations in
the domiciliary states of the insurance subsidiaries, and they routinely report
to other jurisdictions.
Most states have also enacted legislation or adopted administrative
regulations that affect the acquisition (or sale) of control of insurance
companies. The nature and extent of such legislation and regulations vary from
state to state. Generally, these regulations require an acquirer of control to
file detailed information concerning such acquirer and the plan of acquisition,
and to obtain administrative approval prior to the acquisition of control.
"Control" is generally defined as the direct or indirect power to direct or
cause the direction of the management and policies of a person and is rebuttably
presumed to exist if a person or group of affiliated persons directly or
indirectly owns or controls 10% or more of the voting securities of another
person.
The affiliated party transaction and change of control laws and regulations
described in the preceding two paragraphs may require notices to and/or prior
approvals by certain of our insurance regulators before our plan of
reorganization pursuant to Chapter 11 of the Bankruptcy Code may be consummated.
The regulators for Texas and Pennsylvania are requiring the Company to request
an exemption from the change of control laws and regulations. The Illinois
Department of Insurance, the New York Department of Insurance and the Indiana
Department of Insurance have each indicated that they are requiring an
application of a change in control. Such requests and filings have been or soon
will be made and the exemptions or required approvals are expected to be
obtained for all states concurrently with the other voting and confirmation
procedures required for our plan of reorganization. Arizona has not indicated
whether or not an exemption from the change in control application requirement
or a change of control application is required.
14
On the basis of statutory statements filed with state regulators annually,
the NAIC calculates certain financial ratios to assist state regulators in
monitoring the financial condition of insurance companies. A "usual range" of
results for each ratio is used as a benchmark. In the past, variances in certain
ratios of our insurance subsidiaries have resulted in inquiries from insurance
departments, to which we have responded. These inquiries have not led to any
restrictions affecting our operations.
In addition, the NAIC issues model laws and regulations, many of which have
been adopted by state insurance regulators, relating to: (i) investment reserve
requirements; (ii) risk-based capital ("RBC") standards; (iii) codification of
insurance accounting principles; (iv) additional investment restrictions; (v)
restrictions on an insurance company's ability to pay dividends; and (vi)
product illustrations.
The NAIC's Risk-Based Capital for Life and/or Health Insurers Model Act
(the "Model Act") provides a tool for insurance regulators to determine the
levels of statutory capital and surplus an insurer must maintain in relation to
its insurance and investment risks and whether there is a need for possible
regulatory attention. The Model Act provides four levels of regulatory
attention, varying with the ratio of the insurance company's total adjusted
capital (defined as the total of its statutory capital and surplus, asset
valuation reserve and certain other adjustments) to its authorized control level
RBC ("ACLRBC"): (i) if a company's total adjusted capital is less than or equal
to 200 percent but greater than 150 percent of its ACLRBC (the "Company Action
Level"), the company must submit a comprehensive plan to the regulatory
authority proposing corrective actions aimed at improving its capital position;
(ii) if a company's total adjusted capital is less than or equal to 150 percent
but greater than 100 percent of its ACLRBC (the "Regulatory Action Level"), the
regulatory authority will perform a special examination of the company and issue
an order specifying the corrective actions that must be followed; (iii) if a
company's total adjusted capital is less than or equal to 100 percent but
greater than 70 percent of its ACLRBC (the "Authorized Control Level"), the
regulatory authority may take any action it deems necessary, including placing
the company under regulatory control; and (iv) if a company's total adjusted
capital is less than or equal to 70 percent of its ACLRBC (the "Mandatory
Control Level"), the regulatory authority must place the company under its
control. In addition the Model Law provides for an annual trend test if a
company's total adjusted capital is between 200 percent and 250 percent of its
ACLRBC at the end of the year. The trend test calculates the greater of the
decrease in the margin of total adjusted capital over ACLRBC: (i) between the
current year and the prior year; and (ii) for the average of the last 3 years.
It assumes that such decrease could occur again in the coming year. Any company
whose trended total adjusted capital is less than 190 percent of its ACLRBC
would trigger a requirement to submit a comprehensive plan as described above
for the Company Action Level.
The 2002 statutory annual statements filed with the state insurance
regulators of each of our insurance subsidiaries reflected total adjusted
capital in excess of the levels subjecting the subsidiary to any regulatory
action. However, our ACLRBC ratios have declined significantly over the last
year and some of our subsidiaries are near the level which would require them to
submit a comprehensive plan aimed at improving their capital position.
The aggregate ACLRBC ratio for our insurance subsidiaries was 332 percent
at December 31, 2002, compared to 480 percent at December 31, 2001. The ratios
for our insurance subsidiaries that are subject to the four levels of regulatory
attention described above ranged from 250 percent (just above the trend test
level) to 563 percent. We are taking actions intended to improve the ACLRBC
ratios of our insurance subsidiaries. Such actions include: (i) discontinuing or
reducing sales of products that create initial reductions in statutory surplus
because of the costs of selling the products; (ii) reducing operating expenses;
(iii) merging some of our insurance subsidiaries with other insurance
subsidiaries; and (iv) restructuring our investment portfolio to better match
the risk profile of the portfolio with the insurance subsidiary's earnings and
capital requirements. We have discussed these actions with insurance regulators
in each of the states in which our insurance subsidiaries are domiciled. The
audited financial statements of our insurance subsidiaries generally are not
completed until around June 1 of each year (the date such audited financial
statements are generally required to be filed with state insurance departments).
Any significant audit adjustments to the financial statements of our insurance
subsidiaries resulting in a reduction in capital could cause the ACLRBC ratio of
one or more of our insurance subsidiaries to fall below the trend test level
requiring the trended total adjusted capital to be calculated. In addition, the
Company has been and will be discussing the appropriate statutory accounting
treatment for certain investments with the state insurance regulators. If the
ultimate outcome of these discussions resulted in adjustments to the December
31, 2002 statutory financial statements of our insurance subsidiaries, some of
our subsidiaries could be required to complete the trend test. If a trend test
were required for any of our subsidiaries, such a test would likely result in
trended total adjusted capital which is less than 190 percent of ACLRBC.
Our internal actuaries must annually render opinions concerning the
adequacy of our insurance reserves. Our actuaries rendered unqualified opinions
at December 31, 2002. Such opinions reference the Chapter 11 Cases and recent
downgrades of our insurance company ratings as being outside the scope of the
actuarial opinion, meaning that the actuaries did not believe it was appropriate
to calculate what impact, if any, such events would have on the life insurance
reserves. Regulators have raised the question as to whether or not such
references result in the actuarial opinions becoming qualified opinions. We
continue to believe the actuarial opinions are qualified opinions. If the
actuarial opinions were qualified opinions, more stringent rules would apply for
calculating ACLRBC which we believe would result in the ACLRBC for several of
our insurance subsidiaries falling below the trend test level.
15
The NAIC has adopted a revised manual of statutory accounting principles in
a process referred to as codification. These principles are summarized in the
Accounting Practices and Procedures Manual. The revised manual was effective
January 1, 2001. The domiciliary states of our insurance subsidiaries have
adopted the provisions of the revised manual or, with respect to some states,
adopted the manual with certain modifications. The revised manual has changed,
to some extent, prescribed statutory accounting practices and resulted in
changes to the accounting practices that our insurance subsidiaries use to
prepare their statutory-basis financial statements. The impact of these changes
increased our insurance subsidiaries' statutory-based capital and surplus by
approximately $198 million as of January 1, 2001.
The NAIC has adopted model long-term care policy language providing
nonforfeiture benefits and has proposed a rate stabilization standard for
long-term care policies. Various bills are proposed from time to time in the
U.S. Congress which would provide for the implementation of certain minimum
consumer protection standards for inclusion in all long-term care policies,
including guaranteed renewability, protection against inflation and limitations
on waiting periods for pre-existing conditions. Federal legislation permits
premiums paid for qualified long-term care insurance to be treated as
tax-deductible medical expenses and for benefits received on such policies to be
excluded from taxable income.
Our insurance subsidiaries are required under guaranty fund laws of most
states in which we transact business, to pay assessments up to prescribed limits
to fund policyholder losses or liabilities of insolvent insurance companies.
Assessments can be partially recovered through a reduction in future premium
taxes in some states.
Most states mandate minimum benefit standards and loss ratios for accident
and health insurance policies. We are generally required to maintain, with
respect to our individual long-term care policies, minimum anticipated loss
ratios over the entire period of coverage of not less than 60 percent. With
respect to our Medicare supplement policies, we are generally required to attain
and maintain an actual loss ratio, after three years, of not less than 65
percent. We provide to the insurance departments of all states in which we
conduct business annual calculations that demonstrate compliance with required
minimum loss ratios for both long-term care and Medicare supplement insurance.
These calculations are prepared utilizing statutory lapse and interest rate
assumptions. In the event that we fail to maintain minimum mandated loss ratios,
our insurance subsidiaries could be required to provide retrospective refunds
and/or prospective rate reductions. We believe that our insurance subsidiaries
currently comply with all applicable mandated minimum loss ratios.
NAIC model regulations, adopted in substantially all states, created 10
standard Medicare supplement plans (Plans A through J). Plan A provides the
least extensive coverage, while Plan J provides the most extensive coverage.
Under NAIC regulations, Medicare insurers must offer Plan A, but may offer any
of the other plans at their option. Our insurance subsidiaries currently offer
nine of the model plans. We have declined to offer Plan J, due in part to its
high benefit levels and, consequently, high costs to the consumer.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation, securities regulation, privacy laws and federal taxation, do affect
the insurance business. Legislation has been introduced from time to time in
Congress that could result in the federal government assuming some role in
regulating the companies or allowing combinations between insurance companies,
banks and other entities.
Numerous proposals to reform the current health care system (including
Medicare) have been introduced in Congress and in various state legislatures.
Proposals have included, among other things, modifications to the existing
employer-based insurance system, a quasi-regulated system of "managed
competition" among health plans, and a single-payer, public program. Changes in
health care policy could significantly affect our business. For example, Federal
comprehensive major medical or long-term care programs, if proposed and
implemented, could partially or fully replace some of Conseco's current
products.
During recent years, the health insurance industry has experienced
substantial changes, including those caused by healthcare legislation. Recent
federal and state legislation and legislative proposals relating to healthcare
reform contain features that could severely limit or eliminate our ability to
vary our pricing terms or apply medical underwriting standards with respect to
individuals which could have the effect of increasing our loss ratios and
adversely affecting our financial results. In particular, Medicare reform and
legislation concerning prescription drugs could affect our ability to price or
sell our products.
In addition, proposals currently pending in Congress and some state
legislatures may also affect our financial results. These proposals include the
implementation of minimum consumer protection standards for inclusion in all
long-term care policies, including: guaranteed premium rates; protection against
inflation; limitations on waiting periods for pre-existing conditions; setting
standards for sales practices for long-term care insurance; and guaranteed
consumer access to information about insurers, including lapse and replacement
rates for policies and the percentage of claims denied. Enactment of any of
these proposals could affect our financial results.
16
The United States Department of Health and Human Services has issued
regulations under the Health Insurance Portability and Accountability Act
("HIPAA") relating to standardized electronic transaction formats, code sets and
the privacy of member health information. These regulations and any
corresponding state legislation, will affect the Company's administration of
health insurance.
A number of states have passed or are considering legislation that would
limit the differentials in rates that insurers could charge for health care
coverages between new business and renewal business for similar demographic
groups. State legislation has also been adopted or is being considered that
would make health insurance available to all small groups by requiring coverage
of all employees and their dependents, by limiting the applicability of
pre-existing conditions exclusions, by requiring insurers to offer a basic plan
exempt from certain benefits as well as a standard plan, or by establishing a
mechanism to spread the risk of high risk employees to all small group insurers.
Congress and various state legislators have from time to time proposed changes
to the health care system that could affect the relationship between health
insurers and their customers, including external review. We cannot predict with
certainty the effect that any proposals, if adopted, or legislative developments
could have on our insurance businesses and operations.
The asset management activities of CCM are subject to federal and state
securities, fiduciary (including the Employee Retirement Income Security Act of
1974, as amended) and other laws and regulations. The SEC, the National
Association of Securities Dealers, state securities commissions and the
Department of Labor are the principal regulators of our asset management
operations.
Finance
CFC's finance operations are subject to regulation by certain federal and
state regulatory authorities. A substantial portion of CFC's consumer loans and
assigned sales contracts are originated or purchased by finance subsidiaries
licensed under applicable state law. The licensed entities are subject to
examination by and reporting requirements of the state administrative agencies
issuing such licenses. CFC's subsidiaries are subject to state laws and
regulations, which in certain states: (i) limit the amount, duration and charges
for such loans and contracts; (ii) require disclosure of certain loan terms and
regulate the content of documentation; (iii) place limitations on collection
practices; and (iv) govern creditor remedies. The licenses granted are renewable
and may be subject to revocation by the respective issuing authority for
violation of such state's laws and regulations. Some states have adopted or are
considering the adoption of consumer protection laws or regulations that impose
requirements or restrictions on lenders who make certain types of loans secured
by real estate.
In addition to the subsidiaries of CFC licensed under state law, Mill Creek
Bank and Retail Bank (both of which are wholly-owned subsidiaries of CFC), are
regulated and subject to examination by the Federal Deposit Insurance
Corporation. Mill Creek Bank is also regulated and examined by the Utah
Department of Financial Institutions. Retail Bank is regulated and examined by
the South Dakota Department of Banking. The ownership of these entities does not
subject CFC to regulation by the Federal Reserve Board as a bank holding
company. Mill Creek Bank has the authority to engage generally in the banking
business and may accept all types of deposits, other than demand deposits.
Retail Bank is limited by its charter to engage in the credit card business and
may issue only certificates of deposit in denominations of $100,000 or greater.
Mill Creek Bank and Retail Bank are subject to regulations relating to capital
adequacy, leverage, loans, loss reserves, deposits, consumer protection,
community reinvestment, payment of dividends and transactions with affiliates.
A number of states have usury and other consumer protection laws which may
place limitations on the amount of interest and other charges and fees charged
on loans originated in such state. Generally, state law has been preempted by
federal law under the Depositary Institutions Deregulation and Monetary Control
Act of 1980 ("DIDA") which deregulates the rate of interest, discount points and
finance charges with respect to first lien residential loans, including
manufactured home loans and real estate secured mortgage loans. As permitted
under DIDA, a number of states enacted legislation timely opting out of coverage
of either or both of the interest rate and/or finance charge provisions of the
DIDA. States may no longer opt out of the interest rate provisions of the DIDA,
but could in the future opt out of the finance charge provisions. To be eligible
for federal preemption for manufactured home loans, CFC's licensed finance
subsidiaries must comply with certain restrictions providing protection to
consumers. In addition, another provision of DIDA applicable to state-chartered
insured depository institutions permits both Mill Creek Bank and Retail Bank to
export interest, finance charges and certain fees from the states where they are
located to all other states, with the exception of Iowa which opted out of the
DIDA during the permitted time period. Interest, finance charges and fees in
Utah and South Dakota are, for the most part, unregulated.
CFC's operations are subject to regulation under other applicable federal
laws and regulations, the more significant of which include: the Truth in
Lending Act ("TILA"); the Equal Credit Opportunity Act ("ECOA"); the Fair Credit
Reporting Act ("FCRA"); the Real Estate Settlement and Procedures Act ("RESPA");
the Home Mortgage Disclosure Act ("HMDA"); the Home Owner Equity Protection Act
("HOEPA"); and certain rules and regulations of the Federal Trade Commission
("FTC Rules").
17
The TILA and related regulations require certain disclosures designed to
provide consumers with uniform, understandable information with respect to the
terms and conditions of extensions of credit and the ability to compare credit
terms. The TILA also provides consumers with certain substantive protection such
as a three day right to cancel certain credit transactions, including certain of
the loans originated by CFC.
The ECOA requires certain disclosures to applicants for credit regarding
information that is used as a basis for denial of credit and prohibits
discrimination against applicants on the basis of sex, race, color, religion,
national origin, age, marital status, derivation of income from a public
assistance program or the good faith exercise of a right under the TILA. The
ECOA also requires that notices be given to applicants who are denied credit.
The FCRA regulates the process of obtaining, using and reporting of credit
information on consumers. The FCRA also regulates the use of credit information
among affiliates.
The RESPA regulates the disclosure of information to consumers on loans
involving a mortgage on real estate. The RESPA and related regulations also
govern payment for and disclosure of payments for settlement services in
connection with mortgage loans and prohibits the payment of fees for the
referral of a loan.
The HMDA requires reporting of certain information to the Department of
Housing and Urban Development, including the race and sex of applicants in
connection with mortgage loan applications. A lender is required to obtain and
report such information if the application is made in person, but is not
required to obtain such information if the application is taken over the
telephone.
The HOEPA provides for additional disclosure and regulation of certain
consumer mortgage loans which are defined as "covered loans". A covered loan is
a mortgage loan (other than a mortgage loan to finance the initial purchase of a
dwelling, a reverse mortgage transaction, or an open-end credit plan) which: (i)
has total origination fees in excess of the greater of eight percent of the loan
amount, or $488; or (ii) has an annual percentage interest rate that is more
than ten percent higher than comparably maturing United States treasury
obligations for second mortgage loans or has an annual percentage interest rate
that is more than eight percent higher than comparably maturing United States
treasury obligations for first mortgage loans. A number of CFC's home equity and
home improvement loans meet the requirements to be considered covered loans.
The FTC Rules provide, among other things, that in connection with the
purchase of consumer sales finance contracts from dealers, the holder of the
contract is subject to all claims and defenses which the consumer could assert
against the dealer. However, the consumer's recovery under such provisions
cannot exceed the amount paid under the sales contract.
In the judgment of the management of CFC, existing federal and state law
and regulations have not had a material adverse effect on CFC's operations. It
is possible that more restrictive laws, rules or regulations will be adopted in
the future and will place additional burdens on CFC.
CFC's commercial lending operations are not subject to material regulation
in most states, although certain states do require licensing. In addition,
certain provisions of the ECOA apply to commercial loans to small businesses.
CFC has designed internal controls to manage the risks associated with its
finance activities. However, there is a risk that one or more employees will
circumvent these controls, as has occurred at other financial institutions.
FEDERAL INCOME TAXATION
The annuity and life insurance products marketed and issued by our
insurance subsidiaries generally provide the policyholder with an income tax
advantage, as compared to other savings investments such as certificates of
deposit and bonds, in that income taxation on the increase in value of the
product is deferred until it is received by the policyholder. With other savings
investments, the increase in value is taxed as earned. Annuity benefits and life
insurance benefits, which accrue prior to the death of the policyholder, are
generally not taxable until paid. Life insurance death benefits are generally
exempt from income tax. Also, benefits received on immediate annuities (other
than structured settlements) are recognized as taxable income ratably, as
opposed to the methods used for some other investments which tend to accelerate
taxable income into earlier years. The tax advantage for annuities and life
insurance is provided in the Internal Revenue Code (the "Code"), and is
generally followed in all states and other United States taxing jurisdictions.
In addition, the interest paid on home equity and home improvement loans by
customers of CFC are generally tax deductible for individuals who itemize their
tax deductions.
Recently, Congress enacted legislation to lower marginal tax rates, reduce
the federal estate tax gradually over a ten-year period, with total elimination
of the federal estate tax in 2010, and increase contributions that may be made
to individual retirement accounts and 401(k) accounts. While these tax law
changes will sunset at the beginning of 2011 absent future congressional action,
they could in the interim diminish the appeal of our annuity and life insurance
products. Additionally, Congress has considered, from
18
time to time, other possible changes to the U.S. tax laws, including elimination
of the tax deferral on the accretion of value within certain annuities and life
insurance products. It is possible that further tax legislation will be enacted
which would contain provisions with possible adverse effects on our annuity and
life insurance products.
Our insurance company subsidiaries are taxed under the life insurance
company provisions of the Code. Provisions in the Code require a portion of the
expenses incurred in selling insurance products to be deducted over a period of
years, as opposed to immediate deduction in the year incurred. This provision
increases the tax for statutory accounting purposes, which reduces statutory
earnings and surplus and, accordingly, decreases the amount of cash dividends
that may be paid by the life insurance subsidiaries.
In certain securitization transactions historically used by CFC, a special
tax structure was used referred to as a Real Estate Mortgage Investment Conduit
("REMIC"). When this tax structure was used, CFC was required to account for the
transfer of the finance receivables into the securitization trust as a sale
(even when such transfers were accounted for as collateralized borrowings
pursuant to generally accepted accounting principles ("GAAP")). Additionally,
since CFC retained the residual interests of the REMIC, the REMIC tax rules
require CFC to pay a minimum amount of tax each year based on the taxable income
of the retained residual interest.
At December 31, 2002, Conseco had net federal income tax loss carryforwards
of $1,757.4 million available (subject to various statutory restrictions) for
use on future tax returns (including $552.4 million of federal income tax
carryforwards attributable to discontinued operations). These carryforwards will
expire as follows: $2.3 million in 2003; $11.2 million in 2004, $4.9 million in
2005; $.6 million in 2006; $7.9 million in 2007; $7.5 million in 2008; $14.7
million in 2009; $30.7 million in 2010; $6.2 million in 2011; $10.1 million in
2012; $43.9 million in 2013; $6.9 million in 2014; $60.5 million in 2016; $90.0
million in 2017; $244.6 million in 2018; $159.1 million in 2019; $594.3 million
in 2020; and $462.0 million in 2022. The following restrictions exist with
respect to the utilization of portions of the loss carryforwards: (i) $145.2
million attributable to certain acquired companies may be used only to offset
the taxable income of those companies; and (ii) $1,612.2 million is available to
offset income from certain life insurance subsidiaries and other non-life
insurance subsidiaries.
The Company is currently in bankruptcy and expects to restructure and
emerge from bankruptcy. As a result of the restructuring that is expected to
occur upon the anticipated emergence from bankruptcy, the aggregate outstanding
indebtedness will be substantially reduced. The cancellation of the indebtedness
is expected to result in the realization of cancellation of indebtedness income
("COD Income"). The COD Income will not be recognized as taxable income because
the Company is under the jurisdiction of a court in a Title 11 bankruptcy
proceeding. Instead, as a consequence of such exclusion from taxable income, the
Company must reduce its tax attributes by the amount of COD Income, which it
excluded from taxable income. Tax attributes are reduced in the following order:
(i) net operating loss carryforwards ("NOLs"); (ii) tax credits and capital loss
carryforwards; and (iii) tax basis in assets. Although it is expected that a
reduction of tax attributes will be required, because the determination of the
COD Income is dependent upon the fair market value of the various debt and
capital instruments at the Effective Date, the exact amount of the reduction
cannot be predicted.
The restructuring will be accomplished by the formation of a new company
("New Conseco"), which will issue new debt, preferred stock and common stock, in
exchange for substantially all of the assets of the Company. The Company intends
to accomplish this transaction as a reorganization described in Code Section 368
(a)(1)(G) ("G Reorganization"). Assuming that the restructuring constitutes a G
Reorganization, the Company will recognize no gain or loss with respect to such
transactions to effect the G Reorganization, the Company's taxable year will
close on the date the Company emerges from bankruptcy (the "Effective Date") and
New Conseco will begin a new taxable year on the day after the Effective Date,
and all of the Company's tax attributes existing on the Effective Date,
including NOLs and other loss and credit carryovers will be transferred to New
Conseco as of the close of the Effective Date.
Any NOLs and other loss and credit carryovers transferred to New Conseco
will be limited under the Code to a maximum amount in any one year. This amount
is equal to the product of the fair market value of the loss corporation's
outstanding stock immediately before the ownership change and the long term
tax-exempt rate (which is published monthly by the Treasury Department and most
recently was approximately 4.61 percent) in effect for the month in which the
ownership change occurs. This amount will not be known until the Effective Date.
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting and tax bases of assets
and liabilities and NOLs. In assessing the realization of our deferred income
tax assets, we consider whether it is more likely than not that the deferred
income tax assets will be realized. The ultimate realization of our deferred
income tax assets depends upon generating future taxable income during the
periods in which our temporary differences become deductible and before our NOLs
expire.
A valuation allowance of $1.7 billion (of which $.9 billion relates to
discontinued operations) has been provided for the entire balance of net
deferred income tax assets at December 31, 2002, as we believe the realization
of such assets in future periods is
19
uncertain. We reached this conclusion after considering the availability of
taxable income in prior carryback years, tax planning strategies, and the
likelihood of future taxable income exclusive of reversing temporary differences
and carryforwards.
ITEM 2. PROPERTIES.
Headquarters. Our headquarters is located on a Company-owned 168-acre
corporate campus in Carmel, Indiana, immediately north of Indianapolis. The ten
buildings on the campus contain approximately 854,500 square feet of space and
house Conseco's executive offices and certain administrative operations of its
subsidiaries. Management believes that Conseco's offices are adequate for its
current needs. Some of our properties are or soon may be available for sale or
lease.
Insurance operations. Our professional independent producer distribution
channel operations are administered from our Carmel, Indiana headquarters. Our
career agent operations are primarily administered from a single facility of
300,000 square feet in downtown Chicago, Illinois, leased under an agreement
whereby 107,000 square feet is leased until 2018; 70,000 square feet is leased
until 2008; and the remaining 123,000 square feet is leased through November
2003. We also lease approximately 130,000 square feet of warehouse space in a
second Chicago facility; this lease has a remaining life of approximately 11
months. Conseco owns an office building (currently listed for sale) in Rockford,
Illinois (total of 44,400 square feet), which served as an administrative center
for portions of our insurance operations. Conseco owns an office building in
Philadelphia, Pennsylvania (127,000 square feet), which serves as the
administrative center for our direct response life insurance operations;
approximately 60 percent of this space is occupied by the Company, with the
remainder leased to tenants. Conseco also leases 215 sales offices in various
states totaling approximately 507,000 square feet; these leases are short-term
in length, with remaining lease terms ranging from six months to five years.
Finance operations. CFC is headquartered in St. Paul, Minnesota in a
CFC-owned building (110,000 square feet of which is occupied by CFC). CFC leases
additional space in downtown St. Paul (185,000 square feet), which is used by
its mortgage services, manufactured housing and private credit card divisions.
CFC owns a building in Rapid City, South Dakota (137,000 square feet), which is
used by its manufactured housing, private label credit card and retail bank
servicing units. CFC also leases buildings in Tempe, Arizona (200,000 square
feet) and Atlanta, Georgia (48,000 square feet) which serve as collection and
service centers. CFC had previously leased an additional 75,000 square feet in
Rapid City, South Dakota, and 48,000 square feet in Atlanta, Georgia, however
CFC rejected these leases in its bankruptcy proceedings in January 2003. CFC
leases 31 regional manufactured housing division offices and 88 mortgage
services branch offices across the United States; the lease terms generally
range from one to five years.
ITEM 3. LEGAL PROCEEDINGS.
As described in Item 1. "Business of Conseco", CNC and several of its
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the Bankruptcy Code in the Bankruptcy Court. The Company's insurance
subsidiaries and other subsidiaries who did not file petitions are separate
legal entities and are not included in the petitions filed by the parent. The
Debtors retain control of the insurance subsidiaries and related subsidiaries
and are authorized to operate these businesses as debtors-in-possession while
being subject to the jurisdiction of the Bankruptcy Court. The Finance Company
Debtors filed a separate plan in connection with their Chapter 11 Cases on April
2, 2003. As of the Petition Date, pending litigation against the Debtors or the
Finance Company Debtors is stayed, and absent further order of the Bankruptcy
Court, substantially all prepetition liabilities of the Debtors and the Finance
Company Debtors are subject to settlement under a plan of reorganization. Based
on the Plan of the Debtors, liabilities subject to compromise exceed the fair
value of the Debtors' assets, and most unsecured claims will be satisfied at
less than 100 percent of their fair value.
We and our subsidiaries are involved on an ongoing basis in lawsuits
(including purported class actions) relating to our operations, including with
respect to sales practices, and we and current and former officers and directors
are defendants in pending class action lawsuits asserting claims under the
securities laws and derivative lawsuits. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
Legal Proceedings Related to CFC Only
CFC was served with various related lawsuits filed in the United States
District Court for the District of Minnesota. These lawsuits were generally
filed as purported class actions on behalf of persons or entities who purchased
common stock or options to purchase common stock of CFC during alleged class
periods that generally run from July 1995 to January 1998. One action (Florida
State Board of Admin. v. Green Tree Financial Corp., et. al, Case No. 98-1162)
was brought not on behalf of a class, but by the Florida State Board of
Administration, which invests and reinvests retirement funds for the benefit of
state employees. In addition to CFC, certain former officers and directors of
CFC are named as defendants in one or more of the lawsuits. CFC and other
defendants obtained an order consolidating the lawsuits seeking class action
status into two actions, one of which pertains to a purported class of common
stockholders (In re Green Tree Financial Corp. Stock Litig., Case No. 97-2666)
and the other of which pertains to a purported class of stock option traders (In
re Green Tree Financial Corp. Options Litig., Case No. 97-2679). Plaintiffs in
the lawsuits
20
assert claims under Sections 10(b) (and Rule 10b-5 promulgated thereunder) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that CFC and the other defendants violated federal securities laws by, among
other things, making false and misleading statements about the current state and
future prospects of CFC (particularly with respect to prepayment assumptions and
performance of certain loan portfolios of CFC), which allegedly rendered CFC's
financial statements false and misleading. On August 24, 1999, the United States
District Court for the District of Minnesota issued an order dismissing with
prejudice all claims alleged in the lawsuits. The plaintiffs subsequently
appealed the decision to the U.S. Court of Appeals for the 8th Circuit. A three
judge panel issued an opinion on October 25, 2001, reversing the United States
District Court's dismissal order and remanding the actions to the United States
District Court. The parties to these lawsuits have entered into a stipulation of
settlement, which is subject only to review and approval by the court.
CFC is a defendant in two arbitration proceedings in South Carolina (Lackey
v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp. and Bazzle v.
Green Tree Financial Corporation, n/k/a Conseco Finance Corp.) where the
arbitrator, over CFC's objection, allowed the plaintiffs to pursue purported
class action claims in arbitration. The two purported arbitration classes
consist of South Carolina residents who obtained real estate secured credit from
CFC's Manufactured Housing Division (Lackey) and Home Improvement Division
(Bazzle) in the early and mid 1990s, and did not receive a South Carolina
specific disclosure form relating to selection of attorneys and insurance agents
in connection with the credit transactions. The arbitrator, in separate awards
issued on July 24, 2000, awarded a total of $26.8 million in penalties and
attorneys' fees. The awards were confirmed as judgments in both Lackey and
Bazzle. These cases were consolidated into one case, and CFC appealed them to
the South Carolina Supreme Court. Oral argument was heard on March 21, 2002. On
August 26, 2002 the South Carolina Supreme Court affirmed the arbitration
judgments, and CFC filed a petition for writ of certiorari with the U.S. Supreme
Court on October 23, 2002. CFC's petition was granted in January 2003, and the
U.S. Supreme Court will hear oral argument on April 22, 2003. CFC has posted
appellate bonds, including $23 million of cash, for these cases. CFC intends to
challenge the awards vigorously and believes that the arbitrator erred by, among
other things, conducting class action arbitrations without the authority to do
so. The ultimate outcome of this proceeding cannot be predicted with certainty.
Securities Litigation
A total of forty-five suits were filed in 2000 against CNC in the United
States District Court for the Southern District of Indiana. Nineteen of these
cases were putative class actions on behalf of persons or entities that
purchased CNC's common stock during alleged class periods that generally run
from April 1999 through April 2000. Two cases were putative class actions on
behalf of persons or entities that purchased CNC's bonds during the same alleged
class periods. Three cases were putative class actions on behalf of persons or
entities that purchased or sold option contracts, not issued by CNC, on CNC's
common stock during the same alleged class periods. One case was a putative
class action on behalf of persons or entities that purchased CNC's "FELINE
PRIDES" convertible preferred stock instruments during the same alleged class
periods. With four exceptions, in each of these twenty-five cases two former
officers/directors of CNC were named as defendants. In each case, the plaintiffs
asserted claims under Sections 10(b) (and Rule 10b-5 promulgated thereunder) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs alleged
that CNC and the individual defendants violated the federal securities laws by,
among other things, making false and misleading statements about the current
state and future prospects of CFC (particularly with respect to performance of
certain loan portfolios of CFC) which allegedly rendered CNC's financial
statements false and misleading.
Eleven of the cases in the United States District Court for the Southern
District of Indiana were filed as purported class actions on behalf of persons
or entities that purchased preferred securities issued by various Conseco
Financing Trusts, including Conseco Financing Trust V, Conseco Financing Trust
VI, and Conseco Financing Trust VII. Each of these complaints named as
defendants CNC, the relevant trust (with two exceptions), two former
officers/directors of CNC, and underwriters for the particular issuance (with
one exception). One complaint also named an officer and all of CNC's directors
at the time of issuance of the preferred securities by Conseco Financing Trust
VII. In each case, plaintiffs asserted claims under Section 11 and Section 15 of
the Securities Act of 1933, and eight complaints also asserted claims under
Section 12(a)(2) of that Act. Two complaints also asserted claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and one complaint also
asserted a claim under Section 10(b) of that Act. In each case, plaintiffs
alleged that the defendants violated the federal securities laws by, among other
things, making false and misleading statements in Prospectuses and/or
Registration Statements related to the issuance of preferred securities by the
Trust involved regarding the current state and future prospects of CFC
(particularly with respect to performance of certain loan portfolios of CFC)
which allegedly rendered the disclosure documents false and misleading.
All of the CNC securities cases were consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Securities Litigation", Case number IP00-C585-Y/S (the
"securities litigation"). An amended complaint was filed on January 12, 2001,
which asserted claims under Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933,
with respect to common stock and various other securities issued by CNC and
Conseco Financing Trust VII. The Company filed a motion to dismiss the amended
complaint on April 27, 2001. On January 10, 2002, CNC entered into a Memorandum
of Understanding (the "MOU") to settle the litigation for $120 million subject
to court approval. Under the MOU, as amended on February 12, 2002, $106 million
was required to be placed in
21
escrow by March 8, 2002; the remaining $14 million was to be paid in two
installments: $6 million by April 1, 2002, and $8 million by October 1, 2002
(all payments with interest from January 25, 2002). The $106 million due on
March 8, 2002, was not paid, for reasons set forth in the following paragraph,
and the MOU was terminated by the plaintiffs. On April 15, 2002, a new MOU was
executed (the "April 15 MOU"). Pursuant to the April 15 MOU, $95 million was
funded on April 25, 2002, with the remaining $25 million to await the outcome of
the coverage litigation between CNC and certain of its directors' and officers'
liability insurance carriers as described in the next paragraph. Court approval
of the settlement was received on August 7, 2002.
We maintained certain directors' and officers' liability insurance that was
in force at the time the Indiana securities and derivative litigation (the
derivative litigation is described below) was commenced and which, in our view,
applies to the claims asserted in that litigation. The insurers denied coverage
for those claims, so we commenced a lawsuit against them on June 13, 2001, in
Marion County Circuit Court in Indianapolis, Indiana (Conseco, Inc., et al. v.
National Union Fire Insurance Company of Pittsburgh, PA, Royal & SunAlliance,
Westchester Fire Insurance Company, RLI Insurance Company, Greenwich Insurance
Company and Certain Underwriters at Lloyd's of London, Case No.
49C010106CP001467) (the "coverage litigation") seeking, among other things, a
judicial declaration that coverage for those claims exists. The primary
insurance carrier, National Union Fire Insurance Co. of Pittsburgh, PA, has paid
its full $10 million in policy proceeds toward the settlement of the securities
litigation; in return, National Union has been released from the coverage
litigation. The first excess insurance carrier, Royal & SunAlliance ("Royal"),
has paid its full $15 million in policy proceeds toward the settlement, but
reserved rights to continue to litigate coverage. Royal subsequently asserted
counterclaims seeking repayment of the $15 million it previously provided to CNC
as part of the settlement. The second excess insurance carrier, Westchester Fire
Insurance Company, has paid its full $15 million in policy proceeds toward the
settlement without a reservation of rights and has been released from the
coverage litigation. The third excess insurance carrier, RLI Insurance Company
("RLI"), has paid its full $10 million in policy proceeds toward the settlement,
but initially reserved rights to continue to litigate coverage. RLI has
subsequently settled (for $50,000 paid by certain of the individual insureds as
partial payment of RLI's attorneys' fees incurred in the coverage litigation),
and RLI is no longer continuing to dispute coverage. The fourth excess insurance
carrier, Greenwich Insurance Company ("Greenwich"), has paid its full $25
million in policy proceeds toward the settlement without a reservation of rights
and has been released from the coverage litigation. The final excess carrier,
Certain Underwriters at Lloyd's of London ("Lloyd's"), refused to pay or to
escrow its $25 million in policy proceeds toward the settlement and is
continuing to litigate coverage. Under the April 15 MOU, the settlement of the
securities litigation will proceed notwithstanding the continuing coverage
litigation between CNC, Royal and Lloyd's. Since the United States District
Court for the Southern District of Indiana has approved the settlement of the
securities litigation prior to resolution of the coverage litigation, $90
million plus accrued interest is available for distribution to the putative
class. The remaining funds, with interest, will be distributed at the conclusion
of the coverage litigation (or, in the case of the $25 million at issue in the
litigation with Lloyd's, on December 31, 2005, if the litigation with Lloyd's
has not been resolved by that date), with such funds coming either from Lloyd's
(if CNC prevails in the coverage litigation) or from CNC (if CNC does not
prevail). We intend to pursue our coverage rights vigorously. Because the
directors' and officers' liability insurance that was in force at the time the
litigation commenced provides for coverage of $100 million, CNC believes its
exposure in the litigation should be $20 million (i.e., the excess of the $100
million in coverage). CNC believes that the insurance applies to the claims in
the securities litigation and that the two insurers who are continuing to
litigate the coverage issue were obligated to pay their policy limits to fund
the settlement, as the other four carriers have done. We recorded $20 million as
our best estimate of a probable loss in 2001. Such amount has been placed in
escrow. We also previously established the estimated remaining liability of $40
million and a claim receivable of $40 million. Such amount includes: (i) $15
million related to Royal who paid its portion of the settlement into a fund but
reserved its rights to continue to litigate coverage (which litigation is
proceeding); and (ii) $25 million related to Lloyd's who has refused to pay.
Following the filing of our Chapter 11 Case, the trial court granted Lloyd's
motion to dismiss our lawsuit resulting in our decision to establish an
allowance for the entire $40 million claim receivable CNC believes is due from
Royal and Lloyd's. We intend to appeal the decision to dismiss in part because
we believe the decision violates the stay in the Chapter 11 Case. CNC believes
that the coverage litigation should result in a determination that the insurer
that paid under a reservation of rights has no right to recoup the payment that
it made, and that the insurer that refused to pay is obligated to do so under
its policy. We believe the latter insurer should pay its portion of the coverage
once such determination is made. The ultimate outcome cannot be predicted with
certainty. CNC is also pursuing settlement discussions with Royal and Lloyd's.
In the event that CNC does not reach settlement and does not prevail in the
coverage litigation, it will seek to subordinate the securities plaintiffs'
claims under section 510 of the Bankruptcy Code, or disallow such claims under
sections 502(d) and 547 of the Bankruptcy Code, in which case CNC may not be
required to pay the portion of the settlement not covered by its directors' and
officers' liability insurance. CNC has asked the Bankruptcy Court to stay the
Indiana state court action, and the Bankruptcy Court is scheduled to hear that
motion on May 19, 2003.
Since we announced our intention to restructure our capital on August 9,
2002, a total of eight purported securities fraud class action lawsuits have
been filed in the United States District Court for the Southern District of
Indiana. The complaints name CNC as a defendant, along with certain current and
former officers of CNC. These lawsuits were filed on behalf of persons or
entities who purchased CNC's common stock on various dates between October 24,
2001 and August 9, 2002. In each case Plaintiffs allege claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and allege material
omissions and dissemination of materially misleading statements regarding, among
other things, the liquidity of CNC and alleged problems in CFC's manufactured
housing division, allegedly resulting in the artificial inflation of CNC's stock
price. Plaintiffs in one of these lawsuits have filed an
22
uncontested consolidation and lead plaintiff motion, which, if granted, would
result in the consolidation of these eight cases into one. On March 13, 2003,
all of these cases were consolidated into one case in the United States District
Court for the Southern District of Indiana, captioned "Franz Schleicher, et al.
v. Conseco, Inc., et al.," File No. 02-CV-1332 DFH-TAB. CNC believes these
lawsuits are without merit and intends to defend them vigorously. The ultimate
outcome of these lawsuits cannot be predicted with certainty. CNC has filed an
adversary proceeding to extend the automatic stay provided for by the Bankruptcy
Code to this litigation as it pertains to current and former officers and
directors of CNC.
In October 2002, Roderick Russell, on behalf of himself and a class of
persons similarly situated, and on behalf of the ConsecoSave Plan filed an
action in the United States District Court for the Southern District of Indiana
against CNC, Conseco Services LLC and certain current and former officers of CNC
(Roderick Russell, et al. v Conseco, Inc., et al., Case No. 1:02-CV-1639 LJM).
The purported class action consists of all individuals whose 401(k) accounts
held common stock of CNC at any time from April 28, 1999 through the present.
The complaint alleges, among other things, breaches of fiduciary duties under
ERISA by continuing to permit employees to invest in CNC's common stock without
full disclosure of the Company's true financial condition. CNC believes the
lawsuit is without merit and intends to defend it vigorously. The ultimate
outcome of the lawsuit cannot be predicted with certainty. CNC has filed an
adversary proceeding to extend the automatic stay provided for by the Bankruptcy
Code to this litigation as it pertains to current and former officers and
directors of CNC.
Derivative Litigation
Nine shareholder derivative suits were filed in 2000 in the United States
District Court for the Southern District of Indiana. The complaints named as
defendants the current directors, certain former directors, certain non-director
officers of CNC (in one case), and, alleging aiding and abetting liability,
certain banks that allegedly made loans in relation to CNC's "Stock Purchase
Plan" (in three cases). CNC is also named as a nominal defendant in each
complaint. Plaintiffs allege that the defendants breached their fiduciary duties
by, among other things, intentionally disseminating false and misleading
statements concerning the acquisition, performance and proposed sale of CFC, and
engaged in corporate waste by causing CNC to guarantee loans that certain
officers, directors and key employees of CNC used to purchase stock under the
Stock Purchase Plan. These cases have now been consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Derivative Litigation", Case Number IP00655-C-Y/S. An
amended complaint was filed on April 12, 2001, making generally the same
allegations and allegations of violation of the Federal Reserve Board's margin
rules. Three similar cases have been filed in the Hamilton County Superior Court
in Indiana. Schweitzer v. Hilbert, et al., Case No. 29D01-0004CP251; Evans v.
Hilbert, et al., Case No. 29D01-0005CP308 (both Schweitzer and Evans name as
defendants certain non-director officers); Gintel v. Hilbert, et al., Case No.
29003-0006CP393 (naming as defendants, and alleging aiding and abetting
liability as to, banks that allegedly made loans in relation to the Stock
Purchase Plan). CNC believes that these lawsuits are without merit and intends
to defend them vigorously. The cases filed in Hamilton County have been stayed
pending resolution of the derivative suits filed in the United States District
Court. CNC asserts that these lawsuits are assets of the estate pursuant to
section 541(a) of the Bankruptcy Code and does not currently intend to pursue
them postpetition because they are meritless. The ultimate outcome of these
lawsuits cannot be predicted with certainty.
Other Litigation
On January 15, 2002, Carmel Fifth, LLC ("Carmel"), an indirect,
wholly-owned subsidiary of CNC, exercised its rights to require 767 Manager, LLC
("Manager"), an affiliate of Donald J. Trump, to elect within 60 days, either to
acquire Carmel's interests in 767 LLC for $499.4 million, or to sell its
interests in 767 LLC to Carmel for $15.6 million (the "Buy/Sell Right"). Such
rights were exercised pursuant to the Limited Liability Company Agreement of 767
LLC. 767 LLC is a Delaware limited liability company that indirectly owns the
General Motors Building, a 50-story office building in New York, New York (the
"GM Building"). 767 LLC is owned by Carmel and Manager. On February 6, 2002, Mr.
Trump commenced a civil action against CNC, Carmel and 767 LLC in New York State
Supreme Court, entitled Donald J. Trump v. Conseco, Inc., et al. (the "State
Court Action"). Plaintiff claims that CNC and Carmel breached an agreement,
dated July 3, 2001, to sell Carmel's interests to plaintiff for $295 million on
or before September 15, 2001 (the "July 3rd Agreement"). Specifically, plaintiff
claims that CNC and Carmel improperly refused to accept a reasonable guaranty of
plaintiff's payment obligations, refused to complete the sale of Carmel's
interest before the September 15, 2001 deadline, repudiated an oral promise to
extend the September 15 deadline indefinitely and repudiated the July 3rd
Agreement by exercising Carmel's Buy/Sell Right. Plaintiff asserts claims for
breach of contract, breach of the implied covenant of good faith and fair
dealing, promissory estoppel, unjust enrichment and breach of fiduciary duty.
Plaintiff is seeking compensatory and punitive damages of approximately $1
billion and declaratory and injunctive relief blocking Carmel's Buy/Sell Right.
On March 25, 2002, Carmel filed a Demand for Arbitration and Petition and
Statement of Claim with the American Arbitration Association ("AAA") to have the
issues relating to the Buy/Sell Right resolved by arbitration (the
"Arbitration"). Manager and Mr. Trump requested the New York State Supreme Court
to stay that arbitration, but the Court denied Manager's and Trump's request on
May 2, 2002, allowing the arbitration to proceed. In addition, CNC and Carmel
filed a Motion to Dismiss Mr. Trump's lawsuit on March 25, 2002. By Stipulation
and Order, dated June 14, 2002, the State Court Action was stayed, pending
resolution of the Arbitration. CNC plans to vigorously pursue its options to
compel prompt resolution of this dispute. CNC believes that Mr. Trump's lawsuit
is without merit and intends to vigorously pursue its own rights to acquire the
GM Building. The ultimate outcome cannot be predicted with certainty. On
23
February 21, 2003, the Trump entities filed a proof of claim asserting a general
unsecured claim of $1 billion against CNC. On March 3, 2003, CNC and Carmel
Fifth initiated an adversary proceeding against the Trump entities. CNC and
Carmel Fifth's adversary complaint seeks declaratory and injunctive relief
against the Trump entities. CNC and Carmel Fifth's adversary action requests
that the court find (1) that the July 3rd Agreement terminated due to Trump's
failure to comply with the terms of that agreement, and (2) that the Trump
entities are required to convey their interest in 767 LLC to Carmel Fifth
pursuant to Carmel Fifth's rights under the LLC Agreement. On March 5, 2003, CNC
and Carmel Fifth, in the adversary proceeding, filed an emergency motion for
preliminary injunction and an emergency motion for expedited hearing. Through
those motions, CNC and Carmel Fifth sought: an accelerated schedule for
resolution of their claims against the Trump entities, removal of Mr. Trump from
management of the GM Building, and an order restraining Mr. Trump and the Trump
entities from interference with CNC and Carmel Fifth's efforts to market the GM
Building. The Bankruptcy Court has assumed jurisdiction of the matters related
to the July 3rd Agreement and has denied jurisdiction with respect to Carmel
Fifth's rights under the LLC Agreement and ordered that the arbitration of the
LLC Agreement matters be completed or nearly completed by May 19, 2003. After
such time, the Bankruptcy Court will set the July 3rd Agreement matters for
trial. In connection with the Bankruptcy Court's ruling on the jurisdictional
issues, the parties stipulated that they would appear before the Bankruptcy
Court to provide updates with respect to the pending arbitration in order to
keep the arbitration process on schedule for resolution or near resolution by
May 19, 2003. The Court also ordered the Trump entities to stipulate that they
would take no actions that would delay completion or near completion of
arbitration by May 19, 2003.
On June 24, 2002, the heirs of a former officer, Lawrence Inlow, commenced
an action against CNC, Conseco Services, LLC, and two former officers in the
Boone Circuit Court (Inlow et al. v. Conseco, Inc., et al., Cause No.
06C01-0206-CT-244). The heirs assert that unvested options to purchase 756,248
shares of CNC common stock should have been vested at Mr. Inlow's death. The
heirs further claim that if such options had been vested, they would have been
exercised, and that the resulting shares of common stock would have been sold
for a gain of approximately $30 million based upon a stock price of $58.125 per
share, the highest stock price during the alleged exercise period of the
options. CNC believes the heirs' claims are without merit and will defend the
action vigorously. The maximum exposure to the Company for this lawsuit is
estimated to be $33 million. The ultimate outcome cannot be predicted with
certainty.
CNC is also a party to litigation related to the death of Lawrence Inlow
with the manufacturer of a corporate helicopter and other parties. This
litigation was consolidated in the United States District Court for the Southern
District of Indiana (In re: Inlow Accident Litigation, Cause No.
IP99-0830-C-H/G) and is currently on appeal to the Seventh Circuit Court of
Appeals. The maximum exposure for this litigation is estimated to be $25
million, although CNC believes that the claims against it are without merit. The
ultimate outcome cannot be predicted with certainty. CNC is also party to
litigation with Associated Aviation Underwriters, Inc. in Hamilton County
Superior Court (Associated Aviation Underwriters, Inc. v. Conseco Inc., et al,
Cause No. 29C01-9909-CP588) relating to Associated Aviation Underwriters'
obligation to defend and/or indemnify CNC in the aforementioned litigation. If
CNC prevails in this lawsuit, Associated Underwriters may be obligated to
indemnify CNC for all or part of its liability in the aforementioned litigation.
This litigation has been stayed until final judgments are rendered in the former
litigation.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other lawsuits and arbitrations (including purported class actions)
related to their operations. These actions include one action brought by the
Texas Attorney General regarding long-term care policies, two purported
nationwide class actions involving claims related to "vanishing premiums," and
two purported nationwide class actions involving claims related to "modal
premiums" (the alleged imposition and collection of insurance premium surcharges
in excess of stated annual premiums. The ultimate outcome of all of these other
legal matters pending against the Company or its subsidiaries cannot be
predicted, and, although such lawsuits are not expected individually to have a
material adverse effect on the Company, such lawsuits could have, in the
aggregate, a material adverse effect on the Company's consolidated financial
condition, cash flows or results of operations.
Other Proceedings
The Company has been notified that the staff of the SEC has obtained a
formal order of investigation in connection with an inquiry that relates to
events in and before the spring of 2000, including CFC's accounting for its
interest-only securities and servicing rights. These issues were among those
addressed in the Company's write-down and restatement in the spring of 2000, and
were the subject of shareholder class action litigation, which has recently been
settled as described above. The Company is cooperating with the SEC staff in
this matter.
The Company has been notified that the Alabama Securities Commission is
examining the Company's 1998 Directors/Officers & Key Employees Stock Purchase
Program and the 2000 Employee Stock Purchase Program Work-Down Plan. The Company
is cooperating with the Commission's staff in this matter.
24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Optional Item. Executive Officers of the Registrant.
Officer Positions with Conseco, Principal
Name and Age (a) Since Occupation and Business Experience (b)
------------ ----- ----------------------------------
William J. Shea, 54............. 2001 Since November 2002, President and Chief Executive Officer of Conseco. From
September 2001, President; from March 2002 to November 2002, Acting Chief
Financial Officer of Conseco; from 1998 to 2001, Chairman of the Board of
Demoulas Supermarkets, Inc.; from 1999 to 2000, CEO of View Tech, Inc.
(integrated videoconferencing); and from 1993 to 1998, Vice Chairman and Chief
Financial Officer of BankBoston Corporation. Since September 2001, Director of
Conseco.
Eugene M. Bullis, 57............ 2002 Since November 2002, Executive Vice President and Chief Financial Officer of
Conseco. From July 2002 to November 2002, Mr. Bullis was Executive Vice
President, Finance Administration of Conseco. Chief Financial Officer of
Managed Ops. Com, Inc. from April 2000 to May 2002. Executive Vice President
and Chief Financial Officer of Manufacturers' Services, Ltd. from October 1999
to March 2000. From March 1998 to October 1999, Chief Operating Officer and
Chief Financial Officer of Physicians Quality Care.
John R. Kline, 45............... 2002 Since 2002, Senior Vice President and Chief Accounting Officer of Conseco; from
2000 to 2002, Senior Vice President of various Conseco subsidiaries; from 1992
to 2000, Vice President of various Conseco subsidiaries.
Maxwell E. Bublitz, 46.......... 1998 Since 1998, Senior Vice President, Investments of Conseco; since 1994, President
and Chief Executive Officer of Conseco Capital Management, Inc., a subsidiary of
Conseco.
- -------------------
(a) The executive officers serve as such at the discretion of the Board of
Directors and are elected annually.
(b) Business experience is given for at least the last five years.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
MARKET INFORMATION
On January 21, 2003, the Bankruptcy Court granted our motion to restrict
the trading of CNC's common stock to assist the Company in preserving its net
operating losses. Under Section 382 of the Code, a company can lose the benefit
of its NOLs if the company is deemed to undergo an ownership change as defined
under that Section of the Code.
On August 9, 2002, we announced that we had engaged legal and financial
advisors to begin discussions with creditors in order to effectuate a
fundamental restructuring of the Company's capital structure. After the
announcement, the New York Stock Exchange ("NYSE") halted trading in Conseco's
common stock and all of its other listed securities. The SEC subsequently
granted the NYSE's application for removal from listing and registration with
respect to the following Conseco securities: (i) common stock; (ii) 8.125%
senior notes due 2003; (iii) 10.5% senior notes due 2004; (iv) 9.16% trust
originated preferred securities; (v) 8.70% trust originated preferred
securities; (vi) 9% trust originated preferred securities; and (vii) 9.44% trust
originated preferred securities, effective on the opening of the trading session
on September 25, 2002.
The following table sets forth the ranges of high and low sales prices per
share for the last two fiscal years. There have been no dividends paid or
declared during this period.
Period Market price
- ------ ------------------
High Low
---- ---
2001:
First Quarter........................................... $18.60 $11.69
Second Quarter.......................................... 20.20 13.05
Third Quarter........................................... 16.20 5.25
Fourth Quarter.......................................... 7.40 2.51
2002:
First Quarter ......................................... $ 4.59 $ 2.77
Second Quarter ......................................... 5.07 1.51
Third Quarter ......................................... 2.05 .03
Fourth Quarter ......................................... .13 .03
The closing market price for a share of our common stock on April 10, 2003
was $.037. As of March 20, 2003, there were approximately 144,100 holders of the
outstanding shares of common stock, including individual participants in
securities position listings.
DIVIDENDS
The Company does not anticipate declaring or paying dividends on its common
stock in the foreseeable future, and is currently prohibited from doing so.
26
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
CONSECO, INC. AND SUBSIDIARIES
(DEBTORS-IN-POSSESSION AS OF DECEMBER 17, 2002)
Years ended December 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Amounts in millions, except per share data)
STATEMENT OF OPERATIONS DATA(a)
Insurance policy income..................................... $3,602.3 $3,992.7 $4,170.7 $3,977.9 $3,869.6
Net investment income....................................... 1,342.9 1,564.5 1,597.0 2,300.8 1,882.4
Net realized investment gains (losses) ..................... (597.0) (379.4) (346.5) (146.3) 189.6
Total revenues.............................................. 4,418.3 5,467.1 5,558.6 6,249.1 6,032.9
Interest expense on corporate notes payable and
investment borrowings (contractual interest for 2002
of $366.5)................................................ 363.1 400.0 454.3 300.2 242.2
Total benefits and expenses................................. 6,052.3 5,727.5 6,328.5 5,242.3 4,928.3
Income (loss) before income taxes, minority interest,
discontinued operations, extraordinary gain (loss)
and cumulative effect of accounting change................ (1,634.0) (260.4) (769.9) 1,006.8 1,104.6
Extraordinary gain (loss) on extinguishment of debt,
net of income tax......................................... 8.1 17.2 (5.0) - (42.6)
Cumulative effect of accounting change, net of income tax... (2,949.2) - (55.3) - -
Net income (loss)........................................... (7,835.7) (405.9) (1,191.2) 595.0 467.1
Preferred stock dividends .................................. 2.1 12.8 11.0 1.5 7.8
Net income (loss) applicable to common stock................ (7,837.8) (418.7) (1,202.2) 593.5 459.3
PER SHARE DATA
Net income (loss), basic.................................... $(22.67) $(1.24) $(3.69) $1.83 $1.47
Net income (loss), diluted.................................. (22.67) (1.24) (3.69) 1.79 1.40
Dividends declared per common share......................... - - .10 .58 .53
Book value (deficit) per common share outstanding........... (7.38) 12.34 11.95 15.50 16.37
Shares outstanding at year-end.............................. 346.0 344.7 325.3 327.7 315.8
Weighted average shares outstanding for diluted earnings.... 345.8 338.1 326.0 332.9 332.7
BALANCE SHEET DATA - PERIOD END
Total investments........................................... $21,783.7 $25,067.1 $25,017.6 $26,431.6 $26,073.0
Goodwill .................................................. 100.0 3,695.4 3,800.8 3,927.8 3,960.2
Total assets................................................ 46,509.0 61,432.2 58,589.2 52,185.9 43,599.9
Corporate notes payable and commercial paper ............... - 4,085.0 5,055.0 4,624.2 3,809.9
Liabilities subject to compromise........................... 4,873.3 - - - -
Total liabilities........................................... 46,637.9 54,764.7 51,810.9 43,990.6 36,229.4
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.............. 1,921.5 1,914.5 2,403.9 2,639.1 2,096.9
Shareholders' equity (deficit).............................. (2,050.4) 4,753.0 4,374.4 5,556.2 5,273.6
- -------------
(a) Our financial condition and results of operations have been significantly
affected during the periods presented by the discontinued finance
operations. Please refer to the section of Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations
entitled "Financial Condition and Results of Operations of CFC -
Discontinued Finance Operations" for additional information.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
In this section, we review the consolidated financial condition of Conseco
at December 31, 2002 and 2001, the consolidated results of operations for the
three years ended December 31, 2002, and, where appropriate, factors that may
affect future financial performance. Please read this discussion in conjunction
with the accompanying consolidated financial statements, notes and selected
consolidated financial data.
All statements, trend analyses and other information contained in this
report and elsewhere (such as in filings by Conseco with the Securities and
Exchange Commission, press releases, presentations by Conseco or its management
or oral statements) relative to markets for Conseco's products and trends in
Conseco's operations or financial results, as well as other statements including
words such as "anticipate," "believe," "plan," "estimate," "expect," "project,"
"intend," "may," "will," "would," "contemplate," "possible," "attempts,"
"seeks," "should," "could," "goal," "target," "on track," "comfortable with,"
"optimistic" and other similar expressions, constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements are subject to known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements to be materially different from the future results, performance or
achievements expressed or implied by the forward-looking statements. Assumptions
and other important factors that could cause our actual results to differ
materially from those anticipated in our forward-looking statements include,
among other things: (i) the ability of Conseco to develop, prosecute, confirm
and consummate one or more plans of reorganization with respect to the Chapter
11 petitions under the Bankruptcy Code filed by Conseco and some of its
subsidiaries, including CFC and CIHC, Incorporated (the "Chapter 11 petitions");
(ii) the potential adverse impact of the Chapter 11 petitions on Conseco's
operations, management and employees; (iii) the outcome and timing of Conseco's
efforts to restructure and/or sell assets of Conseco Finance; (iv) general
economic conditions and other factors, including prevailing interest rate
levels, stock and credit market performance and health care inflation, which may
affect (among other things) Conseco's ability to sell its products, its ability
to make loans and access capital resources and the costs associated therewith,
the market value of Conseco's investments, the lapse rate and profitability of
policies, and the level of defaults and prepayments of loans made by Conseco;
(v) Conseco's ability to achieve anticipated synergies and levels of operational
efficiencies, including from our process excellence initiatives, and to achieve
the goals of recent restructuring initiatives undertaken at Conseco Insurance
Group; (vi) customer response to new products, distribution channels, marketing
initiatives and the Chapter 11 petitions; (vii) mortality, morbidity, usage of
health care services and other factors which may affect the profitability of
Conseco's insurance products; (viii) performance of our investments; (ix)
changes in the Federal income tax laws and regulations which may affect the
relative tax advantages of some of Conseco's products; (x) increasing
competition in the sale of insurance and annuities and in the finance business;
(xi) regulatory changes or actions, including those relating to regulation of
the financial affairs of our insurance companies, regulation of the sale,
underwriting and pricing of products, and health care regulation affecting
health insurance products; (xii) actions by rating agencies and the effects of
past or future actions by these agencies on Conseco's business, including the
impact of recent rating downgrades; (xiii) the ultimate outcome of lawsuits
filed against Conseco; (xiv) the risk factors or uncertainties listed from time
to time in Conseco's filings with the SEC and with the U.S. Bankruptcy Court in
connection with the Chapter 11 petitions; (xv) our ability to continue as a
going concern; and (xvi) our ability to obtain Bankruptcy Court approval with
respect to motions in the Chapter 11 proceedings from time to time. Other
factors and assumptions not identified above are also relevant to the
forward-looking statements, and if they prove incorrect, could also cause actual
results to differ materially from those projected.
All written or oral forward-looking statements attributable to us are
expressly qualified in their entirety by the foregoing cautionary statement. Our
forward-looking statements speak only as of the date made. We assume no
obligation to update or to publicly announce the results of any revisions to any
of the forward-looking statements to reflect actual results, future events or
developments, changes in assumptions or changes in other factors affecting the
forward-looking statements.
These and other factors, including the terms of the Plan, will affect the
value of our various prepetition liabilities, Trust Preferred Securities and
preferred and common stock.
Our Plan would result in holders of CNC's common stock and preferred stock
(other than Series F Preferred Stock) receiving no value and the holders of
CNC's Trust Preferred Securities and Series F Preferred Stock receiving little
value on account of the cancellation of their interests. In addition, holders of
unsecured claims against the Debtors would, in most cases, receive less than
full recovery for the cancellation of their interests.
28
OVERVIEW
Since commencing operations in 1982, CNC pursued a strategy of growth
through acquisitions. Primarily as a result of these acquisitions and the
funding requirements necessary to operate and expand the acquired businesses,
CNC amassed outstanding indebtedness of approximately $6.0 billion as of June
30, 2002. In 2001 and early 2002, we undertook a series of steps designed to
reduce and extend the maturities of our parent company debt. Notwithstanding
these efforts, the Company's financial position continued to deteriorate,
principally due to our leveraged condition, losses experienced by our finance
business and losses in the value of our investment portfolio.
As a result of these developments, on August 9, 2002, we announced that we
would seek to fundamentally restructure the Company's capital, and announced
that we had retained legal and financial advisors to assist us in these efforts.
We ultimately decided to seek judicial reorganization under Chapter 11 of the
Bankruptcy Code.
Under Chapter 11 we are operating as a debtor-in-possession. As of the
Petition Date, actions to collect prepetition indebtedness of the Debtors as
well as other pending litigation involving the Debtors, are stayed and other
contractual obligations generally may not be enforced against the Debtors.
Information regarding the Chapter 11 Cases appears in Item 1. "Proceedings Under
Chapter 11 of the Bankruptcy Code" of this Form 10-K.
As a result of the formalization of the plan to sell the finance business
and the filing of petitions under the Bankruptcy Code by the Finance Company
Debtors, the finance business is being accounted for as a discontinued
operation. Information regarding the planned sale of the finance business
appears in Item 1. "Discontinued Finance Business - Planned Sale of CFC".
At this time, it is not possible to predict with certainty the effect of
the Chapter 11 Cases on our business or various creditors, or when we will
emerge from Chapter 11. Our future results depend upon our confirming and
successfully implementing, on a timely basis, a plan of reorganization.
The consolidated financial statements included in Item 8. "Financial
Statements and Supplementary Data" have been prepared on a going concern basis
which assumes continuity of operations and realization of assets and
satisfaction of liabilities in the ordinary course of business. Our Plan will
materially change amounts reported in the financial statements, which do not
give effect to all adjustments of the carrying value of assets and liabilities
that are necessary as a consequence of reorganization.
The ability of Conseco to continue as a going concern is predicated upon
many issues, including various bankruptcy considerations and risks related to
our business and financial condition. See "Cautionary Statement Regarding
Forward-Looking Information" above.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Management has made estimates in the past
that we believed to be appropriate but were subsequently revised to reflect
actual experience. If our future experience differs materially from these
estimates and assumptions, our results of operations and financial condition
could be affected.
We base our estimates on historical experience and other assumptions that
we believe are reasonable under the circumstances. We continually evaluate the
information used to make these estimates as our business and the economic
environment change. The use of estimates is pervasive throughout our financial
statements. The accounting policies and estimates we consider most critical are
summarized below. Additional information on our accounting policies is included
in the note to our consolidated financial statements entitled "Summary of
Significant Accounting Policies".
Critical Accounting Policies Related to our Continuing Business
Investments
At December 31, 2002, the carrying value of our investment portfolio was
$21.8 billion. The accounting risks associated with these assets relate to the
recognition of income, our determination of other-than-temporary impairments and
our estimation of fair values.
29
We defer any fees received or costs incurred when we originate investments.
We amortize fees, costs, discounts and premiums as yield adjustments over the
contractual lives of the investments. We consider anticipated prepayments on
mortgage-backed securities in determining estimated future yields on such
securities.
When we sell a security (other than trading securities or venture capital
investments), we report the difference between the sale proceeds and the
amortized cost (determined based on specific identification) as a realized
investment gain or loss.
We regularly evaluate all of our investments for possible impairment based
on current economic conditions, credit loss experience and other
investee-specific developments. If there is a decline in a security's net
realizable value that is other than temporary, the decline is recognized as a
realized loss and the cost basis of the security is reduced to its estimated
fair value. For 2002, the Company recorded $556.8 million of writedowns of fixed
maturities, equity securities, and other invested assets as a result of
conditions that caused us to conclude a decline in the fair value of the
investments was other than temporary. The facts and circumstances resulting in
the other-than-temporary losses are described in the note to our accompanying
financial statements entitled "Investments".
If a decline in value is determined to be other than temporary and the cost
basis of the security is written down to fair value, we review the circumstances
which caused us to believe that the decline was other than temporary with
respect to other investments in our portfolio. If such circumstances exist with
respect to other investments, those investments are also written down to fair
value. Future events may occur, or additional or updated information may become
available, which may necessitate future realized losses of securities in our
portfolio. Significant losses in the carrying value of our investments could
have a material adverse effect on our earnings in future periods.
Our evaluation of investments for impairment requires significant judgments
to be made including: (i) the identification of potentially impaired securities;
(ii) the determination of their estimated fair value; and (iii) assessment of
whether any decline in estimated fair value is other than temporary. Our
periodic assessment of whether unrealized losses are "other than temporary" also
requires significant judgment. Factors considered include: (i) the extent to
which market value is less than the cost basis; (ii) the length of time that the
market value has been less than cost; (iii) whether the unrealized loss is event
driven, credit-driven or a result of changes in market interest rates; (iv) the
near-term prospects for improvement in the issuer and/or its industry; (v)
whether the investment is investment-grade and our security analyst's view of
the investment's rating and whether the investment has been downgraded since its
purchase; (vi) whether the issuer is current on all payments in accordance with
the contractual terms of the investment and is expected to meet all of its
obligations under the terms of the investment; (vii) our ability and intent to
hold the investment for a period of time sufficient to allow for any anticipated
recovery; and (viii) the underlying asset and enterprise values of the issuer.
If new information becomes available or the financial condition of the investee
changes, our judgments may change resulting in the recognition of an investment
loss at that time. At December 31, 2002, our net accumulated other comprehensive
income included gross unrealized losses on investments of $508.9 million; we
consider all such declines in estimated fair value to be temporary. Our
assessments of the potential other-than-temporary losses related to investments
in our portfolio at December 31, 2002 are described in the note to our
consolidated financial statements entitled "Investments".
Estimated fair values for our investments are determined based on estimates
from nationally recognized pricing services, broker-dealer market makers, and
internally developed methods. Our internally developed methods require us to
make judgments about the security's credit quality, liquidity and market spread.
Below investment grade securities have different characteristics than
investment grade corporate debt securities. Risk of loss upon default by the
borrower is significantly greater with respect to below investment grade
securities than with other corporate debt securities. Below investment grade
securities are generally unsecured and are often subordinated to other creditors
of the issuer. Also, issuers of below investment grade securities usually have
higher levels of debt and are more sensitive to adverse economic conditions,
such as recession or increasing interest rates, than are investment grade
issuers. The Company attempts to reduce the overall risk in the below investment
grade portfolio, as in all investments, through careful credit analysis, strict
investment policy guidelines, and diversification by issuer and/or guarantor and
by industry.
During 2002, we sold $19.5 billion of fixed maturity investments which
resulted in net realized investment losses (before income taxes) of $40.2
million. Securities sold at a loss are sold for a number of reasons including:
(i) changes in the investment environment; (ii) expectation that the market
value could deteriorate further; (iii) desire to reduce our exposure to an
issuer or an industry; (iv) changes in credit quality; and (v) our analysis
indicating there is a high probability that the security is
other-than-temporarily impaired.
We seek to closely match the estimated duration of our invested assets to
the expected duration of our insurance liabilities. When the estimated durations
of assets and liabilities are similar, exposure to interest rate risk is
minimized because a change in the value of assets should be largely offset by a
change in the value of liabilities. A mismatch of the durations of invested
assets and insurance liabilities could have a significant impact on our results
of operations and financial position.
30
For more information on our investment portfolio and our critical
accounting policies related to investments, see the note to our consolidated
financial statements entitled "Investments".
Cost of Policies Purchased and Cost of Policies Produced
The cost of policies purchased are the costs assigned to the right to
receive future cash flows from contracts existing at the date of an acquisition.
The cost of policies produced are those costs that vary with, and are primarily
related to, producing new insurance business. These amounts are amortized using
the interest rate credited to the underlying policy: (i) in relation to the
estimated gross profits for universal life-type products; or (ii) in relation to
future anticipated premium revenue for other products.
At December 31, 2002, the combined balance of our cost of policies
purchased and cost of policies produced was $3.2 billion. The recovery of these
costs is dependent on the future profitability of the related business.
Each year, we evaluate the recoverability of the unamortized balance of the
cost of policies purchased and the cost of policies produced. We consider
estimated future gross profits or future premiums, expected mortality or
morbidity, interest earned and credited rates, persistency and expenses in
determining whether the balance is recoverable. If we determine a portion of the
unamortized balance is not recoverable, it is charged to amortization expense.
The assumptions we use to amortize and evaluate the recoverability of the
cost of policies produced and cost of policies purchased involve significant
judgment. A revision to these assumptions could have a significant adverse
effect on our results of operations and financial position in future periods.
Goodwill
Goodwill is the excess of the amount we paid to acquire a company over the
fair value of its net assets. As more fully described in the note to our
consolidated financial statements entitled "Summary of Significant Accounting
Policies", the Company recorded the cumulative effect of the accounting change
for goodwill impairment of $2,949.2 million in 2002. In addition, we recognized
an impairment charge of $500 million in 2002, due to changes in the value of our
insurance businesses resulting from events occurring during 2002.
The significant factors used to determine the amount of the impairments
included analyses of industry market valuations, historical and projected
performance of our insurance segment, discounted cash flow analyses and the
market value of our capital. The valuations utilized the best available
information, including assumptions and projections we considered reasonable and
supportable. The assumptions we used to determine the discounted cash flows
involved significant judgments regarding the best estimate of future premiums,
expected mortality and morbidity, interest earned and credited rates,
persistency and expenses. The discount rates used were based on analyses of the
weighted average cost of capital for other insurance companies and considered
the specific risk factors related to Conseco. Pursuant to the guidance in
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), quoted market prices in active markets are the
best evidence of fair value and shall be used as the basis for measurement, if
available. Management believes that the assumptions and estimates used are
reasonable given all available facts and circumstances. However, if projected
cash flows are not realized in the future, we may be required to recognize
additional impairments. Subsequent impairment tests will be performed on an
annual basis, or more frequently if circumstances indicate a possible
impairment. Subsequent impairments, if any, would be classified as an operating
expense.
31
Income Taxes
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting and tax bases of assets
and liabilities, capital loss carryforwards and operating loss carryforwards.
The net deferred tax assets totalled $1,719.6 million at December 31, 2002
(including $925.7 million of deferred tax assets related to CFC which is
classified as a discontinued operation). In assessing the realization of our
deferred income tax assets, we consider whether it is more likely than not that
the deferred income tax assets will be realized. The ultimate realization of our
deferred income tax assets depends upon generating future taxable income during
the periods in which our temporary differences become deductible and before our
NOLs expire. We evaluate the recoverability of our deferred income tax assets by
assessing the need for a valuation allowance on a quarterly basis.
A valuation allowance of $1,719.6 million (of which $925.7 million relates
to discontinued operations) has been provided for the entire net deferred income
tax asset balance at December 31, 2002, as we believe the realization of such
asset in future periods is uncertain. We reached this conclusion after
considering the availability of taxable income in prior carryback years, tax
planning strategies, and the likelihood of future taxable income exclusive of
reversing temporary differences and carryforwards. This conclusion was greatly
influenced by recent unfavorable developments affecting the Company such as
rating downgrades that decrease the Company's likelihood to generate adequate
future taxable income to realize the tax benefits.
The Company established valuation contingencies related to certain tax
uncertainties of the insurance companies we acquired on the date of their
acquisition. We have determined that $146.2 million of such valuation
contingencies are no longer necessary because the tax uncertainties no longer
exist. Pursuant to Financial Accounting Standards Board Statement No. 109,
"Accounting for Income Taxes", the benefit for the reduction of such valuation
contingencies is first applied to reduce the related goodwill balances related
to the acquisition. Accordingly, we reduced such valuation contingencies
(increasing deferred taxes) and goodwill balances by $146.2 million during 2002.
At December 31, 2002, Conseco had federal income tax loss carryforwards of
$1,757.4 million available (subject to various statutory restrictions) for use
on future tax returns (including $552.4 million of federal income tax
carryforwards attributable to discontinued operations). These carryforwards will
expire as follows: $2.3 million in 2003; $11.2 million in 2004; $4.9 million in
2005; $.6 million in 2006; $7.9 million in 2007; $7.5 million in 2008; $14.7
million in 2009; $30.7 million in 2010; $6.2 million in 2011; $10.1 million in
2012; $43.9 million in 2013; $6.9 million in 2014; $60.5 million in 2016; $90.0
million in 2017; $244.6 million in 2018; $159.1 million in 2019; $594.3 million
in 2020; and $462.0 million in 2022.
The Company is currently in bankruptcy and expects to restructure and
emerge from bankruptcy. As a result of the restructuring that is expected to
occur upon the anticipated emergence from bankruptcy, the aggregate outstanding
indebtedness will be substantially reduced. The cancellation of the indebtedness
is expected to result in the realization of COD Income. The COD Income will not
be recognized as taxable income because the Company is under the jurisdiction of
a court in a Title 11 bankruptcy proceeding. Instead, as a consequence of such
exclusion from taxable income, the Company must reduce its tax attributes by the
amount of COD Income, which it excluded from taxable income. Tax attributes are
reduced in the following order: (i) NOLs; (ii) tax credits and capital loss
carryforwards; and (iii) tax basis in assets. Although it is expected that a
reduction of tax attributes will be required, because the determination of the
COD Income is dependent upon the fair market value of the various debt and
capital instruments at the Effective Date, the exact amount of the reduction
cannot be predicted.
The restructuring will be accomplished by the formation of New Conseco,
which will issue new debt, preferred stock and common stock, in exchange for
substantially all of the assets of the Company. The Company intends to
accomplish this transaction as a G Reorganization. Assuming that the
restructuring constitutes a G Reorganization, the Company will recognize no gain
or loss with respect to such transactions to effect the G Reorganization, the
Company's taxable year will close on the Effective Date and New Conseco will
begin a new taxable year on the day after the Effective Date, and all of the
Company's tax attributes existing on the Effective Date, including NOLs and
other loss and credit carryovers will be transferred to New Conseco as of the
close of the Effective Date.
Any NOLs and other loss and credit carryovers transferred to New Conseco
will be limited under the Code to a maximum amount in any one year. This amount
is equal to the product of the fair market value of the loss corporation's
outstanding stock immediately before the ownership change and the long term
tax-exempt rate (which is published monthly by the Treasury Department and most
recently was approximately 4.61 percent) in effect for the month in which the
ownership change occurs. This amount will not be known until the Effective Date.
32
Liabilities for Insurance Products
At December 31, 2002, the total balance of our liabilities for insurance
and asset accumulation products was $22.8 billion. These liabilities are often
payable over an extended period of time and the profitability of the related
products is dependent on the pricing of the products and other factors.
Differences between what we expected when we sold these products and actual
experience could result in future losses.
We calculate and maintain reserves for the estimated future payment of
claims to our policyholders based on actuarial assumptions. For our health
insurance business, we establish an active life reserve plus a liability for due
and unpaid claims, claims in the course of settlement and incurred but not
reported claims, as well as a reserve for the present value of amounts not yet
due on claims. Many factors can affect these reserves and liabilities, such as
economic and social conditions, inflation, hospital and pharmaceutical costs,
changes in doctrines of legal liability and extra-contractual damage awards.
Therefore, the reserves and liabilities we establish are necessarily based on
extensive estimates, assumptions and historical experience. Establishing
reserves is an uncertain process, and it is possible that actual claims will
materially exceed our reserves and have a material adverse effect on our results
of operations and financial condition. Our financial results depend
significantly upon the extent to which our actual claims experience is
consistent with the assumptions we used in determining our reserves and pricing
our products. If our assumptions with respect to future claims are incorrect,
and our reserves are insufficient to cover our actual losses and expenses, we
would be required to increase our liabilities, negatively affecting our
operating results.
Liabilities for insurance products are calculated using management's best
judgments of mortality, morbidity, lapse rates, investment experience and
expense levels that are based on the Company's past experience and standard
actuarial tables.
Liabilities for Loss Contingencies Related to Lawsuits and Our Guarantees
of Bank Loans and Related Interest Loans
We are involved on an ongoing basis in lawsuits relating to our operations,
including with respect to sales practices, and we and current and former
officers and directors are defendants in pending class action lawsuits asserting
claims under the securities laws and in derivative lawsuits. The ultimate
outcome of these lawsuits cannot be predicted with certainty. We recognize an
estimated loss from these loss contingencies when we believe it is probable that
a loss has been incurred and the amount of the loss can be reasonably estimated.
However, it is difficult to measure the actual loss that might be incurred
related to litigation. The ultimate outcome of these lawsuits could have a
significant impact on our results of operations and financial position.
We also establish a liability for potential losses related to our
guarantees of bank loans and the related interest loans to approximately 155
current and former directors, officers and key employees for the purchase of
Conseco common stock. This liability is based on an assessment of the value of
collateral held for the loans, the personal wealth of the participants in the
stock purchase plan, and other factors (such as current and expected future
earnings of the participants) which could affect the participants' ability to
repay the loans. As of December 31, 2002, we had guaranteed loans totaling
$481.3 million. In addition, Conseco has provided loans to participants for
interest on the bank loans totaling $179.2 million. During 2002, Conseco
purchased $55.5 million of loans from the banks utilizing cash held in a
segregated cash account as collateral for our guarantee of the bank loans
(including accrued interest, the balance on these loans was $56.7 million at
December 31, 2002). At December 31, 2002, we had recognized a reserve liability
of $660.0 million based on our estimate. A change in the ability of participants
to meet their obligations related to the bank loans and related interest loans
would have an effect on our results of operations and financial position.
Critical Accounting Policies Related to Our Discontinued Finance Business
Retained Interests in Securitization Trusts and Guarantee Liability Related
to Interests in Securitization Trusts Held by Others
Retained interests in securitization trusts represent CFC's right to
receive certain future cash flows from securitization transactions structured
prior to September 8, 1999, and the value of these interests totaled $252.6
million at December 31, 2002. Such cash flows generally are equal to the value
of the principal and interest to be collected on the underlying financial
contracts of each securitization in excess of the sum of the principal and
interest to be paid on the securities sold and contractual servicing fees. CFC
carries retained interests at estimated fair value. CFC estimates fair value by
discounting the projected cash flows over the expected life of the receivables
sold using current estimates of future prepayment, default, loss and interest
rates. CFC records any unrealized gain or loss determined to be temporary, net
of tax, as a component of shareholders' equity. Declines in value are considered
to be other than temporary when: (i) the fair value of the security is less than
its carrying value; and (ii) the timing and/or amount of cash expected to be
received from the security has changed adversely from the previous valuation
which determined the carrying value of the security. When declines in value
considered to be other than temporary occur, CFC reduces the amortized cost to
estimated fair value and recognizes a loss in its statement of operations. The
assumptions used to determine new values are based on CFC's internal
evaluations.
33
The estimation of the value of CFC's retained interests in securitization
trusts requires significant judgment. CFC has recognized significant impairment
charges when the retained interests did not perform as well as anticipated based
on the assumptions and expectations of CFC management.
CFC's current valuation of retained interests in securitization trusts may
prove inaccurate in future periods. In the securitizations to which these
retained interests relate, CFC has retained certain contingent risks in the form
of guarantees of certain lower-rated securities issued by the securitization
trusts. As of December 31, 2002, the total nominal amount of these guarantees
was $1.4 billion. The net present value of expected future guarantee payments
are recognized as a liability by CFC and totaled $326.7 million at December 31,
2002. Management of CFC valued the guarantee liability using the same
assumptions used in valuing its retained interests in securitization trusts. If
CFC has to make more payments on these guarantees than anticipated, or CFC
experiences higher than anticipated rates of loan prepayments, including those
due to foreclosures or charge-offs, or any adverse changes in CFC's other
assumptions used for such valuation (such as interest rates and loss mitigation
policies), CFC could be required to recognize additional impairment charges
(including potential payments related to $1.4 billion of guarantees) which could
have a material adverse effect on CFC's financial condition or results of
operations. CFC considers any estimated payments related to these guarantees in
the projected cash flows used to determine the value of its retained interests
in securitization transactions.
During 2002, CFC recognized an impairment charge related to the value of
its retained interests in securitization trusts of $1,077.2 million. CFC also
recognized a $336.5 million increase in the valuation allowance related to
servicing rights as a result of changes in assumptions in 2002. See "Finance
Operations - Impairment Charge" included in this "Management's Discussion and
Analysis of Financial Condition" for additional discussion.
Finance Receivables
At December 31, 2002, the balance of CFC's finance receivables was $14.5
billion. This value is significantly affected by CFC's assessment of the
collectibility of the receivables, servicing actions and the provision for
credit losses that CFC establishes.
The provision for credit losses charged to expense is based upon an
assessment of current and historical loss experience, loan portfolio trends, the
value of collateral, prevailing economic and business conditions, and other
relevant factors. CFC reduces the carrying value of finance receivables to net
realizable value at the earlier of: (i) six months of contractual delinquency;
or (ii) when CFC takes possession of the property securing the finance
receivable. Estimates of the provision are revised each period, and changes are
recorded in the period they become known. A significant change in the level of
collectible finance receivables would have a significant adverse effect on CFC's
results of operations and financial position in future periods.
RISK FACTORS
Conseco and its businesses are subject to a number of risks including: (i)
bankruptcy related risk factors; and (ii) general business and financial risk
factors. Any or all of such factors, which are enumerated below, could have a
material adverse effect on the business, financial condition or results of
operations of Conseco. Also see "Cautionary Statement Regarding Forward-Looking
Statements" above. For additional risk factors specific to the Chapter 11 cases,
readers of this report should refer to the Plan and the Disclosure Statement,
which were filed with the SEC on March 21, 2003 as exhibits to CNC's Current
Report on Form 8-K dated March 18, 2003.
Certain Bankruptcy Considerations
The Bankruptcy Filing May Further Disrupt Our Operations and the Operations
of Our Subsidiaries.
The impact that the Chapter 11 Cases may have on our operations and the
operations of our subsidiaries cannot be accurately predicted or quantified.
Since the announcement of our intention to seek a restructuring of our capital
in August 2002 and the filing of the Chapter 11 Cases, we have suffered
significant disruptions in our operations. Our leveraged condition and liquidity
difficulties have eliminated CFC's access to the securitization markets, which
have historically served as CFC's main source of funding. As a result, CFC has
had to terminate the origination of loans which it is unable to sell profitably
in the whole-loan market. In addition, insurance regulators in each of the
states in which our insurance subsidiaries are domiciled have been monitoring
the Company's activities associated with its financial restructuring. Bankers
National Life Insurance Company and Conseco Life Insurance Company of Texas, our
insurance subsidiaries domiciled in Texas, each entered into consent orders with
the Commissioner of Insurance for the State of Texas, which, among other things,
has limited their ability to pay dividends without regulatory approval and to
make disbursements other than in the ordinary course of business. Conseco Life
Insurance Company of Texas is the parent of all of the Company's insurance
subsidiaries, except for Bankers National Life Insurance Company. In August
2002, A.M. Best further downgraded the financial strength ratings of our primary
insurance subsidiaries to "B (fair)." These ratings downgrades and other adverse
publicity concerning the Company's financial condition have caused sales of our
insurance products to decline and
34
policyholder redemptions and lapses to increase. In some cases, we have
experienced defections among our sales force of agents and/or have increased
commissions in order to retain them.
The continuation of the Chapter 11 Cases, particularly if the Plan is not
approved or confirmed in the time frame currently contemplated, could further
adversely affect our operations and relationship with our customers, employees,
regulators, distributors and agents. If confirmation and consummation of the
Plan do not occur expeditiously, the Chapter 11 Cases could result in, among
other things, increased costs for professional fees and similar expenses. In
addition, prolonged Chapter 11 Cases may make it more difficult to retain and
attract management and other key personnel and would require senior management
to spend a significant amount of time and effort dealing with our financial
reorganization instead of focusing on the operation of our business.
We May Not Be Able to Obtain Confirmation of the Plan.
We cannot assure you that we will receive the requisite acceptances to
confirm the Plan. Even if we receive the requisite acceptances, we cannot assure
you that the Bankruptcy Court will confirm the Plan. The Bankruptcy Court could
also decline to confirm the Plan if it found that any of the statutory
requirements for confirmation had not been met, including that the terms of the
Plan are fair and equitable to non-accepting holders of claims. Section 1129 of
the Bankruptcy Code sets forth the requirements for confirmation and requires,
among other things, (i) a finding by the Bankruptcy Court that the Plan "does
not unfairly discriminate" and is "fair and equitable" with respect to any
non-accepting holders of claims, (ii) confirmation of the Plan is not likely to
be followed by a liquidation or a need for further financial reorganization and
(iii) the value of distributions to non-accepting holders of claims and
interests within a particular class under the Plan will not be less than the
value of distributions such holders would receive if the Company were liquidated
under Chapter 7 of the Bankruptcy Code. While there can be no assurance that
these requirements will be met, we believe that the Plan will not be followed by
a need for further financial reorganization and that non-accepting holders
within each class under the Plan will receive distributions at least as great as
would be received following a liquidation under Chapter 7 of the Bankruptcy Code
when taking into consideration all administrative claims and costs associated
with any such Chapter 7 case. We believe that holders of equity interests in
Conseco would receive no distribution under either a liquidation pursuant to
Chapter 7 or Chapter 11.
The confirmation and consummation of the Plan are also subject to various
conditions. One condition is the cancellation of the guarantee CIHC has given
Lehman for up to $125 million of obligations CFC owes to Lehman. The CFC
unsecured creditors have indicated that they intend to bring a lawsuit in the
Chapter 11 Cases to prevent Lehman from getting paid in full from the proceeds
of the sale of CFC's assets. If such suit were successful, the guarantee
provided by CIHC may not be cancelled resulting in the plan condition not being
satisfied. We can not predict the outcome of the threatened lawsuit by the CFC
unsecured creditors or the delay to consummation of the Plan that may result
from any such lawsuit against Lehman. If the Plan is not confirmed, it is
unclear whether a restructuring of Conseco could be implemented and what
distributions holders of claims or equity interests ultimately would receive
with respect to their claims or equity interests. If an alternative
reorganization could not be agreed to, it is possible that we would have to
liquidate our assets, in which case it is likely that holders of claims and
equity interests would receive substantially less favorable treatment than they
would receive under the Plan.
The Finance Company Debtors May be Unable to Close the Sale of CFC Assets
The Finance Company Debtors anticipate that they will be able to close the
sale of CFC assets to CFN and GE. There are many factors outside of the Finance
Company Debtors control, however, including the ability of CFN and/or GE to
finance the purchase and the ability of the Finance Company Debtors to obtain
necessary governmental consents to the sale or transfer of certain of their
assets. Moreover, it is possible that the Finance Company Debtors may not be
able to meet various closing conditions, and that either CFN or GE would elect
to cancel their respective sale agreements as a result of these failures. If
these sales transactions are not completed, it is possible that the Finance
Company Debtors would have to liquidate their assets under Chapter 7 of the
Bankruptcy Code.
Risks Related To Our Business And Financial Condition
Our Degree of Leverage May Limit Our Financial and Operating Activities.
We will have significant indebtedness even if the Plan is consummated.
Furthermore, our historical capital requirements have been significant and our
future capital requirements could vary significantly and may be affected by
general economic conditions, industry trends, performance, and many other
factors that are not within our control. Recently, we have had difficulty
financing our operations due, in part, to our significant losses and leveraged
condition, and we cannot assure you that we will be able to obtain financing in
the future. Even if the Plan is approved and consummated, we cannot assure you
that we will not experience losses. Our profitability and ability to generate
cash flow will likely depend upon our ability to successfully implement our
business strategy and meet or exceed the results forecasted in the projections.
However, we cannot assure you that we will be able to accomplish these results.
35
A Failure to Improve and Maintain the Financial Strength Ratings of Our
Insurance Subsidiaries Could Negatively Impact Our Operations and Financial
Results.
An important competitive factor for our insurance subsidiaries is the
ratings they receive from nationally recognized rating organizations as
discussed in Item 1. "Competition." In July 2002, A.M. Best downgraded the
financial strength ratings of Conseco's primary insurance subsidiaries to "B++
(Very Good)" and placed the ratings "under review with negative implications."
On August 14, 2002, A.M. Best further lowered the financial strength ratings of
our primary insurance subsidiaries from "B++ (very good)" to "B (fair)". The
A.M. Best downgrades caused sales of our insurance products to decline and
policyholder redemptions and lapses to increase. In some cases, the downgrades
also caused defections among our independent agent sales force and increases in
the commissions we must pay. These events have had a material adverse effect on
our operations, financial results and liquidity.
Although our Plan contemplates that our insurance subsidiaries will achieve
a category "A" rating by the end of 2004, we cannot assure you that we will be
able to achieve or maintain this rating. If we fail to achieve and maintain a
category "A" rating, sales of our insurance products could continue to fall and
additional existing policyholders may redeem or lapse their policies, adversely
affecting our future operations, financial results and liquidity.
The Covenants in the New Credit Facility Restrict Our Activities and
Require Us to Meet or Maintain Various Financial Ratios and Minimum
Insurance Ratings.
Our Plan contemplates that we will enter into a senior secured credit
facility (the "New Credit Facility") with our lenders in connection with our
reorganization. We have agreed to a number of covenants and other provisions
that restrict our ability to engage in various financing transactions and pursue
certain operating activities without the prior consent of the lenders under the
New Credit Facility. We have also agreed to meet or maintain various financial
ratios and minimum financial strength ratings for our insurance subsidiaries.
For instance, if we experience a ratings downgrade following confirmation of the
Plan, if we fail to achieve an "A-" rating by a specified date following
confirmation of the Plan or if we experience a ratings downgrade after achieving
an "A-" rating, we will suffer an event of default under the New Credit
Facility. Our ability to meet these financial and ratings covenants may be
affected by events beyond our control. Although we expect to be in compliance
with these requirements as of the date the Company emerges from bankruptcy,
these requirements represent significant restrictions on the manner in which we
may operate our business. If we default under any of these requirements, the
lenders could declare all outstanding borrowings, accrued interest and fees to
be due and payable. If that were to occur, we cannot assure you that we would
have sufficient liquidity to repay or refinance this indebtedness or any of our
other debts.
CNC and CIHC are Holding Companies and Depend on their Subsidiaries for
Cash.
CNC and CIHC are holding companies with no business operations of their
own; they depend on their operating subsidiaries for cash to make principal and
interest payments on debt, and to pay administrative expenses and income taxes.
The cash CNC and CIHC receive from insurance subsidiaries consists of fees for
services, tax sharing payments, dividends and distributions, and from our
non-insurance subsidiaries, loans and advances. A deterioration in the financial
condition, earnings or cash flow of the material subsidiaries of CNC or CIHC for
any reason could limit such subsidiaries' ability to pay cash dividends or other
disbursements to CNC and/or CIHC, which, in turn, would limit CNC's and/or
CIHC's ability to meet debt service requirements and satisfy other financial
obligations.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid from earned surplus of the insurance company for any
12-month period in amounts equal to the greater of (or in a few states, the
lesser of): (i) net gain from operations or net income for the prior year; or
(ii) 10 percent of capital and surplus as of the end of the preceding year. Any
dividends in excess of these levels require the approval of the director or
commissioner of the applicable state insurance department. As described in Item
1. "Government Regulation", Bankers National Life Insurance Company and Conseco
Life Insurance Company of Texas (on behalf of itself and its subsidiaries),
entered into consent orders with the Commissioner of Insurance for the State of
Texas on October 30, 2002. These consent orders, among other things, limit the
ability of our insurance subsidiaries to pay dividends. In addition, actions
that we may need to take to improve the ACLRBC ratios of our insurance
subsidiaries could affect the ability of our insurance subsidiaries to pay
dividends.
Our results for future periods are subject to numerous uncertainties. We
may encounter liquidity problems, which could affect our ability to meet our
obligations while attempting to meet competitive pressures or adverse economic
conditions following the confirmation of the Plan.
36
The Obligations of CNC and CIHC are Structurally Subordinated to the
Obligations of CNC's and CIHC's Subsidiaries.
Because our operations are conducted through subsidiaries, claims of the
creditors of those subsidiaries (including policyholders) will rank senior to
claims to distributions from the subsidiaries, which we depend on to make
payments on our obligations. CIHC's subsidiaries excluding CFC had indebtedness
for borrowed money (including capitalized lease obligations but excluding
indebtedness to affiliates), policy reserves and other liabilities of
approximately $24.1 billion at December 31, 2002. The obligations of CNC and
CIHC, as parent holding companies, will rank effectively junior to these
liabilities.
If an insurance company subsidiary were to be liquidated, that liquidation
would be conducted under the insurance law of its state of domicile by such
state's insurance regulator as the receiver with respect to such insurer's
property and business. In the event of a default on our debt or our insolvency,
liquidation or other reorganization, our creditors and stockholders will not
have the right to proceed against the assets of our insurance subsidiaries or to
cause their liquidation under federal and state bankruptcy laws.
Our Insurance Business Performance May Decline if Our Premium Rates Are Not
Adequate.
We set the premium rates on our health insurance policies based on facts
and circumstances known at the time we issue the policies and on assumptions
about numerous variables, including the actuarial probability of a policyholder
incurring a claim, the severity of the claim, and the interest rate earned on
our investment of premiums. In setting premium rates, we consider historical
claims information, industry statistics, the rates of our competitors and other
factors. If our actual claims experience proves to be less favorable than we
assumed and we are unable to raise our premium rates, our financial results may
be adversely affected. Our estimates of insurance liabilities assume we will be
able to raise rates if future experience results in blocks of our health
insurance business becoming unprofitable. We generally cannot raise our health
insurance premiums in any state unless we first obtain the approval of the
insurance regulator in that state. We review the adequacy of our premium rates
regularly and file rate increases on our products when we believe existing
premium rates are too low. It is possible that we will not be able to obtain
approval for premium rate increases from currently pending requests or requests
filed in the future. If we are unable to raise our premium rates because we fail
to obtain approval for a rate increase in one or more states, our net income may
decrease. If we are successful in obtaining regulatory approval to raise premium
rates due to unfavorable actual claims experience, the increased premium rates
may reduce the volume of our new sales and cause existing policyholders to allow
their policies to lapse. This could result in anti-selection if healthier
policyholders allow their policies to lapse. This would reduce our premium
income in future periods. Increased lapse rates also could require us to expense
all or a portion of the deferred policy costs relating to lapsed policies in the
period in which those policies lapse, adversely affecting our financial results
in that period.
We May Not Achieve the Goals of Certain Initiatives We Have Undertaken With
Respect to the Restructuring of Our Principal Insurance Business.
Several of our principal insurance businesses have experienced substantial
recent losses in their investment portfolio, declining sales and expense levels
that do not match product pricing. We have adopted several initiatives designed
to improve these operations, including focusing sales efforts on higher margin
products; reducing operating expenses by eliminating or reducing the costs of
marketing certain products; personnel reductions and streamlined administrative
procedures; stabilizing the profitability of inforce business, particularly
long-term care policies; combining certain legal insurance entities to reduce
burdens associated with statutory capital requirements; and improving the
performance of investments by reducing exposure to credit events and certain
types of higher risk assets. We have only recently adopted these initiatives and
we cannot assure you that they will be successfully implemented.
Our Reserves for Future Insurance Policy Benefits and Claims May Prove To
Be Inadequate, Requiring Us To Increase Liabilities and Resulting In
Reduced Net Income and Shareholders' Equity.
We calculate and maintain reserves for the estimated future payment of
claims to our policyholders based on assumptions made by our actuaries. For our
health insurance business, we establish an active life reserve plus a liability
for due and unpaid claims, claims in the course of settlement, and incurred but
not reported claims, as well as a reserve for the present value of amounts not
yet due on claims. Many factors can affect these reserves and liabilities, such
as economic and social conditions, inflation, hospital and pharmaceutical costs,
changes in doctrines of legal liability, and extra-contractual damage awards.
Therefore, the reserves and liabilities we establish are necessarily based on
extensive estimates, assumptions and prior years' statistics. Establishing
reserves is an uncertain process, and it is possible that actual claims will
materially exceed our reserves and have a material adverse effect on our results
of operations and financial condition. Our financial performance depends
significantly upon the extent to which our actual claims experience is
consistent with the assumptions we used in setting our reserves and pricing our
policies. If our assumptions with respect to future claims are incorrect, and
our reserves are insufficient to cover our actual losses and expenses, we would
be required to increase our liabilities resulting in an adverse effect to our
financial results and financial position.
37
Our Insurance Subsidiaries May be Required to Pay Assessments to Fund
Policyholder Losses or Liabilities; This May Have a Material Adverse Effect
on Our Results of Operations.
The solvency or guaranty laws of most states in which an insurance company
does business may require that company to pay assessments (up to certain
prescribed limits) to fund policyholder losses or liabilities of insurance
companies that become insolvent. Recent insolvencies of insurance companies
increase the possibility that these assessments may be required. These
assessments may be deferred or forgiven under most guaranty laws if they would
threaten an insurer's financial strength and, in certain instances, may be
offset against future premium taxes. We cannot estimate the likelihood and
amount of future assessments. Any future assessments may have a material adverse
effect on our financial results and financial position.
We are Subject to Further Risk of Loss Notwithstanding Our Reinsurance
Arrangements.
We transfer exposure to certain risks to others through reinsurance
arrangements. Under these arrangements, other insurers assume a portion of our
losses and expenses associated with reported and unreported claims in exchange
for a portion of policy premiums. The availability, amount and cost of
reinsurance depend on general market conditions and may vary significantly.
Furthermore, we face credit risk with respect to reinsurance. When we obtain
reinsurance, we are still liable for those transferred risks if the reinsurer
cannot meet its obligations. Therefore, the inability of our reinsurers to meet
their financial obligations could materially affect our operations and financial
condition.
We Are Subject to Extensive Regulation.
Our insurance business is subject to extensive regulation and supervision
in the jurisdictions in which we operate, which is primarily for the benefit and
protection of our customers, and not for the benefit of our investors or
creditors. Our insurance subsidiaries are subject to state insurance laws that
establish supervisory agencies with broad administrative powers relative to
granting and revoking licenses to transact business, regulating sales and other
practices, licensing agents, approving policy forms, setting reserve and
solvency requirements, determining the form and content of required statutory
financial statements, limiting dividends and prescribing the type and amount of
investments.
We have been operating under heightened scrutiny from state insurance
regulators. As described in Item 1. "Competition", our insurance subsidiaries
domiciled in Texas, Bankers National Life Insurance Company and Conseco Life
Insurance Company of Texas (on behalf of itself and its subsidiaries), entered
into consent orders with the Commissioner of Insurance for the State of Texas on
October 30, 2002.
In Certain Circumstances, Regulatory Authorities May Place Our Insurance
Subsidiaries Under Regulatory Control.
Our insurance subsidiaries are subject to risk-based capital requirements.
These requirements were designed to evaluate the adequacy of statutory capital
and surplus in relation to investment and insurance risks associated with: asset
quality; mortality and morbidity; asset and liability matching; and other
business factors. The requirements are used by states as an early warning tool
to discover potential weakly-capitalized companies for the purpose of initiating
regulatory action. Generally, if an insurer's ACLRBC falls below specified
levels, the insurer would be subject to different degrees of regulatory action
depending upon the magnitude of the deficiency. Possible regulatory actions
range from requiring the insurer to propose actions to correct the ACLRBC
deficiency to placing the insurer under regulatory control. The 2002 statutory
annual statements filed with the state insurance regulators of each of our
insurance subsidiaries reflected total adjusted capital in excess of levels
subjecting the subsidiary to any regulatory action. However, our ACLRBC ratios
have declined significantly over the last year and some of our subsidiary's
capital levels are near the level which would require them to submit a
comprehensive plan aimed at improving their capital position to the regulatory
authority.
Recently Enacted and Pending or Future Legislation Could Also Affect the
Financial Performance of Our Insurance Operations.
During recent years, the health insurance industry has experienced
substantial changes, including those caused by healthcare legislation. Recent
federal and state legislation and legislative proposals relating to healthcare
reform contain features that could severely limit or eliminate our ability to
vary our pricing terms or apply medical underwriting standards with respect to
individuals which could have the effect of increasing our loss ratios and have
an adverse effect on our financial results. In particular, Medicare reform and
legislation concerning prescription drugs could affect our ability to price or
sell our products.
Proposals currently pending in Congress and some state legislatures may
also affect our financial results. These proposals include the implementation of
minimum consumer protection standards for inclusion in all long-term care
policies, including: guaranteed premium rates; protection against inflation;
limitations on waiting periods for pre-existing conditions; setting standards
for sales practices for long-term care insurance; and guaranteed consumer access
to information about insurers (including lapse and
38
replacement rates for policies and the percentage of claims denied). Enactment
of any of these proposals could adversely affect our financial results.
In addition, the federal government may seek to regulate the insurance
industry, and recent government regulation may increase competition in the
insurance industry and may affect our insurance subsidiaries' current sales
methods. Although the federal government generally does not directly regulate
the insurance industry, federal initiatives often have a direct impact on the
insurance business. Current and proposed measures that may significantly affect
the insurance business generally include limitations on antitrust immunity and
minimum solvency requirements.
Changing Interest Rates May Adversely Affect Our Results of Operations.
Our profitability may be directly affected by the level of and fluctuations
in interest rates. While we monitor the interest rate environment and have
previously employed hedging strategies designed to mitigate the impact of
changes in interest rates, our financial results could be adversely affected by
changes in interest rates. Our spread-based insurance and annuity business is
subject to several inherent risks arising from movements in interest rates,
especially if we fail to anticipate or respond to such movements. First,
interest rate changes can cause compression of our net spread between interest
earned on investments and interest credited on customer deposits, thereby
adversely affecting our results. Second, if interest rate changes produce an
unanticipated increase in surrenders of our spread-based products, we may be
forced to sell investment assets at a loss in order to fund such surrenders. At
December 31, 2002, approximately 20 percent of our total insurance liabilities
(or approximately $4.5 billion) could be surrendered by the policyholder without
penalty. Finally, changes in interest rates can have significant effects on the
performance of our mortgage-backed securities portfolio, including
collateralized mortgage obligations, as a result of changes in the prepayment
rate of the loans underlying such securities. We follow asset/liability
strategies that are designed to mitigate the effect of interest rate changes on
our profitability. However, there can be no assurance that management will be
successful in implementing such strategies and achieving adequate investment
spreads.
Litigation and Regulatory Investigations May Harm Our Financial Strength
and Reduce Our Profitability.
Insurance companies historically have been subject to substantial
litigation resulting from claims disputes and other matters. In addition to the
traditional policy claims associated with their businesses, insurance companies
are increasingly facing policyholder suits, class actions and disputes with
reinsurers. The class actions and policyholder suits are often in connection
with insurance sales practices, policy and claims administration practices and
other market conduct issues. State insurance departments are increasingly
focusing on sales practices and product issues in their market conduct
examinations. Negotiated settlements of class action and other lawsuits have had
a material adverse effect on the business, financial condition and results of
operations of insurance companies. As a result of these trends, we are in the
ordinary course of our business a plaintiff or defendant in actions arising out
of our insurance business and investment operations, including class actions and
reinsurance disputes, and, from time to time, are also involved in various
governmental and administrative proceedings. Such litigation and proceedings may
harm our financial strength and reduce our profitability. We cannot assure you
that such litigation will not adversely affect our future business, financial
condition or results of operations.
A Delay or an Unfavorable Outcome in the Dispute Surrounding Our Interest
in the GM Building May Adversely Affect Our Financial Condition and Our
Ability to Fund Our Business Plan.
As described in Item 3. "Legal Proceedings", entities controlled by Donald
J. Trump currently dispute CNC's subsidiary's ability to acquire the GM Building
and later to monetize that asset. This dispute could delay our subsidiary's
ability to sell the GM Building and distribute the profits of that sale. Our
Plan presumes that our interest in the GM Building will be monetized in the
first quarter of 2004, although timing of actual resolution of the dispute with
Trump and sale of the building is not certain. The mortgages on the GM Building,
which total $700 million, are due on August 1, 2003.
The Markets in Which We Compete Are Highly Competitive.
Each of the markets in which we operate is highly competitive. Competitors
include other life insurers, commercial banks, thrifts, mutual funds and
broker-dealers. Many of our competitors in different segments and regions are
larger companies that have greater capital, technological and marketing
resources, and have access to capital at a lower cost. Because the actual cost
of products is unknown when they are sold, we are subject to competitors who may
sell a product at a price that does not cover its actual cost. Agents placing
insurance business with our insurance subsidiaries generally are compensated on
a commission basis. There are many life and health insurance companies in the
U.S. Some of these companies may pay higher commissions and charge lower premium
rates, and many companies have more substantial resources than we do. Publicity
about our recent financial difficulties may cause agents to place business with
other insurers.
We must attract and retain sales representatives to sell our insurance and
annuity products. Strong competition exists among
39
financial services companies for efficient sales representatives. We compete
with other financial services companies for sales representatives primarily on
the basis of our financial position, support services and compensation and
product features. Our competitiveness for such agents also depends upon the
relationships we develop with these agents. If we are unable to attract and
retain sufficient numbers of sales representatives to sell our products, our
ability to compete and our revenues would suffer.
Tax Law Changes Could Adversely Affect Our Insurance Product Sales and
Profitability.
We sell deferred annuities and some forms of life insurance products which
are attractive to purchasers, in part, because policyholders generally are not
subject to United States federal income tax on increases in policy values until
some form of distribution is made. Recently, Congress enacted legislation to
lower marginal tax rates, reduce the federal estate tax gradually over a
ten-year period, with total elimination of the federal estate tax in 2010 and
increase contributions which may be made to individual retirement accounts and
401(k) accounts. While these tax law changes will sunset at the beginning of
2011 absent future congressional action, they could in the interim diminish the
appeal of our annuity and life insurance products. Additionally, Congress has
considered, from time to time, other possible changes to the U.S. tax laws,
including elimination of the tax deferral on the accretion of value within
certain annuities and life insurance products. There can be no assurance that
further tax legislation will not be enacted which would contain provisions with
possible adverse effects on our annuity and life insurance products.
The Impact of Recent Terrorist Attacks and the War in Iraq May Adversely
Affect the Insurance Industry and Financial Markets.
Terrorist attacks in New York City and Washington, D.C. on September 11,
2001 adversely affected commerce throughout the United States and resulted in
significant disruption to the insurance industry and significant declines and
volatility in financial markets. The continued threat of terrorism within the
United States and abroad, and the military action and heightened security
measures in response to that threat, including the possibility of extended
hostilities in Iraq, may cause additional disruptions to the insurance industry,
reduced economic activity and continued volatility in markets throughout the
world, which may adversely impact our financial results.
40
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 2002:
The following tables and narratives summarize our operating results for the
three years ended December 31, 2002. Please read this discussion in conjunction
with the accompanying consolidated financial statements and notes.
2002 2001 2000
---- ---- ----
(Dollars in millions)
Operating earnings (losses) from continuing operations before taxes and
goodwill amortization:
Insurance and fee-based segment operating earnings................... $ 284.6 $ 776.7 $ 780.5
Holding company activities:
Corporate expenses, less charges to subsidiaries for services
provided......................................................... (87.3) (22.0) (71.0)
Interest and dividends, net of corporate investment income......... (487.2) (551.4) (654.1)
--------- ------- ---------
Operating earnings (losses) from continuing operations
before taxes and goodwill amortization......................... (289.9) 203.3 55.4
Taxes................................................................ (53.1) (79.0) (20.2)
--------- ------- ---------
Operating earnings (losses) from continuing operations
before goodwill amortization................................... (343.0) 124.3 35.2
Goodwill amortization................................................ - (107.0) (104.2)
--------- ------- ---------
Operating earnings (losses) from continuing operations
applicable to common stock..................................... (343.0) 17.3 (69.0)
--------- ------- ---------
Non-operating items, net of tax:
Deferred income tax valuation allowance................................ (811.2) - -
Loss related to reinsurance transactions and businesses
sold to raise cash................................................... (47.5) - (56.3)
Net realized losses.................................................... (569.2) (222.4) (193.1)
Provision for losses related to loan guarantees........................ (240.0) (110.2) (150.0)
Venture capital loss related to our investment
in AT&T Wireless Services, Inc....................................... (99.3) (15.2) (99.4)
Costs related to debt modification and refinancing
transactions......................................................... (17.7) - -
Restructuring items.................................................... (14.4) - -
Major medical business in run-off and other
non-recurring items.................................................. (31.3) (121.3) (192.1)
Discontinued operations:
CFC(a)............................................................... (1,969.6) (101.1) (399.7)
CVIC................................................................. (253.5) (5.6) 17.7
Gain on sale of interest in riverboat.................................. - 122.6 -
Extraordinary gain (loss) on extinguishment of debt ................... 8.1 17.2 (5.0)
Cumulative effect of accounting change................................. (2,949.2) - (55.3)
Goodwill impairment ................................................... (500.0) - -
--------- ------- ---------
Total non-operating items, net of tax.............................. (7,494.8) (436.0) (1,133.2)
--------- ------- ---------
Net loss applicable to common stock....................................... $(7,837.8) $(418.7) $(1,202.2)
========= ======= =========
- --------------------
(a) See the section of this Management's discussion and Analysis of Financial
Condition and Results of Operation entitled "Financial Condition and
Results of Operations of CFC" for information on CFC.
41
We evaluate performance and determine future earnings goals based on
operating earnings which we define as income before: (i) net investment gains
(losses)(less that portion of amortization of cost of policies purchased and
cost of policies produced and income taxes relating to such gains (losses));
(ii) the venture capital income (loss) related to our investment in AT&T
Wireless Services, Inc. ("AWE"); (iii) the gain on the sale of our interest in a
riverboat; (iv) special items not related to the continuing operations of our
businesses (including changes in the deferred income tax valuation allowance,
goodwill impairments, special charges and the provision for losses related to
loan guarantees); (v) the net income (loss) related to the major medical
business in run-off; and (vi) discontinued operations and the effect of
accounting changes and extraordinary gain (loss) on extinguishment of debt. The
criteria used by management to identify the items excluded from operating
earnings include whether the item: (i) relates to other than the continuing
operations of our businesses; (ii) is infrequent; (iii) is material to net
income (loss); (iv) results from restructuring activities; (v) results from a
change in the regulatory environment; and/or (vi) relates to the sale of an
investment or the change in estimated market value of our venture capital
investments. The non-operating items which may occur will vary from period to
period and since these items are determined based on management's discretion,
inconsistencies in the application of the criteria may exist. Operating earnings
are determined by adjusting GAAP net income for the above mentioned items. While
these items may be significant components in understanding and assessing our
consolidated financial performance, we believe that the presentation of
operating earnings enhances the understanding of our results of operations by
highlighting net income attributable to the normal, recurring operations of the
business and by excluding events that materially distort trends in net income.
However, operating earnings are not a substitute for net income (loss)
determined in accordance with GAAP.
42
Insurance and Fee-based Operations: 2002 2001 2000
---- ---- ----
(Dollars in millions)
Premiums and asset accumulation product collections:
Annuities...................................................................... $ 1,092.8 $ 1,223.7 $ 1,229.8
Supplemental health............................................................ 2,424.2 2,344.5 2,263.9
Life........................................................................... 637.0 839.6 901.1
Group major medical............................................................ 315.6 370.9 502.8
--------- --------- ---------
Collections on insurance products from continuing lines of business........ 4,469.6 4,778.7 4,897.6
Individual major medical in run-off ........................................... 93.9 366.2 407.3
Discontinued operations........................................................ 260.8 446.8 886.2
--------- --------- ---------
Total collections on insurance products.................................... 4,824.3 5,591.7 6,191.1
Deposit type contracts......................................................... 287.6 178.0 147.7
Deposit type contracts - discontinued operations.................................. 5.8 8.7 25.6
Mutual funds................................................................... 207.9 468.7 794.2
--------- --------- ---------
Total premiums and asset accumulation product collections.................. $ 5,325.6 $ 6,247.1 $ 7,158.6
========= ========= =========
Average liabilities for insurance and asset accumulation products (excluding
discontinued operations and our major medical business in run-off):
Annuities:
Mortality based............................................................ $ 250.7 $ 358.2 $ 399.3
Equity-linked.............................................................. 2,170.6 2,632.2 2,550.6
Deposit based.............................................................. 7,902.2 7,955.9 8,718.6
Separate accounts and investment trust liabilities......................... 672.6 738.0 824.3
Health....................................................................... 5,459.9 5,106.3 4,753.8
Life:
Interest sensitive......................................................... 4,109.7 4,033.2 3,985.8
Non-interest sensitive..................................................... 1,985.3 2,483.0 2,467.0
--------- --------- ---------
Total average liabilities for insurance and asset accumulation products,
net of reinsurance ceded................................................. $22,551.0 $23,306.8 $23,699.4
========= ========= =========
Revenues:
Insurance policy income........................................................ $ 3,183.5 $ 3,240.5 $ 3,265.4
Net investment income:
General account invested assets.............................................. 1,516.7 1,683.6 1,763.8
Equity-indexed products based on the change in value of the S&P 500
Call Options............................................................... (100.5) (114.2) (111.0)
Separate account assets...................................................... - (5.4) 54.9
Fee revenue and other income................................................... 85.8 100.2 128.9
--------- --------- ---------
Total revenues (a)......................................................... 4,685.5 4,904.7 5,102.0
--------- --------- ---------
Expenses:
Insurance policy benefits...................................................... 2,562.4 2,420.0 2,423.1
Amounts added to policyholder account balances:
Annuity products and interest-sensitive life products other than those
listed below............................................................... 501.7 530.0 560.7
Equity-indexed products based on S&P 500 Index............................... (.3) .8 11.4
Separate account liabilities................................................. - (5.4) 54.9
Amortization related to operations............................................. 773.1 596.0 591.7
Interest expense on investment borrowings...................................... 15.4 30.5 15.8
Other operating costs and expenses............................................. 548.6 556.1 663.9
--------- --------- ---------
Total benefits and expenses (a)............................................ 4,400.9 4,128.0 4,321.5
--------- --------- ---------
Operating income before goodwill amortization, goodwill impairment,
income taxes and minority interest....................................... 284.6 776.7 780.5
Goodwill amortization............................................................. - (107.0) (104.2)
Goodwill impairment............................................................... (500.0) - -
Net investment losses, including related costs and amortization................... (569.2) (342.1) (297.1)
Special charges................................................................... (44.3) (21.5) -
--------- --------- ---------
Income (loss) before income taxes, minority interest,
extraordinary gain (loss) and cumulative effect of accounting change..... $ (828.9) $ 306.1 $ 379.2
========= ========= =========
(continued)
43
2002 2001 2000
---- ---- ----
(Dollars in millions)
(continued from previous page)
Ratios:
Investment income, net of interest credited on annuities and universal life
products and interest expense on investment borrowings, as a percentage of
average liabilities for insurance and asset accumulation
products (b)................................................................... 4.12% 4.38% 4.53%
Operating costs and expenses (excluding amortization of cost of policies
produced and cost of policies purchased) as a percentage of average
liabilities for insurance and asset accumulation products (c).................. 2.51% 2.46% 2.90%
Health loss ratios:
All health lines:
Insurance policy benefits...................................................... $1,987.5 $1,750.4 $1,741.1
Loss ratio.......................................................................... 83.03% 74.28% 76.21%
Medicare supplement:
Insurance policy benefits...................................................... $655.2 $635.9 $675.5
Loss ratio..................................................................... 65.08% 65.25% 71.60%
Long-term care:
Insurance policy benefits...................................................... $990.2 $762.7 $691.5
Loss ratio..................................................................... 110.08% 86.39% 84.17%
Interest-adjusted loss ratio................................................... 88.06% 67.32% 66.77%
Specified disease:
Insurance policy benefits...................................................... $259.5 $250.9 $256.4
Loss ratio..................................................................... 69.61% 67.35% 69.00%
Other:
Insurance policy benefits...................................................... $82.6 $100.9 $117.7
Loss ratio..................................................................... 72.11% 79.66% 79.53%
- --------------------
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to realized gains and goodwill amortization
(b) Investment income includes income from general account assets only. Average
insurance liabilities exclude liabilities related to separate accounts,
investment trust and reinsurance ceded.
(c) Average insurance liabilities exclude liabilities related to separate
accounts, investment trust and reinsurance ceded.
General: As more fully described in "Liquidity for insurance and fee-based
operations," within "Management's Discussion and Analysis of Financial Condition
and Results of Operations", our insurance subsidiaries financial strength
ratings were downgraded by A.M. Best on August 14, 2002 to "B (fair)" and the
ratings remain "under review with developing implications". The downgrade has
caused sales of our insurance products to fall and policyholder redemptions and
lapses to increase. This has had a material adverse impact on our financial
results. Conseco's insurance subsidiaries develop, market and administer
annuity, supplemental health, individual life insurance and other insurance
products. We distribute these products through a career agency force,
professional independent producers and direct response marketing. This segment
excludes our discontinued operations and the major medical business in run-off.
Liabilities for insurance products are calculated using management's best
judgments of mortality, morbidity, lapse rates, investment experience and
expense levels that are based on the Company's past experience and standard
actuarial tables.
Collections on insurance products from continuing operations in 2002 were
$4.5 billion, down 6.5 percent from 2001. Such collections in 2001 were $4.8
billion, down 2.4 percent from 2000. Sales of our insurance products were
adversely affected by the declines in our financial strength ratings during
2002, 2001 and 2000. See "Premium and Asset Accumulation Product Collections"
for further analysis.
Average liabilities for insurance and asset accumulation products, net of
reinsurance receivables, were $22.6 billion in 2002, down 3.2 percent from 2001,
and $23.3 billion in 2001, down 1.7 percent from 2000. The decrease in such
liabilities is primarily due
44
to ceding approximately $870 million of insurance liabilities pursuant to
reinsurance agreements entered into during the first quarter of 2002. In
addition, policyholder redemptions and lapses have increased following the
downgrade of our A.M. Best financial strength rating to "B (fair)". See the note
to our consolidated financial statements entitled "Summary of Significant
Accounting Policies" for additional discussion of the reinsurance transactions.
See "Liquidity for insurance and fee-based operations" within "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
additional discussion of the A.M. Best ratings downgrade. Such decrease in 2001
primarily reflects the decreased sales of interest-sensitive products.
Surrenders exceeded sales in both 2002 and 2001.
Insurance policy income is comprised of: (i) premiums earned on policies
which provide mortality or morbidity coverage; and (ii) fees and other charges
made against other policies. See "Premium and Asset Accumulation Product
Collections" for further analysis.
Net investment income on general account invested assets (which excludes
income on separate account assets related to variable annuities; and the income
(loss), cost and change in the fair value of S&P 500 Call Options related to
equity-indexed products) decreased by 9.9 percent, to $1,516.7 million, in 2002,
and by 4.5 percent, to $1,683.6 million, in 2001. The average balance of general
account invested assets decreased by 2.9 percent in 2002 to $23.3 billion and
increased by .7 percent in 2001 to $24.0 billion. The yield on these assets was
6.5 percent in 2002, 7.0 percent in 2001 and 7.4 percent in 2000. The decrease
in yield reflects general decreases in market interest rates between periods.
Net investment income and the average balance of general account invested assets
both reflect the transfer of a portion of our investment portfolio to reinsurers
pursuant to recent reinsurance transactions. See the note to our consolidated
financial statements entitled "Summary of Significant Accounting Policies" for
additional discussion of reinsurance transactions.
Net investment income related to equity-indexed products based on the
change in value of the S&P 500 Call Options represents the change in the
estimated fair value of our S&P 500 Call Options which are purchased in an
effort to cover certain benefits accruing to the policyholders of our
equity-indexed products. Our equity-indexed products are designed so that the
investment income spread earned on the related insurance liabilities should be
more than adequate to cover the cost of the S&P 500 Call Options and other costs
related to these policies. Option costs that are attributable to benefits
provided were $97.5 million, $119.0 million and $123.9 million in 2002, 2001 and
2000, respectively. These costs are reflected in the change in market value of
the S&P 500 Call Options included in the investment income amounts. Net
investment income (loss) related to equity-indexed products before this expense
was $(3.0) million, $4.8 million and $12.9 million in 2002, 2001 and 2000,
respectively. Such amounts were partially offset by the corresponding charge
(credit) to amounts added to policyholder account balances for equity-indexed
products of $(.3) million, $.8 million and $11.4 million in 2002, 2001 and 2000,
respectively. Such income and related charge fluctuated based on the value of
options embedded in the Company's equity-indexed annuity policyholder account
balances subject to this benefit and to the performance of the S&P 500 Index to
which the returns on such products are linked.
Net investment income (loss) from separate account assets is offset by a
corresponding charge (credit) to amounts added to policyholder account balances
for separate account liabilities. Such income (loss) and related charge (credit)
fluctuated in relationship to total separate account assets and the return
earned on such assets.
Fee revenue and other income includes: (i) revenues we receive for managing
investments for other companies; and (ii) fees received for marketing insurance
products of other companies. In 2002, this amount includes $16.7 million of
affiliated fee revenue earned by our subsidiary in India compared to $5.4
million in 2001 and nil in 2000. Such revenue is eliminated in consolidation.
Excluding such affiliated income, fee revenue and other income decreased in 2002
and 2001 primarily as a result of a decrease in the market value of investments
managed for others, upon which these fees are based. The Company sold its India
subsidiary in the fourth quarter of 2002 and has significantly reduced the
customer service and backroom operations conducted there.
Insurance policy benefits fluctuated in 2002 and 2001 as a result of the
factors summarized in the explanations for loss ratios related to specific
products which follow. Loss ratios are calculated by taking the related
insurance product's: (i) policy benefits; divided by (ii) policy income.
The loss ratio for Medicare supplement products has been within the range
we expected it to be in during 2002 and 2001. Such ratio was higher in 2000, for
the following reasons: (i) our estimate of 1999 year end reserves proved to be
less than necessary to cover pre-2000 claims; (ii) the mix of our Medicare
supplement business in 2000 included a higher percentage of less profitable
standard Medicare supplement policies than the prior year (and a lower
percentage of more profitable nonstandard policies that we are no longer able to
offer to new policyholders); and (iii) a larger portion of certain older blocks
of our Medicare supplement business had remained inforce longer than we
expected. While the Company benefited from the additional profits earned on the
larger blocks of business, the loss ratio will generally increase since the
older policies have higher claim costs. Governmental regulations generally
require us to attain and maintain a loss ratio, after three years, of not less
than 65 percent.
During 2002, the Company conducted an extensive examination of the
assumptions used to estimate its claim reserves for long-
45
term care products sold through its independent agent distribution channel. The
examination was prompted by the continuing claim reserve deficiencies that we
experienced in recent periods based on the assumptions and estimates made by our
actuaries. The Company engaged an independent actuarial firm to assist in the
examination.
The Company's prior estimates for long-term care reserves were based on
claim continuance tables using experience for the period from January 1, 1990
through September 30, 1999. These tables are used to estimate the length of time
an insured will receive covered long-term care for an incurred event. In 2002,
we completed studies which indicated that the average length of time an insured
will receive covered care has increased in recent periods. In addition, the
Company has experienced significant fluctuations in claim inventories for these
products. Accordingly, our actuaries and the independent actuarial firm
concluded that estimates of future claim payments for incurred claims using the
more recent data reflecting the longer covered care time periods were more
appropriate than estimates based on prior data. The changes in estimation in
calculating the reserves resulted in an increase to insurance policy benefits of
$130.0 million in 2002. Excluding this adjustment related to the change in
estimate, insurance policy benefits on long-term care policies would have been
$880.2 million, the loss ratio for the year ended December 31, 2002 would have
been 97.85 percent, and the interest-adjusted loss ratio for the year ended
December 31, 2002 would have been 75.84 percent.
The loss ratios for long-term care products also increased in 2002 due to
the higher level of benefits paid out on these products as the policies age. The
net cash flows from our long-term care products generally result in the
accumulation of amounts in the early years of a policy (accounted for as reserve
increases) which will be paid out as benefits in later policy years (accounted
for as reserve decreases). Accordingly, as the policies age, the loss ratio will
typically increase, but the increase in the change in reserve will be partially
offset by investment income earned on the assets which have accumulated. The
interest-adjusted loss ratio for long-term care products is calculated by taking
the insurance product's (i) policy benefits less interest income on the
accumulated assets which back the insurance liabilities; divided by (ii) policy
income.
The loss ratios for long-term care products increased in 2001 and 2000,
reflecting the effects of the asset accumulation phase of these products. In
addition, the estimated liabilities for claims at December 31, 2001 were
deficient by approximately $19 million based on subsequent payments through
December 31, 2002. Such claims at December 31, 2000 were deficient by
approximately $14 million based on subsequent claim payments through December
31, 2001.
We experienced higher than expected claims on our specified disease
business in 2002. As a result, our loss ratio increased. Notwithstanding the
increased loss ratio, this block of business is performing within our
expectations. Our general expectation is for the loss ratio for specified
disease products to be approximately 68 percent. The 2001 loss ratio for
specified disease products was within our expectations. The higher loss ratio in
2000 reflects changes in estimates of period end claim liabilities. Our estimate
of 1999 claim liabilities proved to be inadequate to cover pre-2000 claims.
The loss ratios on our other products will fluctuate due to the smaller
size of these blocks of business. The loss ratios on this business have
generally been within our expectations.
Amounts added to policyholder account balances for annuity products
decreased by 5.3 percent, to $501.7 million, in 2002, and 5.5 percent, to $530.0
million, in 2001. The decrease in 2002 as compared to 2001 is primarily due to
the decrease in the weighted average crediting rates as the average liabilities
for this block of business were approximately $11.7 billion for both 2002 and
2001. The weighted average crediting rates for these products was 4.3 percent
and 4.5 percent in 2002 and 2001, respectively. The decrease in 2001 as compared
to 2000 is primarily due to a smaller block of this type of business inforce.
Average liabilities for these products were $11.7 billion in 2001, down 7.1
percent from 2000. The weighted average crediting rates for these products was
4.5 percent in both 2001 and 2000.
Amounts added to equity indexed products and separate account liabilities
correspond to the related investment income accounts described above.
Amortization related to operations includes amortization of the cost of
policies produced and the cost of policies purchased. Amortization generally
fluctuates in relationship to the total account balances subject to
amortization.
Policyholder redemptions of annuity and, to a lesser extent, life products
have increased in recent periods. We have experienced additional redemptions
following the downgrade of our A.M. Best financial strength rating to "B
(fair)". When redemptions are greater than our previous assumptions, we are
required to accelerate the amortization of our cost of policies produced and
cost of policies purchased to write off the balance associated with the redeemed
policies. Accordingly, amortization expense has increased. We have changed the
lapse assumptions used to determine the amortization of the cost of policies
produced and the cost of policies purchased related to certain universal life
products and our annuities to reflect our current estimates of future lapses.
For certain universal life products, we changed the ultimate lapse assumption
from: (i) a range of 6 percent to 7 percent; to (ii) a tiered assumption based
on the level of funding of the policy of a range of 2 percent to 10 percent.
Policyholder withdrawals in recent periods have exceeded our estimates. Such
withdrawals were $3,708.3 million in 2002 and $2,528.3 million in 2001.
Accordingly,
46
we increased the expected future lapse rates on these products to reflect our
current belief that lapses on these policies will continue to be higher than
previously expected for the next several quarters. We recorded additional
amortization of $203.2 million in 2002 related to higher redemptions and changes
to our lapse assumptions.
As a result of economic developments, actual experience of our products and
changes in our expectations, we changed our investment yield assumptions used in
calculating the estimated gross profits to be earned on our annuity products in
2001 and 2000. Such changes resulted in additional amortization of the cost of
policies produced and cost of policies purchased of $27.8 million and $25.6
million in 2001 and 2000, respectively.
Interest expense on investment borrowings decreased in 2002 while our
investment borrowing activities increased. Average investment borrowings were
$1,155.8 million during 2002, compared to $927.0 million during 2001 and $238.1
million during 2000. The weighted average interest rate on such borrowings were
1.3 percent, 3.3 percent and 6.6 percent during 2002, 2001 and 2000,
respectively.
Other operating costs and expenses decreased in 2002 and 2001 consistent
with our cost cutting programs and the current business plans for the segment.
The increase in such expenses in 2000 was primarily the result of our increased
business and marketing initiatives. The ratio of operating expenses (excluding
amortization of cost of policies produced and cost of policies purchased) as a
percentage of average liabilities for insurance and asset accumulation products
was 2.51 percent for 2002 compared to 2.46 percent for 2001 and 2.90 percent for
2000. The increase in the ratio in 2002, as compared to the prior year, is
primarily due to the decrease in average liabilities for insurance and asset
accumulation products resulting from the ceding of approximately $870 million of
insurance liabilities in the first quarter of 2002.
Net investment gains (losses), including related costs and amortization
fluctuate from period to period. During 2002, 2001 and 2000, we recognized net
investment losses of $597.0 million, $379.4 million and $346.5 million,
respectively. The net investment losses during 2002 included: (i) $556.8 million
to write down certain securities to fair value due to an other-than-temporary
decline in value (including issuers who have faced significant problems: K-Mart
Corp., Amerco, Inc., Global Crossing, MCI Communications, Mississippi Chemical,
United Airlines and Worldcom, Inc.); and (ii) $40.2 million of net losses from
the sales of investments (primarily fixed maturities) which generated proceeds
of $19.5 billion. The net investment losses during 2001 included: (i) $141.9
million to recognize the impact of higher default rate assumptions on certain
structured investments; (ii) $62.4 million to recognize losses on investments
held in our private equity portfolio; (iii) $150.5 million to write down certain
securities to fair value due to an other-than-temporary decline in value or the
Company's plan to sell the securities in connection with investment
restructuring activities (including issuers who have faced significant problems:
Sunbeam Corp., Enron Corp., Crown Cork & Seal Company Inc., Global Crossing Ltd.
and K-Mart Corp.); and (iv) $24.6 million of losses from the sales of
investments (primarily fixed maturities) which generated proceeds of $24.2
billion. During 2000, we recorded $180.6 million of writedowns; $106.7 million
of losses from the sales of investments; and a $59.2 million loss related to the
termination of certain swap agreements.
When we sell securities at a gain (loss) and reinvest the proceeds at a
different yield, we increase (reduce) the amortization of cost of policies
purchased and cost of policies produced in order to reflect the change in future
yields. Sales of fixed maturity investments resulted in a reduction in the
amortization of the cost of policies purchased and the cost of policies produced
of $21.5 million in 2002, $37.3 million in 2001 and $49.4 million in 2000.
Special charges in 2002 include: (i) losses of $35.0 million on reinsurance
and asset sale transactions entered into as part of our cash raising
initiatives; and (ii) other items totaling $9.3 million primarily related to
severance benefits and costs incurred with the transfer of certain customer
service and backroom operations to our India subsidiary. Special charges in 2001
were $21.5 million. Such charges primarily relate to severance benefits and
costs incurred in conjunction with the transfer of certain customer service and
backroom operations to our former India subsidiary. These charges are described
in greater detail in the note to our consolidated financial statements entitled
"Special Charges."
47
Corporate Operations
2002 2001 2000
---- ---- ----
(Dollars in millions)
Corporate operations:
Interest expense on corporate debt, net of investment
income on cash and cash equivalents............................ $(312.0) $(354.7) $ (419.6)
Investment income.................................................. - 4.4 31.3
Other items........................................................ (87.2) (26.4) (20.2)
------- ------- ---------
Operating loss before non-operating items, income
taxes and minority interest.................................. (399.2) (376.7) (408.5)
Provision for losses and expense related to stock purchase ........
plan............................................................. (240.0) (169.6) (231.5)
Venture capital loss related to investment in
AWE, net of related expenses..................................... (99.3) (23.4) (152.8)
Major medical business in run-off.................................. - (130.3) (51.3)
Gain on sale of interest in riverboat.............................. - 192.4 -
Special charges.................................................... (52.2) (58.9) (305.0)
Reorganization items............................................... (14.4) - -
------- ------- ---------
Loss before income taxes and minority
interest..................................................... $(805.1) $(566.5) $(1,149.1)
======= ======= =========
Interest expense on corporate debt, net of investment income on cash and
cash equivalents has decreased as a result of the repayment of debt and lower
interest rates. The average debt outstanding was $4.1 billion, $4.5 billion and
$5.2 billion in 2002, 2001 and 2000, respectively. The average interest rate on
such debt was 8.0 percent, 8.2 percent and 8.4 percent in 2002, 2001 and 2000,
respectively.
Investment income includes the income from our investment in a riverboat
casino (prior to its sale in the first quarter of 2001) and miscellaneous other
income.
Other items include general corporate expenses, net of amounts charged to
subsidiaries for services provided by the corporate operations. Such amount in
2002 includes the establishment of a $40.0 million allowance for a claim
receivable as further discussed in the note to our consolidated financial
statements entitled "Other Disclosures - Securities Litigation".
Provision for losses and expense related to stock purchase plan represents
the non-cash provision we established in connection with our guarantees of bank
loans to approximately 155 current and former directors, officers and key
employees and our related loans for interest. The funds from the bank loans were
used by the participants to purchase approximately 18.0 million shares of
Conseco common stock. In 2002, 2001 and 2000, we established provisions of
$240.0 million, $169.6 million and $231.5 million, respectively, in connection
with these guarantees and loans. We determine the reserve based upon the value
of the collateral held by the banks (primarily the purchased common stock). At
December 31, 2002, the reserve for losses on the loan guarantees totaled $660.0
million. The outstanding principal balance on the bank loans was $481.3 million.
In addition, Conseco has provided loans to participants for interest on the bank
loans totaling $179.2 million. During 2002, Conseco purchased $55.5 million of
loans from the banks utilizing cash held in a segregated cash account as
collateral for our guarantee of the bank loans (including accrued interest, the
balance on these loans was $56.7 million at December 31, 2002). The guarantees
of the bank loans are discussed in greater detail in the note to our
consolidated financial statements entitled "Other Disclosures."
Venture capital loss relates to our investment in TeleCorp PCS, Inc.
("TeleCorp"), a company in the wireless communication business. In the first
quarter of 2002, AWE acquired TeleCorp. Pursuant to the merger agreement, our
shares of TeleCorp were converted into 11.4 million shares of AWE. This
transaction is described in greater detail in the note to our consolidated
financial statements entitled "Summary of Significant Accounting Policies" Our
investment in AWE is carried at estimated fair value, with changes in fair value
recognized as investment income. The market values of AWE and many other
companies in this sector have declined significantly in recent years.
The major medical business in run-off includes individual major medical
health insurance products. These lines of business had losses of $130.3 million
and $51.3 million in 2001 and 2000, respectively. These lines of business, which
have substantially run-off,
48
did not incur additional losses in 2002. The amount in 2001 includes $77.4
million of amortization, which represented the unrecoverable cost of policies
produced and cost of policies purchased related to the major medical business in
run-off.
Gain on sale of interest in riverboat represents the gain recognized in the
first quarter of 2001 as a result of our sale of our 29 percent ownership
interest in the riverboat casino in Lawrenceberg, Indiana, for $260 million.
Special charges in corporate operations for 2002 include: (i) a loss of
$20.0 million associated with the sale of our India subsidiary; (ii) $17.7
million related to debt modification and refinancing transactions; (iii) other
items totaling $22.0 million; partially offset by (iv) net gains of $7.5 million
related to the sale of certain non-core assets. Special charges in corporate
operations for 2001 include: (i) litigation accrual and expenses of $23.8
million; (ii) severance benefits of $2.9 million; (iii) losses related to office
closings and the sale of artwork totaling $6.8 million; (iv) losses related to
disputed reinsurance balances totaling $8.5 million; and (v) other losses
totaling $16.9 million. Special charges in 2000 include: (i) advisory and
professional fees related to debt restructuring of $9.9 million; (ii) a portion
of the loss on the sale of asset-backed loans (excluding loss related to loans
held by the finance segment) of $15.2 million; (iii) advisory fees paid to
investment banks of $44.0 million; (iv) the loss related to our exit from the
subprime automobile business of $71.6 million; (v) the amount paid to a
terminated executive pursuant to his employment agreement of $72.5 million; (vi)
the amount paid to the newly hired Chief Executive Officer of $45.0 million;
(vii) the value of warrants issued to release the newly hired Chief Executive
Officer from a noncompete provision of a prior agreement of $21.0 million; and
(viii) other charges of $25.8 million. These charges are described in greater
detail in the note to our consolidated financial statements entitled "Special
Charges".
Reorganization items are professional fees associated with CNC's bankruptcy
proceedings which are expensed as incurred in accordance with Statement of
Position 90-7 "Financial Reporting by Entities in Reorganization under the
Bankruptcy Code" ("SOP 90-7").
PREMIUM AND ASSET ACCUMULATION PRODUCT COLLECTIONS
In accordance with GAAP, insurance policy income as shown in our
consolidated statement of operations consists of premiums earned for policies
that have life contingencies or morbidity features. For annuity and universal
life contracts without such features, premiums collected are not reported as
revenues, but as deposits to insurance liabilities. We recognize revenues for
these products over time in the form of investment income and surrender or other
charges.
Agents, insurance brokers and marketing companies who market our products
and prospective purchasers of our products use the ratings of our insurance
subsidiaries as an important factor in determining which insurer's products to
market or purchase. Ratings have the most impact on our annuity and
interest-sensitive life insurance products. During 2000, rating agencies lowered
their financial strength ratings of our insurance companies, and many were
placed on review as the agencies analyzed the impact of the events which
occurred during 2000. Such rating actions adversely affected the marketing and
persistency of our insurance products and other asset accumulation products. On
November 7, 2000, A.M. Best upgraded the financial strength ratings of our
principal insurance subsidiaries to A- (Excellent) from B++ (Very Good). On
October 3, 2001, A.M. Best placed the Company's principal insurance subsidiaries
"under review with negative implications" following our announcement regarding
charges to be taken in the third quarter of 2001. In July 2002, A.M. Best
downgraded the financial strength ratings of our primary insurance subsidiaries
to "B++ (Very Good)" and placed the ratings "under review with negative
implications." On August 14, 2002, A.M. Best further lowered the financial
strength ratings of our primary insurance subsidiaries from "B++ (very good)" to
"B (fair)." A.M. Best ratings for the industry currently range from "A++
(Superior)" to "F (In Liquidation)" and some companies are not rated. An "A++"
ranking indicates superior overall performance and a strong ability to meet
obligations to policyholders over a long period of time. The "B" rating is
assigned to companies which have, on balance, fair balance sheet strength,
operating performance and business profile, when compared to the standards
established by A.M. Best, and have an ability in A.M. Best's opinion to meet
their current obligations to policyholders, but their financial strength is
vulnerable to adverse changes in underwriting and economic conditions. The
rating reflects A.M. Best's view of the uncertainty surrounding our
restructuring initiatives and the potential adverse financial impact on the
subsidiaries if negotiations are protracted and execution of the restructuring
plan is delayed. S&P has given our insurance subsidiaries a financial strength
rating of "B+". Rating categories from "BB" to "CCC" are classified as
"vulnerable," and pluses and minuses show the relative standing within a
category. In S&P's view, an insurer rated "B" has the capacity to meet its
financial commitments but adverse business conditions could lead to insufficient
ability to meet financial commitments.
These ratings downgrades caused sales of our insurance products to decline
and policyholder redemptions and lapses to increase. In some cases, the
downgrades also caused defections among our independent agent sales force and
increases in the commissions we had to pay to retain them. These events have had
a material adverse effect on our financial results. Further downgrades by A.M.
Best or S&P would likely have further material and adverse effects on our
financial results and liquidity.
We set the premium rates on our health insurance policies based on facts
and circumstances known at the time we issue the policies and on assumptions
about numerous variables, including the actuarial probability of a policyholder
incurring a claim, the
49
severity, and the interest rate earned on our investment of premiums. In setting
premium rates, we consider historical claims information, industry statistics,
premiums charged by competitors and other factors. If our actual claims
experience proves to be less favorable than we assumed and we are unable to
raise our premium rates, our financial results will be adversely affected. We
generally cannot raise our premiums in any state unless we first obtain the
approval of the insurance regulator in that state. We review the adequacy of our
premium rates regularly and file requests for rate increases on our products
when we believe existing premium rates are too low. It is possible that we will
not be able to obtain approval for premium rate increases from currently pending
requests or requests filed in the future. If we are unable to raise our premium
rates because we fail to obtain approval for a rate increase in one or more
states, our financial results will be adversely affected. If we are successful
in obtaining regulatory approval to raise premium rates due to unfavorable
actual claims experience, the increased premium rates may reduce the volume of
our new sales and cause existing policyholders to allow their policies to lapse.
This would reduce our premium income in future periods. Increased lapse rates
also could require us to expense all or a portion of the cost of policies
produced or the cost of policies purchased relating to lapsed policies in the
period in which those policies lapse, adversely affecting our financial results
in that period.
We sell our insurance products through three primary distribution channels
career agents, independent producers and direct marketing. Our career agency
force sells primarily Medicare Supplement and long-term care insurance policies,
senior life insurance and annuities. These agents visit the customer's home
which permits one-on-one contacts with potential policyholders and promotes
strong personal relationships with existing policyholders. Our independent
producer distribution channel consists of a general agency and insurance
brokerage distribution system comprised of independent licensed agents doing
business in all fifty states, the District of Columbia, and certain
protectorates of the United States. Independent producers are a diverse network
of independent agents, insurance brokers and marketing organizations. Our direct
marketing distribution channel is engaged primarily in the sale of "graded
benefit life" insurance policies which are sold directly from the Company to the
policyholder.
50
Total premiums and accumulation product collections were as follows:
2002 2001(a) 2000(a)
---- ------- -------
(Dollars in millions)
Premiums collected by our insurance subsidiaries:
Annuities:
Equity-indexed (first-year)............................................ $ 193.0 $ 347.6 $ 602.9
Equity-indexed (renewal)............................................... 27.1 33.3 40.6
-------- -------- --------
Subtotal - equity-indexed annuities.................................. 220.1 380.9 643.5
-------- -------- --------
Other fixed (first-year)............................................... 842.0 808.9 531.9
Other fixed (renewal).................................................. 30.7 33.9 54.4
-------- -------- --------
Subtotal - other fixed annuities..................................... 872.7 842.8 586.3
-------- -------- --------
Total annuities...................................................... 1,092.8 1,223.7 1,229.8
-------- -------- --------
Supplemental health:
Medicare supplement (first-year)....................................... 166.6 121.4 101.9
Medicare supplement (renewal).......................................... 867.2 853.7 829.1
-------- -------- --------
Subtotal - Medicare supplement....................................... 1,033.8 975.1 931.0
-------- -------- --------
Long-term care (first-year)............................................ 97.7 105.2 119.2
Long-term care (renewal)............................................... 819.7 783.1 716.8
-------- -------- --------
Subtotal - long-term care............................................ 917.4 888.3 836.0
-------- -------- --------
Specified disease (first-year)......................................... 36.8 42.1 39.1
Specified disease (renewal)............................................ 331.9 329.7 332.0
-------- -------- --------
Subtotal - specified disease......................................... 368.7 371.8 371.1
-------- -------- --------
Other health (first-year).............................................. 13.9 11.5 29.9
Other health (renewal)................................................. 90.4 97.8 95.9
-------- -------- --------
Subtotal - other health.............................................. 104.3 109.3 125.8
-------- -------- --------
Total supplemental health............................................ 2,424.2 2,344.5 2,263.9
-------- -------- --------
Life insurance:
First-year............................................................. 96.7 120.1 185.3
Renewal................................................................ 540.3 719.5 715.8
-------- -------- --------
Total life insurance................................................. 637.0 839.6 901.1
-------- -------- --------
Group major medical:
Group (first-year)..................................................... .5 16.4 79.6
Group (renewal)........................................................ 315.1 354.5 423.2
-------- -------- --------
Total group major medical............................................ 315.6 370.9 502.8
-------- -------- --------
Collections on insurance products from continuing lines of business:
Total first-year premium collections on insurance products............ 1,447.2 1,573.2 1,689.8
Total renewal premium collections on insurance products............... 3,022.4 3,205.5 3,207.8
-------- -------- --------
Total collections on insurance products............................. $4,469.6 $4,778.7 $4,897.6
======== ======== ========
Mutual funds (excludes variable annuities)................................. $ 207.9 $ 468.7 $ 794.2
======== ======== ========
Deposit type contracts..................................................... $ 287.6 $ 178.0 $ 147.7
======== ======== ========
(continued)
51
(continued from previous page)
2002 2001(a) 2000(a)
---- ------- -------
(Dollars in millions)
Premiums collected from major medical business in run-off and discontinued
operations:
Major medical in run-off:
Individual (first-year)................................................ $ 15.6 $112.8 $ 161.1
Individual (renewal)................................................... 78.3 253.4 246.2
------ ------ --------
Total major medical in run-off....................................... 93.9 366.2 407.3
------ ------ --------
Discontinued operations:
Annuities:
Fixed (first year)................................................... 7.4 21.6 18.7
Fixed (renewal)...................................................... 4.4 6.6 6.9
------ ------ --------
Subtotal other fixed annuities..................................... 11.8 28.2 25.6
------ ------ --------
Variable (first year)................................................ 199.6 313.5 747.8
Variable (renewal)................................................... 49.0 72.6 80.4
------ ------ --------
Subtotal variable annuities........................................ 248.6 386.1 828.2
------ ------ --------
Total annuities.................................................... 260.4 414.3 853.8
------ ------ --------
Life insurance:
First-year........................................................... .4 .8 .6
Renewal.............................................................. - 31.7 31.8
------ ------ --------
Total life insurance............................................... .4 32.5 32.4
------ ------ --------
Collections on insurance products from major medical business
in run-off and discontinued operations............................... $354.7 $813.0 $1,293.5
====== ====== ========
Deposit type contracts.................................................... $ 5.8 $ 8.7 $ 25.6
====== ====== ========
- ---------------
(a) Certain amounts related to deposit type contracts have been reclassified to
a separate category, to conform to the 2002 presentation.
Continuing Operations
Annuities include equity-indexed annuities and other fixed annuities sold
through both career agents and professional independent producers. Pursuant to
our initiatives to increase capital and focus on the sale of products that
result in less strain on our statutory capital and surplus, we are taking
actions to de-emphasize the sales of annuity products through professional
independent producers.
We introduced our first equity-indexed annuity product in 1996. The
accumulation value of these annuities is credited with interest at an annual
guaranteed minimum rate of 3 percent (or, including the effect of applicable
sales loads, a 1.7 percent compound average interest rate over the term of the
contracts). These annuities provide for potentially higher returns based on a
percentage of the change in the S&P 500 Index during each year of their term. We
purchase S&P 500 Call Options in an effort to hedge increases to policyholder
benefits resulting from increases in the S&P 500 Index. Total collected premiums
for this product decreased by 42 percent, to $220.1 million, in 2002 and
decreased by 41 percent, to $380.9 million, in 2001. The decrease can be
attributed to: (i) the general stock market performance which has made other
investment products more attractive; and (ii) the effect of the A.M. Best
ratings downgrade to "B (fair)".
Other fixed rate annuity products include SPDAs, FPDAs and SPIAs, which are
credited with a declared rate. The demand for traditional fixed-rate annuity
contracts has increased in 2002 as such products became more attractive than
equity-indexed or variable annuity products due to the general stock market
performance. SPDA and FPDA policies typically have an interest rate that is
52
guaranteed for the first policy year, after which we have the discretionary
ability to change the crediting rate to any rate not below a guaranteed rate.
The interest rate credited on SPIAs is based on market conditions existing when
a policy is issued and remains unchanged over the life of the SPIA. Annuity
premiums on these products increased by 3.5 percent, to $872.7 million, in 2002
and by 44 percent, to $842.8 million, in 2001.
Supplemental health products include Medicare supplement, long-term care,
specified disease and other insurance products distributed through a career
agency force and professional independent producers. Our profits on supplemental
health policies depend on the overall level of sales, the length of time the
business remains inforce, investment yields, claim experience and expense
management.
Collected premiums on Medicare supplement policies increased by 6.0
percent, to $1,033.8 million, in 2002 and by 4.7 percent, to $975.1 million, in
2001. Sales of Medicare supplement policies have been affected by increased
premium rates and new sales.
Premiums collected on long-term care policies increased by 3.3 percent, to
$917.4 million, in 2002 and by 6.3 percent, to $888.3 million, in 2001. Such
sales have been affected by increased premium rates and new sales. We have
determined that we will cease selling new long-term care policies through
professional independent producers in the second quarter of 2003.
Premiums collected on specified disease products did not fluctuate
significantly in 2002, 2001 and 2000.
Other health products include disability income, dental and various other
health insurance products. The disability income and dental products are
marketed to school systems located in nearly all states. The other health
insurance products are generally not being actively marketed. Premiums collected
in 2002 were $104.3 million, down 4.6 percent from 2001. Premiums collected in
2001 were $109.3 million, down 13 percent from 2000. The inforce business
continues to be profitable.
Life products are sold through career agents, professional independent
producers and direct response distribution channels. Life premiums collected in
2002 were $637.0 million, down 24 percent from 2001. Life premiums collected in
2001 were $839.6 million, down 6.8 percent from 2000. Such decreases are
primarily a result of the reinsurance agreements we entered into during 2002. In
addition, the A.M. Best ratings downgrade to "B (fair)" has negatively affected
our sales of life products. We are currently considering the discontinuation of
selling many of our life products through the professional independent producer
channel. We expect our review to result in eliminating the sale of many life
products.
Group major medical premiums decreased by 15 percent, to $315.6 million, in
2002 and by 26 percent, to $370.9 million, in 2001. We no longer actively market
these products.
Mutual fund sales decreased 56 percent, to $207.9 million in 2002, and by
41 percent, to $468.7 million, in 2001. Mutual fund sales have been adversely
affected by the recent performance of the stock market and our decreased
marketing efforts.
Deposit type contracts include guaranteed interest contracts, supplemental
contracts without life contingencies and other deposit funds. Amounts collected
from deposit type contracts increased by 62 percent, to $287.6 million, in 2002,
and by 21 percent, to $178.0 million in 2001. Such amounts often fluctuate from
period-to-period.
Major Medical Business in Run-off and Discontinued Operations
Major medical in run-off includes major medical health insurance products
sold to individuals. In the second half of 2001, we stopped renewing a large
portion of our major medical lines of business. In early 2002, we decided to
stop renewing all inforce individual and small group business and discontinue
new sales. Individual health premiums collected in 2002 decreased by 74 percent,
to $93.9 million, and by 10 percent, to $366.2 million in 2001. These premiums
will continue to decrease in future periods.
Variable annuities offer contract holders the ability to direct premiums
into specific investment portfolios; rates of return are based on the
performance of the portfolio. Profits on variable annuities are earned from the
fees charged to contract holders. Variable annuity collected premiums decreased
by 36 percent, to $248.6 million in 2002, and by 53 percent, to $386.1 million
in 2001. The decreases can be attributed to: (i) the general stock market
performance, which has made other investment products more attractive; (ii) our
announcement that we planned to sell this business; and (iii) the A.M. Best
ratings downgrade to "B (fair)". We sold our variable annuity business in the
fourth quarter of 2002.
Life product premiums from discontinued operations represent the life
business of CVIC, which was sold in the fourth quarter of 2002.
53
INVESTMENTS
Our investment strategy is to: (i) maintain a predominately
investment-grade fixed income portfolio; (ii) provide adequate liquidity to meet
our cash obligations to policyholders and others; and (iii) maximize current
investment income and total investment return through active investment
management. Consistent with this strategy, investments in fixed maturity
securities, mortgage loans and policy loans made up 98 percent of our $21.8
billion investment portfolio at December 31, 2002. The remainder of the invested
assets were equity securities, venture capital investments and other invested
assets.
Insurance statutes regulate the type of investments that our insurance
subsidiaries are permitted to make and limit the amount of funds that may be
used for any one type of investment. In light of these statutes and regulations
and our business and investment strategy, we generally seek to invest in United
States government and government-agency securities and corporate securities
rated investment grade by established nationally recognized rating organizations
or in securities of comparable investment quality, if not rated.
The following table summarizes investment yields earned over the past three
years on the general account invested assets of our insurance subsidiaries
(excluding the investment income from our major medical business in run-off).
General account investments exclude our venture capital investment in AWE,
separate account assets, the value of S&P 500 call options and the investments
held by CFC.
2002 2001 2000
---- ---- ----
(Dollars in millions)
Weighted average general account invested assets as defined:
As reported ................................................................. $23,264.5 $23,259.9 $22,493.4
Excluding unrealized depreciation (a)........................................ 23,344.0 24,029.8 23,853.4
Net investment income on general account invested assets............................ 1,516.7 1,683.6 1,763.8
Yields earned:
As reported.................................................................. 6.5% 7.2% 7.8%
Excluding unrealized depreciation (a) ....................................... 6.5% 7.0% 7.4%
- ------------------------
(a) Excludes the effect of reporting fixed maturities at fair value as
described in the note to our consolidated financial statements entitled
"Investments".
Although investment income is a significant component of total revenues,
the profitability of certain of our insurance products is determined primarily
by the spreads between the interest rates we earn and the rates we credit or
accrue to our insurance liabilities. At December 31, 2002, the average yield,
computed on the cost basis of our actively managed fixed maturity portfolio, was
6.7 percent, and the average interest rate credited or accruing to our total
insurance liabilities (excluding interest rate bonuses for the first policy year
only and excluding the effect of credited rates attributable to variable or
equity-indexed products) was 5.1 percent.
Actively Managed Fixed Maturities
Our actively managed fixed maturity portfolio at December 31, 2002,
included primarily debt securities of the United States government, public
utilities and other corporations, and mortgage-backed securities.
Mortgage-backed securities included collateralized mortgage obligations ("CMOs")
and mortgage-backed pass-through securities.
At December 31, 2002, our fixed maturity portfolio had $926.6 million of
unrealized gains and $499.0 million of unrealized losses, for a net unrealized
gain of $427.6 million. Estimated fair values for fixed maturity investments
were determined based on estimates from: (i) nationally recognized pricing
services (85 percent of the portfolio); (ii) broker-dealer market makers (8
percent of the portfolio); and (iii) internally developed methods (7 percent of
the portfolio).
At December 31, 2002, approximately 5.8 percent of our invested assets (6.5
percent of fixed maturity investments) were fixed maturities rated
below-investment grade by nationally recognized statistical rating organizations
(or, if not rated by such firms, with ratings below Class 2 assigned by the
NAIC). We plan to maintain approximately the present level of
below-investment-grade fixed maturities. These securities generally have greater
risks than other corporate debt investments, including risk of loss upon default
by the borrower, and are often unsecured and subordinated to other creditors.
Below-investment-grade issuers usually have higher levels of indebtedness and
are more sensitive to adverse economic conditions, such as recession or
increasing interest rates, than are investment-grade issuers. We are aware of
these risks and monitor our below-investment-grade securities closely. At
December 31, 2002, our below-investment-grade fixed maturity investments had an
amortized cost of $1,435.1 million and an estimated fair value of $1,261.2
million.
54
We continually evaluate the creditworthiness of each issuer whose
securities we hold. We pay special attention to those securities whose market
values have declined materially for reasons other than changes in interest rates
or other general market conditions. We evaluate the realizable value of the
investment, the specific condition of the issuer and the issuer's ability to
comply with the material terms of the security. Information reviewed may include
the recent operational results and financial position of the issuer, information
about its industry, information about the variety of factors affecting the
issuer's performance and other information. Conseco employs a staff of
experienced securities analysts in a variety of specialty areas who compile and
review such data. If evidence does not exist to support a realizable value equal
to or greater than the carrying value of the investment, and such decline in
market value is determined to be other than temporary, we reduce the carrying
amount to its fair value, which becomes the new cost basis. We report the amount
of the reduction as a realized loss. We recognize any recovery of such
reductions in the cost basis of an investment only upon the sale, repayment or
other disposition of the investment. In 2002, we recorded writedowns of fixed
maturity investments, equity securities and other invested assets totaling
$556.8 million. Our investment portfolio is subject to the risks of further
declines in realizable value. However, we attempt to mitigate this risk through
the diversification and active management of our portfolio.
As of December 31, 2002, our fixed maturity investments in substantive
default (i.e., in default due to nonpayment of interest or principal) or
technical default (i.e., in default, but not as to the payment of interest or
principal) had an amortized cost of $203.9 million and a carrying value of
$174.8 million. Conseco employs a staff of experienced professionals to manage
non-performing and impaired investments. There were no other fixed maturity
investments about which we had serious doubts as to the ability of the issuer to
comply with the material terms of the instrument on a timely basis.
When a security defaults, our policy is to discontinue the accrual of
interest and eliminate all previous interest accruals, if we determine that such
amounts will not be ultimately realized in full. Investment income forgone due
to defaulted securities was $60.4 million, $17.6 million and $15.3 million for
the years ended December 31, 2002, 2001 and 2000, respectively.
At December 31, 2002, fixed maturity investments included $6.4 billion of
mortgage-backed securities (or 33 percent of all fixed maturity securities).
CMOs are backed by pools of mortgages that are segregated into sections or
"tranches" that provide for reprioritizing of retirement of principal.
Pass-through securities receive principal and interest payments through their
regular pro rata share of the payments on the underlying mortgages backing the
securities. The yield characteristics of mortgage-backed securities differ from
those of traditional fixed-income securities. Interest and principal payments
for mortgage-backed securities occur more frequently, often monthly.
Mortgage-backed securities are subject to risks associated with variable
prepayments because borrowers are generally allowed to pre-pay their mortgages
without penalty. Prepayment rates are influenced by a number of factors that
cannot be predicted with certainty, including: the relative sensitivity of the
underlying mortgages backing the assets to changes in interest rates; a variety
of economic, geographic and other factors; and the repayment priority of the
securities in the overall securitization structures.
In general, prepayments on the underlying mortgage loans and the securities
backed by these loans increase when prevailing interest rates decline
significantly relative to the interest rates on such loans. The yields on
mortgage-backed securities purchased at a discount to par will increase when the
underlying mortgages prepay faster than expected. The yields on mortgage-backed
securities purchased at a premium will decrease when they prepay faster than
expected. When interest rates decline, the proceeds from the prepayment of
mortgage-backed securities are likely to be reinvested at lower rates than we
were earning on the prepaid securities. When interest rates increase,
prepayments on mortgage-backed securities decrease, as fewer underlying
mortgages are refinanced. When this occurs, the average maturity and duration of
the mortgage-backed securities increase, which decreases the yield on
mortgage-backed securities purchased at a discount, because the discount is
realized as income at a slower rate, and increases the yield on those purchased
at a premium as a result of a decrease in the annual amortization of the
premium.
The following table sets forth the par value, amortized cost and estimated
fair value of mortgage-backed securities, summarized by interest rates on the
underlying collateral at December 31, 2002:
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
Below 7 percent.............................................................. $4,895.4 $4,857.3 $5,125.2
7 percent - 8 percent........................................................ 1,000.4 1,007.6 1,059.1
8 percent - 9 percent........................................................ 171.9 179.8 187.1
9 percent and above.......................................................... 42.1 44.2 44.8
-------- -------- --------
Total mortgage-backed securities (a)............................... $6,109.8 $6,088.9 $6,416.2
======== ======== ========
55
- --------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
The amortized cost and estimated fair value of mortgage-backed securities
at December 31, 2002, summarized by type of security, were as follows:
Estimated Fair Value
Percent of
Amortized fixed
Type Cost Amount maturities
---- ------ ----------
(Dollars in millions)
Pass-throughs and sequential and targeted amortization classes............... $2,849.5 $3,000.8 16%
Planned amortization classes and accretion-directed bonds.................... 2,439.8 2,580.6 13
Commercial mortgage-backed securities........................................ 441.3 461.4 2
Subordinated classes and mezzanine tranches.................................. 348.7 365.7 2
Other........................................................................ 9.6 7.7 -
-------- -------- --
Total mortgage-backed securities (a)...................................... $6,088.9 $6,416.2 33%
======== ======== ==
- --------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
Pass-throughs and sequential and targeted amortization classes have similar
prepayment variability. Pass-throughs historically provide the best liquidity in
the mortgage-backed securities market. Pass-throughs are also used frequently in
the dollar roll market and can be used as the collateral when creating
collateralized mortgage obligations. Sequential classes are a series of tranches
that return principal to the holders in sequence. Targeted amortization classes
offer slightly better structure in return of principal than sequentials when
prepayment speeds are close to the speed at the time of creation.
Planned amortization classes and accretion-directed bonds are some of the
most stable and liquid instruments in the mortgage-backed securities market.
Planned amortization class bonds adhere to a fixed schedule of principal
payments as long as the underlying mortgage collateral experiences prepayments
within a certain range. Changes in prepayment rates are first absorbed by
support or companion classes. This insulates the planned amortization class from
the consequences of both faster prepayments (average life shortening) and slower
prepayments (average life extension).
Commercial mortgage-backed securities ("CMBS") are bonds secured by
commercial real estate mortgages. Commercial real estate encompasses income
producing properties that are managed for economic profit. Property types
include multi-family dwellings including apartments, retail centers, hotels,
restaurants, hospitals, nursing homes, warehouses, and office buildings. The
CMBS market currently offers high yields, strong credits, and call protection
compared to similar-rated corporate bonds. Most CMBS have call protection
features where borrowers are locked out from prepaying their mortgages for a
stated period of time. If the borrower does prepay any or all of the loan, they
will be required to pay prepayment penalties.
Subordinated and mezzanine tranches are classes that provide credit
enhancement to the senior tranches. The rating agencies require that this credit
enhancement not deteriorate due to prepayments for a period of time, usually
five years of complete lockout followed by another period of time where
prepayments are shared pro rata with senior tranches. The credit risk of
subordinated and mezzanine tranches is derived from owning a small percentage of
the mortgage collateral, while bearing a majority of the risk of loss due to
property owner defaults. Subordinated bonds can be rated "AA" or lower; we
typically do not invest in such securities rated lower than "BB".
During 2002, we sold $19.5 billion of investments (primarily fixed
maturities), resulting in $40.2 million of net investment losses (before related
amortization and taxes). Securities sold at a loss are sold for a number of
reasons including: (i) changes in the investment environment; (ii) expectation
that the market value could deteriorate; (iii) desire to reduce our exposure to
an issuer or an industry; (iv) changes in credit quality; and (v) our analysis
indicating there is a high probability that the security is permanently impaired
and subject to further declines in value. As discussed in the notes to our
consolidated financial statements, the realization of gains and losses affects
the timing of the amortization of the cost of policies produced and the cost of
policies purchased related to universal life and investment products.
56
Venture Capital Investment in AT&T Wireless Services, Inc.
Our venture capital investment in AWE was made by our subsidiary which
engages in venture capital investment activity. AWE is a company in the wireless
communication business. In 2002, Conseco sold 10.3 million shares of AWE
generating net proceeds of $75.7 million. Our investment in AWE is carried at
estimated fair value, with changes in fair value recognized as investment income
(loss). At December 31, 2002, our holdings of AWE common stock included 4.1
million shares valued at $25.0 million. The market values of AWE and many other
companies in AWE's business sector have declined significantly in recent
periods. We recognized venture capital investment losses of $99.3 million, $42.9
million and $199.5 million in 2002, 2001 and 2000, respectively, related to this
investment.
Other Investments
At December 31, 2002, we held mortgage loan investments with a carrying
value of $1,308.3 million (or 6.0 percent of total invested assets) and a fair
value of $1,335.7 million. Mortgage loans were substantially comprised of
commercial loans. Noncurrent mortgage loans were insignificant at December 31,
2002. Realized losses on mortgage loans were not significant in any of the past
three years. At December 31, 2002, we had a mortgage loan loss reserve of $3.5
million. Approximately 9 percent, 8 percent, 7 percent, 6 percent, 6 percent and
6 percent of the mortgage loan balance were on properties located in New York,
Massachusetts, Florida, California, Ohio and Pennsylvania, respectively. No
other state accounted for more than 5 percent of the mortgage loan balance.
At December 31, 2002, we held no trading securities; they were historically
included in other invested assets. Trading securities were investments we
intended to sell in the near term. We carried trading securities at estimated
fair value; changes in fair value were reflected in the statement of operations.
Other invested assets also include: (i) S&P 500 Call Options; and (ii)
certain nontraditional investments, including investments in limited
partnerships and promissory notes.
As part of our investment strategy, we enter into reverse repurchase
agreements and dollar-roll transactions to increase our return on investments
and improve our liquidity. Reverse repurchase agreements involve a sale of
securities and an agreement to repurchase the same securities at a later date at
an agreed-upon price. Dollar rolls are similar to reverse repurchase agreements
except that the repurchase involves securities that are only substantially the
same as the securities sold. We enhance our investment yield by investing the
proceeds from the sales in short-term securities pending the contractual
repurchase of the securities at discounted prices in the forward market. We are
able to engage in such transactions due to the market demand for mortgage-backed
securities to form CMOs. At December 31, 2002, we had investment borrowings of
$669.7 million. Such investment borrowings averaged $1,155.8 million during 2002
and were collateralized by investment securities with fair values approximately
equal to the loan value. The weighted average interest rate on such borrowings
was 1.3 percent in 2002. The primary risk associated with short-term
collateralized borrowings is that the counterparty might be unable to perform
under the terms of the contract. Our exposure is limited to the excess of the
net replacement cost of the securities over the value of the short-term
investments (which was not material at December 31, 2002). We believe that the
counterparties to our reverse repurchase and dollar-roll agreements are
financially responsible and that counterparty risk is minimal.
CONSOLIDATED FINANCIAL CONDITION
Changes in the Consolidated Balance Sheet of 2002 Compared with 2001
Changes in our consolidated balance sheet between December 31, 2002 and
December 31, 2001, reflect: (i) the accounting for our finance operations as a
discontinued operation (as described in the note to our consolidated financial
statement entitled "Discontinued Finance Business - Planned Sale of CFC"; (ii)
the preparation of such statement in accordance with SOP 90-7, including the
segregation of all prepetition liabilities into an account entitled "liabilities
subject to compromise" at the estimated amount of allowable claims; (iii) our
net loss for 2002, including the effect of establishing a valuation allowance
for deferred tax assets; (iv) the cumulative effect of an accounting change
recognizing an impairment of our goodwill asset; (v) changes in the fair value
of actively managed fixed maturity securities and interest-only securities; and
(vi) various financing and reinsurance transactions including the sale of CVIC
(as described in the notes to our consolidated financial statements).
In accordance with GAAP, we record our actively managed fixed maturity
investments, equity securities and certain other invested assets at estimated
fair value with any unrealized gain or loss (excluding impairment losses which
are recognized through earnings), net of tax and related adjustments, recorded
as a component of shareholders' equity. At December 31, 2002, we increased the
carrying value of such investments by $448.1 million as a result of this fair
value adjustment. The fair value adjustment resulted in a $816.0 million
decrease in carrying value at year-end 2001.
57
Total capital shown below excludes the debt of the discontinued finance
segment used to fund finance receivables in both periods. Total capital, before
the fair value adjustment recorded in accumulated other comprehensive loss,
decreased $7.8 billion, or 70 percent, to $3.3 billion. The decrease is
primarily due to the net loss realized in 2002, including the cumulative effect
of an accounting change to recognize an impairment of our goodwill asset.
2002 2001
---- ----
(Dollars in millions)
Total capital, excluding accumulated other comprehensive loss:
Corporate notes payable............................................ $ 4,057.1 $ 4,085.0
Trust Preferred Securities...................................... 1,921.5 1,914.5
Shareholders' equity (deficit):
Preferred stock................................................. 501.7 499.6
Common stock and additional paid-in capital..................... 3,497.0 3,484.3
Retained earnings (accumulated deficit)......................... (6,629.7) 1,208.1
--------- ---------
Total shareholders' equity (deficit), excluding accumulated
other comprehensive loss.................................. (2,631.0) 5,192.0
--------- ---------
Total capital, excluding accumulated other
comprehensive income (loss)............................... 3,347.6 11,191.5
Accumulated other comprehensive income (loss)................... 580.6 (439.0)
--------- ---------
Total capital................................................ $ 3,928.2 $10,752.5
========= =========
Corporate notes payable decreased during 2002 primarily due to: (i) open
market repurchases of our 8.5% notes due 2002; partially offset by (ii) the
increase in unamortized fair market value of terminated interest rate swap
agreements (see the note to our consolidated financial statements entitled
"Summary of Significant Accounting Policies"). Pursuant to SOP 90-7, all
corporate notes payable have been classified as "liabilities subject to
compromise".
Shareholders' equity (deficit), excluding accumulated other comprehensive
loss, decreased by $7.8 billion in 2002, to $(2.6) billion. The significant
component of the decrease was our net loss of $7.8 billion. The accumulated
other comprehensive income (loss) increased by $1.0 billion, principally related
to the increase in the unrealized gains of our insurance companies' investment
portfolio.
Book value (deficit) per common share outstanding decreased to $(7.38) at
December 31, 2002, from $12.34 a year earlier. Such change was primarily
attributable to our net loss for 2002. Excluding accumulated other comprehensive
income (loss), book value (deficit) per common share outstanding was $(9.05) at
December 31, 2002, and $13.61 at December 31, 2001.
Goodwill (representing the excess of the amounts we paid to acquire
companies over the fair value of net assets acquired in transactions accounted
for as purchases) was $100.0 million and $3,695.4 million at December 31, 2002
and 2001, respectively. Amortization of goodwill totaled $109.6 million and
$112.5 million during 2001 and 2000, respectively.
The FASB issued SFAS 142, in June 2001. Under the new rule, intangible
assets with an indefinite life are no longer amortized in periods subsequent to
December 31, 2001, but are subject to annual impairment tests (or more frequent
under certain circumstances), effective January 1, 2002. The Company has
determined that all of its goodwill has an indefinite life and is therefore
subject to the new rules.
Pursuant to SFAS 142, the goodwill impairment test has two steps. For
Conseco, the first step consisted of comparing the estimated fair value of each
of the business units comprising our insurance segment to the unit's book value.
Since all of our goodwill relates to the insurance segment (which is also a
reportable segment), the goodwill impairment test is not relevant to the finance
business. If the estimated fair value exceeds the book value, the test is
complete and goodwill is not impaired. If the fair value is less than the book
value, the second step of the impairment test must be performed, which compares
the implied fair value of the applicable business unit's goodwill with the book
value of that goodwill to measure the amount of goodwill impairment, if any.
Pursuant to the transitional rules of SFAS 142, we completed the two-step
impairment test during 2002 and, as a result of that test, we recorded the
cumulative effect of the accounting change for the goodwill impairment charge of
$2,949.2 million. The
58
impairment charge is reflected in the cumulative effect of an accounting change
in the accompanying consolidated statement for the year ended December 31, 2002.
Subsequent impairment tests will be performed on an annual basis, or more
frequently if circumstances indicate a possible impairment. Subsequent
impairment charges are classified as an operating expense. As described below
the Company performed additional impairment tests in 2002, as a result of
circumstances which indicated a possible impairment.
The significant factors used to determine the amount of the initial
impairment included analyses of industry market valuations, historical and
projected performance of our insurance segment, discounted cash flow analyses
and the market value of our capital. The valuation utilized the best available
information, including assumptions and projections we considered reasonable and
supportable. The assumptions we used to determine the discounted cash flows
involve significant judgments regarding the best estimate of future premiums,
expected mortality and morbidity, interest earned and credited rates,
persistency and expenses. The discount rate used was based on an analysis of the
weighted average cost of capital for several insurance companies and considered
the specific risk factors related to Conseco. Pursuant to the guidance in SFAS
142, quoted market prices in active markets are the best evidence of fair value
and shall be used as the basis for measurement, if available.
On August 14, 2002, our insurance subsidiaries' financial strength ratings
were downgraded by A.M. Best to "B (fair)" and on September 8, 2002, the Company
defaulted on its public debt. These developments caused sales of our insurance
products to fall and policyholder redemptions and lapses to increase. The
adverse impact on our insurance subsidiaries resulting from the ratings
downgrade and parent company default required that additional impairment tests
be performed as of September 30, 2002 in accordance with SFAS 142.
In connection with our negotiations with debt holders, we retained an
outside actuarial consulting firm to assist in valuing our insurance
subsidiaries. That valuation work and our internal evaluations were used in
performing the additional impairment tests that resulted in an impairment charge
to goodwill of $500.0 million. The charge is reflected in the line item entitled
"Goodwill impairment" in our consolidated statement of operations for the year
ended December 31, 2002. The most significant changes made to the January 1,
2002 valuation that resulted in additional impairment charge were: (i) reduced
estimates of projected future sales of insurance products; (ii) increased
estimates of future policyholder redemptions and lapses; and (iii) a higher
discount rate to reflect the current rates used by the market to value life
insurance companies. Management believes that the assumptions and estimates used
are reasonable given all available facts and circumstances. However, if
projected cash flows are not realized in the future, we may be required to
recognize additional impairments.
59
Financial Ratios
2002 2001 2000
---- ---- ----
Book value (deficit) per common share:
As reported............................................................................ $(7.38) $12.34 $11.95
Excluding accumulated other comprehensive income (loss) (a)............................ (9.05) 13.61 13.95
Excluding goodwill and accumulated other comprehensive
income (loss) (a).................................................................... (9.34) 2.89 2.27
Ratio of earnings to fixed charges:
As reported............................................................................ (d) (f) (h)
Excluding interest added to policyholder account balances.............................. (d) (f) (h)
Ratio of earnings to fixed charges, preferred dividends and distributions on
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts:
As reported.......................................................................... (e) (g) (i)
Excluding interest added to policyholder account balances............................ (e) (g) (i)
Rating agency ratios (a) (b) (c):
Corporate debt to total capital........................................................ 121% 37% 40%
Corporate debt and Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts to total capital........................... 178% 54% 60%
- ------------------------
(a) Excludes accumulated other comprehensive income (loss).
(b) Excludes the direct debt of the finance segment used to fund finance
receivables and investment borrowings of the insurance segment.
(c) These ratios are calculated in a manner discussed with rating agencies.
(d) For such ratios, adjusted earnings were $1,634.0 million less than fixed
charges. Adjusted earnings for the year ended December 31, 2002, included:
(i) special charges and reorganization items totaling $110.9 million; (ii)
goodwill impairment charges of $500.0 million; and (iii) provision for
losses related to loan guarantees of $240.0 million, as described in
greater detail in the notes to our consolidated financial statements.
(e) For such ratios, adjusted earnings were $1,810.4 million less than fixed
charges. Adjusted earnings for the year ended December 31, 2002, included:
(i) special charges and reorganization items totaling $110.9 million; (ii)
goodwill impairment charges of $500.0 million; and (iii) provision for
losses related to loan guarantees of $240.0 million, as described in
greater detail in the notes to our consolidated financial statements.
(f) For such ratios, adjusted earnings were $260.4 million less than fixed
charges. Adjusted earnings for the year ended December 31, 2001, included:
(i) special charges of $80.4 million; and (ii) provision for losses related
to loan guarantees of $169.6 million, as described in greater detail in the
notes to our consolidated financial statements.
(g) For such ratios, adjusted earnings were $464.1 million less than fixed
charges. Adjusted earnings for the year ended December 31, 2001, included:
(i) special charges of $80.4 million; and (ii) provision for losses related
to loan guarantees of $169.6 million, as described in greater detail in the
notes to our consolidated financial statements.
(h) For such ratios, adjusted earnings were $769.9 million less than fixed
charges. Adjusted earnings for the year ended December 31, 2000, included:
(i) special charges of $305.0 million; and (ii) provision for losses
related to loan guarantees of $231.5 million, as described in greater
detail in the notes to our consolidated financial statements.
(i) For such ratios, adjusted earnings were $1,010.4 million less than fixed
charges. Adjusted earnings for the year ended December 31, 2000, included:
(i) special charges of $305.0 million; and (ii) provision for losses
related to loan guarantees of $231.5 million, as described in greater
detail in the notes to our consolidated financial statements.
60
Liquidity for Insurance and Fee-Based Operations
Our insurance operating companies generally receive adequate cash flow from
premium collections and investment income to meet their obligations. Life
insurance and annuity liabilities are generally long-term in nature.
Policyholders may, however, withdraw funds or surrender their policies, subject
to any applicable surrender and withdrawal penalty provisions. We seek to
balance the duration of our invested assets with the estimated duration of
benefit payments arising from contract liabilities.
Only a small portion of our insurance liabilities have a time for
contractual payment; the majority of such liabilities are payable upon
occurrence of the insured event or upon surrender. Of our total insurance
liabilities at December 31, 2002, approximately 20 percent could be surrendered
by the policyholder without a penalty. Approximately 62 percent could be
surrendered by the policyholder subject to penalty or the release of an
insurance liability in excess of surrender benefits paid. The remaining 18
percent do not provide a surrender benefit.
Approximately 46 percent of insurance liabilities were subject to interest
rates that may be reset annually; 36 percent have a fixed explicit interest rate
for the duration of the contract; 12 percent have credited rates which
approximate the income earned by the Company; and the remainder have no explicit
interest rate.
Insurance liabilities for interest-sensitive products by credited rate
(excluding interest rate bonuses for the first policy year only) at December 31,
2002 were as follows (dollars in millions):
Below 4.00 percent............................................................. $ 3,735.8 (a)
4.00 percent - 4.50 percent.................................................... 3,332.3
4.50 percent - 5.00 percent.................................................... 4,542.5
5.00 percent - 5.50 percent.................................................... 867.9
5.50 percent and above......................................................... 991.0
---------
Total insurance liabilities on interest-sensitive products............... $13,469.5
=========
- ------------------
(a) Includes liabilities related to our equity-indexed annuity products of
$1,987.2 million. The accumulation value of these annuities is credited
with interest at an annual guaranteed minimum rate of 3 percent (or,
including the effect of applicable sales loads, a 1.7 percent compound
average interest rate over the term of the contract). These annuities
provide for potentially higher returns based on a percentage of the change
in the S&P 500 Index during each year of their term. We purchase S&P 500
Call Options in an effort to hedge increases to insurance liabilities
resulting from increases in the S&P 500 Index.
On August 14, 2002, A.M. Best lowered the financial strength ratings of our
primary insurance subsidiaries from "B++ (very good)" to "B (fair)". A.M. Best
ratings for the industry currently range from "A++ (Superior)" to "F (In
Liquidation)" and some companies are not rated. An "A++" ranking indicates
superior overall performance and a strong ability to meet obligations to
policyholders over a long period of time. The "B" rating is assigned to
companies which have, on balance, fair balance sheet strength, operating
performance and business profile, when compared to the standards established by
A.M. Best, and have an ability in A.M. Best's opinion to meet their current
obligations to policyholders, but their financial strength is vulnerable to
adverse changes in underwriting and economic conditions. The rating reflects
A.M. Best's view of the uncertainty surrounding our restructuring initiatives
and the potential adverse financial impact on the subsidiaries if negotiations
are protracted and execution of the restructuring plan is delayed. S&P has given
our insurance subsidiaries a financial strength rating of "B+". Rating
categories from "BB" to "CCC" are classified as "vulnerable", and pluses and
minuses show the relative standing within a category. In S&P's view an insurer
rated "B" currently has the capacity to meet its financial commitments but
adverse business conditions could lead to insufficient ability to meet financial
commitments.
The ratings downgrades have caused sales of our insurance products to
decline and policyholder redemptions and lapses to increase. In some cases, the
downgrades have also caused defections among our independent agent sales force
and increases in the commissions we must pay. These events have had a material
adverse effect on our financial results. Further downgrades by A.M. Best or S&P
could have further material and adverse effects on our financial results and
liquidity.
During 2002, our insurance subsidiaries paid dividends to Conseco totaling
$240 million. As more fully described in the note to our consolidated financial
statements entitled "Statutory Information", our two insurance subsidiaries
domiciled in Texas entered into consent orders with the Texas Department of
Insurance. The consent orders apply to all of our insurance subsidiaries and,
among other things, restrict the ability of our insurance subsidiaries to pay
dividends and other amounts to the parent company. State laws generally provide
state insurance regulatory agencies with broad authority to protect
policyholders in their jurisdictions. Accordingly, there can be no assurance
that the regulators will not seek to assert greater supervision and control over
our insurance subsidiaries' businesses and financial affairs.
61
Our insurance subsidiaries experienced increased lapse rates on annuity
policies during 2002. We believe that the diversity of the investment portfolios
of our insurance subsidiaries and the concentration of investments in
high-quality, liquid securities provide sufficient liquidity to meet foreseeable
cash requirements of our insurance subsidiaries. At December 31, 2002, we held
$1.1 billion of cash and cash equivalents and $15.8 billion of publicly traded
investment grade bonds. Our insurance subsidiaries could readily liquidate
portions of their investments, if lapses continue at current levels. In
addition, investments could be used to facilitate borrowings under
reverse-repurchase agreements or dollar-roll transactions. Such borrowings have
been used by the insurance subsidiaries from time to time to increase their
return on investments and to improve liquidity. The availability of
reverse-repurchase agreements and dollar-roll transactions is dependent on
counter parties' willingness to enter into the transactions, and, consequently,
no assurance can be given that such transactions will be available in the
future.
Liquidity of the Debtors
The liquidity and capital resources of the Debtors are significantly
affected by the Chapter 11 Cases. Our bankruptcy proceedings have resulted in
various restrictions on our activities, limitations on financing and a need to
obtain Bankruptcy Court approval for various matters. As a result of our
bankruptcy filing, the Debtors are not permitted to make any payments on its
prepetition liabilities. At December 31, 2002, the Debtors held cash of $41.9
million. In addition, the non-life insurance companies held cash of
approximately $60 million.
Under the priority schedule established by the Bankruptcy Code, certain
postpetition and prepetition liabilities need to be satisfied before unsecured
creditors and holders of CNC's common and preferred stock and Trust Preferred
Securities are entitled to receive any distribution. The Plan (as summarized in
the Disclosure Statement) sets forth the Debtors' proposed treatment of claims
and equity interests. No assurance can be given as to what values, if any, will
be ascribed in the bankruptcy proceedings to each of these constituencies. Our
Plan would result in holders of CNC's common stock and preferred stock (other
than Series F Preferred Stock) receiving no value and the holders of CNC's Trust
Preferred Securities and Series F Preferred Stock receiving little value on
account of the cancellation of their interests. In addition, holders of
unsecured claims against the Debtors would, in most cases, receive less than
full recovery for the cancellation of their interests.
At this time, it is not possible to predict with certainty the effect of
the Chapter 11 cases on our business or various creditors, or when we will
emerge from Chapter 11. Our future results depend upon our confirming and
successfully implementing, on a timely basis, a plan of reorganization.
CNC and CIHC are holding companies with no business operations of their
own; they depend on their operating subsidiaries for cash to make principal and
interest payments on debt, and to pay administrative expenses and income taxes.
The cash CNC and CIHC receive from insurance subsidiaries consists of fees for
services, tax sharing payments, dividends and distributions, and from our
non-insurance subsidiaries, loans and advances. A further deterioration in the
financial condition, earnings or cash flow of the material subsidiaries of CNC
or CIHC for any reason could further limit such subsidiaries' ability to pay
cash dividends or other disbursements to CNC and/or CIHC, which, in turn, would
limit CNC's and/or CIHC's ability to meet debt service requirements and satisfy
other financial obligations.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid from earned surplus of the insurance company for any
12-month period in amounts equal to the greater of (or in a few states, the
lesser of): (i) net gain from operations or net income for the prior year; or
(ii) 10 percent of capital and surplus as of the end of the preceding year. Any
dividends in excess of these levels require the approval of the director or
commissioner of the applicable state insurance department. As described in Item
1. "Government Regulation", Bankers National Life Insurance Company and Conseco
Life Insurance Company of Texas (on behalf of itself and its subsidiaries),
entered into consent orders with the Commissioner of Insurance for the State of
Texas on October 30, 2002. These consent orders, among other things, limit the
ability of our insurance subsidiaries to pay dividends.
The continuation of the Chapter 11 Cases, particularly if the Plan is not
approved or confirmed in the time frame currently contemplated, could further
adversely affect our operations and relationship with our customers, employees,
regulators, distributors and agents. If confirmation and consummation of the
Plan do not occur expeditiously, the Chapter 11 Cases could result in, among
other things, increased costs for professional fees and similar expenses. In
addition, prolonged Chapter 11 Cases may make it more difficult to retain and
attract management and other key personnel and would require senior management
to spend a significant amount of time and effort dealing with our financial
reorganization instead of focusing on the operation of our business. However, we
currently expect that our current cash resources and additional cash flows from
the operations of our non-life subsidiaries will be adequate to complete our
financial reorganization if the Plan is approved in the time frame currently
contemplated.
Our cash flow may be affected by a variety of factors, many of which are
outside of our control, including insurance and banking regulatory issues,
competition, financial markets and other general business conditions. We cannot
assure you that we will possess sufficient income and liquidity to meet all of
our liquidity requirements and other obligations. Although we believe that
62
amounts required for us to meet our financial and operating obligations will be
available from our subsidiaries and from funds currently held by CNC and CIHC,
our results for future periods are subject to numerous uncertainties. We may
encounter liquidity problems, which could affect our ability to meet our
obligations while attempting to meet competitive pressures or adverse economic
conditions.
Because our operations are conducted through subsidiaries, claims of the
creditors of those subsidiaries (including policyholders) will rank senior to
claims to distributions from the subsidiaries, which we depend on to make
payments on our obligations. CIHC's subsidiaries, excluding CFC, had
indebtedness for borrowed money (including capitalized lease obligations but
excluding indebtedness to affiliates), policy reserves and other liabilities of
approximately $24.1 billion at December 31, 2002. The obligations of CNC and
CIHC, as parent holding companies, will rank effectively junior to these
liabilities.
If an insurance company subsidiary were to be liquidated, that liquidation
would be conducted under the insurance law of its state of domicile by such
state's insurance regulator as the receiver with respect to such insurer's
property and business. In the event of a default on our debt or our insolvency,
liquidation or other reorganization, our creditors and stockholders will not
have the right to proceed against the assets of our insurance subsidiaries or to
cause their liquidation under federal and state bankruptcy laws.
We will have significant indebtedness even if the Plan is consummated.
Further, our historical capital requirements have been significant and our
future capital requirements could vary significantly and may be affected by
general economic conditions, industry trends, performance, and many other
factors that are not within our control. Recently, we have had difficulty
financing our operations due, in part, to our significant losses and leveraged
condition, and we cannot assure you that we will be able to obtain financing in
the future. Even if the Plan is approved and consummated, we cannot assure you
that we will not continue to experience losses in the future. Our profitability
and ability to generate cash flow will likely depend upon our ability to
successfully implement our business strategy. However, we cannot assure you that
we will be able to accomplish these results.
Our Plan contemplates that we will enter into a senior secured credit
facility (the "New Credit Facility") with our lenders in connection with our
reorganization. We have agreed to a number of covenants and other provisions
that restrict our ability to engage in various financing transactions and pursue
certain operating activities without the prior consent of the lenders under the
New Credit Facility. We have also agreed to meet or maintain various financial
ratios and minimum financial strength ratings for our insurance subsidiaries.
For instance, if we experience a ratings downgrade following confirmation of the
Plan, if we fail to achieve an "A-" rating by a specified date following
confirmation of the Plan or if we experience a ratings downgrade after achieving
an "A-" rating, we will suffer an event of default under the New Credit
Facility. Our ability to meet these financial and ratings covenants may be
affected by events beyond our control. Although we expect to be in compliance
with these requirements as of the Effective Date, these requirements represent
significant restrictions on the manner in which we may operate our business. If
we default under any of these requirements, the lenders could declare all
outstanding borrowings, accrued interest and fees to be due and payable. If that
were to occur, we cannot assure you that we would have sufficient liquidity to
repay or refinance this indebtedness or any of our other debts.
INFLATION
Inflation does not have a significant effect on our balance sheet; we have
minimal investments in property, equipment or inventories. To the extent that
interest rates may change to reflect inflation or inflation expectations, such
change would effect our balance sheet and operations. Lower interest rates will
typically result in increased value of our fixed maturities investments. Lower
rates may also make it more difficult to issue new fixed rate annuities. Rising
interest rates will typically result in decreased value of our fixed maturities
investments.
Medical cost inflation has had a significant impact on our supplemental
health operations. Generally, these costs have increased more rapidly than the
Consumer Price Index. Medical costs will likely continue to rise. The impact of
medical cost inflation on our operations depends on our ability to increase
premium rates. Such increases are subject to approval by state insurance
departments. We seek to price our new standardized supplement plans to reflect
the impact of these filings and the lengthening of the period required to
implement rate increases.
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
Our spread-based insurance business is subject to several inherent risks
arising from movements in interest rates, especially if we fail to anticipate or
respond to such movements. First, interest rate changes can cause compression of
our net spread between interest earned on investments and interest credited on
customer deposits, thereby adversely affecting our results. Second, if interest
rate changes produce an unanticipated increase in surrenders of our spread-based
products, we may be forced to sell investment assets at a loss in order to fund
such surrenders. At December 31, 2002, approximately 20 percent of our total
insurance liabilities (or approximately $4.5 billion) could be surrendered by
the policyholder without penalty. Finally, changes in interest rates can have
significant effects on the performance of our mortgage-backed securities
portfolio, including collateralized mortgage obligations, as a
63
result of changes in the prepayment rate of the loans underlying such
securities. We follow asset/liability strategies that are designed to mitigate
the effect of interest rate changes on our profitability. However, there can be
no assurance that management will be successful in implementing such strategies
and achieving adequate investment spreads.
We seek to invest our available funds in a manner that will fund future
obligations to policyholders, subject to appropriate risk considerations. We
seek to meet this objective through investments that: (i) have similar
characteristics to the liabilities they support; (ii) are diversified among
industries, issuers and geographic locations; and (iii) make up a predominantly
investment-grade fixed maturity securities portfolio. Many of our products
incorporate surrender charges, market interest rate adjustments or other
features to encourage persistency.
We seek to maximize the total return on our investments through active
investment management. Accordingly, we have determined that our entire portfolio
of fixed maturity securities is available to be sold in response to: (i) changes
in market interest rates; (ii) changes in relative values of individual
securities and asset sectors; (iii) changes in prepayment risks; (iv) changes in
credit quality outlook for certain securities; (v) liquidity needs; and (vi)
other factors. From time to time, we invest in securities for trading purposes,
although such investments account for a relatively small portion of our total
portfolio.
The profitability of many of our products depends on the spreads between
the interest yield we earn on investments and the rates we credit on our
insurance liabilities. In addition, changes in competition and other factors,
including the impact of the level of surrenders and withdrawals, may limit our
ability to adjust or to maintain crediting rates at levels necessary to avoid
narrowing of spreads under certain market conditions. Approximately 46 percent
of our insurance liabilities were subject to interest rates that may be reset
annually; 36 percent have a fixed explicit interest rate for the duration of the
contract; 12 percent have credited rates which approximate the income earned by
the Company; and the remainder have no explicit interest rates. As of December
31, 2002, the average yield, computed on the cost basis of our investment
portfolio, was 6.7 percent, and the average interest rate credited or accruing
to our total insurance liabilities (excluding interest rate bonuses for the
first policy year only and excluding the effect of credited rates attributable
to variable or equity-indexed products) was 5.1 percent.
We use computer models to simulate the cash flows expected from our
existing insurance business under various interest rate scenarios. These
simulations help us to measure the potential gain or loss in fair value of our
interest rate-sensitive financial instruments. With such estimates, we seek to
closely match the duration of our assets to the duration of our liabilities.
When the estimated durations of assets and liabilities are similar, exposure to
interest rate risk is minimized because a change in the value of assets should
be largely offset by a change in the value of liabilities. At December 31, 2002,
the adjusted modified duration of our fixed maturity securities and short-term
investments was approximately 6.6 years and the duration of our insurance
liabilities was approximately 6.0 years. We estimate that our fixed maturity
securities and short-term investments (net of corresponding changes in the value
of cost of policies purchased, cost of policies produced and insurance
liabilities) would decline in fair value by approximately $595 million if
interest rates were to increase by 10 percent from their December 31, 2002
levels. This compares to a decline in fair value of $555 million based on
amounts and rates at December 31, 2001. The calculations involved in our
computer simulations incorporate numerous assumptions, require significant
estimates and assume an immediate change in interest rates without any
management of the investment portfolio in reaction to such change. Consequently,
potential changes in value of our financial instruments indicated by the
simulations will likely be different from the actual changes experienced under
given interest rate scenarios, and the differences may be material. Because we
actively manage our investments and liabilities, our net exposure to interest
rates can vary over time.
We are subject to the risk that our investments will decline in value. This
has occurred in the past and may occur again. During 2002, we recognized net
realized investment losses of $597.0 million, compared to net realized
investment losses of $379.4 million during 2001. The net realized investment
losses during 2002 included: (i) $556.8 million of writedowns of fixed maturity
investments, equity securities and other invested assets as a result of
conditions which caused us to conclude a decline in fair value of the investment
was other than temporary; and (ii) $40.2 million of net losses from the sales of
investments (primarily fixed maturities) which generated proceeds of $19.5
billion. During 2002, we recognized other-than-temporary declines in value of
several of our investments including K-Mart Corp., Amerco, Inc., Global
Crossing, MCI Communications, Mississippi Chemical, United Airlines and
Worldcom, Inc.
The operations of the Company are subject to risk resulting from
fluctuations in market prices of our equity securities and venture-capital
investments. In general, these investments have more year-to-year price
variability than our fixed maturity investments. However, returns over longer
time frames have been consistently higher. We manage this risk by limiting our
equity securities and venture-capital investments to a relatively small portion
of our total investments.
Our investment in S&P 500 Call Options is closely matched with our
obligation to equity-indexed annuity holders. Market value changes associated
with that investment are substantially offset by an increase or decrease in the
amounts added to policyholder account balances for equity-indexed products.
64
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF CFC - DISCONTINUED FINANCE
OPERATIONS
Operating Results of the Discontinued Finance Operations:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Contract originations:
Manufactured housing......................................................... $ 1,026.7 $ 2,499.5 $ 4,395.8
Mortgage services............................................................ 2,535.9 3,043.7 4,448.3
Retail credit................................................................ 3,237.9 3,585.8 2,582.1
Consumer finance - closed-end................................................ 37.1 - 544.6
Other lines (discontinued in early 2002 or previous periods)................. 476.8 2,188.3 4,919.5
--------- --------- ---------
Total...................................................................... $ 7,314.4 $11,317.3 $16,890.3
========= ========= =========
Sales of finance receivables:
Manufactured housing......................................................... $ 398.8 $ 3.6 $ 600.7
Mortgage services............................................................ 1,738.7 833.8 913.1
Consumer finance - closed-end................................................ 3.3 - -
Other lines (discontinued in early 2002 or previous periods)................. 462.9 802.3 1,174.9
--------- --------- ---------
Total...................................................................... $ 2,603.7 $ 1,639.7 $ 2,688.7
========= ========= =========
Managed receivables (average):
Manufactured housing......................................................... $24,482.8 $25,979.1 $25,700.4
Mortgage services............................................................ 10,643.5 12,555.5 13,254.6
Retail credit................................................................ 2,702.7 2,248.0 1,523.0
Consumer finance - closed-end................................................ 1,218.6 1,735.2 2,173.1
Other lines (discontinued in early 2002 or previous periods)................. 709.4 1,856.4 4,770.7
--------- --------- ---------
Total...................................................................... $39,757.0 $44,374.2 $47,421.8
========= ========= =========
Revenues:
Net investment income:
Finance receivables and other.............................................. $ 2,074.2 $ 2,169.7 $ 1,853.6
Retained interest.......................................................... 75.0 125.3 180.7
Gain (loss) on sale of finance receivables................................... (49.5) 26.9 7.5
Fee revenue and other income................................................. 273.8 335.8 365.6
--------- --------- ---------
Total revenues............................................................. 2,373.5 2,657.7 2,407.4
--------- --------- ---------
Expenses:
Provision for losses......................................................... 950.0 537.7 344.7
Finance interest expense..................................................... 1,130.0 1,234.4 1,152.4
Other operating costs and expenses........................................... 616.0 642.4 753.5
--------- --------- ---------
Total expenses............................................................. 2,696.0 2,414.5 2,250.6
--------- --------- ---------
Operating income (loss) before special charges, impairment charges
and income taxes......................................................... (322.5) 243.2 156.8
Special charges................................................................. (121.9) (21.5) (394.3)
Reorganization items............................................................ (17.3) - -
Impairment charges.............................................................. (1,449.9) (386.9) (515.7)
--------- --------- --------
Loss before income taxes................................................... $(1,911.6) $ (165.2) $ (753.2)
========= ========= ========
General: CFC has historically provided financing for manufactured housing,
home equity, home improvements, consumer products and equipment, and consumer
and commercial revolving credit. As a result of the formalization of the plan to
sell the
65
finance business and the filing of petitions under the Bankruptcy Code by the
Finance Company Debtors, the finance business is being accounted for as a
discontinued business in Conseco's consolidated financial statements. See the
note to our consolidated financial statements entitled "Discontinued Finance
Business - Planned Sale of CFC" for additional information. CFC's finance
products include both fixed-term and revolving loans and leases. CFC also
markets physical damage and other credit protection relating to the loans it
services.
After September 8, 1999, CFC no longer structured securitizations in a
manner that resulted in recording a sale of the loans. Instead, new
securitization transactions were structured to include provisions that entitle
CFC to repurchase assets transferred to the special purpose entity when the
aggregate unpaid principal balance reaches a specified level. Until these assets
are repurchased, however, the assets are the property of the special purpose
entity and are not available to satisfy the claims of creditors of CFC. In
addition, CFC's securitization transactions were structured so that CFC, as
servicer for the loans, is able to exercise significant discretion in making
decisions about the serviced portfolio. Pursuant to Financial Accounting
Standards Board Statement No. 140, "Accounting for the Transfer and Servicing of
Financial Assets and Extinguishments of Liabilities" ("SFAS 140"), such
discretion requires the securitization transactions to be accounted for as
secured borrowings whereby the loans and securitization debt remain on the
balance sheet, rather than as sales.
The change to the structure of CFC's securitizations has no effect on the
total profit CFC recognizes over the life of each new loan, but it changes the
timing of profit recognition. Under the portfolio method (the accounting method
required for CFC securitizations which are structured as secured borrowings),
CFC recognizes: (i) earnings over the life of new loans as interest revenues are
generated; (ii) interest expense on the securities which are sold to investors
in the loan securitization trusts; and (iii) provisions for losses. As a result,
CFC's reported earnings from new loans securitized in transactions accounted for
under the portfolio method are lower in the period in which the loans are
securitized (compared to CFC's historical method) and higher in later periods,
as interest spread is earned on the loans.
CNC's leveraged condition and liquidity difficulties severely impacted the
operations of CFC, principally by eliminating CFC's access to the securitization
markets. The securitization markets have been CFC's main source of funding. The
loss of access to the securitization markets has severely affected CFC's ability
to originate, purchase and sell loans. In addition, CFC has historically relied
on these markets to finance the sale of repossessed manufactured housing units
which have historically lowered the loss on defaulted loans. CFC's inability to
access this market for repossessed manufactured housing units has forced CFC to
utilize the wholesale channel to dispose of its repossessed units, resulting in
higher losses on these portfolios. Increased losses have resulted in significant
reductions in cash flow from servicing and residual income, as well as CFC being
obligated to incur increasing amounts of guarantee liabilities on certain
securitizations. Additionally, market valuations of CFC's securitization trusts
have decreased due to uncertainty regarding CFC's liquidity position and its
ability to continue to provide servicing for the securitized portfolios,
thereby, reducing the value of CFC's retained interest pledged as collateral on
its residual facility.
CFC's remaining liquidity sources (excluding its bank subsidiaries) are a
warehouse and a residual facility with Lehman and a postpetition financing
facility. CFC's diminished access to the securitization markets and the
constrained liquidity under its other funding sources have had a material
adverse effect on CFC's business and results of operations, resulting in CFC's
petition for relief under the Bankruptcy Code. On December 19, 2002, shortly
after the filing of the Chapter 11 Cases, CFC obtained debtor-in-possession
("DIP") financing provided by U.S. Bank and FPS DIP LLC, an affiliate of
Fortress Investment Group LLC ("Fortress"), J.C. Flowers & Co. LLC. ("Flowers")
and Cerberus Capital Management, L.P. ("Cerberus"). The DIP financing motion was
granted by the Bankruptcy Court on January 14, 2003. On April 14, 2003, the
Bankruptcy Court approved an amendment to the DIP Facility to increase the
maximum permitted borrowings thereunder, from $125 million to $150 million.
CFC is currently in violation of several financial covenants required by
its warehouse and residual facilities. CFC has entered into a forbearance
agreement with Lehman pursuant to which Lehman has agreed to temporarily refrain
from exercising any rights arising from events of default that occurred under
the warehouse and residual facilities as of the date of such forbearance
agreement, including certain events of default triggered by CFC not being in
compliance with certain financial covenants. This forbearance agreement expires
on June 1, 2003 and is subject to various conditions.
CFC's residual facility is collateralized by retained interests in
securitizations. CFC is required to maintain collateral based on current
estimated fair values in accordance with the terms of such facility. Due to the
decrease in the estimated fair value of its retained interests, CFC's collateral
was deficient at December 31, 2002 (as calculated in accordance with the
relevant transaction documents). Under the terms of the forbearance agreement,
Lehman has agreed not to cause accelerated repayment of the residual facility
based on the collateral deficiency through June 1, 2003. However, Lehman is
retaining certain cash flows from CFC's retained interests pledged to this
facility and applying these cash flows to the margin deficit. CFC is currently
unable to provide sufficient additional collateral or repay this residual
facility.
On October 22, 2002, Conseco announced that its board of directors approved
a plan to seek new investors or acquirers for CFC's businesses and that it had
engaged the investment banking firms of Lazard Freres & Co., LLC and Credit
Suisse First Boston to pursue various alternatives, including securing new
investors and/or selling CFC's three primary lines of business: (i) manufactured
66
housing; (ii) mortgage services; and (iii) consumer finance. On December 19,
2002, CFC announced that it had signed a purchase agreement for the sale of
substantially all of its assets to CFN. The Bankruptcy Court approved bidding
and sales procedures pursuant to which the assets of CFC were sold in a public
auction supervised by the Trustee appointed by the Bankruptcy Court, on March 4
and 5 of 2003. On March 14, 2003, the Bankruptcy Court approved the sale of
substantially all of the CFC assets to CFN and GE. These sales transactions are
expected to close in the second quarter of 2003.
Prior to Conseco's October 22, 2002 announcement, CFC was undertaking
efforts to restructure its manufactured housing business. Originations had been
significantly curtailed and CFC began analyzing potential approaches to reducing
the negative cash flow that currently results from the servicing of this
portfolio and the payment of guarantees on the B-2 securities issued in
connection with securitizations of manufactured housing receivables. As a result
of CFC's decreased liquidity position and inability to sell manufactured housing
loans in the wholesale market at reasonable prices, CFC announced it would
suspend originating manufactured housing loans November 25, 2002. As part of the
Chapter 11 bankruptcy filing, CFC has requested a change in the servicing fee
structure for the servicing of manufactured housing portfolios. The contractual
servicing rate was 50 bps per annum on receivable balances. On December 18, 2002
the Bankruptcy Court approved an interim order to increase the servicing rate
for the manufactured housing portfolios to the lesser of 125 bps per annum based
on the balance of the receivables or the costs incurred to service the
manufactured portfolio as defined in the motion. During the first quarter of
2003, CFC reached an agreement with bondholders to amend the servicing agreement
for the manufactured housing portfolios, which was approved by the Bankruptcy
Court on March 14, 2003. The amendment provides for an increase in the servicing
fee to 125 bps per annum for one year following closing of the sale of the
assets to CFN Investment Holdings, LLC and to 115 bps per annum for subsequent
periods based on average unpaid principal balance of finance receivables,
excluding those in repossession status.
During 2000 and 2001, management completed several actions with respect to
CFC, including: (i) the sale, closing or runoff of several units (including
asset-based lending, vendor leasing, bankcards, transportation and park
construction, which are collectively referred to as the "other lines"); (ii)
monetization of certain on-balance sheet financial assets through sales or as
collateral for additional borrowings; and (iii) cost savings and restructuring
of ongoing businesses such as streamlining of loan origination operations in the
manufactured housing and home equity divisions. The transactions CFC completed
to raise cash during 2001 and 2000 included: (i) the sale of a $568.4 million
portfolio of high-loan-to-value loans (which generated $80 million of cash after
repayment of debt collateralized by the loans); (ii) the sale of a $802.3
million portfolio of vendor services loans (which generated $180 million of cash
after repayment of debt collateralized by the loans); (iii) the sale of a 15
percent interest in the interest-only securities and new borrowing agreements
collateralized by the interest-only securities (which generated cash of $100
million); (iv) the sale of substantially all of the bankcard (Visa and
Mastercard) portfolio (which generated $154 million of cash); (v) the sale of
$216.1 million of asset-backed loans (which generated $43 million of cash after
repayment of debt collateralized by the loans); (vi) the sale of a $566.0
million portfolio of loans which finance the purchase of trucks (which generated
$30 million of cash after repayment of debt collateralized by the loans); and
(vii) new or revised borrowing agreements which provided financing for loans not
previously pledged under other borrowing agreements (which generated over $300
million of cash). The cash generated from these transactions was primarily used
toward the reduction of debt due to CNC of $674.1 million in 2000 and $537.2
million in 2001. These courses of action have caused significant fluctuations in
account balances.
The risks associated with the finance business become more acute in any
economic slowdown or recession. Periods of economic slowdown or recession may be
accompanied by decreased demand for consumer credit and declining asset values.
In the home equity mortgage and manufactured housing businesses, any material
decline in real estate values reduces the ability of borrowers to use home
equity to support borrowing and increases the loan-to-value ratios of loans
previously made, thereby weakening collateral coverage and increasing the size
of losses in the event of a default. Delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions. For CFC's finance
customers, loss of employment, increases in cost-of-living or other adverse
economic conditions impair their ability to meet their payment obligations.
Higher industry inventory levels of repossessed manufactured homes have affected
recovery rates and may result in future impairment charges and provision for
losses. In addition, in an economic slowdown or recession, CFC's servicing and
litigation costs increase. Any sustained period of increased delinquencies,
foreclosures, losses or increased costs would have a material adverse effect on
CFC's financial condition and results of operations.
Loan originations in 2002 were $7.3 billion, down 35 percent from 2001.
Loan originations in 2001 were $11.3 billion, down 33 percent from 2000. Given
CFC's limited liquidity and inability to access the securitization market, CFC
is no longer originating certain types of loans. CFC is limiting future
originations primarily to loans that can be sold at a profit in whole-loan sale
transactions. CFC discontinued originating manufactured housing loans in
November 2002. These decisions and continued constraints on liquidity have
resulted in origination volume which is significantly lower than in prior
periods.
Sales of finance receivables in 2002 and 2001 include the sale of $2.1
billion and $.8 billion, respectively, of finance receivables, on which CFC
recognized a loss of $17.1 million and a gain of $26.9 million, respectively.
These sales are further explained below under "Gain on sale of finance
receivables". CFC also sold $.5 billion and $.8 billion of certain other finance
receivables in 2002 and 2001, respectively, as part of CFC's cash raising
arrangements.
67
Managed receivables include finance receivables recorded on CFC's
consolidated balance sheet and those managed by CFC but held by trusts
applicable to holders of asset-backed securities sold in securitizations
structured in a manner that resulted in gain-on-sale revenue. Average managed
receivables decreased to $39.8 billion in 2002, down 10 percent from 2001, and
decreased to $44.4 billion in 2001, down 6.4 percent from 2000.
Net investment income on finance receivables and other consists of: (i)
interest earned on finance receivables; and (ii) interest income on short-term
and other investments. Such income decreased by 4.4 percent, to $2,074.2
million, in 2002 and increased by 17 percent, to $2,169.7 million, in 2001,
consistent with the changes in average on-balance sheet finance receivables. The
weighted average yields earned on finance receivables and other investments were
11.5 percent, 12.6 percent and 12.9 percent during 2002, 2001 and 2000,
respectively. The average yields decreased due to the declining interest rate
environment, change in product mix of the portfolio and rising delinquencies
primarily in CFC's manufactured housing business.
Net investment income on retained interests is the income recognized on the
retained interests in securitizations CFC retains after it sells finance
receivables. Such income decreased by 40 percent, to $75.0 million, in 2002 and
by 31 percent, to $125.3 million, in 2001. The decrease is consistent with the
change in the average balance of retained interests. The weighted average yields
earned on retained interests were 12.3 percent, 14.4 percent and 13.6 percent
during 2002, 2001 and 2000, respectively. As a result of the change in the
structure of CFC's securitizations, securitization transactions are accounted
for as secured borrowings and CFC does not recognize gain-on-sale revenue or
additions to retained interests from such transactions. Accordingly, future
investment income accreted on the retained interests will decrease, as cash
remittances from the prior gain-on-sale securitizations reduce the retained
interests balances. In addition, the balance of the retained interests was
reduced by $1,077.2 million in 2002, $264.8 million in 2001 and $504.3 million
in 2000 (including $70.2 million due to the accounting change described in the
note to Conseco's consolidated financial statements entitled "Summary of
Significant Accounting Policies") due to impairment charges. Impairment charges
are further explained below. The weighted average yield was also adversely
affected by the decline in guarantee payments received on certain lower-rated
securities in the fourth quarter of 2002.
Gain (loss) on sales of finance receivables resulted from various loan sale
transactions in 2002, 2001 and 2000. During 2002, CFC sold $2.1 billion of
finance receivables which generated net losses of $17.1 million. In 2002, CFC
also recognized $32.4 million loss to reduce the value of unsecuritized finance
receivables, which are being held for eventual sale and have market values below
their cost basis. During 2001, CFC sold $1.6 billion of finance receivables
which included: (i) $802.3 million vendor services loan portfolio (the value of
which was reduced in the fourth quarter of 2000 since the market value of these
loans exceeded their cost basis, and no additional gain or loss was recognized
in 2001); (ii) $568.4 million of high-loan-to-value mortgage loans; and (iii)
$269.0 million of other loans. These sales resulted in net gains of $26.9
million. In 2000, CFC sold approximately $147.1 million of finance receivables
in whole-loan sales resulting in net gains of $7.5 million. Gain on sales of
finance receivables in 2000 excludes the gain realized on the sale of CFC's
bankcard portfolio which is included in special charges.
Fee revenue and other income includes servicing income, commissions earned
on insurance policies written in conjunction with financing transactions and
other income from late fees. Such income decreased by 18 percent, to $273.8
million, in 2002 and by 8.2 percent, to $335.8 million, in 2001. Such decreases
are primarily due to decreases in commission income as a result of reduced
origination activities and the termination of sales of single premium credit
life insurance. In addition, as a result of the change in the structure of CFC's
securitizations, CFC no longer records an asset for servicing rights at the time
of its securitizations, nor does CFC record servicing fee revenue; instead, the
entire amount of interest income is recorded as investment income. The amount of
servicing income (which is net of the amortization of servicing assets and
liabilities) was $83.9 million in 2002, $115.3 million in 2001 and $108.2
million in 2000. Servicing income will continue to decline in future periods as
the managed receivables in these securitizations are paid down. In 2000, the
decrease in servicing income was partially offset by higher commissions and late
fee income.
Provision for losses related to finance operations increased by 77 percent,
to $950.0 million, in 2002 and by 56 percent, to $537.7 million, in 2001. These
amounts relate to CFC's on-balance sheet finance receivables. CFC's credit
losses as a percentage of related loan balances for the on-balance sheet
portfolio have been increasing over the last several quarters (2.26 percent,
2.36 percent, 2.53 percent, 2.61 percent, 2.76 percent and 3.74 percent for the
quarters ended September 30, 2001, December 31, 2001, March 31, 2002, June 30,
2002, September 30, 2002 and December 31, 2002, respectively). The increases to
the provision and CFC's credit losses are due to many factors including: (i)
CFC's inability to finance the sale of repossessed assets, resulting in CFC's
use of wholesale markets to sell such assets through which recovery rates are
significantly lower; (ii) the natural increase in delinquencies in some of CFC's
products as they age into periods in which CFC has historically experienced
higher delinquencies; (iii) the increase in retail credit receivables which
typically experience higher credit losses; (iv) economic factors which have
resulted in an increase in defaults; and (v) a decrease in the manufactured
housing recovery rates when repossessed properties are sold given current
industry levels of repossessed assets. At December 31, 2002 and 2001, the
60-days-and-over delinquencies as a percentage of on-balance sheet finance
receivables were 3.21 percent and 2.19 percent, respectively. Under the
portfolio method, CFC estimates an allowance for credit losses based upon its
assessment of current and historical loss experience, loan portfolio trends, the
value of collateral, prevailing economic and business conditions, and other
relevant factors. Increases in CFC's allowance for credit losses are recognized
68
as expense based on CFC's current assessments of such factors. For loans
previously recorded as sales, the anticipated discounted credit losses over the
expected life of the loans were reflected through a reduction in the
gain-on-sale revenue recorded at the time of securitization or through
impairment charges when assessments of estimated losses have changed.
Delinquencies on loans held in CFC's loan portfolio and CFC's ability to
recover collateral and mitigate loan losses are adversely impacted by a variety
of factors, many of which are outside of CFC's control. When loans are
delinquent and CFC forecloses on the loan, its ability to sell collateral to
recover or mitigate its losses is subject to the market value of such
collateral. In manufactured housing, these values are affected by the available
inventory of manufactured homes on the market, a factor over which CFC has no
control. It is also dependent upon demand for new homes, which is tied to
economic factors in the general economy. In addition, repossessed collateral is
generally in poor condition, which reduces its value.
Many consumer lenders have stopped or significantly scaled back their
consumer finance operations in the manufactured housing sector. These lenders
began to foreclose on collateral pledged to secure loans at a more aggressive
rate. CFC has faced increased competition from such lenders in disposing of
collateral pledged to secure its loans. Often collateral is in similar forms.
There is a limited number of collateral buyers and the exiting consumer lenders
have been willing to sell their foreclosed collateral at prices significantly
below fair market value. As a result, collateral recovery rates for CFC have
fallen significantly and could fall further, which could have a further material
adverse effect on the financial position and results of CFC's operations.
At December 31, 2002, CFC had a total of 20,918 unsold manufactured housing
properties (11,939 of which relate to off-balance sheet securitizations) in
repossession, compared to 15,057 properties (10,814 of which relate to
off-balance sheet securitizations) at December 31, 2001. CFC reduces the value
of repossessed property to its estimate of net realizable value upon
repossession. CFC liquidated 25,017 managed manufactured housing units at an
average loss severity rate (the ratio of the loss realized to the principal
balance of the foreclosed loan) of 65 percent in 2002 compared to 25,750 units
at an average loss severity rate of 57 percent in 2001. The loss severity rate
related to the on-balance sheet manufactured housing portfolio was 59 percent in
2002, compared to 49 percent in 2001. The higher industry levels of repossessed
manufactured homes which existed in the marketplace in 2002, have adversely
affected recovery rates, specifically wholesale severity, as other lenders
(including lenders who have exited the manufactured home lending business) have
acted to more quickly dispose of repossessed manufactured housing inventory.
Additionally, the higher level of repossessed inventory that currently exists in
the marketplace has made it more difficult for CFC to liquidate its inventory at
rates it has recovered in the past. CFC also believes the higher average
severity rate in 2002 related to the on-balance sheet manufactured housing
portfolio is partially due to the increased age of such portfolio.
During the quarter ended September 30, 2002, CFC's ability to access the
securitization markets was eliminated. The securitization markets had been CFC's
main source of funding for loans made to purchasers of repossessed manufactured
homes. CFC believes that its severity rates have been historically positively
impacted when it used retail channels to dispose of repossessed inventory (where
the repossessed units are sold through company-owned sales lots or its dealer
network). Since CFC is no longer able to fund the loans made on repossessed
homes sold through these channels, sales through these channels have decreased
and CFC must rely on the wholesale channel to dispose of repossessed
manufactured housing units, through which recovery rates are significantly
lower.
CFC believes that its historical loss experience has been favorably
affected by various loss mitigation policies. Under one such policy, CFC works
with the defaulting obligor and its dealer network to find a new buyer who meets
CFC's underwriting standards and is willing to assume the defaulting obligor's
loan. Under other loss mitigation policies, CFC may permit qualifying obligors
(obligors who are currently unable to meet the obligations under their loans,
but are expected to be able to meet them in the future under modified terms) to
defer scheduled payments or CFC may reduce the interest rate on the loan, in an
effort to avoid loan defaults.
Due to the prevailing economic conditions in 2002 and 2001, CFC increased
the use of the aforementioned mitigation policies. Based on past experience, CFC
believes these policies will reduce the ultimate losses it recognizes. If CFC
applies loss mitigation policies, CFC generally reflects the customer's
delinquency status as not being past due. Accordingly, the loss mitigation
policies favorably impact CFC's delinquency ratios. CFC attempts to
appropriately reserve for the effects of these loss mitigation policies when
establishing loan loss reserves. These policies are also considered when CFC
determines the value of its retained interests in securitization trusts. Loss
mitigation policies were applied to 10.7 percent of average managed accounts in
2002 compared to 8.8 percent in 2001. Such loss mitigation policies were applied
to 3.0 percent, 2.7 percent, 2.8 percent and 2.2 percent of average managed
accounts during the first, second, third and fourth quarters of 2002,
respectively. Due to CFC's liquidity limitations, many loss mitigation policies
were curtailed in the fourth quarter of 2002.
Finance interest expense decreased by 8.5 percent, to $1,130.0 million, in
2002 and increased by 7.1 percent, to $1,234.4 million, in 2001. Such decrease
was primarily the result of: (i) lower average borrowing rates; and (ii)
decreased borrowings to fund the decreased finance receivables. CFC's average
borrowing rate was 6.1 percent, 7.0 percent and 7.7 percent during 2002, 2001
and 2000, respectively. The decrease in average borrowing rates in 2002 as
compared to 2001 is primarily due to the decrease in the general interest rate
environment between periods and the repurchase and retirement of some of CFC's
public debt.
69
Other operating costs and expenses include the costs associated with
servicing CFC's managed receivables, non-deferrable costs related to originating
new loans and other operating costs. Such expense decreased by 4.1 percent, to
$616.0 million, in 2002 and by 15 percent, to $642.4 million, in 2001. In 2002,
CFC accrued $26.8 million pursuant to judgments issued in two arbitration
proceedings. Such litigation is described in greater detail in the note to
Conseco's consolidated financial statements entitled "Other Disclosures".
Excluding the litigation accrual, such costs have decreased due to the
realization of the benefits from cost saving initiatives and a decrease in
origination volumes. In 2001, CFC began to realize some of the cost savings from
its restructuring.
Special charges in the finance segment for 2002 include: (i) the loss of
$96.0 million related to the sales of certain finance receivables of $463
million and $1.6 million of additional loss related to receivables required to
be repurchased from the purchaser of the vendor services receivables pursuant to
the repurchase clauses in the agreements; (ii) a $39.4 million charge for costs
associated with various modifications to financing arrangements and recognition
of deferred expenses for terminated warehouse facilities; (iii) a $16.3 million
charge for the abandonment of computer processing systems; (iv) a $38.1 million
benefit due to the reduction in the value of the warrant held by Lehman to
purchase five percent of CFC, which is currently expected to have no value due
to CFC's bankruptcy proceedings; and (v) restructuring and other charges of $6.7
million. Special charges recorded in 2001 include: (i) the loss related to the
sale of certain finance receivables of $11.2 million; (ii) severance benefits,
litigation reserves and other restructuring charges of $12.8 million; (iii) a
$7.5 million charge related to the decision to discontinue the sale of certain
types of life insurance in conjunction with lending transactions; and (iv) a
$10.0 million benefit due to the reduction in the value of the warrant held by
Lehman to purchase five percent of CFC which was caused by a decrease in the
value of CFC. Special charges recorded in 2000 include: (i) the $103.3 million
reduction in the value of finance receivables identified for sale; (ii) the
$53.0 million loss on the sale of asset-based loans; (iii) $29.5 million of
costs related to closing offices and streamlining businesses; (iv) $35.8 million
related to the abandonment of computer processing systems; (v) $30.3 million of
fees paid to Lehman including a $25.0 million fee paid in conjunction with the
sale of $1.3 billion of finance receivables to Lehman; (vi) the issuance of a
warrant valued at $48.1 million related to the modification of the Lehman master
repurchase financing facilities; (vii) the $51.0 million loss on sale of
transportation loans and vendor services financing business; (viii) a $48.0
million increase in the allowance for loan losses at our bank subsidiary; and
(ix) $4.7 million of net gains related to the sale of certain lines of business,
net of other items. These charges are described in greater detail in the note to
Conseco's consolidated financial statements entitled "Financial Information
Regarding CFC."
Reorganization items are professional fees associated with CFC's bankruptcy
proceedings which are expensed as incurred in accordance with SOP 90-7.
Impairment charges represent reductions in the value of CFC's retained
interests in securitization trusts (including interest-only securities and
servicing rights) recognized as a loss. CFC carries interest-only securities at
estimated fair value and servicing rights at the lower of cost or fair value.
Fair value is determined by discounting the projected cash flows over the
expected life of the receivables sold using current prepayment, default, loss,
interest rate and servicing cost assumptions. CFC considers any potential
payments related to the guarantees of certain lower-rated securities issued by
the securitization trusts in the projected cash flows used to determine the
value of its retained interests. When declines in value considered to be other
than temporary occur, CFC reduces the amortized cost to estimated fair value and
recognizes a loss. The assumptions used to determine new values are based on the
internal evaluations of CFC's management. Under current accounting rules
(pursuant to Emerging Issues Task Force Issue No. 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" ("EITF 99-20")) which were adopted on July 1,
2000, declines in the value of CFC's retained interests are recognized when: (i)
the fair value of the security is less than its carrying value; and (ii) the
timing and/or amount of cash expected to be received from the security has
changed adversely from the previous valuation which determined the carrying
value of the security. When both occur, the security is written down to fair
value. The assumptions used to determine new values for CFC's retained interests
are based on internal evaluations. Although CFC believes its methodology is
reasonable, many of the assumptions and expectations underlying CFC's
determination may prove inaccurate, in which case there may be an adverse effect
on CFC's financial results.
The determination of the value of CFC's retained interests in
securitization trusts requires significant judgment. CFC has recognized
significant charges when the retained interests did not perform as well as
anticipated based on CFC's assumptions and expectations. CFC's current valuation
of retained interests may prove inaccurate in future periods. In securitizations
to which these retained interests relate, CFC has retained certain contingent
risks in the form of guarantees of certain lower-rated securities issued by the
securitization trusts. As of December 31, 2002, the total amount of these
guarantees was approximately $1.4 billion. CFC considers any potential payments
related to these guarantees in the projected cash flows used to determine the
value of its retained interests. See the note to Conseco's consolidated
financial statements entitled "Financial Information Regarding CFC."
During 2002, CFC's ability to access the securitization markets was
eliminated. The securitization markets had been CFC's main source of funding for
loans made to purchasers of repossessed manufactured homes. CFC believes that
its loss severity rates historically have been positively impacted when it used
retail channels to dispose of repossessed inventory (where the repossessed units
are sold through company-owned sales lots or CFC's dealer network). Since CFC is
no longer able to fund the loans made on repossessed homes, sales through these
channels have ceased and CFC must rely on the wholesale channel to dispose of
repossessed
70
manufactured housing units, through which recovery rates are significantly
lower. Accordingly, CFC changed the loss severity assumptions used to value its
retained interests to reflect the higher loss severity CFC expects to experience
in the future. In addition, CFC's previous assumptions reflected its belief that
the adverse manufactured housing default experience in recent periods would
continue through the first half of 2002 and then improve over time. Default
experience did not improve as expected. Accordingly, CFC increased the default
assumptions used to value its retained interests to reflect CFC's future
expectations based on current default rates. CFC's home equity/home improvement
assumptions have also been adjusted to reflect recent default experience as well
as CFC's future expectations.
CFC's access to liquidity was further limited during the fourth quarter of
2002. CFC was unable to access alternative funding sources to replace the
financing it previously obtained through the securitization markets. Further,
CFC continued to experience high levels of delinquencies and foreclosures. As a
result of the inability to obtain financing, CFC was required to suspend all
originations of manufactured housing loans, including the financing of
repossessed manufactured housing units, in the fourth quarter of 2002. In
addition, CFC discontinued the use of some of its loss mitigation strategies
including its inventory loan assumption program. Prices of used manufactured
housing units in the wholesale channels are at historical lows due to the high
levels of repossessed manufactured housing inventories available in the market.
Accordingly, CFC increased the loss severity and default assumptions used to
value its retained interests to reflect CFC's future expectations based on
current experience. During 2002, CFC increased the assumption for the expected
rates of loss severity (the expected weighted average ratio of losses realized
to the principal balance of the foreclosed loans) from 65.4 percent to 89.5
percent. CFC increased the assumption for the expected rates of default (the
expected weighted average constant ratio of defaulting loans to the balance of
all loans sold) from 2.34 percent to 2.97 percent.
As a result of the requirements of EITF 99-20 and the assumption changes
described above, CFC recognized an impairment charge of $1,077.2 million in 2002
for the retained interests. CFC also recognized a $336.5 million increase in the
valuation allowance related to its servicing rights as a result of the changes
in assumptions in 2002. The valuation allowance related to the servicing rights
increased as a result of changes to the expected future cost of servicing the
finance receivables. The levels of delinquent and defaulting loans have caused
servicing costs to increase. In addition, future servicing costs are expected to
increase as the portfolio ages. Such assumptions reflect the subordination of
the servicing fees to other cash flows in certain securitization transactions.
In addition, CFC recognized impairment charges of: (i) $29.3 million to
establish a valuation allowance for advances CFC was required to make to the
securitization trusts which are estimated to be uncollectible; and (ii) $6.9
million to establish a liability of guarantee payments due to certain holders of
lower-rated securities issued by the securitization trusts which CFC was unable
to pay.
CFC recognized an impairment charge of $386.9 million in 2001 which
included an impairment charge of $264.8 million related to its interest-only
securities. During 2001, CFC's interest-only securities did not perform as well
as anticipated. In addition, CFC's expectations regarding future economic
conditions changed. Accordingly, CFC increased its loss severity assumptions
related to the performance of the underlying loans to be consistent with its
expectations. CFC increased the assumption for the expected rates of loss
severity (the expected weighted average ratio of losses realized to the
principal balance of the foreclosed loans) from 59.8 percent to 65.4 percent.
The impairment charge also included a $122.1 million increase in the valuation
allowance related to CFC's servicing rights as a result of the changes in
assumptions. CFC carries its servicing rights at the lower of carrying value or
estimated fair value. Refer to "Finance Receivables and Retained Interests in
Securitization Trusts - Retained Interests in Securitization Trusts" for
additional discussion of the impairment charge and interest-only securities.
During 2000, actual default and loss trends were worse than CFC's previous
estimates. In light of these trends, CFC's management analyzed the assumptions
used to determine the estimated fair value of the interest-only securities and
made changes to the credit loss assumptions and the discount rate used to
determine the value of its securities. These changes also reflected other
economic factors and further methodology enhancements made by CFC. During 2000,
CFC increased the assumption for the expected rates of default (the expected
weighted average constant ratio of defaulting loans to the balance of all loans
sold) from 2.25 percent to 2.45 percent. CFC also increased the assumption for
the expected rates of loss severity (the expected weighted average ratio of
losses realized to the principal balance of the foreclosed loans) from 55.3
percent to 59.8 percent. As a result, the expected future cash flows from
interest-only securities changed adversely from previous estimates. Pursuant to
the requirements of EITF 99-20, the effect of these changes was reflected
immediately in earnings as an impairment charge. The effect of the impairment
charge and adjustments to the value of CFC's interest-only securities and
servicing rights totaled $515.7 million ($324.9 million after the income tax
benefit) for 2000 (in addition to the cumulative effect of adopting EITF 99-20
of $70.2 million, or $45.5 million after the income tax benefit).
71
Finance Receivables and Retained Interests in Securitization Trusts Held by
CFC
Finance Receivables
During the last several years, CFC has completed several actions in an
attempt to raise cash and improve its financial position and results of
operations. These actions have caused significant fluctuations in account
balances. See the section above entitled "Operating Results of the Discontinued
Finance Operations" for a description of such actions. Finance receivables,
including receivables which serve as collateral for the notes issued to
investors in securitization trusts of $12,460.0 million and $14,198.5 million at
December 31, 2002 and 2001, respectively, summarized by business line and
categorized as either a part of CFC's primary lines or a part of other lines
(discontinued in previous periods), were as follows:
December 31,
2002 2001
---- ----
(Dollars in millions)
Primary lines:
Manufactured housing............................................................... $ 7,124.8 $ 7,549.7
Mortgage services.................................................................. 5,266.6 6,787.1
Retail credit...................................................................... 2,240.6 2,690.0
Consumer finance - closed-end...................................................... 443.5 587.1
--------- ---------
15,075.5 17,613.9
Less allowance for credit losses................................................... 646.9 400.1
--------- ---------
Net finance receivables - for primary lines...................................... 14,428.6 17,213.8
--------- ---------
Other lines (discontinued in previous periods)........................................ 71.4 816.6
Less allowance for credit losses................................................... 16.9 21.2
--------- ---------
Net finance receivables - for other lines........................................ 54.5 795.4
--------- ---------
Total finance receivables........................................................ $14,483.1 $18,009.2
========= =========
Managed finance receivables by loan type were as follows:
December 31,
2002 2001
---- ----
(Dollars in millions)
Primary lines:
Fixed term............................................................ $32,901.6 $38,876.5
Revolving credit...................................................... 2,255.5 2,695.1
Other lines (discontinued in previous periods)........................... 125.4 1,430.7
--------- ---------
Total............................................................... $35,282.5 $43,002.3
========= =========
Number of contracts serviced:
Fixed term contracts - continuing lines............................... 978,000 1,164,000
Revolving credit accounts - continuing lines.......................... 835,000 1,486,000
Other lines (discontinued in previous periods)........................ 54,000 124,000
--------- ---------
Total............................................................... 1,867,000 2,774,000
========= =========
Approximately 9 percent, 8 percent, 7 percent and 6 percent of the loans
that CFC serviced were in Texas, North Carolina, Florida and Georgia,
respectively. No other state comprised more than 5 percent of the loans
serviced. In addition, no single contractor, dealer or vendor accounted for more
than 1 percent of the total contracts CFC originated.
72
The credit quality of managed finance receivables was as follows:
December 31,
2002 2001
---- ----
60-days-and-over delinquencies as a percentage of managed finance
receivables at period end:
Manufactured housing.................................................... 3.62% 2.45%
Mortgage services (a)................................................... 1.47 1.23
Retail credit........................................................... 3.14 3.39
Consumer finance - closed-end........................................... .91 1.08
Other lines (discontinued in early 2002 or previous periods)............ 8.58 1.58
Total................................................................. 3.00% 2.10%
Net credit losses incurred during the last twelve months as a percentage of
average managed finance receivables during the period:
Manufactured housing.................................................... 3.09% 2.14%
Mortgage services....................................................... 2.66 1.95
Retail credit........................................................... 6.33 6.65
Consumer finance - closed-end........................................... 3.09 2.50
Other lines (discontinued in early 2002 or previous periods)............ 3.98 2.72
Total................................................................. 3.21% 2.35%
Repossessed collateral inventory as a percentage of managed finance receivables
at period end (b):
Manufactured housing.................................................... 3.58% 2.45%
Mortgage services (c)................................................... 5.97 4.07
Retail credit........................................................... .35 .13
Consumer finance - closed-end........................................... 1.75 1.03
Other lines (discontinued in early 2002 or previous periods)............ 3.38 1.91
Total................................................................. 3.92% 2.68%
- --------------------
(a) 60-days-and-over delinquencies exclude loans in the process of foreclosure.
(b) Ratio of: (i) outstanding loan principal balance related to the repossessed
inventory (before writedown) to: (ii) total receivables. CFC writes down
the value of its repossessed inventory to estimated realizable value at the
time of repossession.
(c) Repossessed collateral inventory includes loans in the process of
foreclosure.
73
The credit quality of on-balance sheet finance receivables was as follows:
December 31,
2002 2001
---- ----
60-days-and-over delinquencies as a percentage of on-balance sheet
finance receivables at period end:
Manufactured housing.................................................... 4.61% 3.08%
Mortgage services (a)................................................... 1.30 .94
Retail credit........................................................... 3.14 3.39
Consumer finance - closed-end........................................... 1.14 1.33
Other lines (discontinued in early 2002 or previous periods)............ 9.77 1.22
Total................................................................. 3.21% 2.19%
Net credit losses incurred during the last twelve months as a percentage of
average on-balance sheet finance receivables during the period:
Manufactured housing.................................................... 4.35% 1.87%
Mortgage services....................................................... 2.07 1.53
Retail credit........................................................... 6.33 6.65
Consumer finance - closed-end........................................... 2.54 2.02
Other lines (discontinued in early 2002 or previous periods)............ 2.97 2.11
Total................................................................. 3.74% 2.36%
Repossessed collateral inventory as a percentage of on-balance sheet finance
receivables at period end (b) (c):
Manufactured housing.................................................... 4.93% 2.41%
Mortgage services (d)................................................... 6.02 3.50
Retail credit........................................................... .35 .13
Consumer finance - closed-end........................................... 2.08 1.15
Other lines (discontinued in early 2002 or previous periods)............ 2.85 1.36
Total................................................................. 4.56% 2.37%
- --------------------
(a) 60-days-and-over delinquencies exclude loans in the process of foreclosure.
(b) Ratio of: (i) outstanding loan principal balance related to the repossessed
inventory (before writedown) to: (ii) total receivables.
(c) Although the ratio is calculated using the outstanding loan principal
balance related to the repossessed inventory, the repossessed inventory is
written down to net realizable value at the time of repossession or
completed foreclosure.
(d) Repossessed collateral inventory includes loans in the process of
foreclosure.
These ratios increased during 2002 primarily as a result of the factors
described above under "Provision for losses related to finance operations."
Retained Interests in Securitization Trusts
As stated above in the section entitled "Operating Results of the
Discontinued Finance Operations", CFC changed the manner in which it structured
securitization of loans on September 8, 1999. The securitizations structured
prior to the September 8, 1999, announcement met the applicable criteria to be
accounted for as sales. At the time the loans were securitized and sold, CFC
recognized a gain and recorded its retained interest represented by the
interest-only security. The interest-only security represents the right to
receive, over the life of the pool of receivables: (i) the excess of the
principal and interest received on the receivables transferred to the special
purpose entity over the principal and interest paid to the holders of other
interests in the securitization; and (ii) contractual servicing fees. CFC
considers any potential payments related to the guarantees of certain
lower-rated securities issued by the securitization trusts in the projected cash
flows used to determine the value of its interest-only securities. In some of
those securitizations, CFC also retained certain lower-rated securities that are
senior in payment priority to the interest-only securities. Such retained
securities had a par value, fair market value and amortized cost of $718.7
million, $611.5 million and $548.0 million, respectively, at December 31, 2002.
The interest-only securities and subordinated securities are carried at
estimated fair value. On a quarterly basis, CFC estimates the fair value of
these securities by discounting the projected future cash flows using current
assumptions. If CFC determines that the differences between the estimated fair
value and the book value of these securities is a temporary difference, CFC
adjusts shareholders' equity. At December 31, 2002, this adjustment increased
the carrying value of the retained interests by $63.5 million to $252.6 million.
74
The assumptions CFC uses to determine new values are based on its internal
evaluations. Although CFC's management believes its methodology is reasonable,
many of the assumptions and expectations underlying CFC's determinations are not
possible to predict with certainty and may change adversely in the future for
reasons beyond CFC's control. Largely as a result of adverse changes in the
underlying assumptions (as discussed above in the section entitled "Operating
Results of the Discontinued Finance Operations"), CFC recognized impairment
charges of $1,077.2 million in 2002, $386.9 million ($250.4 million after tax)
in 2001 and $515.7 million ($324.9 million after tax) in 2000 to reduce the book
value of interest-only securities and servicing rights as described above under
"Operating Results of the Discontinued Finance Operations."
In conjunction with the sale of certain finance receivables, CFC provided
guarantees related to the principal and interest payments of certain lower-rated
securities issued to third parties by the securitization trusts. Such securities
had a total principal balance outstanding of $1.4 billion at December 31, 2002.
CFC considers any potential payments related to these guarantees in the
projected net cash flows used to determine the value of its retained interests.
At December 31, 2002, the net deficit value of CFC's retained interests of
$(74.1) million, reflected estimated guarantee payments related to bonds held by
others of $326.7 million.
Based on CFC's current assumptions and expectations as to future events
related to the loans underlying its retained interests, management has projected
that the adverse loss experience in 2002 will continue into 2003 and then
improve over time. As a result of these assumptions, CFC projects that payments
related to the guarantees (including the guarantee payments described in the
preceding paragraph and guarantee payments related to the subordinated
securities we hold) will exceed the gross undiscounted cash flows from the
interest-only securities by approximately $225 million in 2003, $100 million in
2004, $60 million in 2005 and $10 million in 2006. CFC projects that the gross
cash flows from the interest-only securities will exceed the payments related to
guarantees issued in conjunction with the sales of certain finance receivables
by approximately $175 million in all years thereafter.
Effective September 30, 2001, CFC transferred substantially all of its
interest-only securities into a securitization trust. The transaction provided a
means to finance a portion of the value of its interest-only securities by
selling some of the cash flows to Lehman. The transfer was accounted for as a
sale in accordance with SFAS 140. However, no gain or loss was recognized
because the aggregate fair value of the interest retained by CFC and the cash
received from the sale were equal to the carrying value of the interest-only
securities prior to their transfer to the trust. The trust is a qualifying
special purpose entity and is not consolidated pursuant to SFAS 140. CFC
received a trust security representing an interest in the trust equal to 85
percent of the estimated future cash flows of the interest-only securities held
in the trust. Lehman purchased the remaining 15 percent interest. The value of
the interest purchased by Lehman was $20.4 million at December 31, 2002. CFC
continues to be the servicer of the finance receivables underlying the
interest-only securities transferred to the trust. Lehman has the ability to
accelerate the principal payments related to their interest after a stated
period. Until such time, Lehman is required to maintain a 15 percent interest in
the estimated future cash flows of the trust. By aggregating the interest-only
securities into one structure, the impairment tests for these securities are
conducted on a single set of cash flows representing CFC's 85 percent interest
in the trust. Accordingly, adverse changes in cash flows from one interest-only
security may be offset by positive changes in another. The new structure does
not avoid an impairment charge if sufficient positive cash flows in the
aggregate are not available (such as was the case at December 31, 2002).
CFC carries its servicing rights at the lower of carrying value or
estimated fair value stratified by product type and year of securitization. To
the extent the recorded amount exceeds the fair value for a given strata, CFC
establishes a valuation allowance through a charge to earnings. Such valuation
allowance increased by $336.5 million and $122.1 million in 2002 and 2001,
respectively. The fees CFC receives for servicing the securitized portfolio are
often subordinate to the interests of other security holders in the trusts.
No assurances can be given that CFC's current valuation of retained
interests will prove accurate in future periods. In addition, CFC has retained
certain contingent risks in the form of guarantees of certain lower-rated
securities issued by the securitization trusts. If CFC has to make more payments
on these guarantees than anticipated, CFC may be required to recognize
additional impairment charges or to make payments on the guarantees, which, in
turn, could have a material adverse effect on its financial condition or results
of operations.
Liquidity for Finance Operations
CFC requires cash to originate finance receivables. CFC's primary sources
of cash have historically been: (i) the collection of receivable balances; (ii)
proceeds from the issuance of debt, certificates of deposit, bank credit
facility, securitizations, warehouse and residual lines, and sales of loans; and
(iii) cash provided by operations. CFC's lenders have severely restricted its
access to liquidity. The liquidity needs of CFC could increase in the event of
an extended economic slowdown or recession. Loss of employment, increases in
cost-of-living or other adverse economic conditions impair the ability of CFC's
customers to meet their payment obligations. Higher industry levels of
repossessed manufactured homes have affected recovery rates and resulted in
decreased cash flows. In addition, in an economic slowdown or recession, CFC's
servicing and litigation costs generally increase. Any sustained period of
increased delinquencies, foreclosures, losses or increased costs would have an
adverse effect on its liquidity. See "Operating Results of the Discontinued
Finance Operations" above for additional discussion.
75
The most significant source of liquidity for CFC has historically been its
ability to finance the receivables it originates in the secondary markets
through loan securitizations. Under certain securitization structures, CFC has
provided a variety of credit enhancements, which have taken the form of
corporate guarantees with respect to certain securitizations (although such
guarantees were not provided during 2001 and 2002), and have also included bank
letters of credit, surety bonds, cash deposits and over-collateralization or
other equivalent collateral. The nominal value of these guarantees is
approximately $1.4 billion. CFC suspended guarantee payments in the fourth
quarter of 2002 and without additional liquidity in the near future, CFC will be
unable to make these guarantee payments when such payments are required to be
made. See the section above entitled "Retained Interests in Securitization
Trusts" for additional information on the guarantee payments.
The ratings downgrades that followed announcements regarding CNC's
defaulted debt and restructuring discussions with debt holders (see the section
entitled "Liquidity of Conseco (parent company)" in this "Management's
Discussion and Analysis of Financial Condition and Results of Operations") have
eliminated CFC's access to the securitization markets. The securitization
markets have been CFC's main source of funding. The loss of access to the
securitization markets has severely affected CFC's ability to originate,
purchase and sell loans. It has also affected the value of the retained
interests CFC holds in securitization trusts, since CFC relied on these markets
to finance the sale of repossessed manufactured housing units which often helped
to minimize the loss on defaulted loans (compared to selling directly to the
manufactured housing wholesale channel).
CFC's remaining liquidity sources (excluding its bank subsidiaries) are a
warehouse and a residual facility with Lehman and a postpetition financing
facility. CFC's inability to access the securitization markets and the
constrained liquidity under its other funding sources have had a material
adverse effect on its business and results of operations, resulting in CFC's
petition for relief under the Bankruptcy Code. As part of the Chapter 11
bankruptcy filing, CFC requested and received an interim order from the
Bankruptcy Court to increase the servicing fees it is paid by the securitization
trusts for manufactured housing loans (see the section above entitled "Operating
Results of the Discontinued Finance Operations").
CFC is currently in violation of several of its financial covenants
required by its warehouse and residual facilities. CFC has entered into a
forbearance agreement with Lehman pursuant to which Lehman has agreed to
temporarily refrain from exercising any rights arising from events of default
that occurred under the facilities as of the date of such forbearance agreement,
including certain events of default triggered by CFC not being in compliance
with certain financial covenants. This forbearance agreement expires on June 1,
2003. The forbearance agreement with Lehman contains additional provisions
which: (i) prohibit CFC from making any dividend or other payments to CNC or any
affiliates; (ii) during the forbearance period, grant Lehman rights over cash
proceeds resulting from the sale of assets in excess of $25 million; (iii)
provide Lehman with the right to consent to amendments to the documents
governing certain of CFC's securitization facilities; and (iv) provide Lehman
with additional security interests in CFC's otherwise unencumbered assets
(including, but not limited to, rights on servicing fees received by CFC). In
connection with the execution of the forbearance agreement, CFC and Lehman
amended the warehouse and residual facilities. These amendments provide for a
level of increased liquidity during the forbearance period and provide Lehman
with a security interest in cash flows received by CFC from its securitization
facilities.
CFC's residual facility is collateralized by retained interests in
securitizations. CFC is required to maintain collateral based on current
estimated fair values in accordance with the terms of such facility. Due to the
decrease in estimated fair value of its retained interests, CFC's collateral was
deficient at December 31, 2002 (as calculated in accordance with the relevant
transaction documents). CFC has executed a forbearance agreement with Lehman in
which, among other things, Lehman has agreed not to require additional
collateral with respect to the residual facility through June 1, 2003. Under the
terms of the forbearance agreement, Lehman is retaining certain cash flows from
CFC's retained interests pledged to this facility and applying these cash flows
to the margin deficit. CFC is currently unable to provide sufficient additional
collateral or to repay this credit facility. The value of the retained interests
in the manufactured housing portfolio may also decrease based on CFC's inability
to continue to effectuate its historical loss mitigation strategy with respect
to the sale of repossessed manufactured housing units resulting in a reduction
of collateral pledged on its residual facility. CFC had historically provided
financing to retail buyers of repossessed units and funded that financing
through the securitization of those refinancing loans. Without access to the
securitization market, CFC's ability to provide financing to purchasers of
repossessed manufactured housing units has ceased. On November 25, 2002, CFC
announced it was suspending originations of loans for manufactured housing,
which required CFC to sell repossessed manufactured housing units in the
wholesale market at significantly reduced prices, thereby reducing cash flow
available to the retained interests. Additionally, the uncertainty with respect
to CFC's liquidity position and its ability to continue to provide servicing for
the securitized portfolios has reduced and may further reduce the value of its
retained interests pledged as collateral on the residual facility.
During 2002, CFC repurchased $46.9 million par value of its senior
subordinated notes and medium term notes resulting in an extraordinary gain of
$3.9 million (net of income taxes). In March 2002, CFC completed a tender offer
pursuant to which it purchased $75.8 million par value of its senior
subordinated notes due June 2002. The purchase price was equal to 100 percent of
the principal amount of the notes plus accrued interest. The remaining principal
amount outstanding of $34.8 million of the senior subordinated notes after the
tender offer and other debt repurchases completed prior to the tender offer was
retired at maturity on June 3, 2002.
76
In April 2002, CFC completed a tender offer pursuant to which it purchased
$158.5 million par value of its medium term notes due September 2002 and $3.7
million par value of its medium term notes due April 2003. The purchase price
was equal to 100 percent of the principal amount of the notes plus accrued
interest. In June 2002, CFC commenced a tender offer for the remaining $8.2
million par value of its medium term notes due September 2002. Pursuant to the
tender offer $5.5 million par value of the notes was tendered in July. The
purchase price was equal to 101 percent of the principal amount of the notes
plus accrued interest. The remaining principal amount outstanding of the medium
term notes after giving effect to both tender offers and other debt repurchases
completed prior to the tender offers of $2.7 million was retired at maturity on
September 26, 2002. Since that date, CFC has had no outstanding public debt.
CFC has historically pursued alternative and supplementary methods to
finance its lending operations. In late 1998, CFC began issuing certificates of
deposit through its bank subsidiaries. At December 31, 2002, $2.3 billion of
such deposits were outstanding. The average annual rate paid on these deposits
was 3.9 percent during 2002. Proceeds from the issuance of the certificates of
deposit are used to fund the origination of certain consumer/credit card finance
receivables. To the extent that CFC is unable to issue certificates of deposit,
loan origination activities would be adversely affected, which would have
additional material adverse effects on its operations, financial results and
cash position. The sale of Mill Creek Bank, CFC's subsidiary which issues the
certificates of deposit, to GE was approved by the Bankruptcy Court on March 14,
2003.
Market-Sensitive Instruments and Risk Management - CFC
Profitability may be directly affected by the level of and fluctuations in
interest rates which affect CFC's ability to earn a spread between interest
received on loans and the costs of liabilities. While CFC monitors the interest
rate environment, its financial results could be adversely affected by changes
in interest rates. During periods of increasing interest rates, CFC has
historically experienced market pressure to reduce servicing spreads in its
financing operations. In addition, increases in interest rates have historically
decreased the demand for consumer credit. If CFC was able to resume originating
loans and finance them through securitization transactions, a substantial and
sustained increase in interest rates could, among other things: (i) adversely
affect CFC's ability to purchase or originate loans or other assets; (ii) reduce
the average size of loans underwritten; and (iii) increase securitization
funding costs. A significant decline in interest rates could decrease the size
of CFC's loan servicing portfolio by increasing the level of loan prepayments,
thereby shortening the life and impairing the value of CFC's interest-only
securities. Fluctuating interest rates also may affect CFC's net interest income
earned resulting from the difference between the yield to CFC on loans held
pending securitization and the cost of funds obtained by CFC to finance such
loans.
CFC has historically reduced interest rate risk of its finance operations
by funding most of the loans it makes through securitization transactions. The
finance receivables transferred in these transactions and the asset-backed
securities purchased by investors generally both have fixed rates. Principal
payments on the assets are passed through to investors in the securities as
received, thereby reducing interest rate exposure in these transactions that
might otherwise arise from maturity mismatches between debt instruments and
assets.
Prior to September 8, 1999, CFC retained interests in the finance
receivables sold through investments in interest-only securities that are
subordinated to the rights of other investors. Interest-only securities do not
have a stated maturity or amortization period. The expected amount of the cash
flow as well as the timing depends on the performance of the underlying
collateral supporting each securitization. The actual cash flow of these
instruments could vary substantially if performance is different from CFC's
assumptions. CFC develops assumptions to value these investments by analyzing
past portfolio performance, current loan characteristics, current and expected
market conditions and the expected effect of its actions to mitigate adverse
performance.
CFC uses computer models to simulate the cash flows (including any
potential payments related to the guarantees of certain lower-rated securities
issued by the securitization trusts) expected from its retained interests in
securitization trusts (including interest-only securities) under various
interest rate scenarios. These simulations help CFC to measure the potential
gain or loss in fair value of these financial instruments, including the effects
of changes in interest rates on prepayments. CFC estimates that its retained
interests would decline in fair value by approximately $10 million if interest
rates were to decrease by 10 percent from their December 31, 2002 levels. This
compares to a decline in fair value of approximately $60 million based on
amounts and rates at December 31, 2001. The calculations involved in CFC's
computer simulations incorporate numerous assumptions, require significant
estimates and assume an immediate change in interest rates without any
management of the interest-only securities in reaction to such change.
Consequently, potential changes in value of its retained interests indicated by
the simulations will likely be different from the actual changes experienced
under given interest rate scenarios, and the differences may be material. See
the note to Conseco's consolidated financial statements entitled "Financial
Information Regarding CFC" for a summary of the key economic assumptions used to
determine the estimated fair value of all of its retained interests in
securitizations and the sensitivity of the current fair value of cash flows to
immediate 10 percent and 20 percent changes in those assumptions.
We estimate that CFC's finance receivables (including both "finance
receivables" and "finance receivables-securitized") would decline in fair value
by approximately $240 million if interest rates were to increase by 10 percent
from their December 31, 2002
77
levels. This compares to a decline in fair value of $362.3 million based on
amounts and rates at December 31, 2001. The increase in the estimated decline
corresponds with the increase to its finance receivable balances.
CFC's finance receivables were primarily funded with the fixed rate
asset-backed securities purchased by investors in securitization transactions
and floating-rate debt. Such borrowings included bank credit facilities, master
repurchase agreements and the notes payable related to securitized finance
receivables structured as collateralized borrowings ($10.9 billion of which was
at fixed rates and $3.0 billion of which was at floating rates). Based on the
interest rate exposure and prevalent rates at December 31, 2002, a relative 10
percent decrease in interest rates would increase the fair value of the finance
segment's fixed-rate borrowed capital by approximately $65 million. The interest
expense on this segment's floating-rate debt will fluctuate as prevailing
interest rates change. CFC is exposed to market risk from the time a loan is
originated to the time the loan is financed as interest rates may fluctuate
during such period of time.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information included under the caption "Market-Sensitive Instruments
and Risk Management" and "Market-Sensitive Instruments and Risk Management -
CFC" in Item 7. "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations" is incorporated herein by reference.
78
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Index to Consolidated Financial Statements
Page
----
Report of Independent Accountants....................................................................................... 80
Consolidated Balance Sheet at December 31, 2002 and 2001................................................................ 81
Consolidated Statement of Operations for the years ended
December 31, 2002, 2001 and 2000.................................................................................... 83
Consolidated Statement of Shareholders' Equity
for the years ended December 31, 2002, 2001 and 2000................................................................ 85
Consolidated Statement of Cash Flows for the years ended
December 31, 2002, 2001 and 2000.................................................................................... 88
Notes to Consolidated Financial Statements.............................................................................. 89
79
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Conseco, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, shareholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of
Conseco, Inc. and subsidiaries at December 31, 2002 and 2001, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
The accompanying consolidated financial statements have been prepared
assuming that Conseco, Inc. will continue as a going concern, which contemplates
continuity of Conseco's operations and realization of its assets and payments of
its liabilities in the ordinary course of business. As more fully described in
the notes to the consolidated financial statements, on December 17, 2002,
Conseco, Inc. and several of its wholly-owned subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the United States Bankruptcy
Code. The uncertainties inherent in the bankruptcy process and Conseco's
recurring losses from operations raise substantial doubt about Conseco's ability
to continue as a going concern. Conseco, Inc. is currently operating its
business as a Debtor-in-Possession under the jurisdiction of the Bankruptcy
Court, and continuation of Conseco as a going concern is contingent upon, among
other things, the confirmation of Conseco's Plan of Reorganization and Conseco's
ability to generate sufficient cash from operations and obtain financing sources
to meet its future obligations. If no reorganization plan is approved, it is
possible that Conseco's assets may be liquidated. The consolidated financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of these
uncertainties.
As discussed in note 4 to the consolidated financial statements, the
Company adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" in 2000 and Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" in 2002.
/s/ PricewaterhouseCoopers LLP
----------------------------------
PricewaterhouseCoopers LLP
Indianapolis, Indiana
April 11, 2003
80
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED BALANCE SHEET
December 31, 2002 and 2001
(Dollars in millions)
ASSETS
2002 2001
---- ----
Investments:
Actively managed fixed maturities at fair value (amortized cost:
2002 - $18,989.8; 2001 - $22,422.8)............................................. $19,417.4 $21,818.5
Retained interests in securitization trusts at fair value (amortized cost:
2001 - $876.1).................................................................. - 710.1
Equity securities at fair value (cost: 2002 - $161.4; 2001 - $257.3)............... 156.0 227.0
Mortgage loans..................................................................... 1,308.3 1,228.0
Policy loans....................................................................... 536.2 635.8
Venture capital investment in AT&T Wireless Services, Inc. at fair value
(cost: 2002 - $14.2; 2001 - $39.0).............................................. 25.0 155.3
Other invested assets ............................................................. 340.8 292.4
--------- ---------
Total investments............................................................ 21,783.7 25,067.1
Cash and cash equivalents:
Held by the parent company......................................................... 41.9 152.2
Held by the parent company in segregated accounts.................................. - 54.7
Held by subsidiaries............................................................... 1,227.0 2,853.9
Accrued investment income.............................................................. 389.8 688.6
Finance receivables.................................................................... - 3,810.7
Finance receivables - securitized...................................................... - 14,198.5
Cost of policies purchased............................................................. 1,170.0 1,657.8
Cost of policies produced.............................................................. 2,014.4 2,570.2
Reinsurance receivables................................................................ 934.2 663.0
Income tax assets...................................................................... 101.5 678.1
Goodwill ............................................................................. 100.0 3,695.4
Assets held in separate accounts and investment trust.................................. 447.0 2,376.3
Cash held in segregated accounts for investors......................................... - 550.2
Cash held in segregated accounts related to servicing agreements and
securitization transactions........................................................ - 994.6
Assets of discontinued operations...................................................... 17,624.3 -
Other assets........................................................................... 675.2 1,420.9
--------- ---------
Total assets................................................................. $46,509.0 $61,432.2
========= =========
(continued on next page)
The accompanying notes are an integral part
of the consolidated financial statements.
81
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED BALANCE SHEET (Continued)
December 31, 2002 and 2001
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
2002 2001
---- ----
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products..................................................... $13,469.5 $15,787.7
Traditional products............................................................ 7,971.4 8,172.8
Claims payable and other policyholder funds..................................... 909.2 1,005.5
Liabilities related to separate accounts and investment trust................... 447.0 2,376.3
Liabilities related to certificates of deposit.................................. - 1,790.3
Investor payables.................................................................. - 550.2
Guarantee liability related to interests in securitization trusts held by others... - 39.9
Other liabilities.................................................................. 673.5 1,701.9
Liabilities of discontinued operations............................................. 17,624.3 -
Investment borrowings.............................................................. 669.7 2,242.7
Notes payable:
Direct corporate obligations.................................................... - 4,085.0
Direct finance obligations:
Master repurchase agreements................................................. - 1,670.8
Credit facility collateralized by retained interests in securitizations...... - 507.3
Other borrowings............................................................. - 349.8
Related to securitized finance receivables structured as collateralized
borrowings................................................................... - 14,484.5
--------- ---------
Total liabilities not subject to compromise................................ 41,764.6 54,764.7
Liabilities subject to compromise.................................................. 4,873.3 -
--------- ---------
Total liabilities............................................................ 46,637.9 54,764.7
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts............................................................ 1,921.5 1,914.5
Shareholders' equity (deficit):
Preferred stock.................................................................... 501.7 499.6
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 2002 - 346,007,133;
2001 - 344,743,196)............................................................. 3,497.0 3,484.3
Accumulated other comprehensive income (loss)...................................... 580.6 (439.0)
Retained earnings (deficit)........................................................ (6,629.7) 1,208.1
--------- ---------
Total shareholders' equity (deficit)....................................... (2,050.4) 4,753.0
--------- ---------
Total liabilities and shareholders' equity (deficit)....................... $46,509.0 $61,432.2
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
82
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF OPERATIONS
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions, except per share data)
2002 2001 2000
---- ---- ----
Revenues:
Insurance policy income....................................................... $ 3,602.3 $3,992.7 $ 4,170.7
Net investment income:
Insurance and fee-based segment general account assets..................... 1,528.0 1,706.1 1,800.8
Equity-indexed and separate account products............................... (100.5) (119.6) (56.1)
Venture capital loss related to investment in AT&T Wireless Services, Inc.. (99.3) (42.9) (199.5)
Other ..................................................................... 14.7 20.9 51.8
Gain on sale of interest in riverboat......................................... - 192.4 -
Net realized investment losses.................................................... (597.0) (379.4) (346.5)
Fee revenue and other income.................................................. 70.1 96.9 137.4
--------- -------- ---------
Total revenues............................................................. 4,418.3 5,467.1 5,558.6
--------- -------- ---------
Benefits and expenses:
Insurance policy benefits..................................................... 3,332.5 3,588.5 3,807.6
Provision for losses.......................................................... 210.8 169.6 231.5
Interest expense (contractual interest for 2002 of $366.5).................... 363.1 400.0 454.3
Amortization.................................................................. 822.9 766.8 657.2
Other operating costs and expenses............................................ 712.1 722.2 872.9
Goodwill impairment........................................................... 500.0 - -
Special charges............................................................... 96.5 80.4 305.0
Reorganization items.......................................................... 14.4 - -
--------- -------- ---------
Total benefits and expenses................................................ 6,052.3 5,727.5 6,328.5
--------- -------- ---------
Loss before income taxes, minority interest, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change..... (1,634.0) (260.4) (769.9)
Income tax expense (benefit):
Tax expense (benefit) on period income..................................... 53.1 (63.5) (166.2)
Valuation allowance for deferred tax assets................................ 811.2 - -
--------- -------- ---------
Loss before minority interest, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change..... (2,498.3) (196.9) (603.7)
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes
(contractual distributions for 2002 of $179.8)............................. 173.2 119.5 145.3
--------- -------- ---------
Loss before discontinued operations, extraordinary gain (loss)
and cumulative effect of accounting change .............................. (2,671.5) (316.4) (749.0)
Discontinued operations, net of income taxes...................................... (2,223.1) (106.7) (381.9)
Extraordinary gain (loss) on extinguishment of debt, net of income taxes.......... 8.1 17.2 (5.0)
Cumulative effect of accounting change, net of income taxes....................... (2,949.2) - (55.3)
--------- -------- ---------
Net loss................................................................... (7,835.7) (405.9) (1,191.2)
Preferred stock dividends (contractual distributions for 2002 of $2.1)............ 2.1 12.8 11.0
--------- -------- ---------
Net loss applicable to common stock........................................ $(7,837.8) $ (418.7) $(1,202.2)
========= ======== =========
(continued)
The accompanying notes are an integral part
of the consolidated financial statements.
83
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF OPERATIONS (Continued)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions, except per share data)
2002 2001 2000
---- ---- ----
Loss per common share:
Basic:
Weighted average shares outstanding......................... 345,807,000 338,145,000 325,953,000
Loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change ... $ (7.73) $ (.97) $(2.34)
Discontinued operations..................................... (6.43) (.32) (1.17)
Extraordinary gain (loss) on extinguishment of debt......... .02 .05 (.01)
Cumulative effect of accounting change...................... (8.53) - (.17)
------- ------ ------
Net loss.................................................. $(22.67) $ (1.24) $(3.69)
======= ======= ======
Diluted:
Weighted average shares outstanding......................... 345,807,000 338,145,000 325,953,000
Loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.... $ (7.73) $ (.97) $(2.34)
Discontinued operations..................................... (6.43) (.32) (1.17)
Extraordinary gain (loss) on extinguishment of debt ........ .02 .05 (.01)
Cumulative effect of accounting change...................... (8.53) - (.17)
------- ------ ------
Net loss.................................................. $(22.67) $(1.24) $(3.69)
======= ====== ======
The accompanying notes are an integral part
of the consolidated financial statements.
84
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital loss earnings
----- ----- --------------- ---- --------
Balance, December 31,1999................................$ 5,556.2 $478.4 $2,987.1 $(771.6) $2,862.3
Comprehensive loss, net of tax:
Net loss............................................. (1,191.2) - - - (1,191.2)
Change in unrealized depreciation
of investments (net of applicable income tax
expense of $72.0).................................. 120.6 - - 120.6 -
---------
Total comprehensive loss......................... (1,070.6)
Issuance of common shares for stock options and for
employee benefit plans............................... 6.6 - 6.6 - -
Issuance of convertible preferred shares............... 8.4 8.4 - - -
Issuance of warrants................................... 21.0 - 21.0 - -
Settlement of forward contract......................... (90.5) - (90.5) - -
Cost of shares acquired................................ (12.4) - (12.4) - -
Dividends on preferred stock........................... (11.0) - - - (11.0)
Dividends on common stock.............................. (33.3) - - - (33.3)
--------- ------ -------- ------- --------
Balance, December 31, 2000................................$ 4,374.4 $486.8 $2,911.8 $(651.0) $1,626.8
(continued on following page)
The accompanying notes are an integral part
of the consolidated financial statements.
85
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) (Continued)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital loss earnings
----- ----- --------------- ---- --------
Balance, December 31, 2000 (carried forward
from prior page).............................. $4,374.4 $486.8 $2,911.8 $(651.0) $1,626.8
Comprehensive loss, net of tax:
Net loss........................................ (405.9) - - - (405.9)
Change in unrealized depreciation of
investments (net of applicable income tax
expense of $121.8)............................ 212.0 - - 212.0 -
--------
Total comprehensive loss.................... (193.9)
Issuance of shares pursuant to stock purchase
contracts related to FELINE PRIDES.............. 496.6 - 496.6 - -
Issuance of shares pursuant to acquisition of
ExlService.com, Inc............................. 52.1 - 52.1 -
Issuance of shares for stock options and for
employee benefit plans.......................... 23.8 - 23.8 - -
Payment-in-kind dividends on convertible
preferred stock................................. 12.8 12.8 - - -
Dividends on preferred stock...................... (12.8) - - - (12.8)
-------- ------ -------- ------- --------
Balance, December 31, 2001........................... $4,753.0 $499.6 $3,484.3 $(439.0) $1,208.1
(continued on following page)
The accompanying notes are an integral part
of the consolidated financial statements.
86
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) (Continued)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital income (loss) earnings (deficit)
----- ----- --------------- ------------ ------------------
Balance, December 31, 2001 (carried forward
from prior page) .................................. $ 4,753.0 $499.6 $3,484.3 $(439.0) $ 1,208.1
Comprehensive loss, net of tax:
Net loss......................................... (7,835.7) - - - (7,835.7)
Change in unrealized depreciation
of investments and other (net of applicable
income tax expense of nil)..................... 1,019.6 - - 1,019.6 -
--------
Total comprehensive loss..................... (6,816.1)
Issuance of shares for stock options and for
employee benefit plans........................... 12.7 - 12.7 - -
Payment-in-kind dividends on convertible
preferred stock.................................. 2.1 2.1 - - -
Dividends on preferred stock....................... (2.1) - - - (2.1)
-------- ------ -------- ------- ---------
Balance, December 31, 2002............................ $(2,050.4) $501.7 $3,497.0 $ 580.6 $(6,629.7)
========= ====== ======== ======= =========
The accompanying notes are an integral part
of the consolidated financial statements.
87
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF CASH FLOWS
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Insurance policy income............................................................. $ 3,041.3 $ 3,518.8 $ 3,634.4
Net investment income............................................................... 3,323.9 3,913.6 3,864.1
Fee revenue and other income........................................................ 307.1 389.1 518.7
Insurance policy benefits........................................................... (1,996.9) (2,792.8) (2,686.5)
Interest expense.................................................................... (1,279.6) (1,570.5) (1,331.6)
Policy acquisition costs............................................................ (509.2) (667.0) (794.2)
Special charges..................................................................... (47.2) (29.5) (216.3)
Reorganization items, net........................................................... (31.7) - -
Other operating costs............................................................... (1,406.1) (1,466.8) (1,741.7)
Taxes............................................................................... (105.9) 29.8 (41.6)
--------- --------- ----------
Net cash provided by operating activities....................................... 1,295.7 1,324.7 1,205.3
--------- --------- ----------
Cash flows from investing activities:
Sales of investments................................................................ 19,465.4 24,179.7 6,987.5
Maturities and redemptions of investments........................................... 1,623.9 1,381.4 825.5
Purchases of investments............................................................ (19,879.4) (25,509.5) (7,952.6)
Cash received from the sale of finance receivables, net of expenses................. 2,372.9 867.2 2,501.2
Principal payments received on finance receivables.................................. 8,294.0 8,611.3 8,490.1
Finance receivables originated...................................................... (7,877.9) (12,320.3) (18,515.9)
Cash held by Conseco Finance Corp. and classified as assets held by
discontinued operations........................................................... (562.3) - -
Other............................................................................... (27.6) (136.7) (165.2)
--------- --------- ----------
Net cash provided (used) by investing activities ............................... 3,409.0 (2,926.9) (7,829.4)
--------- --------- ----------
Cash flows from financing activities:
Amounts received for deposit products............................................... 4,584.8 4,204.8 4,966.7
Withdrawals from deposit products................................................... (5,682.8) (4,489.4) (4,545.9)
Issuance of notes payable........................................................... 6,671.9 12,160.5 22,548.9
Payments on notes payable........................................................... (10,481.3) (10,480.5) (14,416.2)
Ceding commission received on reinsurance transaction............................... 83.0 - -
Change in cash held in restricted accounts for settlement of borrowings............. (13.0) (241.8) (689.7)
Investment borrowings............................................................... (1,573.0) 2,022.9 (609.1)
Repurchase of Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts................................................... - - (250.0)
Issuance of common and convertible preferred shares................................. - 4.1 .8
Payments for settlement of forward contract and to repurchase equity securities..... - - (102.6)
Dividends on common and preferred shares and distributions on
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts......................................... (86.2) (181.2) (302.1)
--------- --------- ----------
Net cash provided (used) by financing activities................................ (6,496.6) 2,999.4 6,600.8
--------- --------- ----------
Net increase (decrease) in cash and cash equivalents............................ (1,791.9) 1,397.2 (23.3)
Cash and cash equivalents, beginning of year........................................... 3,060.8 1,663.6 1,686.9
--------- --------- ----------
Cash and cash equivalents, end of year................................................. $ 1,268.9 $ 3,060.8 $ 1,663.6
========= ========= ==========
The accompanying notes are an integral part
of the consolidated financial statements.
88
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
1. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
Conseco, Inc. ("CNC") is the top tier holding company for our two
operating businesses: insurance and finance. Our insurance business is operated
through subsidiaries owned directly and indirectly by CIHC, Incorporated
("CIHC"), an intermediate holding company that is controlled by CNC. Our finance
business has been historically operated through Conseco Finance Corp. ("CFC"), a
wholly-owned subsidiary of CIHC, and its subsidiaries. Effective December 17,
2002 (the date CFC filed a petition for relief under the Bankruptcy Code as
further described below), we began to account for our finance business as a
discontinued operation. Our subsidiaries operate throughout the United States.
We sometimes collectively refer to CNC, together with its consolidated
subsidiaries, as "we," "Conseco" or the "Company."
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. Our finance business has historically provided a variety of finance
products including manufactured housing and floor plan loans, home equity
mortgages, home improvement and consumer product loans and private label credit
cards.
On December 17, 2002 (the "Petition Date"), CNC, CIHC, CTIHC, Inc. and
Partners Health Group, Inc. (collectively, the "Debtors") filed voluntary
petitions for reorganization under Chapter 11 of Title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
(the "Bankruptcy Court") for the Northern District of Illinois. The following
discussion provides general background information regarding the Debtors'
Chapter 11 cases, but is not intended to be a comprehensive summary. The Debtors
are currently operating their business as debtors-in-possession pursuant to the
Bankruptcy Code. As debtors-in-possession, the Debtors are authorized to
continue to operate as ongoing businesses, but may not engage in transactions
outside the ordinary course of business without approval of the Bankruptcy
Court, after notice and an opportunity for a hearing. The Company's insurance
subsidiaries are separate legal entities and are not included in the petitions
filed by the Debtors. On March 18, 2003, the Bankruptcy Court approved the
Debtor's Second Amended Joint Plan of Reorganization (the "Plan"), and the
Second Amended Disclosure Statement (the "Disclosure Statement").
CFC and Conseco Finance Servicing Corp. also filed petitions under the
Bankruptcy Code with the Bankruptcy Court on the Petition Date. In addition, on
February 3, 2003, the following subsidiaries of CFC filed petitions under the
Bankruptcy Code with the Bankruptcy Court: Conseco Finance Corp. - Alabama,
Conseco Finance Credit Corp., Conseco Finance Consumer Discount Company, Conseco
Finance Canada Holding Company, Conseco Finance Canada Company, Conseco Finance
Loan Company, Rice Park Properties Corporation, Landmark Manufactured Housing,
Inc., Conseco Finance Net Interest Margin Finance Corp. I, Conseco Finance Net
Interest Margin Finance Corp. II, Green Tree Finance Corp. - Two, Green Tree
Floorplan Funding Corp., Conseco Agency of Nevada, Inc., Conseco Agency of New
York, Inc., Conseco Agency, Inc., Conseco Agency of Alabama, Inc., Conseco
Agency of Kentucky, Inc., Crum-Reed General Agency, Inc. The foregoing entities
are referred to as the "Finance Company Debtors." The Finance Company Debtors
filed a separate plan in connection with their bankruptcy proceedings. The
bankruptcy proceedings of the Debtors and the Finance Company Debtors are
referred to as the "Chapter 11 Cases".
Since commencing operations in 1982, CNC pursued a strategy of growth
through acquisitions. Primarily as a result of these acquisitions and the
funding requirements necessary to operate and expand the acquired businesses,
CNC amassed outstanding indebtedness of approximately $6.0 billion as of June
30, 2002. In 2001 and early 2002, we undertook a series of steps designed to
reduce and extend the maturities of our parent company debt. Notwithstanding
these efforts, the Company's financial position continued to deteriorate,
principally due to our leveraged condition, losses experienced by our finance
business and losses in the value of our investment portfolio.
As a result of these developments, on August 9, 2002, we announced that
we would seek to fundamentally restructure the Company's capital, and announced
that we had retained legal and financial advisors to assist us in these efforts.
We ultimately decided to seek to reorganize under Chapter 11 of the Bankruptcy
Code.
Under the Bankruptcy Code, actions to collect prepetition indebtedness,
as well as most pending litigation, are stayed and other contractual obligations
against the Debtors generally may not be enforced. Absent an order of the
Bankruptcy Court, substantially all prepetition liabilities are subject to
settlement under a plan of reorganization to be voted upon by creditors and
other stakeholders and approved by the Bankruptcy Court. On March 18, 2003, the
Bankruptcy Court approved the Debtors' Plan, as summarized in the Disclosure
Statement, as containing adequate information, as such term is defined in
Section 1125 of the Bankruptcy Code, to permit the solicitation of votes from
creditors on whether or not to accept the Plan. The Debtors commenced
solicitation on April 4, 2003. The voting record date has been set as March 19,
2003 and the deadline for returning completed ballots is May 14, 2003. A hearing
to consider confirmation of the Plan is scheduled to begin on May 28, 2003. The
Debtors will emerge from bankruptcy if and when
89
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
the Plan receives the requisite stakeholder approval and is approved by the
Bankruptcy Court, and all conditions to the consummation of the Plan, have been
satisfied or waived.
The United States Trustee has appointed a creditors committee
representing the unsecured creditors of the Debtors and a TOPrS committee
representing the claims of the holders of the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts ("Trust Preferred
Securities"). Before the Petition Date, the Company met with and provided
materials to certain prepetition committees and entered into extensive
arms-length negotiations with committees representing the holders of bank debt
and publicly held notes of CNC. Shortly before the Petition Date, the Company
reached a non-binding agreement in principle with respect to the general terms
of a restructuring with certain prepetition committees. However, there can be no
assurance that the appointed committees will support the Debtors' positions in
the bankruptcy proceedings or approve the Plan. The TOPrS committee has raised
certain objections to the Plan which are summarized in the Disclosure Statement.
Disagreements between the Debtors and the appointed committees could protract
the bankruptcy proceedings, could negatively impact the Company's ability to
operate and the results of those operations during bankruptcy, and could delay
the Debtors' emergence from bankruptcy.
The Debtors previously filed with the Bankruptcy Court schedules of
assets and liabilities of the Debtors as reflected on our books and records.
Subject to certain limited exceptions, the Bankruptcy Court established a bar
date of February 21, 2003, for all prepetition claims against the Debtors. A bar
date is the date by which claims against the Debtors must be filed if the
claimants wish to receive any distribution in the bankruptcy proceedings. The
Debtors notified all known or potential claimants subject to the February 21,
2003 bar date of their need to file a proof of claim with the Bankruptcy Court.
Approximately 9,000 proofs of claim were filed on or before the February 21,
2003 bar date and the Company has begun objecting to claims and otherwise
reconciling claims that differ from the Debtors' records. Any differences that
cannot be resolved through negotiations between the Debtors and the claimant
will be resolved by the Bankruptcy Court. Certain creditors have filed claims
substantially in excess of amounts reflected in the Debtors' records.
Accordingly, the ultimate number and amount of allowed claims is not presently
known. Similarly, the ultimate distribution with respect to allowed claims is
not presently known.
We have filed several motions in the Chapter 11 Cases pursuant to which
the Bankruptcy Court has granted us authority or approval with respect to
various items required by the Bankruptcy Code and/or necessary for our
reorganization efforts. We have obtained orders providing for, among other
things: (i) payment of prepetition and postpetition employee compensation and
benefits; (ii) continuing a key-employee retention plan; (iii) obtaining
debtor-in-possession financing for the Finance Company Debtors; and (iv)
increasing the amount of the servicing fee paid to the Finance Company Debtors
as servicers of various manufactured housing securitization trusts.
Under the priority schedule established by the Bankruptcy Code, certain
postpetition and prepetition liabilities need to be satisfied before unsecured
creditors and holders of CNC's common and preferred stock and Trust Preferred
Securities are entitled to receive any distribution. The Plan (as summarized in
the Disclosure Statement) sets forth the Debtors' proposed treatment of claims
and equity interests. No assurance can be given as to what values, if any, will
be ascribed in the bankruptcy proceedings to each of these constituencies. Our
Plan would result in holders of CNC's common stock and preferred stock (other
than Series F Common-Linked Convertible Preferred Stock ("Series F Preferred
Stock")) receiving no value and the holders of CNC's Trust Preferred Securities
and Series F Preferred Stock receiving little value on account of the
cancellation of their interests. In addition, holders of unsecured claims
against the Debtors would, in most cases, receive less than full recovery for
the cancellation of their interests.
At this time, it is not possible to predict with certainty the effect of
the Chapter 11 cases on our business or various creditors, or when we will
emerge from Chapter 11. Our future results depend upon our confirming and
successfully implementing, on a timely basis, a plan of reorganization.
2. DISCONTINUED FINANCE BUSINESS - PLANNED SALE OF CFC
In October 2002, we announced that we had engaged financial advisors to
pursue various alternatives with respect to our finance business and that CNC's
board of directors had approved a plan to sell or seek new investors for our
finance business. On December 19, 2002, CFC entered into an Asset Purchase
Agreement (the "Asset Purchase Agreement") with CFN Investment Holdings LLC
("CFN"), an affiliate of Fortress Investment Group LLC, J.C. Flowers & Co. LLC
and Cerberus Capital Management, L.P., pursuant to which CFC would, subject to
the satisfaction of certain conditions, sell all or substantially all of its
assets (the "CFC Assets") in a sale pursuant to Section 363 of the Bankruptcy
Code as part of CFC's Chapter 11 proceedings, subject to the right of CFN to
exclude certain assets from its purchase. In accordance with Section 363 of the
Bankruptcy Code and the terms of the Asset Purchase Agreement, CFC continued to
seek alternative transactions that would provide greater value to CFC and its
creditors than the
90
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
transactions contemplated by the Asset Purchase Agreement.
As a result of the formalization of the plans to sell the finance
business and the filing of petitions under the Bankruptcy Code by CFC and
certain of its subsidiaries, the finance business is being accounted for as a
discontinued operation. See the note to the consolidated financial statements
entitled "Financial Information Regarding CFC" for information regarding this
discontinued operation.
As part of CFC's efforts to seek alternative transactions that would
provide greater value to CFC, and in accordance with the bidding procedures
order approved by the Bankruptcy Court, CFC conducted an auction for the sale of
its businesses and assets. Potential bidders that submitted bids for the
purchase of the CFC Assets that, by their own terms or aggregated with other
bids, were for more than the purchase price payable under the Asset Purchase
Agreement, plus the amount of the break-up fee of $30 million, plus $5 million
in expense reimbursements, plus the profit sharing rights relating to the
manufactured housing business, were allowed to participate in the auction. The
auction, which commenced on February 28, 2003, promptly adjourned, and was
continued to March 4, 2003, ultimately concluding the morning of March 5, 2003.
At the auction, CFC, with the assistance of its advisors, analyzed each
of the bids presented and determined that CFN's bid of $970 million in cash,
plus the assumption of certain liabilities, represented the highest and best
bid. The terms of the sale included an option for CFC to sell the assets of Mill
Creek Bank, Inc. ("Mill Creek Bank", formerly known as Conseco Bank, Inc.) to
General Electric Capital Corporation ("GE") for approximately $310 million in
cash, plus certain assumed liabilities, which option, if exercised, would
provide CFN with a credit of $270 million to its $970 million bid.
On March 6, 2003, CFC received an offer from Berkadia Equity Holdings,
L.L.C. ("Berkadia") that purported to be a bid in the recently concluded
auction. Concurrently therewith, Berkadia filed an objection to the sale that
the Bankruptcy Court heard, and summarily dismissed, on March 7, 2003. After
further negotiations during the March 7-14, 2003 period, CFN and GE
significantly increased the amount of cash to be paid for the CFC Assets.
Ultimately, each of the major constituencies, including the CFC Committee, the
Ad Hoc Securitization Holders' Committee, U.S. Bank as securitization trustee
for the certificate holders of certain lower-rated securities that are senior in
payment priority to the interest-only securities (the "B-2 securities"), and
Federal National Mortgage Association, as a major B-2 securities certificate
holder, agreed to support the sale of CFC Assets to CFN and GE. The total value
to be received as part of the transactions with CFN and GE upon closing is
expected to be approximately $1.3 billion, representing approximately $1.1
billion in cash and approximately $200 million in assumed liabilities, subject
to certain purchase price adjustments. On March 14, 2003, the Bankruptcy Court
entered orders approving the terms of the sale of the CFC Assets free and clear
of all liens to each of CFN and GE. The closing of the sale of the CFC Assets is
subject to various closing conditions, but is currently expected to occur in the
second quarter of 2003.
Overall, CFC is seeking to maximize the value obtainable from all
restructuring transactions it contemplates as part of its Chapter 11 filing.
However, there can be no assurance that any such transaction will be completed.
Moreover, if such a transaction is completed, no proceeds resulting therefrom
will be available to satisfy any creditors, other than creditors, of CFC or
parties with a security interest in CFC's assets.
3. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared on
a going concern basis, which assumes continuity of operations and realization of
assets and liabilities in the ordinary course of business, and in accordance
with Statement of Position 90-7 "Financial Reporting by Entities in
Reorganization under the Bankruptcy Code" ("SOP 90-7"). Accordingly, all
prepetition liabilities subject to compromise have been segregated in the
consolidated balance sheet and classified as "liabilities subject to compromise"
at the estimated amount of allowable claims.
Pursuant to SOP 90-7, professional fees associated with the Chapter 11
Cases are expensed as incurred and reported as reorganizational items. Interest
expense is reported only to the extent that it will be paid during the Chapter
11 Cases or when it is probable that it will be an allowed claim. During 2002,
the Company recognized a charge of $14.4 million associated with the Chapter 11
Cases for fees payable to professionals to assist with the filing of the Chapter
11 Cases.
The Company is currently operating under the jurisdiction of Chapter 11
of the Bankruptcy Code and the Bankruptcy Court, and continuation of Conseco as
a going concern is contingent upon our ability to obtain confirmation of the
Plan, our ability to return to profitability, generate sufficient cash flows
from operations, obtain financing sources to meet our future obligations and
many other
91
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
issues, ongoing other bankruptcy considerations and risks related to our
business and financial condition. These matters raise substantial doubt about
Conseco's ability to continue as a going concern. The accompanying consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might result from the outcome of these
uncertainties. Additionally, our Plan will materially change amounts reported in
the consolidated financial statements, which do not give effect to all
adjustments of the carrying value of assets and liabilities that are necessary
as a consequence of a reorganization under Chapter 11 of the Bankruptcy Code.
As described in the note entitled "Discontinued Finance Business -
Planned Sale of CFC", CFC is being accounted for as a discontinued operation.
During the third quarter of 2002, Conseco entered into an agreement to
sell Conseco Variable Insurance Company ("CVIC"), its wholly owned subsidiary
and the primary writer of its variable annuity products. The sale was completed
in October 2002. The operating results of CVIC have been reported as
discontinued operations in all periods presented in the accompanying
consolidated statement of operations. See the note to the consolidated financial
statements entitled "Financial Information Regarding CVIC."
During 2001, we stopped renewing a large portion of our major medical
lines of business. These lines of business are referred to herein as the "major
medical business in run-off". These actions had a significant effect on the
Company's operating results during 2001 and 2000. These lines had pre-tax losses
of $130.3 million in 2001 (including a write off of $77.4 million of the cost of
policies produced and the cost of policies purchased related to this business
that is not recoverable) and $51.3 million in 2000.
On July 31, 2001, we completed the acquisition of ExlService.com, Inc.
("Ex1"), a firm that specializes in customer service and backroom outsourcing
with operations in India. We issued 3.4 million shares of our common stock in
exchange for Ex1's common stock. The total value of the transaction was $52.1
million. The Conseco Board of Directors (without Gary C. Wendt, the Company's
former Chief Executive Officer, voting) approved the transaction, after
receiving the recommendation of a special committee of outside directors. Mr.
Wendt was one of the founders of Exl. Mr. Wendt and his wife owned 20.3 percent
of Exl and his other relatives owned an additional 9.4 percent. Mr. Wendt and
his wife received 692,567 shares of Conseco common stock in the transaction
(worth approximately $9.7 million at the time the agreement was negotiated).
However, these shares were restricted until Conseco recovered its $52.1 million
acquisition price through cost savings achieved by transferring work to Exl
and/or pre-tax profits from services provided to third parties by Exl. The
shares also become unrestricted upon a change of control of 51 percent of the
outstanding shares of Conseco common stock. In November 2002, the Company
completed the sale of Exl and recognized a loss of $20.0 million on the
transaction. The Company had previously written off a significant portion of the
value of this investment in conjunction with the impairment charge related to
goodwill pursuant to the Company's adoption of SFAS 142 (as defined in the
following paragraph). Since Conseco did not recover the acquisition price prior
to its sale of Exl, the shares held by Mr. Wendt and his wife remain restricted.
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS 141") eliminated the pooling-of-interests method of
accounting for business combinations initiated after July 1, 2001 and also
changed the criteria used to recognize intangible assets apart from goodwill. We
were required to apply these rules in accounting for the Exl acquisition.
Pursuant to these rules, in the Exl acquisition Conseco acquired: (i) goodwill
with a value of $38.6 million, which had an indeterminate life; and (ii) other
intangible assets with a value of $7.5 million, which were expected to have an
average life of approximately 5 years. Pursuant to SFAS 141 and Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142") described below under "Recently Issued Accounting Standards", this
goodwill was not amortized but was subject to annual impairment tests, effective
January 1, 2002.
The accompanying financial statements include the accounts of the Company
and all of its wholly owned insurance subsidiaries. Our consolidated financial
statements exclude the results of material transactions between us and our
consolidated affiliates, or among our consolidated affiliates. We reclassified
certain amounts in our 2001 and 2000 consolidated financial statements and notes
to conform with the 2002 presentation. These reclassifications have no effect on
net income (loss) or shareholders' equity (deficit).
For certain other special purpose entities related to our investment
portfolio, we consider the requirements of Emerging Issues Task Force Issue
Topic D-14, "Transactions Involving Special-Purpose Entities" ("EITF D-14") in
determining whether to consolidate such entities. We consolidate such entities
if: (i) an independent third party has not made a substantial capital investment
in the entity; (ii) such independent third party does not control the activities
of the entity; and (iii) the independent party does not retain substantial risks
and rewards of the special purpose entity's assets. See the note to the
consolidated financial statements entitled "Investments in Variable Interest
Entities" for additional information.
92
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following summary explains the significant accounting policies we use
to prepare our financial statements. We prepare our financial statements in
accordance with generally accepted accounting principles ("GAAP"). We follow the
accounting standards established by the Financial Accounting Standards Board
("FASB"), the American Institute of Certified Public Accountants ("AICPA") and
the Securities and Exchange Commission (the "SEC").
Investments
Fixed maturities are securities that mature more than one year after
issuance and include bonds, certain notes receivable and redeemable preferred
stock. Fixed maturities that we may sell prior to maturity are classified as
actively managed and are carried at estimated fair value, with any unrealized
gain or loss, net of tax and related adjustments, recorded as a component of
shareholders' equity (deficit). Fixed maturity securities that we intend to sell
in the near term are classified as trading and included in other invested
assets. We include any unrealized gain or loss on trading securities in net
realized investment losses.
Retained interests in securitization trusts represent the right to
receive certain future cash flows from securitization transactions structured
prior to our September 8, 1999 announcement (see "Revenue Recognition for Sales
of Finance Receivables and Amortization of Servicing Rights" below). Such cash
flows generally are equal to the value of the principal and interest to be
collected on the underlying financial contracts of each securitization in excess
of the sum of the principal and interest to be paid on the securities sold and
contractual servicing fees. We carry retained interests at estimated fair value.
We determine fair value by discounting the projected cash flows over the
expected life of the receivables sold using current prepayment, default, loss
and interest rate assumptions. We determine the appropriate discount rate to
value these securities based on our estimates of current market rates of
interest for securities with similar yield, credit quality and maturity
characteristics. The discount rate was 16 percent at December 31, 2002 and
December 31, 2001. We record any unrealized gain or loss determined to be
temporary, net of tax, as a component of shareholders' equity. Declines in value
are considered to be other than temporary when: (i) the fair value of the
security is less than its carrying value; and (ii) the timing and/or amount of
cash expected to be received from the security has changed adversely from the
previous valuation which determined the carrying value of the security. When
declines in value considered to be other than temporary occur, we reduce the
amortized cost to estimated fair value and recognize a loss in the statement of
operations. The assumptions used to determine new values are based on our
internal evaluations. See the note to the consolidated financial statements
entitled "Financial Information Regarding CFC" for additional discussion of gain
on sale of receivables and interest-only securities.
Equity securities include investments in common stocks and non-redeemable
preferred stock. We carry these investments at estimated fair value. We record
any unrealized gain or loss, net of tax and related adjustments, as a component
of shareholders' equity. When declines in value considered to be other than
temporary occur, we reduce the amortized cost to estimated fair value and
recognize a loss in the statement of operations.
Mortgage loans held in our investment portfolio are carried at amortized
unpaid balances, net of provisions for estimated losses.
Policy loans are stated at their current unpaid principal balances.
Venture capital investment in AT&T Wireless Services, Inc. ("AWE") is
carried at fair value, with changes in such value recognized as venture capital
investment income (loss). In 2002, we sold 10.3 million shares of AWE common
stock which generated proceeds of $75.7 million. At December 31, 2002, we held
4.1 million shares of AWE common stock with a value of $25 million. The market
values of AWE common stock and other companies in AWE's business sector have
declined significantly in recent periods. We recognized venture capital
investment losses of $99.3 million, $42.9 million and $199.5 million in 2002,
2001 and 2000, respectively, related to this investment.
Other invested assets include: (i) trading securities; (ii) Standard &
Poor's 500 Index Call Options ("S&P 500 Call Options"); and (iii) certain
non-traditional investments. Trading securities are carried at market value with
the change in value recognized as a charge to net income (loss). These
securities are expected to be sold in the near term or relate to our multibucket
annuity products as described under "Multibucket Annuity Product" below. We
carry the S&P 500 Call Options at estimated fair value as further described
below under "Accounting for Derivatives". Non-traditional investments include
investments in certain limited partnerships and promissory notes; we account for
them using either the cost method, or for investments in partnerships, the
equity method.
93
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We defer any fees received or costs incurred when we originate
investments. We amortize fees, costs, discounts and premiums as yield
adjustments over the contractual lives of the investments. We consider
anticipated prepayments on mortgage-backed securities in determining estimated
future yields on such securities.
When we sell a security (other than trading securities or venture capital
investments), we report the difference between the sale proceeds and amortized
cost (determined based on specific identification) as an investment gain or
loss.
We regularly evaluate all of our investments based on current economic
conditions, credit loss experience and other investee-specific developments. If
there is a decline in a security's fair value that is other than temporary, we
treat it as a realized loss and reduce the cost basis of the security to its
estimated fair value.
Cash and Cash Equivalents
Cash and cash equivalents include commercial paper, invested cash and
other investments purchased with original maturities of less than three months.
We carry them at amortized cost, which approximates estimated fair value.
Finance Receivables
Finance receivables relate to the business of CFC and include
manufactured housing, home equity, home improvement, retail credit and floor
plan loans. CFC carries finance receivables at amortized cost, net of an
allowance for credit losses.
CFC defers fees received and costs incurred when it originates finance
receivables. CFC amortizes deferred fees, costs, discounts and premiums over the
estimated lives of the receivables. CFC includes such deferred fees or costs in
the amortized cost of finance receivables.
CFC generally stops accruing investment income on finance receivables
after three consecutive months of contractual delinquency.
Finance receivables transferred to securitization trusts in transactions
structured as securitized borrowings are classified as finance receivables -
securitized. These receivables are held as collateral for the notes issued to
investors in the securitization trusts. Finance receivables held by CFC that
have not been securitized are classified as finance receivables.
Provision for Losses
The provision for credit losses charged to expense is related to the
business of CFC. This expense is based upon an assessment of current and
historical loss experience, loan portfolio trends, prevailing economic and
business conditions, and other relevant factors. In management's opinion, the
provision is sufficient to maintain the allowance for credit losses at a level
that adequately provides for losses inherent in the portfolio.
CFC reduces the carrying value of finance receivables to net realizable
value at the earlier of: (i) six months of contractual delinquency; or (ii) when
it takes possession of the property securing the finance receivable.
In addition, during 2002, 2001 and 2000, we established additional
provisions for losses related to our guarantees of bank loans and the related
interest loans to approximately 155 current and former directors, officers and
key employees for the purchase of Conseco common stock (see the note to the
consolidated financial statements entitled "Other Disclosures" for additional
information on this provision).
94
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Cost of Policies Produced
The costs that vary with, and are primarily related to, producing new
insurance business are referred to as cost of policies produced. We amortize
these costs using the interest rate credited to the underlying policy: (i) in
relation to the estimated gross profits for universal life-type and
investment-type products; or (ii) in relation to future anticipated premium
revenue for other products.
When we realize a gain or loss on investments backing our universal life
or investment-type products, we adjust the amortization to reflect the change in
estimated gross profits from the products due to the gain or loss realized and
the effect of the event on future investment yields. We also adjust the cost of
policies produced for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current yields. We include
the impact of this adjustment in accumulated other comprehensive income (loss)
within shareholders' equity.
When we replace an existing insurance contract with another insurance
contract with substantially different terms, all unamortized cost of policies
produced related to the replaced contract is immediately written off. When we
replace an existing insurance contract with another insurance contract with
substantially similar terms, we continue to defer the cost of policies produced
associated with the replaced contract. Such costs related to the replaced
contracts which continue to be deferred were $7.6 million, $10.0 million and
$5.6 million in 2002, 2001 and 2000, respectively.
Each year, we evaluate the recoverability of the unamortized balance of
the cost of policies produced. We consider estimated future gross profits or
future premiums, expected mortality or morbidity, interest earned and credited
rates, persistency and expenses in determining whether the balance is
recoverable. If we determine a portion of the unamortized balance is not
recoverable, it is charged to amortization expense.
Cost of Policies Purchased
The cost assigned to the right to receive future cash flows from
contracts existing at the date of an acquisition is referred to as the cost of
policies purchased. We also defer renewal commissions paid in excess of ultimate
commission levels related to the purchased policies in this account. The balance
of this account is amortized, evaluated for recovery, and adjusted for the
impact of unrealized gains (losses) in the same manner as the cost of policies
produced described above.
The discount rate we use to determine the value of the cost of policies
purchased is the rate of return we need to earn in order to invest in the
business being acquired. In determining this required rate of return, we
consider many factors including: (i) the magnitude of the risks associated with
each of the actuarial assumptions used in determining expected future cash
flows; (ii) the cost of our capital required to fund the acquisition; (iii) the
likelihood of changes in projected future cash flows that might occur if there
are changes in insurance regulations and tax laws; (iv) the acquired company's
compatibility with other Conseco activities that may favorably affect future
cash flows; (v) the complexity of the acquired company; and (vi) recent prices
(i.e., discount rates used in determining valuations) paid by others to acquire
similar blocks of business.
Goodwill
Goodwill is the excess of the amount we paid to acquire a company over
the fair value of its net assets. We adopted SFAS 142 effective January 1, 2002,
as further described under the caption "Cumulative Effect of Accounting Change
and Goodwill Impairment". Prior to the adoption of SFAS 142, our analysis of
acquired businesses indicated that the anticipated ongoing cash flows from the
earnings of the purchased businesses extended beyond the maximum 40-year period
allowed for goodwill amortization. Accordingly, for periods prior to 2002, we
amortized goodwill on a straight-line basis generally over a 40-year period.
Pursuant to GAAP in effect at December 31, 2001, we had determined that goodwill
was fully recoverable from projected undiscounted net cash flows from earnings
of the subsidiaries over the remaining amortization period. If we had determined
that the undiscounted projected cash flows no longer supported the
recoverability of goodwill over the remaining amortization period, we would have
reduced its carrying value with a corresponding charge to expense or shortened
the amortization period. Cash flows considered in such an analysis were those of
the business acquired, if separately identifiable, or the product line that
acquired the business, if such earnings were not separately identifiable.
95
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Assets Held in Separate Accounts and Investment Trust
Separate accounts are funds on which investment income and gains or
losses accrue directly to certain policyholders. The assets of these accounts
are legally segregated. They are not subject to the claims that may arise out of
any other business of Conseco. We report separate account assets at market
value; the underlying investment risks are assumed by the contractholders. We
record the related liabilities at amounts equal to the market value of the
underlying assets. We record the fees earned for administrative and
contractholder services performed for the separate accounts in insurance policy
income.
In addition, we hold investments in a trust for the benefit of the
purchasers of certain products of our asset management subsidiary; this amount
is offset by a corresponding liability account, the value of which fluctuates in
relation to changes in the values of these investments. Because we hold the
residual interests in the cash flows from the trust and actively manage its
investments, we are required to include the accounts of the trust in our
consolidated financial statements. We record the fees earned for investment
management and other services provided to the trust as fee revenue. See the
caption "Brickyard Trust" in the note to the consolidated financial statements
entitled "Investments in Variable Interest Entities" for further information on
these investments.
Recognition of Insurance Policy Income and Related Benefits and Expenses
on Insurance Contracts
Generally, we recognize insurance premiums for traditional life and
accident and health contracts as earned over the premium-paying periods. We
establish reserves for future benefits on a net-level premium method based upon
assumptions as to investment yields, mortality, morbidity, withdrawals and
dividends. We record premiums for universal life-type and investment-type
contracts that do not involve significant mortality or morbidity risk as
deposits to insurance liabilities. Revenues for these contracts consist of
mortality, morbidity, expense and surrender charges. We establish reserves for
the estimated present value of the remaining net costs of all reported and
unreported claims.
Liabilities Related to Certificates of Deposit
These liabilities relate to the certificates of deposits issued by the
bank subsidiaries of CFC. The liability and interest expense account are also
increased for the interest which accrues on the deposits. At December 31, 2002
and 2001, the weighted average interest crediting rate on these deposits was 3.5
percent and 4.7 percent, respectively.
Reinsurance
In the first quarter of 2002, we completed a reinsurance agreement
pursuant to which we ceded 80 percent of the inforce traditional life business
of our subsidiary, Bankers Life & Casualty Company, to Reassure America Life
Insurance Company (rated A++ by A.M. Best). The total insurance liabilities
ceded pursuant to the contract were approximately $400 million. The reinsurance
agreement and the related dividends of $110.5 million were approved by the
appropriate state insurance departments and the dividends were paid to CNC. The
ceding commission approximated the amount of the cost of policies purchased and
cost of policies produced related to the ceded business.
On June 28, 2002, we completed a reinsurance transaction pursuant to
which we ceded 100 percent of the traditional life and interest-sensitive life
insurance business of our subsidiary, Conseco Variable Insurance Company, to
Protective Life Insurance Company (rated A+ by A.M. Best). The total insurance
liabilities ceded pursuant to the contract were approximately $470 million. Our
insurance subsidiary received a ceding commission of $49.5 million.
During the second quarter of 2002, one of our subsidiaries, Colonial Penn
Life Insurance Company (formerly known as Conseco Direct Life Insurance
Company), ceded a block of graded benefit life insurance policies to an
unaffiliated company pursuant to a modified coinsurance agreement. Our
subsidiary received a ceding commission of $83.0 million. The cost of policies
purchased and the cost of policies produced were reduced by $123.0 million and
we recognized a loss of $39.0 million related to the transaction.
In the normal course of business, we seek to limit our exposure to loss
on any single insured or to certain groups of policies by ceding reinsurance to
other insurance enterprises. We currently retain no more than $.8 million of
mortality risk on any one policy. We diversify the risk of reinsurance loss by
using a number of reinsurers that have strong claims-paying ratings. If any
reinsurer could not meet its obligations, the Company would assume the
liability. The likelihood of a material loss being incurred as a result of the
failure of one of our reinsurers is considered remote. The cost of reinsurance
is recognized over the life of the reinsured policies using assumptions
consistent with those used to account for the underlying policy. The cost of
reinsurance ceded totaled $327.8 million,
96
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
$249.4 million and $237.2 million in 2002, 2001 and 2000, respectively. A
receivable is recorded for the reinsured portion of insurance policy benefits
paid and liabilities for insurance products. Reinsurance recoveries netted
against insurance policy benefits totaled $323.6 million, $201.3 million and
$273.2 million in 2002, 2001 and 2000, respectively.
From time-to-time, we assume insurance from other companies. Any costs
associated with the assumption of insurance are amortized consistent with the
method used to amortize the cost of policies produced described above.
Reinsurance premiums assumed totaled $78.7 million, $146.0 million and $300.5
million in 2002, 2001 and 2000, respectively.
Income Taxes
Our income tax expense includes deferred income taxes arising from
temporary differences between the tax and financial reporting bases of assets
and liabilities and net operating loss carryforwards. In assessing the
realization of deferred income tax assets, we consider whether it is more likely
than not that the deferred income tax assets will be realized. The ultimate
realization of deferred income tax assets depends upon generating future taxable
income during the periods in which temporary differences become deductible and
net operating loss carryforwards expire. As of December 31, 2002, a valuation
reserve of $1.7 billion has been provided as the realization of the net deferred
tax asset is uncertain.
Investment Borrowings
As part of our investment strategy, we may enter into reverse repurchase
agreements and dollar-roll transactions to increase our investment return or to
improve our liquidity. We account for these transactions as collateral
borrowings, where the amount borrowed is equal to the sales price of the
underlying securities. Reverse repurchase agreements involve a sale of
securities and an agreement to repurchase the same securities at a later date at
an agreed-upon price. Dollar rolls are similar to reverse repurchase agreements
except that, with dollar rolls, the repurchase involves securities that are
substantially the same as the securities sold (rather than being the same
security). Such borrowings averaged $1,155.8 million during 2002 and $927.0
million during 2001. These borrowings were collateralized by investment
securities with fair values approximately equal to the loan value. The weighted
average interest rate on short-term collateralized borrowings was 1.3 percent
and 3.3 percent in 2002 and 2001, respectively. The primary risk associated with
short-term collateralized borrowings is that a counterparty will be unable to
perform under the terms of the contract. Our exposure is limited to the excess
of the net replacement cost of the securities over the value of the short-term
investments (such excess was not material at December 31, 2002). We believe the
counterparties to our reverse repurchase and dollar-roll agreements are
financially responsible and that the counterparty risk is minimal.
Liabilities Subject to Compromise
Under the Bankruptcy Code, actions by creditors to collect indebtedness
we owe prior to the Petition Date are stayed and certain other prepetition
contractual obligations may not be enforced against the Debtors. We have
received approval from the Court to pay certain prepetition liabilities
including employee salaries and wages, benefits and other employee obligations.
All other prepetition liabilities have been classified as "liabilities subject
to compromise" in the December 31, 2002 consolidated balance sheet.
97
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table summarizes the components of the liabilities included
in the line "liabilities subject to compromise" in our consolidated balance
sheet as of December 31, 2002 (dollars in millions):
Other liabilities
Liability for guarantee of bank loans to current and former
directors, officers and key employees to purchase
CNC common stock................................................ $ 480.8
Interest payable................................................... 171.6
Accrual for distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts............ 90.1
Liability for litigation........................................... 41.8
Liability for retirement benefits pursuant to executive
employment agreements........................................... 22.6
Liability for deferred compensation................................ 2.3
Other payables..................................................... 7.0
--------
Total other liabilities subject to compromise................... 816.2
Notes payable - direct corporate obligations........................... 4,057.1
--------
Total liabilities subject to compromise......................... $4,873.3
========
98
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table summarizes condensed consolidating financial
information segregating such information between the Debtors and non-Debtor
subsidiaries.
Condensed Consolidating Balance Sheet as of December 31, 2002
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
ASSETS
Cash and cash equivalents....................................... $ 41.5 $ 1,227.4 $ - $ 1,268.9
Investments..................................................... 5.9 21,777.8 - 21,783.7
Investment in wholly-owned subsidiaries
(eliminated in consolidation)............................... 5,521.5 1,239.0 (6,760.5) -
Receivable from affiliates
(eliminated in consolidation)............................... 1,280.3 1,153.7 (2,434.0) -
Income tax assets............................................... 77.8 23.7 - 101.5
Other assets.................................................... 66.8 5,663.8 - 5,730.6
Assets of discontinued operations............................... 17,624.3 - - 17,624.3
--------- --------- --------- ---------
Total assets.......................................... $24,618.1 $31,085.4 $(9,194.5) $46,509.0
========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Liabilities:
Liabilities for insurance and asset accumulation products... $ - $22,797.1 $ - $22,797.1
Payables to subsidiaries (eliminated in consolidation)...... 4.8 1,298.3 (1,303.1) -
Other liabilities........................................... - 1,343.2 1,343.2
Liabilities of discontinued operations...................... 17,624.3 - - 17,624.3
Liabilities subject to compromise........................... 4,873.3 - - 4,873.3
Affiliated liabilities subject to compromise................ 1,177.4 - (1,177.4) -
--------- --------- --------- ---------
Total liabilities..................................... 23,679.8 25,438.6 (2,480.5) 46,637.9
--------- --------- --------- ---------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts....................................... 1,921.5 - - 1,921.5
Shareholders' equity (deficit):
Preferred stock............................................. 1,644.7 - (1,143.0) 501.7
Common stock and additional paid-in capital (no par value,
1,000,000,000 shares authorized, shares issued and
outstanding: 2002 - 346,007,133; 2001 - 344,743,196)..... 3,497.3 6,393.4 (6,393.7) 3,497.0
Accumulated other comprehensive income (loss)............... 580.6 470.0 (470.0) 580.6
Retained earnings (deficit)................................. (6,705.8) (1,216.6) 1,292.7 (6,629.7)
---------- --------- --------- ---------
Total shareholders' equity (deficit).................. (983.2) 5,646.8 (6,714.0) (2,050.4)
--------- --------- --------- ---------
Total liabilities and shareholders' equity (deficit).. $24,618.1 $31,085.4 $(9,194.5) $46,509.0
========= ========= ========= =========
99
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Statement of Operations
for the year ended December 31, 2002
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Revenues:
Insurance policy income....................................... $ - $3,602.3 $ - $ 3,602.3
Net investment income......................................... 2.4 1,439.8 - 1,442.2
Net investment income from venture capital investments........ (67.1) (32.2) - (99.3)
Dividends from subsidiaries................................... 276.0 - (276.0) -
Fee and interest income - affiliated.......................... 65.5 58.5 (124.0) -
Net investment losses......................................... - (597.0) - (597.0)
Fee revenue and other income.................................. 1.5 68.6 - 70.1
-------- -------- -------- ---------
Total revenue........................................... 278.3 4,540.0 (400.0) 4,418.3
-------- -------- -------- ---------
Expenses:
Insurance policy benefits..................................... - 3,332.5 - 3,332.5
Interest expense on notes payable............................. 326.2 36.9 - 363.1
Interest expense on notes payable - affiliated................ 8.4 48.8 (57.2) -
Provision for loss............................................ 147.2 63.6 - 210.8
Amortization.................................................. - 822.9 - 822.9
Operating costs and expenses - affiliated..................... 17.5 32.2 (49.7) -
Operating costs and expenses.................................. 74.2 637.9 - 712.1
Goodwill impairment........................................... - 500.0 - 500.0
Special charges............................................... 30.5 66.0 - 96.5
Reorganization items, net..................................... 14.4 - - 14.4
-------- -------- -------- ---------
Total expenses.......................................... 618.4 5,540.8 (106.9) 6,052.3
-------- -------- -------- ---------
Loss before income taxes, equity in undistributed
earnings of subsidiaries, distributions on Company-
obligated mandatorily redeemable preferred securities
of subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change.................................... (340.1) (1,000.8) (293.1) (1,634.0)
Income tax expense expense (benefit):
Tax (benefit) expense on period income .................... (49.3) 102.4 - 53.1
Valuation allowance for deferred tax assets................ 811.2 - - 811.2
-------- -------- -------- ---------
Loss before equity in undistributed earnings of
subsidiaries, distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change (eliminated in consolidation)...... (1,102.0) (1,103.2) (293.1) (2,498.3)
Equity in undistributed earnings of subsidiaries before
discontinued operations, extraordinary charge and
cumulative effect of accounting change
(eliminated in consolidation)........................... (4,298.2) - 4,298.2 -
-------- -------- -------- ---------
100
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Statement of Operations
for the year ended December 31, 2002 (Continued)
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Loss before distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect
of accounting change............................... (5,400.2) (1,103.2) 4,005.1 (2,498.3)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.................. 173.2 - - 173.2
--------- --------- -------- ---------
Loss before discontinued operations, extraordinary gain
and cumulative effect of accounting change............... (5,573.4) (1,103.2) 4,005.1 (2,671.5)
Discontinued operations of subsidiaries, net of income tax.... (1,961.6) (253.5) (8.0) (2,223.1)
Extraordinary gain on extinguishment of debt,
net of income taxes:
Parent company........................................... 1.8 - - 1.8
Subsidiary............................................... 6.3 - - 6.3
Cumulative effect of accounting change of subsidiaries, net of
income taxes............................................... (0.8) (2,948.4) - (2,949.2)
--------- --------- -------- ----------
Net loss................................................. (7,527.7) (4,305.1) 3,997.1 (7,835.7)
Preferred stock dividends..................................... 2.1 - - 2.1
Preferred stock dividends - affiliated........................ 60.7 - (60.7) -
--------- --------- -------- ---------
Loss applicable to common stock.......................... $(7,590.5) $(4,305.1) $4,057.8 $(7,837.8)
========= ========= ======== =========
101
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Statement of Cash Flows
for the year ended December 31, 2002
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Net cash provided (used) by operating activities.............. $ 395.2 $ 982.3 $(81.8) $1,295.7
Net cash provided by investing activities..................... 2,555.7 1,119.5 (266.2) 3,409.0
Net cash used by financing activities......................... (3,455.1) (3,389.5) 348.0 (6,496.6)
--------- -------- ------ --------
Net increase (decrease) in cash and cash equivalents.......... (504.2) (1,287.7) - (1,791.9)
Cash and cash equivalents, beginning of year.................. 545.7 2,515.1 - 3,060.8
--------- -------- ------ --------
Cash and cash equivalents, end of year..................... $ 41.5 $1,227.4 $ - $1,268.9
========= ======== ====== ========
102
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Subject to certain limited exceptions, the Bankruptcy Court established a
bar date of February 21, 2003, for all prepetition claims against the Debtors. A
bar date is the date by which claims against the Debtors must be filed if the
claimants wish to receive any distribution in the Chapter 11 Cases. The Debtors
have notified all known or potential claimants subject to the February 21, 2003,
bar date of their need to file a proof of claim with the Bankruptcy Court.
Approximately 9,000 proofs of claim have been filed in connection with
the February 21, 2003, bar date, and the Debtors have begun reconciling claims
that differ from their records. Any remaining differences that cannot be
resolved by negotiated agreement between the Debtors and the claimants will be
resolved by the Bankruptcy Court.
Certain creditors have filed claims substantially in excess of amounts
reflected in the Debtors' records. Consequently, the amount included in the
consolidated balance sheet at December 31, 2002, as liabilities subject to
compromise may be adjusted.
Use of Estimates
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for the cost of policies produced, the
cost of policies purchased, retained interest in securitization trusts
(including interest-only securities and B-2 securities), certain investments,
servicing rights, assets and liabilities related to income taxes, goodwill,
liabilities for insurance and asset accumulation products, the guarantee
liability related to interests in securitizations, liabilities related to
litigation, guaranty fund assessment accruals, liabilities related to guarantees
of securitized debt issued in conjunction with certain sales of finance
receivables and liabilities related to guarantees of bank loans and the related
interest loans to certain current and former directors, officers and key
employees, gain on sale of finance receivables and allowance for credit losses
on finance receivables. If our future experience differs from these estimates
and assumptions, our financial statements would be materially affected.
Accounting for Derivatives
Our equity-indexed annuity products provide a guaranteed base rate of
return and a higher potential return linked to the performance of the Standard &
Poor's 500 Index ("S&P 500 Index") based on a percentage (the participation
rate) over an annual period. At the beginning of each policy year, a new index
period begins. The Company is able to change the participation rate at the
beginning of each index period, subject to contractual minimums. We buy S&P 500
Call Options in an effort to hedge potential increases to policyholder benefits
resulting from increases in the S&P 500 Index to which the product's return is
linked. We include the cost of the S&P 500 Call Options in the pricing of these
products. Policyholder account balances for these annuities fluctuate in
relation to changes in the values of these options. We reflect changes in the
estimated market value of these options in net investment income. Option costs
that are attributable to benefits provided were $97.5 million, $119.0 million
and $123.9 million during 2002, 2001 and 2000, respectively. These costs are
reflected in the change in market value of the S&P 500 Call Options included in
investment income. Net investment income (loss) related to equity-indexed
products before this expense was $(3.0) million, $4.8 million and $12.9 million
in 2002, 2001 and 2000, respectively. Such amounts were substantially offset by
the corresponding charge to insurance policy benefits. The estimated fair value
of the S&P 500 Call Options was $32.8 million and $49.8 million at December 31,
2002 and 2001, respectively. We classify such instruments as other invested
assets. The Company accounts for the options attributed to the policyholder for
the estimated life of the annuity contract as embedded derivatives as defined by
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended by Statement of Financial
Accounting Standards No. 137, "Deferral of the Effective Date of FASB Statement
No. 133" and Statement of Financial Accounting Standards No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities" (collectively
referred to as "SFAS 138"). The Company records the change in the fair values of
the embedded derivatives in current earnings as a component of policyholder
benefits. The fair value of these derivatives, which are classified as
"liabilities for interest-sensitive products" was $274.0 million and $491.2
million at December 31, 2002 and 2001, respectively.
On June 29, 2001, we entered into interest rate swap agreements to
convert the fixed rate on our senior notes (10.75 percent) to a variable rate
based on LIBOR plus 4.75 percent. In accordance with the requirements of SFAS
138, the change in the fair value of the interest rate swap and the gain or loss
on the hedged senior notes attributable to the hedged interest rate risk were
recorded in current-period earnings. Because the terms of the interest rate swap
agreements substantially matched the terms of the senior notes, the gain or loss
on the swap and the senior notes was generally equal and offsetting (although
the effective interest rate on our debt was affected).
103
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
In early October 2001, we terminated these interest rate swap agreements
for cash proceeds of $19.0 million (the value of the terminated swap
agreements). No gain was recognized upon the termination of the interest rate
swap agreements. Instead, the change in the fair value of the senior notes
recorded while the interest rate swaps were outstanding will be amortized as a
reduction to interest expense over the remaining life of our senior notes.
In October 2001, we also entered into new interest rate swap agreements
to replace the terminated agreements which convert the fixed rate on our 10.75%
senior notes to a variable rate based on LIBOR plus 5.7525 percent. At December
31, 2001, "notes payable-direct corporate obligations" was decreased by $13.5
million to reflect the estimated fair value of such interest rate swap
agreements. Such interest rate swap agreements were terminated in April 2002
generating cash proceeds of $3.5 million. Such amount represented $11.9 million
of cash due to the Company pursuant to the terms of the swaps, net of $8.4
million which represented the fair value of the interest rate swaps on the date
of termination. The $8.4 million will be amortized as additional interest
expense over the remaining life of our senior notes.
In the past, we have used interest-rate swaps to hedge the interest rate
risk associated with our borrowed capital. These agreements were terminated
during 2000. We realized a net investment loss of $38.6 million (net of an
income tax benefit of $20.6 million) related to such terminations during 2000.
The Company entered into a forward sale contract related to a portion of
its venture capital investment in AWE. Such contract was carried at market
value, with the change in such value being recognized as venture capital income
(loss). The value of the derivative fluctuated in relation to the AWE common
stock it related to. In the third quarter of 2002, we agreed with the
counterparties to unwind the forward sale contract. The net effect of unwinding
the forward purchase contract resulted in a small gain.
If the counterparties for the derivatives we hold fail to meet their
obligations, Conseco may have to recognize a loss. Conseco limits its exposure
to such a loss by diversifying among several counterparties believed to be
strong and creditworthy. At December 31, 2002, all of the counterparties were
rated "A" or higher by Standard & Poor's Corporation ("S&P").
Multibucket Annuity Product
The Company's multibucket annuity is a fixed annuity product that credits
interest based on the experience of a particular market strategy. Policyholders
allocate their annuity premium payments to several different market strategies
based on different asset classes within the Company's investment portfolio.
Interest is credited to this product based on the market return of the given
strategy, less management fees, and funds may be moved between different
strategies. The Company guarantees a minimum return of premium plus
approximately 3 percent per annum over the life of the contract. The investments
backing the market strategies of these products are designated by the Company as
trading securities. The change in the fair value of these securities is included
in investment income which is substantially offset by the change in insurance
policy benefits for these products.
Revenue Recognition for Sales of Finance Receivables and Amortization of
Servicing Rights
Subsequent to September 8, 1999, CFC generally structured its
securitizations in a manner that required them to be accounted for under the
portfolio method, whereby the loans and securitization debt remain on CFC's
balance sheet pursuant to Financial Accounting Standards Board Statement No.
140, "Accounting for the Transfer and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS 140"). The ratings downgrades and other
events that followed the Company's August 9, 2002, announcement, eliminated
CFC's access to the securitization markets.
For securitizations structured prior to September 8, 1999, CFC accounted
for the transfer of finance receivables as sales. In accordance with GAAP, CFC
recognized a gain, representing the difference between the proceeds from the
sale (net of related sale costs) and the carrying value of the component of the
finance receivable sold. CFC determined such carrying value by allocating the
carrying value of the finance receivables between the portion sold and the
interests retained (generally interest-only securities, servicing rights and, in
some instances, other subordinated securities), based on each portion's relative
fair values on the date of the sale.
CFC amortizes the servicing rights it retains after the sale of finance
receivables in proportion to, and over the estimated period of, net servicing
income.
CFC evaluates servicing rights for impairment on an ongoing basis,
stratified by product type and securitization period. To the extent that the
recorded amount exceeds the fair value for any strata, CFC establishes a
valuation allowance through a charge to
104
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
earnings. If CFC determines, upon subsequent measurement of the fair value of
these servicing rights, that the fair value equals or exceeds the amortized
cost, any previously recorded valuation allowance would be deemed unnecessary
and restored to earnings.
Fair Values of Financial Instruments
We use the following methods and assumptions to determine the estimated
fair values of financial instruments:
Investment securities. For fixed maturity securities (including
redeemable preferred stocks) and for equity and trading securities, we
use quotes from independent pricing services, where available. For
investment securities for which such quotes are not available, we use
values obtained from broker-dealer market makers or by discounting
expected future cash flows using a current market rate appropriate for
the yield, credit quality, and (for fixed maturity securities) the
maturity of the investment being priced.
Retained interests in securitization trusts. These assets relate to the
business of CFC. Management of CFC discounts future expected cash flows
over the expected life of the receivables sold using current estimates of
future prepayment, default, loss severity and interest rates. They
consider any potential payments related to the guarantees of certain
lower-rated securities issued by the securitization trusts in the
projected cash flows used to determine the value of CFC's retained
interests in securitization trusts.
Venture capital investment in AWE. We carry this investment at estimated
fair value based on quoted market prices.
Cash and cash equivalents. The carrying amount for these instruments
approximates their estimated fair value.
Mortgage loans and policy loans. We discount future expected cash flows
for loans included in our investment portfolio based on interest rates
currently being offered for similar loans to borrowers with similar
credit ratings. We aggregate loans with similar characteristics in our
calculations. The market value of policy loans approximates their
carrying value.
Other invested assets. We use quoted market prices, where available. When
quotes are not available, we estimate the fair value based on: (i)
discounted future expected cash flows; or (ii) independent transactions
which establish a value for our investment. When we are unable to
estimate a fair value, we assume a market value equal to carrying value.
Finance receivables. These assets relate to the business of CFC. The
estimated fair value of finance receivables, including those that have
been securitized, is determined based on general market transactions
which establish values for similar loans.
Insurance liabilities for interest-sensitive products. We discount future
expected cash flows based on interest rates currently being offered for
similar contracts with similar maturities.
Liabilities related to certificates of deposit. These assets relate to
the business of CFC. Management of CFC estimates the fair value of these
liabilities using discounted cash flow analyses based on current
crediting rates. Since crediting rates are generally not guaranteed
beyond one year, market value approximates carrying value.
Investment borrowings and notes payable. For publicly traded debt, we use
current market values. For other notes, we use discounted cash flow
analyses based on our current incremental borrowing rates for similar
types of borrowing arrangements.
Trust Preferred Securities. We use quoted market prices.
105
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Here are the estimated fair values of our financial instruments:
2002 2001
----------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
(Dollars in millions)
Financial assets:
Actively managed fixed maturities.......................... $19,417.4 $19,417.4 $21,818.5 $21,818.5
Retained interests in securitization trusts (a)............ - - 710.1 710.1
Equity securities ......................................... 156.0 156.0 227.0 227.0
Mortgage loans............................................. 1,308.3 1,335.7 1,228.0 1,210.7
Policy loans............................................... 536.2 536.2 635.8 635.8
Venture capital investment in AT&T Wireless
Services, Inc............................................ 25.0 25.0 155.3 155.3
Other invested assets...................................... 340.8 340.8 292.4 292.4
Cash and cash equivalents.................................. 1,268.9 1,268.9 3,060.8 3,060.8
Finance receivables (including finance
receivables-securitized) (a)............................. - - 18,009.2 18,376.7
Financial liabilities:
Insurance liabilities for interest-sensitive products (b).. 13,469.5 13,469.5 15,787.7 15,787.7
Liabilities related to certificates of deposit (a)......... - - 1,790.3 1,790.3
Guarantee liability related to interests in securitization
trusts held by others (a)................................ - - 39.9 39.9
Investment borrowings...................................... 669.7 669.7 2,242.7 2,242.7
Notes payable:
Corporate (c)............................................ - - 4,085.0 2,863.5
Finance (a).............................................. - - 2,527.9 2,455.2
Related to securitized finance receivables structured
as collateralized borrowings (a)....................... - - 14,484.5 14,774.3
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts................ 1,921.5 9.7 1,914.5 1,206.5
- --------------------
(a) These accounts relate to the business of CFC, which are classified as
discontinued operations at December 31, 2002. See "Basis of Presentation"
above.
(b) The estimated fair value of the liabilities for interest-sensitive
products was approximately equal to its carrying value at December 31,
2002 and 2001. This was because interest rates credited on the vast
majority of account balances approximate current rates paid on similar
products and because these rates are not generally guaranteed beyond one
year. We are not required to disclose fair values for insurance
liabilities, other than those for interest-sensitive products. However,
we take into consideration the estimated fair values of all insurance
liabilities in our overall management of interest rate risk. We attempt
to minimize exposure to changing interest rates by matching investment
maturities with amounts due under insurance contracts.
(c) At December 31, 2002, corporate notes payable are classified as
liabilities subject to compromise as such amounts may be subject to
adjustment.
Cumulative Effect of Accounting Change and Goodwill Impairment
The FASB issued SFAS 142, in June 2001. Under the new rule, intangible
assets with an indefinite life are no longer amortized in periods subsequent to
December 31, 2001, but are subject to annual impairment tests (or more
frequently under certain circumstances), effective January 1, 2002. The Company
has determined that all of its goodwill has an indefinite life and is therefore
subject to the new rules.
Pursuant to SFAS 142, the goodwill impairment test has two steps. For
Conseco, the first step consisted of comparing the estimated fair value of each
of the business units comprising our insurance segment to the unit's book value.
Since all of our goodwill relates to the insurance segment (which is also a
reportable segment), the goodwill impairment test is not relevant to the finance
106
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
business. If the estimated fair value exceeds the book value, the test is
complete and goodwill is not impaired. If the fair value is less than the book
value, the second step of the impairment test must be performed, which compares
the implied fair value of the applicable business unit's goodwill with the book
value of that goodwill to measure the amount of goodwill impairment, if any.
Pursuant to the transitional rules of SFAS 142, we completed the two-step
impairment test during 2002 and, as a result of that test, we recorded the
cumulative effect of the accounting change for the goodwill impairment charge of
$2,949.2 million. The impairment charge is reflected in the cumulative effect of
an accounting change in the accompanying consolidated statement of operations
for the year ended December 31, 2002. Subsequent impairment tests will be
performed on an annual basis, or more frequently if circumstances indicate a
possible impairment. Subsequent impairment charges are classified as an
operating expense. As described below, the Company performed additional
impairment tests in 2002, as a result of circumstances which indicated a
possible impairment.
The significant factors used to determine the amount of the initial
impairment included analyses of industry market valuations, historical and
projected performance of our insurance segment, discounted cash flow analyses
and the market value of our capital. The valuation utilized the best available
information, including assumptions and projections we considered reasonable and
supportable. The assumptions we used to determine the discounted cash flows
involve significant judgments regarding the best estimate of future premiums,
expected mortality and morbidity, interest earned and credited rates,
persistency and expenses. The discount rate used was based on an analysis of the
weighted average cost of capital for several insurance companies and considered
the specific risk factors related to Conseco. Pursuant to the guidance in SFAS
142, quoted market prices in active markets are the best evidence of fair value
and shall be used as the basis for measurement, if available.
On August 14, 2002, our insurance subsidiaries' financial strength
ratings were downgraded by A.M. Best to "B (fair)" and on September 8, 2002, the
Company defaulted on its public debt. These developments caused sales of our
insurance products to fall and policyholder redemptions and lapses to increase.
The adverse impact on our insurance subsidiaries resulting from the ratings
downgrade and parent company default required that an additional impairment test
be performed as of September 30, 2002, in accordance with SFAS 142.
In connection with our negotiations with debt holders, we retained an
outside actuarial consulting firm to assist in valuing our insurance
subsidiaries. That valuation work and our internal evaluation were used in
performing the additional impairment tests that resulted in an impairment charge
to goodwill of $500.0 million. The charge is reflected in the line item entitled
"Goodwill impairment" in our consolidated statement of operations for the year
ended December 31, 2002. The most significant changes made to the January 1,
2002 valuation that resulted in the additional impairment charge were: (i)
reduced estimates of projected future sales of insurance products; (ii)
increased estimates of future policyholder redemptions and lapses; and (iii) a
higher discount rate to reflect the current rates used by the market to value
life insurance companies. Management believes that the assumptions and estimates
used are reasonable given all available facts and circumstances. However, if
projected cash flows are not realized in the future, we may be required to
recognize additional impairments.
Prior to the adoption of SFAS 142, we determined whether goodwill was
recoverable from projected undiscounted net cash flows for the earnings of our
subsidiaries over the remaining amortization period. If we determined that
undiscounted projected cash flows were not sufficient to recover the goodwill
balance, we would reduce its carrying value with a corresponding charge to
expense or shorten the amortization period. Cash flows considered in such an
analysis were those of the business acquired, if separately identifiable, or the
product line that acquired the business, if such earnings were not separately
identifiable.
107
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the carrying amount of goodwill for the years ended December
31, 2002 and 2001, are as follows:
2002 2001
---- ----
(Dollars in millions)
Goodwill balance, beginning of year......................................... $ 3,695.4 $3,800.8
Amortization expense........................................................ - (109.6)
Cumulative effect of accounting change...................................... (2,949.2) -
Impairment charge........................................................... (500.0) -
Reduction of tax valuation contingencies established at acquisition date
for acquired companies.................................................. (146.2) -
Goodwill related to the acquisition of ExlServices, Inc..................... - 46.1
Goodwill related to businesses sold......................................... - (41.9)
--------- --------
Goodwill balance, end of year............................................... $ 100.0 $3,695.4
========= ========
108
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
In accordance with SFAS 142, we discontinued the amortization of goodwill
expense effective January 1, 2002. The following information summarizes the
impact of goodwill amortization on income before discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change; net
income; and the respective earnings per share amounts for the periods presented
in our consolidated statement of operations for periods prior to January 1,
2002:
2001 2000
----- ----
(Dollars in millions, except per share data)
Reported loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change................................... $(316.4) $ (749.0)
Add back: goodwill amortization.............................................................. 108.2 108.5
------- ---------
Adjusted loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $(208.2) $ (640.5)
======= =========
Reported net loss applicable to common stock................................................. $(418.7) $(1,202.2)
Add back: goodwill amortization.............................................................. 109.6 112.5
----- ---------
Adjusted net loss applicable to common stock.................................................. $(309.1) $(1,089.7)
======= =========
Basic earnings per share:
Reported loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $ (.97) $ (2.34)
Add back: goodwill amortization.............................................................. .32 .33
------- ---------
Adjusted loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $ (.65) $ (2.01)
======= =========
Reported net loss applicable to common stock.................................................. $ (1.24) $ (3.69)
Add back: goodwill amortization.............................................................. .32 .35
------- ---------
Adjusted net loss applicable to common stock.................................................. $ (.92) $ (3.34)
======= =========
Diluted earnings per share:
Reported loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change................................... $ (.97) $ (2.34)
Add back: goodwill amortization............................................................. .32 .33
------- ---------
Adjusted loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $ (.65) $ (2.01)
======= =========
Reported net loss applicable to common stock................................................. $ (1.24) $ (3.69)
Add back: goodwill amortization.............................................................. .32 .35
------- ---------
Adjusted net loss applicable to common stock.................................................. $ (.92) $ (3.34)
======= =========
109
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Pursuant to the transitional rules of SFAS 142, the cumulative effect of
the accounting change for goodwill impairment is reflected in the consolidated
financial statements for the quarter ended March 31, 2002. Accordingly, the
consolidated statement of operations for the three months ended March 31, 2002,
has been restated to reflect the change as summarized below (dollars in
millions, except per share data):
Net loss applicable to common stock, as reported................ $ (96.9)
Cumulative effect of accounting change.......................... (2,949.2)
-----------
Net loss applicable to common stock, as adjusted................ $ (3,046.1)
===========
Net loss per common share:
Basic:
Net loss, as reported........................................ $ (.28)
Cumulative effect of accounting change....................... (8.54)
------
Net loss, as adjusted........................................ $(8.82)
======
Diluted:
Net loss, as reported........................................ $ (.28)
Cumulative effect of accounting change....................... (8.54)
------
Net loss, as adjusted........................................ $(8.82)
======
During the third quarter of 2000, the Emerging Issues Task Force of the
Financial Accounting Standards Board issued EITF 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" ("EITF 99-20").
Under the prior accounting rule, declines in the value of our
interest-only securities and other retained beneficial interests in securitized
financial assets were recognized in the statement of operations when the present
value of estimated cash flows discounted at a risk-free rate using current
assumptions was less than the carrying value of the interest-only security.
Under the new accounting rule, declines in value are recognized when: (i)
the fair value of the retained beneficial interests are less than their carrying
value; and (ii) the timing and/or amount of cash expected to be received from
the retained beneficial interests have changed adversely from the previous
valuation which determined the carrying value of the retained beneficial
interests. When both occur, the retained beneficial interests are written down
to fair value.
110
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We adopted the new accounting rule on July 1, 2000. The cumulative effect
of the accounting change for periods prior to July 1, 2000 was a charge to the
statement of operations of $55.3 million (net of an income tax benefit of $29.9
million), or $.17 per diluted share. The cumulative effect of the accounting
change includes: (i) $45.5 million (net of an income tax benefit of $24.7
million) related to interest-only securities held by CFC; and (ii) $9.8 million
(net of an income tax benefit of $5.2 million) related to other retained
beneficial interests in securitized financial assets held by our insurance
segment.
Impairment Charge
During 2002, 2001 and 2000, the retained interests held by CFC did not
perform as well as anticipated. In addition, CFC's expectations regarding future
economic conditions changed. Accordingly, CFC changed various underlying
assumptions (including default, severity, credit loss, discount rate and
servicing cost assumptions) related to the future performance of the underlying
loans to be consistent with management's expectations. As a result, the expected
future cash flows (including any potential payments related to the guarantees of
certain lower-rated securities issued by the securitization trusts) from
interest-only securities changed adversely from previous estimates. Pursuant to
the requirements of EITF 99-20, the effect of these changes was reflected
immediately in earnings as an impairment charge. In 2002, CFC recognized an
impairment charge of $1,077.2 million related to its retained interests. CFC
also recognized a $336.5 million increase in the valuation allowance related to
its servicing rights as a result of the changes in assumptions in 2002. The
valuation allowance related to the servicing rights increased as a result of
changes to the expected future cost of servicing the finance receivables. The
levels of delinquent and defaulting loans have caused servicing costs to
increase. In addition, future servicing costs are expected to increase as the
portfolio ages. In addition, CFC recognized impairment charges of: (i) $29.3
million to establish a valuation allowance for advances CFC was required to make
to the securitization trusts which are potentially uncollectible; and (ii) $6.9
million to establish a liability of guarantee payments due to certain holders of
lower-rated securities issued by the securitization trusts which CFC was unable
to pay. In 2001, CFC recognized an impairment charge of $264.8 million ($171.3
million after the income tax benefit) related to its retained interests. CFC
also recognized a $122.1 million ($79.1 million after the income tax benefit)
increase in the valuation allowance related to its servicing rights as a result
of the changes in assumptions in 2001. In 2000, the effect of the impairment
charge and adjustments to the value of its retained interests totaled $515.7
million ($324.9 million after the income tax benefit) in addition to the
cumulative effect of adopting EITF 99-20 of $70.2 million ($45.5 million after
the income tax benefit).
Recently Issued Accounting Standards
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires expanded disclosures for
and, in some cases, consolidation of significant investments in variable
interest entities ("VIE"). A VIE is an entity in which the equity investors do
not have the characteristics of a controlling financial interest, or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. Under FIN 46, a
company is required to consolidate a VIE if it is the primary beneficiary of the
VIE. FIN 46 defines primary beneficiary as the party which will absorb a
majority of the VIE's expected losses or receive a majority of the VIE's
expected residual returns, or both. FIN 46 is effective immediately for VIEs
created after January 31, 2003. For VIEs acquired before February 1, 2003, the
additional disclosure requirements are effective for financial statements issued
after January 31, 2003 and the consolidation requirements must be applied not
later than the fiscal year or interim period beginning after June 15, 2003.
The Company has investments in various types of VIEs, some of which
require additional disclosure under FIN 46, and several of which that will
require consolidation under FIN 46. As further discussed in the note to the
consolidated financial statements entitled "Investments in Variable Interest
Entities", certain of our investments in VIEs are already consolidated in our
financial statements. We have identified one additional VIE investment in which
we are the primary beneficiary and, accordingly, will require consolidation in
our financial statements beginning with our September 30, 2003 financial
statements. The additional liabilities, which will be recognized as a result of
consolidating the VIE, do not represent claims on the general assets of the
Company. Likewise, the additional assets, which will be recognized upon
consolidation, are collateral for the additional recognized liabilities.
Consequently, the adoption of the consolidation requirements of FIN 46 is not
expected to have a material impact on our financial condition or results of
operations. The note entitled "Investments in Variable Interest Entities"
includes the expanded disclosures required by FIN 46.
The FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45") in November 2002. FIN 45 requires certain
guarantees to be recognized as liabilities at fair value. In addition, it
requires a guarantor to make new disclosures regarding its obligations. We
implemented the new disclosure requirements as of December 31, 2002; see the
note to the consolidated financial statements entitled "Other Disclosures." FIN
45's liability recognition requirement is effective on a prospective basis for
guarantees issued or modified after December 31, 2002.
111
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We do not expect that FIN 45 will materially impact the Company's results of
operations or financial condition.
The FASB issued Statement of Financial Accounting Standards No. 146,
"Accounting for Exit or Disposal Activities" ("SFAS 146") in June 2002. SFAS 146
addresses financial accounting and reporting for costs that are associated with
exit and disposal activities and supersedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)"
("EITF 94-3"). SFAS 146 is required to be used to account for exit or disposal
activities that are initiated after December 31, 2002. The provisions of EITF
94-3 shall continue to apply for an exit activity initiated prior to the
adoption of SFAS 146. SFAS 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of commitment to an exit or disposal plan. The Company plans to adopt the
provisions of SFAS 146 on January 1, 2003. We do not expect the initial adoption
of SFAS 146 to have a material impact on the Company's consolidated financial
statements.
The FASB issued Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13, and Technical Corrections" ("SFAS 145") in April 2002. Under previous
guidance all gains and losses resulting from the extinguishment of debt were
required to be aggregated and, if material, classified as an extraordinary item,
net of related income tax effect. SFAS 145 rescinds that guidance and requires
that gains and losses from extinguishments of debt be classified as
extraordinary items only if they are both unusual and infrequent in occurrence.
SFAS 145 also amends previous guidance to require certain lease modifications
that have economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale-leaseback transactions. This new guidance is
effective for fiscal years beginning after May 15, 2002. We do not expect SFAS
145 to materially impact the Company's results of operations and financial
position.
The FASB issued Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment of Long-Lived Assets" ("SFAS 144") in August
2001. This standard addresses the measurement and reporting for impairment of
all long-lived assets. It also broadens the definition of what may be presented
as a discontinued operation in the consolidated statement of operations to
include components of a company's business segments. SFAS 144 requires that
long-lived assets currently in use be written down to fair value when considered
impaired. Long-lived assets to be disposed of are written down to the lower of
cost or fair value less the estimated cost to sell. The Company adopted this
standard on January 1, 2002. We have followed this standard in determining when
it is appropriate to recognize impairments on assets we have decided to sell as
part of our efforts to raise cash. We have also followed this standard in
determining that our variable annuity business line and CFC should be presented
as discontinued operations in our consolidated financial statements (see the
notes to the consolidated financial statements entitled "Financial Information
Regarding CFC" and "Financial Information Regarding CVIC").
The FASB issued SFAS 141 and SFAS 142 in June 2001. Under the new rules,
intangible assets with an indefinite life are no longer amortized in periods
subsequent to December 31, 2001, but are subject to annual impairment tests (or
more frequently under certain circumstances), effective January 1, 2002. The
Company adopted SFAS 141 and SFAS 142 effective January 1, 2002 (see the note to
the consolidated financial statements entitled "Summary of Significant
Accounting Policies" for additional discussion).
The FASB issued SFAS 140 (which is a replacement for Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities") and a related
implementation guide in September 2000. SFAS 140 and the implementation guide
have changed the criteria that must be met for securitization transactions to be
recorded under the portfolio method. We did not need to make any significant
changes to our securitization structures to meet the new criteria which are
effective for securitization transactions completed after March 31, 2001. We
first adopted the SFAS 140 requirement for additional disclosures on
securitization in our December 31, 2000, consolidated financial statements.
SFAS 138 requires all derivative instruments to be recorded on the
balance sheet at estimated fair value. Changes in the fair value of derivative
instruments are to be recorded each period either in current earnings or other
comprehensive income (loss), depending on whether a derivative is designated as
part of a hedge transaction and, if it is, on the type of hedge transaction. We
adopted SFAS 138 on January 1, 2001. The initial adoption of the new standard
did not have a material impact on the Company's financial position or results of
operations and there was no cumulative effect of an accounting change related to
its adoption.
Statement of Position No. 98-7, "Accounting for Insurance and Reinsurance
Contracts That Do Not Transfer Insurance Risk" ("SOP 98-7") provides guidance on
the method of accounting for insurance and reinsurance contracts that do not
transfer risk. We adopted SOP 98-7 on January 1, 2000. The adoption did not have
a material impact on the Company's consolidated financial condition or results
of operations.
112
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
5. INVESTMENTS:
At December 31, 2002, the amortized cost and estimated fair value of
actively managed fixed maturities and equity securities were as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
Investment grade:
Corporate securities........................................................... $10,529.0 $517.5 $293.9 $10,752.6
United States Treasury securities and obligations of
United States government corporations and agencies........................... 442.4 25.2 9.0 458.6
States and political subdivisions.............................................. 418.0 23.2 .9 440.3
Debt securities issued by foreign governments.................................. 83.3 7.3 - 90.6
Mortgage-backed securities .................................................... 6,082.0 336.3 4.2 6,414.1
Below-investment grade (primarily corporate securities)........................... 1,435.1 17.1 191.0 1,261.2
--------- ------ ------ ---------
Total actively managed fixed maturities...................................... $18,989.8 $926.6 $499.0 $19,417.4
========= ====== ====== =========
Equity securities................................................................. $161.4 $4.5 $9.9 $156.0
====== ==== ==== ======
At December 31, 2001, the amortized cost and estimated fair value of
actively managed fixed maturities and equity securities were as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
Investment grade:
Corporate securities........................................................... $12,827.2 $121.5 $501.1 $12,447.6
United States Treasury securities and obligations of
United States government corporations and agencies........................... 240.9 11.8 1.0 251.7
States and political subdivisions.............................................. 225.7 5.0 2.0 228.7
Debt securities issued by foreign governments.................................. 103.9 3.8 .9 106.8
Mortgage-backed securities .................................................... 7,488.1 82.8 74.3 7,496.6
Below-investment grade (primarily corporate securities)........................... 1,537.0 15.2 265.1 1,287.1
--------- ------- ------ ----------
Total actively managed fixed maturities...................................... $22,422.8 $240.1 $844.4 $21,818.5
========= ====== ====== =========
Equity securities................................................................. $257.3 $6.0 $36.3 $227.0
====== ==== ===== ======
Accumulated other comprehensive income (loss) is primarily comprised of
unrealized gains (losses) on actively managed fixed maturity investments. Such
amounts, included in shareholders' equity (deficit) as of December 31, 2002 and
2001, were as follows:
2002 2001
---- ----
(Dollars in millions)
Unrealized gains (losses) on investments........................................................... $448.1 $(816.0)
Adjustments to cost of policies purchased and cost of policies produced............................ (95.3) 133.9
Deferred income tax benefit........................................................................ 249.6 249.6
Other.............................................................................................. (21.8) (6.5)
------ -------
Accumulated other comprehensive income (loss)............................................... $580.6 $(439.0)
====== =======
113
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Concentration of Corporate Securities
At December 31, 2002, our corporate securities (including
below-investment grade) were concentrated in the following industries:
Percent of Percent of
amortized estimated
cost fair value
-------------- ----------
Media and communications......................................................... 13.7% 13.5%
Financial institutions........................................................... 10.5 10.5
Bank/savings and loan............................................................ 10.2 10.7
Electric utility................................................................. 9.0 9.0
Energy........................................................................... 8.2 8.8
Insurance ....................................................................... 4.7 5.5
With respect to our corporate securities, no other industry accounted for
more than 5.0 percent of amortized cost or estimated fair value.
Below-Investment Grade Securities
At December 31, 2002, the amortized cost of the Company's fixed maturity
securities in below-investment grade securities was $1,435.1 million, or 7.6
percent of the Company's fixed maturity portfolio. The estimated fair value of
the below-investment grade portfolio was $1,261.2 million, or 88 percent of the
amortized cost. The value of these securities varies based on the economic terms
of the securities, structural considerations and the credit worthiness of the
issuer of the securities. Recently a number of large highly leveraged issuers
have experienced significant financial difficulties, which resulted in our
recognition of other-than-temporary impairments. These impairments have had a
material adverse effect on us.
Below-investment grade securities have different characteristics than
investment grade corporate debt securities. Risk of loss upon default by the
borrower is significantly greater with respect to below-investment grade
securities than with other corporate debt securities. Below-investment grade
securities are generally unsecured and are often subordinated to other creditors
of the issuer. Also, issuers of below-investment grade securities usually have
higher levels of debt and are more sensitive to adverse economic conditions,
such as recession or increasing interest rates, than are investment grade
issuers. The Company attempts to reduce the overall risk in the below-investment
grade portfolio, as in all investments, through careful credit analysis, strict
investment policy guidelines, and diversification by issuer and/or guarantor and
by industry.
Contractual Maturity
The following table sets forth the amortized cost and estimated fair
value of actively managed fixed maturities at December 31, 2002, by contractual
maturity. Actual maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties. Most of the mortgage-backed securities shown below
provide for periodic payments throughout their lives.
114
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
Due in one year or less...................................................................... $ 160.0 $ 162.0
Due after one year through five years........................................................ 1,147.8 1,189.6
Due after five years through ten years....................................................... 4,094.7 4,228.8
Due after ten years.......................................................................... 7,498.4 7,420.8
--------- ---------
Subtotal................................................................................. 12,900.9 13,001.2
Mortgage-backed securities (a)............................................................... 6,088.9 6,416.2
--------- ---------
Total actively managed fixed maturities ............................................. $18,989.8 $19,417.4
========= =========
- --------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
Net Investment Income
Net investment income consisted of the following:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Fixed maturities................................................................. $1,375.2 $1,510.7 $1,550.5
Venture capital investment loss.................................................. (99.3) (42.9) (199.5)
Equity securities................................................................ 13.2 17.8 35.2
Mortgage loans................................................................... 99.0 90.2 96.4
Policy loans..................................................................... 32.6 35.9 33.7
Change in value of S&P 500 Call Options related to equity-indexed products....... (100.5) (114.2) (111.0)
Other invested assets............................................................ 7.7 24.6 91.9
Cash and cash equivalents........................................................ 27.6 60.5 58.0
Separate accounts................................................................ - (5.4) 54.9
-------- -------- --------
Gross investment income....................................................... 1,355.5 1,577.2 1,610.1
Less investment expenses......................................................... 12.6 12.7 13.1
-------- -------- --------
Net investment income......................................................... $1,342.9 $1,564.5 $1,597.0
======== ======== ========
The carrying value of fixed maturity investments and mortgage loans not
accruing investment income totaled $169.6 million, $140.2 million and $98.0
million at December 31, 2002, 2001 and 2000, respectively.
115
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Net Realized Investment Losses
Investment losses, net of related investment expenses, were included in
revenue as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Fixed maturities:
Gross gains...................................................................... $ 260.8 $ 295.8 $ 83.6
Gross losses..................................................................... (251.8) (260.3) (154.4)
Other-than-temporary decline in fair value....................................... (500.6) (293.2) (139.4)
------- ------- -------
Net investment losses from fixed maturities before expenses................. (491.6) (257.7) (210.2)
Equity securities.................................................................... (7.5) (1.8) 11.5
Mortgages............................................................................ (1.4) (1.9) (3.2)
Other-than-temporary decline in fair value of equity securities and
other invested assets............................................................ (56.2) (68.5) (41.2)
Loss related to termination of interest rate swap agreements......................... - - (59.2)
Other ............................................................................... .4 (10.1) (2.4)
------- ------- -------
Net investment losses before expenses....................................... (556.3) (340.0) (304.7)
Investment expenses.................................................................. 40.7 39.4 41.8
------- ------- -------
Net investment losses....................................................... $(597.0) $(379.4) $(346.5)
======= ======= =======
Net realized investment losses during 2002 included: (i) $556.8 million
of writedowns of fixed maturity investments, equity securities and other
invested assets as a result of conditions which caused us to conclude a decline
in fair value of the investment was other than temporary; and (ii) $40.2 million
of net losses from the sales of investments (primarily fixed maturities) which
generated proceeds of $19.5 billion. At December 31, 2002, fixed maturity
securities in default as to the payment of principal or interest had an
aggregate amortized cost of $203.9 million and a carrying value of $174.8
million. Net realized investment losses during 2001 included: (i) $361.7 million
of writedowns of fixed maturity investments, equity securities and other
invested assets as a result of conditions which caused us to conclude a decline
in fair value of the investment was other than temporary; and (ii) $17.7 million
of net losses from the sales of investments (primarily fixed maturities).
During 2002, we sold $11.3 billion of fixed maturity investments which
resulted in gross investment losses (before income taxes) of $251.8 million.
Securities sold at a loss are sold for a number of reasons including: (i)
changes in the investment environment; (ii) expectation that the market value
could deteriorate further; (iii) desire to reduce our exposure to an issuer or
an industry; (iv) changes in credit quality; and (v) our analysis indicating
there is a high probability that the security is other-than-temporarily
impaired.
The following summarizes the investments sold at a loss during 2002 which
had been continuously in an unrealized loss position exceeding 20 percent of the
amortized cost basis prior to the sale for the period indicated:
At date of sale
-----------------
Number of Amortized Estimated Fair
Period issuers cost value
------ ------- ---- -----
(Dollars in millions)
Less than 6 months prior to sale....................... 90 $231.3 $130.4
Greater than or equal to 6 and less than 12 months
prior to sale....................................... 28 79.2 43.1
Greater than 12 months
prior to sale....................................... 24 79.3 48.8
116
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Investments with Other-Than-Temporary Losses
During 2002, we recorded writedowns of fixed maturity investments, equity
securities and other invested assets totaling $556.8 million. The following is a
brief description of the facts and circumstances that resulted in the
other-than-temporary losses.
During 2002, we recorded writedowns totaling $130.1 million on
securitized investments backed by various debt securities and/or commercial
loans (referred to herein as "collateralized debt obligations" or "CDOs").
Principal and interest payments on CDOs are made from cash flows from underlying
loans held by the trusts. The current value of these investments are influenced
by a number of factors, such as the performance of the underlying loans, the
current and future expected economic environment, and the payment priority of
our investment in the securitization structure. In recent periods, general rates
of defaults on commercial loans have increased. In addition, the ratings of
several CDOs which we hold have been downgraded by nationally recognized
statistical rating organizations. Accordingly, we reviewed our CDO portfolio for
potential other-than-temporary impairments in accordance with EITF 99-20.
During 2002, we recorded writedowns totaling $73.7 million related to
fixed maturity investments issued by a merchant energy company rated B3/B-. The
issuer's operating results and liquidity have deteriorated due to lower energy
prices, diminished energy trading profits and higher working capital demands.
Although the issuer has successfully executed certain cash raising activities
and has remained in compliance with the terms of all of its debt securities, its
earnings have significantly declined and its debt service requirements are
significant. We concluded the decline in fair value was other than temporary.
During 2002, we recorded writedowns totaling $67.8 million on certain
lower-rated securities issued by the non-consolidated securitization trusts
which hold loans to purchase manufactured housing originated and managed by CFC.
These securities were acquired by our insurance subsidiaries prior to our
acquisition of CFC. Due to the performance of the underlying portfolios, the
payments on lower-priority securities are dependent on the guarantees of CFC.
Given the current financial condition of CFC, there can be no assurance it will
be able to honor its commitments with respect to such guarantees. Accordingly,
we wrote these investments down to estimated fair value.
During 2002, we recorded writedowns totaling $29.9 million related to
investments in a large capitalization stock fund, a balanced fund, and a
diversified science and technology fund. The events of September 11, 2001 caused
a decline in the value of most equity securities, including net assets in these
funds. Based on the belief that the economy was improving at year-end 2001,
combined with the general equity market improvement in late 2001, we concluded
that the unrealized loss at December 31, 2001 was temporary. However, the equity
markets in the first half of 2002 suffered additional significant losses due to
a combination of corporate restatements, fears over a double-dip recession and
decreased corporate capital spending. We changed our intent to hold these funds
once we concluded that the loss was other than temporary. All of our holdings in
such funds were sold by August 5, 2002.
During 2002, we recorded writedowns totaling $30.2 million related to an
investment in a telecommunications company that was rated investment grade at
the time of purchase and was subsequently downgraded to below-investment grade.
The issuer faced significant financial difficulties and accounting
irregularities that resulted in sequential and material restatements of its
financial statements. The issuer defaulted and filed for Chapter 11 Bankruptcy
protection in July 2002.
During 2002, we recorded writedowns totaling $24.5 million related to
holdings of fixed maturity investments in a retail chain that defaulted in early
2002. A writedown was taken as of December 31, 2001 based upon the estimated
fair value of the investment at that time. Given the subsequent decrease in the
estimated fair value of our investment, subsequent writedowns were taken in
2002.
During 2002, we recorded writedowns totaling $26.5 million based upon our
analysis of the value of the underlying collateral of various investments in the
airline sector. Many major airlines are facing significant liquidity issues and
we believe the current market value of the collateral backing these loans is
less than the book value of our investment. We believe that the decline in fair
value of these investments is other than temporary.
During 2002, we recorded writedowns totaling $10.8 million on a fixed
maturity investment in an Australian nickel mining company. The construction
costs of the processing plant at this start-up nickel project were higher than
anticipated and the plant's ultimate production capacity did not meet projected
levels. Initially, the project's equity sponsors supported this project through
additional equity and cash infusions. However, during the first six months of
2002, the equity sponsors notified bond investors that they were no longer
willing to support the project without a restructuring of the issuer's debt. As
a result, we believe the decline in market value of this security is other than
temporary.
117
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
During 2002, we recorded writedowns totaling $9.4 million of fixed
maturity investments issued by a global energy services company. The issuer is
suffering from reduced profitability due to declining energy prices in key
markets plus the effect of above market purchase contracts. Due to very high
financial leverage related to several acquisitions at high prices and diminished
cash flows, we believe that the decline in fair value is other than temporary.
During 2002, we recorded writedowns totaling $8.5 million related to
investments issued by a moving and storage company. The issuer failed to make a
scheduled principal payment on a public debt security. The issuer recently
cancelled a proposed offering of long-term notes. While the issuer has publicly
expressed its intention and belief that a successful refinancing can be
completed, we believe that the decline in market value of this security is other
than temporary.
During 2002, we recorded writedowns of $8.1 million of fixed maturity
investments issued by a copper producer. The financial condition of this issuer
is significantly affected by the price of copper, which has dropped from as high
as $0.80 per pound earlier this year to a low of $0.68 near the end of the
second quarter. In addition, the issuer was downgraded by a national rating
agency during the first six months of 2002. Despite the fact that the issuer was
still making the coupon payments on this issue, we believed that the decline in
market value of this security was other than temporary. All of our holdings in
this issuer were sold by August 8, 2002.
During 2002, in addition to the specific securities discussed above, we
recorded $105.3 million of writedowns related to various other investments. In
accordance with GAAP, we are required to recognize an impairment charge when we
no longer have an intent to hold an investment with unrealized loss for a period
of time sufficient to allow for any anticipated recovery. In early 2003, we sold
certain securities at a loss in conjunction with decisions made in 2003 to
restructure our portfolio by reducing our exposure to certain credits. We
recorded $32.0 million of investment writedowns in 2002 related to such sales.
No other writedowns of a single issuer exceeded $7.0 million.
Recognition of Losses
We regularly evaluate all of our investments for possible impairment
based on current economic conditions, credit loss experience and other
investee-specific developments. If there is a decline in a security's net
realizable value that is other than temporary, the decline is recognized as a
realized loss and the cost basis of the security is reduced to its estimated
fair value.
Our evaluation of investments for impairment requires significant
judgments to be made including: (i) the identification of potentially impaired
securities; (ii) the determination of their estimated fair value; and (iii)
assessment of whether any decline in estimated fair value is other than
temporary. If new information becomes available or the financial condition of
the investee changes, our judgments may change resulting in the recognition of
an investment loss at that time.
Our periodic assessment of whether unrealized losses are "other than
temporary" requires significant judgment. Factors considered include: (i) the
extent to which market value is less than the cost basis; (ii) the length of
time that the market value has been less than cost; (iii) whether the unrealized
loss is event driven, credit-driven or a result of changes in market interest
rates; (iv) the near-term prospects for improvement in the issuer and/or its
industry; (v) whether the investment is investment-grade and our security
analyst's view of the investment's rating and whether the investment has been
downgraded since its purchase; (vi) whether the issuer is current on all
payments in accordance with the contractual terms of the investment and is
expected to meet all of its obligations under the terms of the investment; (vii)
our ability and intent to hold the investment for a period of time sufficient to
allow for any anticipated recovery; and (viii) the underlying asset and
enterprise values of the issuer.
If a decline in value is determined to be other than temporary and the
cost basis of the security is written down to fair value, we review the
circumstances which caused us to believe that the decline was other than
temporary with respect to other investments in our portfolio. If such
circumstances exist with respect to other investments, those investments are
also written down to fair value. Future events may occur, or additional or
updated information may become available, which may necessitate future realized
losses of securities in our portfolio. Significant losses in the carrying value
of our investments could have a material adverse effect on our earnings in
future periods.
The following table sets forth the amortized cost and estimated fair
value of those actively managed fixed maturities with unrealized losses at
December 31, 2002, by contractual maturity. Actual maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Most of the
mortgage-backed securities shown below provide for periodic payments throughout
their lives.
118
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Estimated
Amortized fair
cost value
--------- ---------
(Dollars in millions)
Due in one year or less................................................................... $ 57.3 $ 56.9
Due after one year through five years..................................................... 259.7 241.0
Due after five years through ten years.................................................... 864.4 786.4
Due after ten years....................................................................... 3,108.9 2,716.0
-------- --------
Subtotal............................................................................... 4,290.3 3,800.3
Mortgage-backed securities (a)............................................................ 127.1 118.1
-------- --------
Total.................................................................................. $4,417.4 $3,918.4
======== ========
- --------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.8 million and $2.1 million,
respectively.
The following summarizes the investments in our portfolio rated
below-investment grade or classified as equity-type securities which have been
continuously in an unrealized loss position exceeding 20 percent of the cost
basis for the period indicated as of December 31, 2002:
Number Cost Unrealized Estimated
Period of issuers basis loss fair value
------ ---------- ----- ---- ----------
(Dollars in millions)
Less than 6 months(1)............................... 25 $190.2 $59.7 $130.5
Greater than or equal to
6 months and less
than 12 months(2)........................... 10 97.4 37.5 59.9
Greater than 12 months(3)........................... 21 238.4 76.4 162.0
-----------------------
(1) These investments include fixed maturity investments in three
commercial airlines with a cost basis of $35.2 million and an
estimated fair value of $20.0 million. See "Investments with
Unrealized Losses" for additional information. No other single
issuer in this category had an unrealized loss exceeding $7.0
million.
(2) These investments include: (i) an investment in an oil-related
production facility with a cost basis of $50.4 million and an
estimated fair value of $33.0; and (ii) an investment in a
telecommunications company with a cost basis of $19.7 million and
an estimated fair value of $10.6 million. See "Investments with
Unrealized Losses" for additional information. No other single
issuer in this category had an unrealized loss exceeding $7.0
million.
(3) These investments include: (i) a fixed maturity investment issued
by a commercial property and casualty insurance company with a
cost basis of $31.6 million and an estimated fair value of $24.1
million; and (ii) a fixed maturity investment in a
telecommunications company with a cost basis of $34.4 million and
an estimated fair value of $21.9 million; and (iii) a fixed
maturity investment issued by a regional retail chain with an
amortized cost basis of $28.8 million and an estimated fair value
of $20.1 million. See "Investments with Unrealized Losses" for
additional information. No other single issuer in this category
had an unrealized loss exceeding $7.0 million.
119
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Our investment strategy is to maximize investment income and total
investment return through active investment management. Accordingly, we may sell
securities at a gain or a loss to enhance the total return of the portfolio as
market opportunities change. While we have both the ability and intent to hold
securities with unrealized losses until they mature or recover in value, we may
sell securities at a loss in the future because of actual or expected changes in
our view of the particular investment, its industry, its type or the general
investment environment.
Based on management's current assessment of these securities and other
investments with unrealized losses at December 31, 2002, the Company believes
the issuers of the securities will continue to meet their obligations (or with
respect to equity-type securities, the investment value will recover to its cost
basis). The Company has no current plans to sell these securities and has the
ability to hold them to maturity. The recognition of an other-than-temporary
impairment through a charge to earnings may be recognized in future periods if
management later concludes that the decline in market value below the cost basis
is other than temporary.
Investments with Unrealized Losses
The following is a brief description of our assessment of the potential
other-than-temporary losses related to investments in our below-investment grade
portfolio (or equity-type securities) with significant unrealized losses at
December 31, 2002 (unrealized losses which exceed $7.0 million and 20 percent of
the cost basis of the securities by the same issuer):
At December 31, 2002, we held fixed maturity investments issued by a
telecommunications company with ratings of Ba3/B- and Caa1/C with an amortized
cost basis of $54.1 million and an estimated fair value of $32.6 million. The
issuer reduced total debt in the fourth quarter of 2002 by $4.6 billion due to
the closing of a sales transaction and a debt exchange offer. The issuer also
expects to receive regulatory approval to close a $4.3 billion transaction in
mid-2003, the proceeds of which will be used to further reduce debt. We believe
that the issuer has sufficient liquidity and the underlying value of the
issuer's customer base provides sufficient value to cover the existing debt.
Therefore, we concluded that the unrealized loss at December 31, 2002 is
temporary.
At December 31, 2002, we held fixed maturity investments in an
oil-related production facility rated Ba1 with an amortized cost basis of $53.9
million and an estimated fair value of $35.5 million. Proceeds from the sale of
the oil produced are used to service the debt. This joint venture includes
purchase guarantees from investment grade companies that will provide sufficient
liquidity to service the debt. Therefore, we concluded that the unrealized loss
at December 31, 2002 is temporary.
At December 31, 2002, we held fixed maturity investments issued by a
commercial property and casualty insurance company rated Ba2/BB+ with an
amortized cost basis of $32.1 million and an estimated fair value of $24.5
million. We believe this issuer currently has sufficient liquidity to cover its
debt service through 2005. They believe the underwriting cycle will improve
before then (consistent with prior cycles), allowing the issuer to continue to
service its debt beyond 2005. In addition, this issuer recently completed the
public issuance of equity securities, which further improves its liquidity and
demonstrates the ability to access the capital market, if needed, to service its
future debt obligations. Therefore, we concluded that the unrealized loss at
December 31, 2002 is temporary.
At December 31, 2002, we held secured fixed maturity investments issued
by a commercial airline rated Ba2/BB+ with an amortized cost of $17.2 million
and an estimated fair value of $10.5 million. The issuer is facing financial
challenges that affect the entire industry, but is implementing a plan to
increase liquidity, reduce debt and reduce costs. Given that the issuer has
demonstrated that it has sufficient cash flows and liquidity to meet its
obligations, we concluded that the unrealized loss at December 31, 2002 is
temporary.
At December 31, 2002, we held fixed maturity investments issued by a
commercial airline rated Ba3/B+ and Caa1/CCC+ with an amortized cost of $29.8
million and an estimated fair value of $14.4 million. We previously recorded
writedowns related to these securities. We believe the collateral supporting
these investments is sufficient and, therefore, concluded that the unrealized
loss at December 31, 2002 is temporary.
At December 31, 2002, we held fixed maturity investments issued by a
regional retail chain rated B2/B+ with an amortized cost basis of $28.8 million,
a par amount of $24.2 million and an estimated fair value of $20.1 million. We
have observed that this issuer has improving fundamentals including its
liquidity position, leverage and operating performance. This fixed maturity has
a long duration and was purchased at a price in excess of par as an investment
grade credit. The market value of this security has increased significantly
during 2002 (from 70 percent of par at December 31, 2001 to 83 percent of par at
December 31, 2002). We believe that
120
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
we will recover full value from this investment and we intend to hold the
security to maturity. Therefore, we concluded that the unrealized loss at
December 31, 2002 is temporary.
At December 31, 2002 we held fixed maturity investments in a reinsurance
company rated Ba2/BB+ with an amortized cost of $23.1 million and an estimated
fair value of $16.0 million. The reinsurance on the books of the issuer is high
quality, with counter parties rated AA or better. The issuer recently received a
capital infusion and is seeing strong price increases across most product lines.
The issuer appears to have sufficient cash flow to retire existing debt. We
concluded that the unrealized loss at December 31, 2002 is temporary.
Investment in General Motors Building
At December 31, 2002, Conseco holds $292.9 million of investments related
to a 50 story office building in New York City known as the General Motors
Building. Such investments are primarily held in our fixed maturity investment
portfolio. In January 2002, Conseco exercised its right to purchase the interest
of the other investor in the building.
Pursuant to GAAP, Conseco's future earnings on these investments are
limited to amounts which are based on the actual earnings related to the
operation of the building (including adjustments to reflect Conseco's actual
cost basis). These earnings were not material in 2002 and are not expected to be
material in 2003; accordingly, our income from these investments will be less
than the stated return on the investment of 12.7 percent.
The other investor in the building has filed a lawsuit against Conseco
which is described in the note to the consolidated financial statements entitled
"Other Disclosures". See the caption "Investment in General Motors Building" in
the note to the consolidated financial statements entitled "Investments in
Variable Interest Entities" for further information on this investment.
Mortgage-Backed Securities
At December 31, 2002, fixed maturity investments included $6.4 billion of
mortgage-backed securities (or 33 percent of all fixed maturity securities). The
yield characteristics of mortgage-backed securities differ from those of
traditional fixed-income securities. Interest and principal payments for
mortgage-backed securities occur more frequently, often monthly. Mortgage-backed
securities are subject to risks associated with variable prepayments. Prepayment
rates are influenced by a number of factors that cannot be predicted with
certainty, including: the relative sensitivity of the underlying mortgages
backing the assets to changes in interest rates; a variety of economic,
geographic and other factors; and the repayment priority of the securities in
the overall securitization structures.
In general, prepayments on the underlying mortgage loans and the
securities backed by these loans increase when prevailing interest rates decline
significantly relative to the interest rates on such loans. The yields on
mortgage-backed securities purchased at a discount to par will increase when the
underlying mortgages prepay faster than expected. The yields on mortgage-backed
securities purchased at a premium will decrease when they prepay faster than
expected. When interest rates decline, the proceeds from the prepayment of
mortgage-backed securities are likely to be reinvested at lower rates than we
were earning on the prepaid securities. When interest rates increase,
prepayments on mortgage-backed securities decrease as fewer underlying mortgages
are refinanced. When this occurs, the average maturity and duration of the
mortgage-backed securities increase, which decreases the yield on
mortgage-backed securities purchased at a discount, because the discount is
realized as income at a slower rate, and increases the yield on those purchased
at a premium as a result of a decrease in the annual amortization of the
premium.
121
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table sets forth the par value, amortized cost and
estimated fair value of mortgage-backed securities, summarized by interest rates
on the underlying collateral at December 31, 2002:
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
Below 7 percent..................................................................... $4,895.4 $4,857.3 $5,125.2
7 percent - 8 percent............................................................... 1,000.4 1,007.6 1,059.1
8 percent - 9 percent............................................................... 171.9 179.8 187.1
9 percent and above................................................................. 42.1 44.2 44.8
-------- -------- --------
Total mortgage-backed securities (a)......................................... $6,109.8 $6,088.9 $6,416.2
======== ======== ========
- -------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
The amortized cost and estimated fair value of mortgage-backed securities
at December 31, 2002, summarized by type of security, were as follows:
Estimated fair value
--------------------
Percent
Amortized of fixed
Type cost Amount maturities
- ---- ---- ------ ----------
(Dollars in millions)
Pass-throughs and sequential and targeted amortization classes............ $2,849.5 $3,000.8 16%
Planned amortization classes and accretion-directed bonds................. 2,439.8 2,580.6 13
Commercial mortgage-backed securities..................................... 441.3 461.4 2
Subordinated classes and mezzanine tranches............................... 348.7 365.7 2
Other..................................................................... 9.6 7.7 -
-------- -------- --
Total mortgage-backed securities (a)............................... $6,088.9 $6,416.2 33%
======== ======== ==
- -------------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
Pass-throughs and sequential and targeted amortization classes have
similar prepayment variability. Pass-throughs historically provide the best
liquidity in the mortgage-backed securities market. Pass-throughs are also used
frequently in the dollar roll market and can be used as the collateral when
creating collateralized mortgage obligations. Sequential classes are a series of
tranches that return principal to the holders in sequence. Targeted amortization
classes offer slightly better structure in return of principal than sequentials
when prepayment speeds are close to the speed at the time of creation.
Planned amortization classes and accretion-directed bonds are some of the
most stable and liquid instruments in the mortgage-backed securities market.
Planned amortization class bonds adhere to a fixed schedule of principal
payments as long as the underlying mortgage collateral experiences prepayments
within a certain range. Changes in prepayment rates are first absorbed by
support or companion classes. This insulates the planned amortization class from
the consequences of both faster prepayments (average life shortening) and slower
prepayments (average life extension).
Commercial mortgage-backed securities ("CMBS") are bonds secured by
commercial real estate mortgages. Commercial real estate encompasses income
producing properties that are managed for economic profit. Property types
include multi-family dwellings including apartments, retail centers, hotels,
restaurants, hospitals, nursing homes, warehouses, and office buildings. The
CMBS market currently offers high yields, strong credits, and call protection
compared to similar-rated corporate bonds. Most CMBS have strong call protection
features where borrowers are locked out from prepaying their mortgages for a
stated period of time. If the
122
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
borrower does prepay any or all of the loan, he or she will be required to pay
prepayment penalties.
Subordinated and mezzanine tranches are classes that provide credit
enhancement to the senior tranches. The rating agencies require that this credit
enhancement not deteriorate due to prepayments for a period of time, usually
five years of complete lockout, followed by another period of time where
prepayments are shared pro rata with senior tranches. The credit risk of
subordinated and mezzanine tranches is derived from owning a small percentage of
the mortgage collateral, while bearing a majority of the risk of loss due to
property owner defaults. Subordinated bonds can be rated "AA" or lower; we
typically do not buy anything rated lower than "BB".
Mortgage Loans
At December 31, 2002, the mortgage loan balance was primarily comprised
of commercial loans. Approximately 9 percent, 8 percent, 7 percent, 6 percent, 6
percent and 6 percent of the mortgage loan balance were on properties located in
New York, Massachusetts, Florida, California, Ohio and Pennsylvania,
respectively. No other state comprised greater than 5 percent of the mortgage
loan balance. Less than one percent of the mortgage loan balance was noncurrent
at December 31, 2002. Our allowance for loss on mortgage loans was $3.5 million
and $3.8 million at December 31, 2002 and 2001, respectively.
Investment Borrowings
Our investment borrowings averaged approximately $1,155.8 million during
2002, compared with approximately $927.0 million during 2001 and were
collateralized by investment securities with fair values approximately equal to
the loan value. The weighted average interest rates on such borrowings were 1.3
percent and 3.3 percent during 2002 and 2001, respectively.
Other Investment Disclosures
Life insurance companies are required to maintain certain investments on
deposit with state regulatory authorities. Such assets had an aggregate carrying
value of $144.5 million at December 31, 2002.
Conseco had two investments in excess of 10 percent of the absolute
dollar amount of shareholders' deficit at December 31, 2002, (other than
investments issued or guaranteed by the United States government or a United
States government agency) which are summarized below:
Amortized Estimated
Issuer cost fair value
------ ---- ----------
(Dollars in millions)
Investors Guaranty Assurance........... $305.0 $283.7
Carmel Fifth, LLC...................... 212.7 212.5
123
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
6. LIABILITIES FOR INSURANCE AND ASSET ACCUMULATION PRODUCTS:
These liabilities consisted of the following:
Interest
Withdrawal Mortality rate
assumption assumption assumption 2002 2001
---------- ---------- ---------- ---- ----
(Dollars in millions)
Future policy benefits:
Interest-sensitive products:
Investment contracts............................ N/A N/A (c) $ 9,203.6 $11,117.1
Universal life-type contracts................... N/A N/A N/A 4,265.9 4,670.6
--------- ---------
Total interest-sensitive products............. 13,469.5 15,787.7
--------- ---------
Traditional products:
Traditional life insurance contracts............ Company (a) 6% 1,821.3 2,091.5
experience
Limited-payment contracts....................... Company (b) 7% 569.7 869.9
experience,
if applicable
Individual and group accident and health ....... Company Company 6% 5,580.4 5,211.4
experience experience --------- ---------
Total traditional products.................... 7,971.4 8,172.8
--------- ---------
Claims payable and other policyholder funds ........ N/A N/A N/A 909.2 1,005.5
Liabilities related to separate accounts and
investment trust.................................. N/A N/A N/A 447.0 2,376.3
--------- ---------
Total........................................... $22,797.1 $27,342.3
========= =========
- --------------------
(a) Principally, modifications of the 1965 - 70 and 1975 - 80 Basic, Select
and Ultimate Tables.
(b) Principally, the 1984 United States Population Table and the NAIC 1983
Individual Annuitant Mortality Table.
(c) In both 2002 and 2001: (i) approximately 96 percent of this liability
represented account balances where future benefits are not guaranteed;
and (ii) approximately 4 percent represented the present value of
guaranteed future benefits determined using an average interest rate of
approximately 6 percent.
124
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the unpaid claims reserve and liabilities related to accident
and health insurance were as follows:
2002 2001 2000
---- ---- -----
(Dollars in millions)
Balance, beginning of year............................. $1,324.2 $1,324.9 $1,224.7
Less reinsurance ceded.............................. (132.7) (89.7) (85.5)
-------- -------- --------
1,191.5 1,235.2 1,139.2
-------- -------- --------
Incurred claims related to:
Current year........................................ 1,906.5 1,986.4 2,053.1
Prior year (a)...................................... 73.1 (19.5) 55.0
-------- -------- --------
Total incurred................................... 1,979.6 1,966.9 2,108.1
-------- -------- --------
Paid claims related to:
Current year........................................ 1,137.9 1,232.4 1,277.4
Prior year.......................................... 699.3 778.2 734.7
-------- -------- --------
Total paid....................................... 1,837.2 2,010.6 2,012.1
-------- -------- --------
Balance, end of year................................... 1,333.9 1,191.5 1,235.2
Reinsurance ceded................................... 107.5 132.7 89.7
-------- -------- --------
$1,441.4 $1,324.2 $1,324.9
======== ======== ========
- -------------
(a) Such amounts will fluctuate based upon the estimation procedures used to
determine the amount of unpaid losses. Such estimates are the result of
ongoing analysis related to recent loss development trends.
125
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
7. INCOME TAXES:
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting and tax bases of assets
and liabilities, capital loss carryforwards and net operating loss
carryforwards. The net deferred tax assets totaled $1,719.6 million at December
31, 2002 (including $925.7 million of deferred tax assets related to CFC which
are classified as discontinued operations). In assessing the realization of our
deferred income tax assets, we consider whether it is more likely than not that
the deferred income tax assets will be realized. The ultimate realization of our
deferred income tax assets depends upon generating future taxable income during
the periods in which our temporary differences become deductible and before our
net operating loss carryforwards expire. We evaluate the realizability of our
deferred income tax assets by assessing the need for a valuation allowance on a
quarterly basis. A valuation allowance of $1,719.6 million (of which $925.7
million relates to discontinued operations) has been provided for the entire
balance of net deferred income tax assets at December 31, 2002, as we believe
the realization of such assets in future periods is uncertain. We reached this
conclusion after considering the availability of taxable income in prior
carryback years, tax planning strategies, and the likelihood of future taxable
income exclusive of reversing temporary differences and carryforwards. This
conclusion was greatly influenced by recent unfavorable developments affecting
the Company such as rating downgrades that decrease the Company's likelihood to
generate adequate future taxable income to realize the tax benefits.
126
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The Company established valuation contingencies related to certain tax
uncertainties of the insurance companies we acquired on the date of their
acquisition. We have determined that $146.2 million of such valuation
contingencies are no longer necessary because the tax uncertainties no longer
exist. Pursuant to Statement of Financial Accounting Standards Statement No.
109, "Accounting for Income Taxes", the benefit for the reduction of such
valuation contingencies shall be first applied to reduce the goodwill balance
related to the acquisition. Accordingly, in the second quarter of 2002, we
reduced such valuation contingencies (increasing deferred tax asset) and reduced
goodwill by $146.2 million. The components of the Company's income tax assets
and liabilities were as follows:
2002 2001
---- ----
(Dollars in millions)
Deferred tax assets:
Net operating loss carryforwards.................................................. $ 615.0 $ 411.7
Deductible temporary differences:
Actively managed fixed maturities.............................................. 196.0 124.9
Capital loss carryforwards..................................................... 112.8 -
Interest-only securities....................................................... 536.3 -
Insurance liabilities.......................................................... 750.4 827.5
Allowance for loan losses...................................................... 252.2 148.2
Reserve for loss on loan guarantees............................................ 229.2 147.0
Unrealized depreciation........................................................ - 247.1
Debt obligations............................................................... 39.4 -
Other.......................................................................... 14.0 -
-------- --------
Total deferred tax assets.................................................... 2,745.3 1,906.4
Valuation allowance............................................................ 1,719.6 -
-------- --------
Net deferred tax assets...................................................... 1,025.7 1,906.4
-------- --------
Deferred tax liabilities:
Venture capital income (loss).................................................. - (36.7)
Interest-only securities....................................................... - (75.2)
Cost of policies purchased and cost of policies produced....................... (773.8) (1,075.6)
Unrealized appreciation........................................................ (126.2) -
Other.......................................................................... (125.7) (56.2)
-------- --------
Total deferred tax liabilities............................................... (1,025.7) (1,243.7)
-------- --------
Current income taxes prepaid.......................................................... 66.9 15.4
Income tax liabilities classified as liabilities of discontinued operations........... 34.6 -
-------- --------
Net income tax assets........................................................ $ 101.5 $ 678.1
======== ========
Included in the components of the consolidated net deferred tax asset are
$925.7 million of net deferred tax assets related to CFC (see the note entitled
"Financial Information Regarding CFC" for further detail). These assets are
offset by a $925.7 million valuation reserve. The CFC deferred taxes are
presented assuming a continuation of its business. The actual realization of
CFC's deferred items may be materially different as the result of the conclusion
of bankruptcy proceedings and the disposition of certain businesses.
At December 31, 2002, Conseco had federal income tax loss carryforwards
of $1,757.4 million available (subject to various statutory restrictions) for
use on future tax returns (including $552.4 million of federal income tax
carryforwards attributable to discontinued operations). These carryforwards will
expire as follows: $2.3 million in 2003; $11.2 million in 2004; $4.9 million in
2005; $.6 million in 2006; $7.9 million in 2007; $7.5 million in 2008; $14.7
million in 2009; $30.7 million in 2010; $6.2 million in 2011; $10.1 million in
2012; $43.9 million in 2013; $6.9 million in 2014; $60.5 million in 2016; $90.0
million in 2017; $244.6 million in 2018; $159.1 million in 2019; $594.3 million
in 2020; and $462.0 million in 2022.
127
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
At December 31, 2002, Conseco had $322.4 million of capital loss
carryforwards. These carryforwards will expire as follows: $23.2 million in
2006; and $299.2 million in 2007.
Income tax expense (benefit) was as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Current tax provision..................................................................... $ 53.1 $ 132.2 $ 65.9
Deferred tax provision (benefit).......................................................... - (195.7) (232.1)
------ ------- -------
Income tax expense (benefit) on period income.................................... 53.1 (63.5) (166.2)
Valuation allowance....................................................................... 811.2 - -
------ ------- -------
Total income tax expense (benefit)............................................... $864.3 $ (63.5) $(166.2)
====== ======= =======
The income tax expense (benefit) recorded in 2002 has been allocated
entirely to continuing operations before the following items: minority interest,
discontinued operations, extraordinary gain, cumulative effect of accounting
change and other comprehensive income. This accounting treatment is required
because the calculation of income tax expense is the same, both "with and
without" the items other than continuing operations discussed above.
A reconciliation of the U.S. statutory corporate tax rate to the
effective rate reflected in the consolidated statement of operations is as
follows:
2002 2001 2000
---- ---- ----
U.S. statutory corporate rate............................................................. (35.0)% (35.0)% (35.0)%
Valuation allowance....................................................................... 49.6 - -
Net deferred benefits not recognized in the current period................................ 27.7 - -
Nondeductible goodwill amortization and impairment........................................ 10.9 15.9 5.1
Other nondeductible expenses.............................................................. (.1) (1.6) 3.8
State taxes............................................................................... (.2) 3.0 1.2
Provision for tax issues and other........................................................ - (6.7) 3.3
----- ----- -----
Effective tax rate............................................................... 52.9% (24.4)% (21.6)%
===== ===== =====
Conseco and its affiliates are currently under examination by the
Internal Revenue Service for tax years ending June 30, 1998 through December 31,
1999. The outcome of the examination is not expected to result in material
adverse deficiencies, but may result in utilization or adjustment to the income
tax loss carryforwards reported above.
128
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
8. NOTES PAYABLE:
Direct Corporate Obligations of CNC
This note contains information regarding notes payable that were direct
corporate obligations of CNC as of December 31, 2002 and 2001. As a result of
the filing of the Chapter 11 Cases previously described, no payments have been
made by CNC on these prepetition notes payable:
December 31, December 31,
2002 2001
---- ----
(Dollars in millions)
$1.5 billion Senior Credit Facility.......................................... $1,531.4 $1,493.3
8.5% senior notes due 2002................................................... 224.9 302.3
8.5% guaranteed senior notes due 2003........................................ 1.0 -
8.125% senior notes due 2003................................................. 63.5 63.5
6.4% senior notes due 2003................................................... 234.1 250.0
6.4% guaranteed senior notes due 2004........................................ 14.9 -
10.5% senior notes due 2004.................................................. 24.5 24.5
8.75% senior notes due 2004.................................................. 423.7 788.0
8.75% guaranteed senior notes due 2006....................................... 364.3 -
6.8% senior notes due 2005................................................... 99.2 250.0
6.8% guaranteed senior notes due 2007........................................ 150.8 -
9.0% senior notes due 2006................................................... 150.8 550.0
9.0% guaranteed senior notes due 2008........................................ 399.2 -
10.75% senior notes due 2008................................................. 37.6 400.0
10.75% guaranteed senior notes due 2009...................................... 362.4 -
-------- --------
Total principal amount.................................................. 4,082.3 4,121.6
Unamortized net discount related to issuance of notes payable ............... (34.0) (42.1)
Mark-to-market adjustment related to hedging transactions (as described in
the note entitled "Summary of Significant Accounting Policies")....... - 5.5
Unamortized fair market value of terminated interest rate swap
agreements (as described in the note entitled "Summary of
Significant Accounting Policies")..................................... 8.8 -
-------- --------
Less amounts subject to compromise........................................... (4,057.1) -
-------- --------
Direct corporate obligations............................................ $ - $4,085.0
======== ========
CNC has not made any interest or principal payments on any of its direct
corporate obligations since its August 9, 2002 announcement that it intends to
effectuate a fundamental restructuring of the Company's capital structure. As a
result of its failure to make such payments and the filing of the Chapter 11
Cases, CNC has defaulted on its debt obligations, $481.3 million of principal
amount of the guaranteed D&O loans and approximately $1.9 billion of trust
preferred securities through cross-default provisions contained in the governing
instruments. CNC is also not in compliance with certain covenants under its bank
credit agreement and the guarantees of the D&O loans. During the reorganization
proceedings the Debtors are not subject to the restrictions contained in the
bank credit agreement and the guarantees of the D&O loans.
CNC has a $1.5 billion credit facility (the "Senior Credit Facility")
with Bank of America, N.A., as administrative agent, and various other lending
institutions. The Senior Credit Facility was scheduled to mature on December 31,
2003. Approximately $38 million of accrued and unpaid interest was added to the
outstanding principal amount of the Senior Credit Facility pursuant to a waiver
dated September 8, 2002.
In 1993, CNC issued $200 million of 8.125% senior notes due February 15,
2003 (the "93 Notes"). In 1994, CCP Insurance, Inc. ("CCP") issued $200 million
of 10.5% senior notes due December 15, 2004 (the "94 Notes"). CNC acquired CCP
by merger on
129
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
August 31, 1995 and assumed CCP's obligations under the 94 Notes in connection
with the merger.
We sometimes refer to the 93 Notes and the 94 Notes collectively as the
"93/94 Notes." The 93/94 Notes are secured by the stock of CIHC, Conseco Capital
Management, Inc. (a registered investment advisor and wholly-owned subsidiary of
CNC), CFC and certain of its subsidiaries and certain intercompany notes. It is
anticipated that substantially all of CFC's assets will be sold in connection
with the Company's reorganization. If certain of these assets have been pledged
to the holders of the 93/94 Notes, and if proceeds of these pledged assets are
used to pay the 93/94 Notes, then CFC may assert, by subrogation, the rights of
such holders against the Debtors.
The collateral that secures the 93/94 Notes was pledged pursuant to an
"equal and ratable" clause in the indentures governing the 93/94 Notes. The
indentures of the 93/94 Notes provide that if another creditor obtains a
security interest in certain property of CNC or any of its significant
subsidiaries, then the 93/94 Notes will automatically obtain an "equal and
ratable" security interest in such property. Certain parties have alleged that
the legal mechanism by which the 93/94 Notes obtained a security interest
somehow impairs that security interest. Such parties allege that because the
holders of the 93/94 Notes did not provide consideration for the security
interest that they received simply because another party received that security
interest, the 93/94 Notes' security interest may be voided under a theory of
unjust enrichment, fraudulent conveyance or lack of consideration. Wilmington
Trust Company, the indenture trustee under the 93/94 Notes, maintains that any
and all claims with respect to the avoidability of the 93/94 Notes are frivolous
and wholly without merit.
Between 1998 and 2001, CNC issued the following series of senior notes:
(i) $450,000,000 of 8.5% senior notes due October 15, 2002 (the "8.5% Original
Notes"); (ii) $250,000,000 of 6.4% senior notes due February 10, 2003 (the "6.4%
Original Notes"); (iii) $800,000,000 of 8.75% senior notes due February 9, 2004
(the "8.75% Original Notes"); (iv) $250,000,000 of 6.8% senior notes due June
15, 2005 (the "6.8% Original Notes"); (v) $550,000,000 of 9.0% senior notes due
October 15, 2006 (the "9.0% Original Notes"); and (vi) $400,000,000 of 10.75%
senior notes due June 15, 2008 (the "10.75% Original Notes").
In April 2002, CNC completed an exchange of approximately $1.3 billion
aggregate principal amount of newly issued guaranteed notes for its senior
unsecured notes held by "qualified institutional buyers," institutional
"accredited investors", or non-U.S. persons in transactions outside the United
States. The bonds which were exchanged have identical principal and interest
components, but the new bonds have extended maturities in exchange for an
enhanced ranking in the Company's capital structure. The purpose of the exchange
offer was to extend the maturity profile of the existing notes in an effort to
improve the Company's financial flexibility and to enhance its future ability to
refinance public debt. The new notes are guaranteed on a senior subordinated
basis by CIHC. As a result, the new notes are structurally senior to the
existing notes. The new notes were not registered under the Securities Act of
1933, as amended, and may not be offered or sold in the United States absent
registration or an exemption from registration. CNC entered into a registration
rights agreement for the benefit of each exchange participant in which we agreed
to file, and did file, an exchange offer registration statement with the SEC
with respect to the new notes. However, as a result of the decision to
restructure the Company's capital, CNC does not intend to make the registered
exchange offer. Accordingly, the affected notes will accrue additional interest
as liquidated damages under the registration rights agreement.
In connection with the exchange offer CNC issued: (i) $991,000 of 8.5%
senior notes due October 15, 2003, in exchange for an equal amount of 8.5%
Original Notes due October 15, 2002 (the "8.5% Exchange Notes"); (ii)
$14,936,000 of 6.4% senior notes due February 10, 2004 in exchange for an equal
amount of 6.4% Original Notes due February 10, 2003 (the "6.4% Exchange Notes");
(iii) $364,294,000 of 8.75% senior notes due August 9, 2006 in exchange for an
equal amount of 8.75% Original Notes due February 9, 2004 (the "8.75% Exchange
Notes"); (iv) $150,783,000 of 6.8% senior notes due June 15, 2007 in exchange
for an equal amount of 6.8% Original Notes due June 15, 2005 (the "6.8% Exchange
Notes"); (v) $399,200,000 of 9.0% senior notes due April 15, 2008 in exchange
for an equal amount of 9.0% Original Notes due October 15, 2006 (the "9.0%
Exchange Notes"); and (vi) $362,433,000 of 10.75% senior notes due June 15, 2009
in exchange for an equal amount of 10.75% Original Notes due June 15, 2008 (the
"10.75% Exchange Notes").
Effective March 20, 2002, CNC reached agreement with the participating
banks in its bank credit facility to modify certain terms and conditions within
the $1.5 billion Senior Credit Facility. The most significant changes in the
amended facility include (i) a change in financial covenant requirements; (ii) a
change in the distribution of proceeds on asset sales; (iii) a reduction in the
minimum liquidity requirement at the holding company necessary to pay trust
preferred dividends; and (iv) a provision permitting the Company to exchange up
to $2.54 billion aggregate principal amount of newly issued notes guaranteed by
CIHC. As noted above, the new notes are structurally senior to the existing
notes, but subordinated to the CIHC guarantee of the Senior Credit Facility.
Absent the default described above, the amended facility would have been due on
December 31, 2003, and could have been extended to March
130
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
31, 2005, subject to the satisfaction of a number of conditions.
Our Senior Credit Facility requires the Company to maintain various
financial ratios and balances, as defined in the agreement. At December 31,
2002, we were not in compliance with these covenants in our Senior Credit
Facility. We were in violation of the following financial covenants we agreed to
maintain at December 31, 2002: (i) a debt to capitalization ratio of less than
..375:1.0 at December 31, 2002 and decreasing over time, as defined in the
agreement, to 0.300:1.0 at March 31, 2004 and thereafter (such ratio was
..567:1.0 at December 31, 2002); (ii) an interest coverage ratio greater than
1.10:1.0 for the four quarters ending December 31, 2002 and changing over time,
as defined in the agreement, to 2.50:1.0 for the four quarters ending June 30,
2004 and thereafter (such ratio was .11:1.0 for the four quarters ended December
31, 2002); (iii) adjusted earnings, as defined in the agreement, of at least
$1,300.0 million for the four quarters ending December 31, 2002 and increasing
over time, as defined in the agreement, to $1,700.0 million for the four
quarters ending September 30, 2004 (the adjusted earnings for the four quarters
ended December 31, 2002 were $926.7 million); and (iv) CFC tangible net worth,
as defined in the agreement, of at least $1.2 billion at December 31, 2002; and
$1.6 billion at March 31, 2005 (such tangible net worth was less than zero at
December 31, 2002). We also agreed to maintain the ratio of aggregate total
adjusted capital to aggregate authorized control level risk-based capital (as
defined by the National Association of Insurance Commissioners) with respect to
our insurance subsidiaries of at least 250 percent (such ratio was greater than
250 percent at December 31, 2002). Our amended credit facility provides that any
charges taken to write off goodwill to the extent required by SFAS 142 will be
excluded from the various financial ratios and covenants that we are required to
meet or maintain.
The Senior Credit Facility reduces the 90-day moving average cash balance
we must maintain at the parent company from $100 million to $50 million. The
Company is required to have at least $50 million of cash on hand immediately
after making a trust preferred dividend payment in addition to the 90-day moving
average requirement. The parent company had less than $50 million in cash at
December 31, 2002. The Senior Credit Facility also states that in the event one
of Conseco's significant insurance subsidiaries is rated "B" or below by A.M.
Best, the Company must take certain actions to generate liquidity and accelerate
the repayment of the amended credit facility. All of our significant insurance
subsidiaries are rated "B" by A.M. Best.
The Senior Credit Facility prohibits the payment of cash dividends on our
common stock until the Company has received investment grade ratings on its
outstanding public debt. Such agreement also prohibits the repurchase of our
common stock. The Senior Credit Facility limits the issuance of additional debt,
contingent obligations, liens, asset dispositions, other restrictive agreements,
affiliate transactions, change in business and modification of terms of debt or
preferred stock, all as defined in the agreements. The obligations under our
credit facility are also guaranteed by CIHC.
Effective September 9, 2002, we were subject to the default interest rate
on the Senior Credit Facility. Such rate is based on the prime rate plus a
margin of 3.75 percent. Prior to September 9, 2002, the interest rate on the
amended credit facility was based on an IBOR rate plus a margin of 3.25 percent.
Borrowings under our Senior Credit Facility averaged $1,499.2 million during
2002, at a weighted average interest rate of 6.0 percent. The interest rate on
the Senior Credit Facility was 8.0 percent at December 31, 2002.
On June 29, 2001, the Company completed the public offering of $400.0
million of senior notes with a stated rate of 10.75 percent (the "10.75%
Original Notes") due June 15, 2008. We entered into interest rate swap
agreements to convert the fixed rate on these notes to a weighted average
variable rate based on LIBOR plus approximately 5.75 percent. Such interest rate
swap agreements were terminated in 2002. See the note to the consolidated
financial statements entitled "Summary of Significant Accounting Policies" for
additional information on these interest rate swap agreements. The indenture for
the 10.75% Original Notes limits our ability to, among other things (all as
described in the indenture): (i) incur additional debt and issue preferred
stock; (ii) make loans and investments; (iii) pay dividends; (iv) create
additional loans on our assets; (v) engage in transactions with our affiliates;
(vi) consolidate, merge or transfer all or substantially all our assets; or
(vii) change lines of business. Most of the foregoing restrictions will expire
if the 10.75% Original Notes have been rated as investment grade securities by
either S & P or Moody's. The 10.75% Original Notes are unsecured and rank
equally with all other unsecured senior indebtedness of CNC. Proceeds from the
offering of approximately $385.9 million (after underwriting discounts and
estimated offering expenses) were used to reduce amounts outstanding under our
credit facilities. As a result, we recognized an extraordinary charge of $.4
million (net of an income tax benefit of $.2 million) in 2001.
During 2002, we repurchased: (i) $76.4 million par value of the 8.5%
Original Notes (resulting in an extraordinary gain of $1.7 million); and (ii)
$1.0 million of the 6.4% Original Notes (resulting in an extraordinary gain of
$.2 million).
During 2001, we repurchased: (i) $64.6 million par value of the 7.6%
senior notes due June 2001 (resulting in an extraordinary gain of $.3 million,
net of income taxes of $.2 million); and (ii) $147.7 million par value of the
8.5% Original Notes (resulting in an
131
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
extraordinary gain of $15.8 million, net of income taxes of $8.5 million).
Pursuant to the terms of the Mandatory Par Put Remarketed Securities, the
Company elected to redeem the notes at a redemption price defined in the
remarketing agreement. As a result, the Company recognized an extraordinary
charge of $4.6 million (net of an income tax benefit of $2.5 million) in the
second quarter of 2001.
During 2000, we repurchased: (i) $18.5 million par value of the 7.875
percent notes due 2000 for $16.7 million; and (ii) $12 million par value of the
8.75% Original Notes for $8.7 million. We recognized an extraordinary gain of
$3.2 million (net of income taxes of $1.7 million) related to these repurchases.
In addition, during 2000, the Company repurchased $250 million of notes payable
due 2003. We recognized an extraordinary loss of $4.9 million (net of an income
tax benefit of $2.6 million) related to this repurchase.
9. OTHER DISCLOSURES:
Leases
The Company rents office space, equipment and computer software under
noncancellable operating leases. Rental expense was $41.5 million in 2002, $45.3
million in 2001 and $42.4 million in 2000. Future required minimum rental
payments as of December 31, 2002, were as follows (dollars in millions):
2003 ...................................................................... $ 33.5
2004 ...................................................................... 19.5
2005 ...................................................................... 15.9
2006 ...................................................................... 11.2
2007 ...................................................................... 9.5
Thereafter................................................................... 10.8
------
Total................................................................ $100.4
======
Postretirement Plans
One of our insurance subsidiaries has a noncontributory, unfunded
deferred compensation plan for qualifying members of its career agency force.
Benefits are based on years of service and career earnings. The liability
recognized in the consolidated balance sheet for the agents' deferred
compensation plan was $54.2 million and $48.4 million at December 31, 2002 and
2001, respectively. Included as an adjustment to accumulated other comprehensive
income (loss) is a $9.1 million adjustment representing the additional minimum
liability associated with this plan. Substantially all of this liability
represents vested benefits. Costs incurred on this plan, primarily representing
interest on unfunded benefit costs, were $5.1 million, $4.9 million and $4.4
million during 2002, 2001 and 2000, respectively.
132
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The Company provides certain health care and life insurance benefits for
certain eligible retired employees under partially funded and unfunded plans in
existence at the date on which certain subsidiaries were acquired. Certain
postretirement benefit plans are contributory, with participants' contributions
adjusted annually. Amounts related to the postretirement benefit plans were as
follows:
Postretirement
benefits
--------------
2002 2001
---- ----
(Dollars in millions)
Benefit obligation, beginning of year........................................ $ 24.5 $ 21.1
Interest cost............................................................ 1.6 1.5
Plan participants' contributions......................................... 1.1 1.1
Actuarial loss (gain).................................................... .4 3.1
Benefits paid............................................................ (3.0) (2.3)
------ ------
Benefit obligation, end of year.............................................. $ 24.6 $ 24.5
====== ======
Fair value of plan assets, beginning of year................................. $ 2.0 $ 3.0
Actual return on plan assets............................................. - .3
Employer contributions................................................... 2.1 1.0
Benefits paid............................................................ (3.0) (2.3)
------ ------
Fair value of plan assets, end of year....................................... $ 1.1 $ 2.0
====== ======
Funded status................................................................ $(23.5) $(22.5)
Unrecognized net actuarial loss (gain)....................................... (7.1) (7.6)
Unrecognized prior service cost.............................................. (1.4) (1.6)
------ ------
Prepaid (accrued) benefit cost........................................ $(32.0) $(31.7)
====== ======
We used the following weighted average assumptions to calculate benefit
obligations for our 2002 and 2001 valuations: discount rate of approximately 6.5
percent and 7.0 percent, respectively; an expected return on plan assets of
approximately 4.6 percent and 4.6 percent, respectively. Beginning in 2000, as a
result of plan amendments, no assumption for compensation increases was
required. For measurement purposes, we assumed an 11.5 percent annual rate of
increase in the per capita cost of covered health care benefits for 2003,
decreasing gradually to 5 percent in 2015 and remaining level thereafter.
Components of the cost we recognized related to postretirement plans were
as follows:
Postretirement
benefits
-----------------------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
Interest cost........................................................................ $1.6 $ 1.5 $1.5
Expected return of plan assets....................................................... (.1) (.1) (.2)
Amortization of prior service cost................................................... (.2) (1.0) (.9)
Recognized net actuarial loss........................................................ (.5) (.1) -
---- ----- ----
Net periodic cost (benefit)................................................... $ .8 $ .3 $ .4
==== ===== ====
A one-percentage-point change in the assumed health care cost trend rates
would have an insignificant effect on the net periodic benefit cost of our
postretirement benefit obligation.
The Company has qualified defined contribution plans for which
substantially all employees are eligible. Company contributions, which match
certain voluntary employee contributions to the plan, totaled $6.6 million in
2002, $4.7 million in 2001, and $9.1 million in 2000. Prior to 2002, employer
matching contributions were made in CNC common stock. For the first nine months
of 2002, employer matching
133
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
contributions were made in cash. In September 2002, the plans were amended to
make future employer matching contributions discretionary. Subsequently, the
Company determined that no additional employer matching contributions will be
made until the Plan of Reorganization has been confirmed.
Litigation
As described in the note to the consolidated financial statements
entitled "Proceedings under Chapter 11 of the Bankruptcy Code", CNC and several
of its subsidiaries filed voluntary petitions for reorganization under Chapter
11 of the Bankruptcy Code in the Bankruptcy Court. The Company's insurance
subsidiaries and other subsidiaries who did not file petitions are separate
legal entities and are not included in the petitions filed by the parent. The
Debtors retain control of the insurance subsidiaries and related subsidiaries
and are authorized to operate these businesses as debtors-in-possession while
being subject to the jurisdiction of the Bankruptcy Court. The Finance Company
Debtors filed a separate plan in connection with their Chapter 11 Cases on April
2, 2003. As of the Petition Date, pending litigation against the Debtors or the
Finance Company Debtors is stayed, and absent further order of the Bankruptcy
Court, substantially all prepetition liabilities of the Debtors and the Finance
Company Debtors are subject to settlement under a plan of reorganization. Based
on the Plan of the Debtors, liabilities subject to compromise exceed the fair
value of the Debtors' assets, and unsecured claims will be satisfied at less
than 100 percent of their fair value.
We and our subsidiaries are involved on an ongoing basis in lawsuits
(including purported class actions) relating to our operations, including with
respect to sales practices, and we and current and former officers and directors
are defendants in pending class action lawsuits asserting claims under the
securities laws and derivative lawsuits. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
Legal Proceedings Related to CFC Only
CFC was served with various related lawsuits filed in the United States
District Court for the District of Minnesota. These lawsuits were generally
filed as purported class actions on behalf of persons or entities who purchased
common stock or options to purchase common stock of CFC during alleged class
periods that generally run from July 1995 to January 1998. One action (Florida
State Board of Admin. v. Green Tree Financial Corp., et. al, Case No. 98-1162)
was brought not on behalf of a class, but by the Florida State Board of
Administration, which invests and reinvests retirement funds for the benefit of
state employees. In addition to CFC, certain former officers and directors of
CFC are named as defendants in one or more of the lawsuits. CFC and other
defendants obtained an order consolidating the lawsuits seeking class action
status into two actions, one of which pertains to a purported class of common
stockholders (In re Green Tree Financial Corp. Stock Litig., Case No. 97-2666)
and the other of which pertains to a purported class of stock option traders (In
re Green Tree Financial Corp. Options Litig., Case No. 97-2679). Plaintiffs in
the lawsuits assert claims under Sections 10(b) (and Rule 10b-5 promulgated
thereunder) and 20(a) of the Securities Exchange Act of 1934. In each case,
plaintiffs allege that CFC and the other defendants violated federal securities
laws by, among other things, making false and misleading statements about the
current state and future prospects of CFC (particularly with respect to
prepayment assumptions and performance of certain loan portfolios of CFC), which
allegedly rendered CFC's financial statements false and misleading. On August
24, 1999, the United States District Court for the District of Minnesota issued
an order dismissing with prejudice all claims alleged in the lawsuits. The
plaintiffs subsequently appealed the decision to the U.S. Court of Appeals for
the 8th Circuit. A three judge panel issued an opinion on October 25, 2001,
reversing the United States District Court's dismissal order and remanding the
actions to the United States District Court. The parties to these lawsuits have
entered into a stipulation of settlement, which is subject only to review and
approval by the court.
CFC is a defendant in two arbitration proceedings in South Carolina
(Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp. and
Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp.) where
the arbitrator, over CFC's objection, allowed the plaintiffs to pursue purported
class action claims in arbitration. The two purported arbitration classes
consist of South Carolina residents who obtained real estate secured credit from
CFC's Manufactured Housing Division (Lackey) and Home Improvement Division
(Bazzle) in the early and mid 1990s, and did not receive a South Carolina
specific disclosure form relating to selection of attorneys and insurance agents
in connection with the credit transactions. The arbitrator, in separate awards
issued on July 24, 2000, awarded a total of $26.8 million in penalties and
attorneys' fees. The awards were confirmed as judgments in both Lackey and
Bazzle. These cases were consolidated into one case, and CFC appealed them to
the South Carolina Supreme Court. Oral argument was heard on March 21, 2002. On
August 26, 2002 the South Carolina Supreme Court affirmed the arbitration
judgments, and CFC filed a petition for writ of certiorari with the U.S. Supreme
Court on October 23, 2002. CFC's petition was granted in January 2003, and the
U.S. Supreme Court will hear oral argument on April 22, 2003. CFC has posted
appellate bonds, including $23 million of cash, for these cases. CFC intends to
challenge the awards vigorously and believes that the arbitrator erred by, among
other things, conducting class action arbitrations without the authority to do
so. The ultimate outcome of this proceeding
134
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
cannot be predicted with certainty.
Securities Litigation
A total of forty-five suits were filed in 2000 against CNC in the United
States District Court for the Southern District of Indiana. Nineteen of these
cases were putative class actions on behalf of persons or entities that
purchased CNC's common stock during alleged class periods that generally run
from April 1999 through April 2000. Two cases were putative class actions on
behalf of persons or entities that purchased CNC's bonds during the same alleged
class periods. Three cases were putative class actions on behalf of persons or
entities that purchased or sold option contracts, not issued by CNC, on CNC's
common stock during the same alleged class periods. One case was a putative
class action on behalf of persons or entities that purchased CNC's "FELINE
PRIDES" convertible preferred stock instruments during the same alleged class
periods. With four exceptions, in each of these twenty-five cases two former
officers/directors of CNC were named as defendants. In each case, the plaintiffs
asserted claims under Sections 10(b) (and Rule 10b-5 promulgated thereunder) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs alleged
that CNC and the individual defendants violated the federal securities laws by,
among other things, making false and misleading statements about the current
state and future prospects of CFC (particularly with respect to performance of
certain loan portfolios of CFC) which allegedly rendered CNC's financial
statements false and misleading.
Eleven of the cases in the United States District Court for the Southern
District of Indiana were filed as purported class actions on behalf of persons
or entities that purchased preferred securities issued by various Conseco
Financing Trusts, including Conseco Financing Trust V, Conseco Financing Trust
VI, and Conseco Financing Trust VII. Each of these complaints named as
defendants CNC, the relevant trust (with two exceptions), two former
officers/directors of CNC, and underwriters for the particular issuance (with
one exception). One complaint also named an officer and all of CNC's directors
at the time of issuance of the preferred securities by Conseco Financing Trust
VII. In each case, plaintiffs asserted claims under Section 11 and Section 15 of
the Securities Act of 1933, and eight complaints also asserted claims under
Section 12(a)(2) of that Act. Two complaints also asserted claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and one complaint also
asserted a claim under Section 10(b) of that Act. In each case, plaintiffs
alleged that the defendants violated the federal securities laws by, among other
things, making false and misleading statements in Prospectuses and/or
Registration Statements related to the issuance of preferred securities by the
Trust involved regarding the current state and future prospects of CFC
(particularly with respect to performance of certain loan portfolios of CFC)
which allegedly rendered the disclosure documents false and misleading.
All of the CNC securities cases were consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Securities Litigation", Case number IP00-C585-Y/S (the
"securities litigation"). An amended complaint was filed on January 12, 2001,
which asserted claims under Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933,
with respect to common stock and various other securities issued by CNC and
Conseco Financing Trust VII. The Company filed a motion to dismiss the amended
complaint on April 27, 2001. On January 10, 2002, CNC entered into a Memorandum
of Understanding (the "MOU") to settle the litigation for $120 million subject
to court approval. Under the MOU, as amended on February 12, 2002, $106 million
was required to be placed in escrow by March 8, 2002; the remaining $14 million
was to be paid in two installments: $6 million by April 1, 2002, and $8 million
by October 1, 2002 (all payments with interest from January 25, 2002). The $106
million due on March 8, 2002, was not paid, for reasons set forth in the
following paragraph, and the MOU was terminated by the plaintiffs. On April 15,
2002, a new MOU was executed (the "April 15 MOU"). Pursuant to the April 15 MOU,
$95 million was funded on April 25, 2002, with the remaining $25 million to
await the outcome of the coverage litigation between CNC and certain of its
directors' and officers' liability insurance carriers as described in the next
paragraph. Court approval of the settlement was received on August 7, 2002.
We maintained certain directors' and officers' liability insurance that
was in force at the time the Indiana securities and derivative litigation (the
derivative litigation is described below) was commenced and which, in our view,
applies to the claims asserted in that litigation. The insurers denied coverage
for those claims, so we commenced a lawsuit against them on June 13, 2001, in
Marion County Circuit Court in Indianapolis, Indiana (Conseco, Inc., et al. v.
National Union Fire Insurance Company of Pittsburgh, PA, Royal & SunAlliance,
Westchester Fire Insurance Company, RLI Insurance Company, Greenwich Insurance
Company and Certain Underwriters at Lloyd's of London, Case No.
49C010106CP001467) (the "coverage litigation") seeking, among other things, a
judicial declaration that coverage for those claims exists. The primary
insurance carrier, National Union Fire Insurance Co. of Pittsburgh, PA, has paid
its full $10 million in policy proceeds toward the settlement of the securities
litigation; in return, National Union has been released from the coverage
litigation. The first excess insurance carrier, Royal & SunAlliance ("Royal"),
has paid its full $15 million in policy proceeds toward the settlement, but
reserved rights to continue to litigate coverage. Royal subsequently asserted
counterclaims seeking repayment of the $15 million it previously provided to CNC
as part of the
135
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
settlement. The second excess insurance carrier, Westchester Fire
Insurance Company, has paid its full $15 million in policy proceeds toward the
settlement without a reservation of rights and has been released from the
coverage litigation. The third excess insurance carrier, RLI Insurance Company
("RLI"), has paid its full $10 million in policy proceeds toward the settlement,
but initially reserved rights to continue to litigate coverage. RLI has
subsequently settled (for $50,000 paid by certain of the individual insureds as
partial payment of RLI's attorneys' fees incurred in the coverage litigation),
and RLI is no longer continuing to dispute coverage. The fourth excess insurance
carrier, Greenwich Insurance Company ("Greenwich"), has paid its full $25
million in policy proceeds toward the settlement without a reservation of rights
and has been released from the coverage litigation. The final excess carrier,
Certain Underwriters at Lloyd's of London ("Lloyd's"), refused to pay or to
escrow its $25 million in policy proceeds toward the settlement and is
continuing to litigate coverage. Under the April 15 MOU, the settlement of the
securities litigation will proceed notwithstanding the continuing coverage
litigation between CNC, Royal and Lloyd's. Since the United States District
Court for the Southern District of Indiana has approved the settlement of the
securities litigation prior to resolution of the coverage litigation, $90
million plus accrued interest is available for distribution to the putative
class. The remaining funds, with interest, will be distributed at the conclusion
of the coverage litigation (or, in the case of the $25 million at issue in the
litigation with Lloyd's, on December 31, 2005, if the litigation with Lloyd's
has not been resolved by that date), with such funds coming either from Lloyd's
(if CNC prevails in the coverage litigation) or from CNC (if CNC does not
prevail). We intend to pursue our coverage rights vigorously. Because the
directors' and officers' liability insurance that was in force at the time the
litigation commenced provides for coverage of $100 million, CNC believes its
exposure in the litigation should be $20 million (i.e., the excess of the $100
million in coverage). CNC believes that the insurance applies to the claims in
the securities litigation and that the two insurers who are continuing to
litigate the coverage issue were obligated to pay their policy limits to fund
the settlement, as the other four carriers have done. We recorded $20 million as
our best estimate of a probable loss in 2001. Such amount has been placed in
escrow. We also previously established the estimated remaining liability of $40
million and a claim receivable of $40 million. Such amount includes: (i) $15
million related to Royal who paid its portion of the settlement into a fund but
reserved its rights to continue to litigate coverage (which litigation is
proceeding); and (ii) $25 million related to Lloyd's who has refused to pay.
Following the filing of our Chapter 11 Case, the trial court granted Lloyd's
motion to dismiss our lawsuit resulting in our decision to establish an
allowance for the entire $40 million claim receivable CNC believes is due from
Royal and Lloyd's. We intend to appeal the decision to dismiss in part because
we believe the decision violates the stay in the Chapter 11 Case. CNC believes
that the coverage litigation should result in a determination that the insurer
that paid under a reservation of rights has no right to recoup the payment that
it made, and that the insurer that refused to pay is obligated to do so under
its policy. We believe the latter insurer should pay its portion of the coverage
once such determination is made. The ultimate outcome cannot be predicted with
certainty. CNC is also pursuing settlement discussions with Royal and Lloyd's.
In the event that CNC does not reach settlement and does not prevail in the
coverage litigation, it will seek to subordinate the securities plaintiffs'
claims under section 510 of the Bankruptcy Code, or disallow such claims under
sections 502(d) and 547 of the Bankruptcy Code, in which case CNC may not be
required to pay the portion of the settlement not covered by its directors' and
officers' liability insurance. CNC has asked the Bankruptcy Court to stay the
Indiana state court action, and the Bankruptcy Court is scheduled to hear that
motion on May 19, 2003.
Since we announced our intention to restructure our capital on August 9,
2002, a total of eight purported securities fraud class action lawsuits have
been filed in the United States District Court for the Southern District of
Indiana. The complaints name CNC as a defendant, along with certain current and
former officers of CNC. These lawsuits were filed on behalf of persons or
entities who purchased CNC's common stock on various dates between October 24,
2001 and August 9, 2002. In each case Plaintiffs allege claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and allege material
omissions and dissemination of materially misleading statements regarding, among
other things, the liquidity of CNC and alleged problems in CFC's manufactured
housing division, allegedly resulting in the artificial inflation of CNC's stock
price. Plaintiffs in one of these lawsuits have filed an uncontested
consolidation and lead plaintiff motion, which, if granted, would result in the
consolidation of these eight cases into one. On March 13, 2003, all of these
cases were consolidated into one case in the United States District Court for
the Southern District of Indiana, captioned "Franz Schleicher, et al. v.
Conseco, Inc., et al.," File No. 02-CV-1332 DFH-TAB. CNC believes these lawsuits
are without merit and intends to defend them vigorously. The ultimate outcome of
these lawsuits cannot be predicted with certainty. CNC has filed an adversary
proceeding to extend the automatic stay provided for by the Bankruptcy Code to
this litigation as it pertains to current and former officers and directors of
CNC.
In October 2002, Roderick Russell, on behalf of himself and a class of
persons similarly situated, and on behalf of the ConsecoSave Plan filed an
action in the United States District Court for the Southern District of Indiana
against CNC, Conseco Services LLC and certain current and former officers of CNC
(Roderick Russell, et al. v Conseco, Inc., et al., Case No. 1:02-CV-1639 LJM).
The purported class action consists of all individuals whose 401(k) accounts
held common stock of CNC at any time from April 28, 1999 through the present.
The complaint alleges, among other things, breaches of fiduciary duties under
ERISA by continuing to permit employees to invest in CNC's common stock without
full disclosure of the Company's true financial condition. CNC believes
136
the lawsuit is without merit and intends to defend it vigorously. The ultimate
outcome of the lawsuit cannot be predicted with certainty. CNC has filed an
adversary proceeding to extend the automatic stay provided for by the Bankruptcy
Code to this litigation as it pertains to current and former officers and
directors of CNC.
Derivative Litigation
Nine shareholder derivative suits were filed in 2000 in the United States
District Court for the Southern District of Indiana. The complaints named as
defendants the current directors, certain former directors, certain non-director
officers of CNC (in one case), and, alleging aiding and abetting liability,
certain banks that allegedly made loans in relation to CNC's "Stock Purchase
Plan" (in three cases). CNC is also named as a nominal defendant in each
complaint. Plaintiffs allege that the defendants breached their fiduciary duties
by, among other things, intentionally disseminating false and misleading
statements concerning the acquisition, performance and proposed sale of CFC, and
engaged in corporate waste by causing CNC to guarantee loans that certain
officers, directors and key employees of CNC used to purchase stock under the
Stock Purchase Plan. These cases have now been consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Derivative Litigation", Case Number IP00655-C-Y/S. An
amended complaint was filed on April 12, 2001, making generally the same
allegations and allegations of violation of the Federal Reserve Board's margin
rules. Three similar cases have been filed in the Hamilton County Superior Court
in Indiana. Schweitzer v. Hilbert, et al., Case No. 29D01-0004CP251; Evans v.
Hilbert, et al., Case No. 29D01-0005CP308 (both Schweitzer and Evans name as
defendants certain non-director officers); Gintel v. Hilbert, et al., Case No.
29003-0006CP393 (naming as defendants, and alleging aiding and abetting
liability as to, banks that allegedly made loans in relation to the Stock
Purchase Plan). CNC believes that these lawsuits are without merit and intends
to defend them vigorously. The cases filed in Hamilton County have been stayed
pending resolution of the derivative suits filed in the United States District
Court. CNC asserts that these lawsuits are assets of the estate pursuant to
section 541(a) of the Bankruptcy Code and does not currently intend to pursue
them postpetition because they are meritless. The ultimate outcome of these
lawsuits cannot be predicted with certainty.
Other Litigation
On January 15, 2002, Carmel Fifth, LLC ("Carmel"), an indirect,
wholly-owned subsidiary of CNC, exercised its rights to require 767 Manager, LLC
("Manager"), an affiliate of Donald J. Trump, to elect within 60 days, either to
acquire Carmel's interests in 767 LLC for $499.4 million, or to sell its
interests in 767 LLC to Carmel for $15.6 million (the "Buy/Sell Right"). Such
rights were exercised pursuant to the Limited Liability Company Agreement of 767
LLC. 767 LLC is a Delaware limited liability company that indirectly owns the
General Motors Building, a 50-story office building in New York, New York (the
"GM Building"). 767 LLC is owned by Carmel and Manager. On February 6, 2002, Mr.
Trump commenced a civil action against CNC, Carmel and 767 LLC in New York State
Supreme Court, entitled Donald J. Trump v. Conseco, Inc., et al. (the "State
Court Action"). Plaintiff claims that CNC and Carmel breached an agreement,
dated July 3, 2001, to sell Carmel's interests to plaintiff for $295 million on
or before September 15, 2001 (the "July 3rd Agreement"). Specifically, plaintiff
claims that CNC and Carmel improperly refused to accept a reasonable guaranty of
plaintiff's payment obligations, refused to complete the sale of Carmel's
interest before the September 15, 2001 deadline, repudiated an oral promise to
extend the September 15 deadline indefinitely and repudiated the July 3rd
Agreement by exercising Carmel's Buy/Sell Right. Plaintiff asserts claims for
breach of contract, breach of the implied covenant of good faith and fair
dealing, promissory estoppel, unjust enrichment and breach of fiduciary duty.
Plaintiff is seeking compensatory and punitive damages of approximately $1
billion and declaratory and injunctive relief blocking Carmel's Buy/Sell Right.
On March 25, 2002, Carmel filed a Demand for Arbitration and Petition and
Statement of Claim with the American Arbitration Association ("AAA") to have the
issues relating to the Buy/Sell Right resolved by arbitration (the
"Arbitration"). Manager and Mr. Trump requested the New York State Supreme Court
to stay that arbitration, but the Court denied Manager's and Trump's request on
May 2, 2002, allowing the arbitration to proceed. In addition, CNC and Carmel
filed a Motion to Dismiss Mr. Trump's lawsuit on March 25, 2002. By Stipulation
and Order, dated June 14, 2002, the State Court Action was stayed, pending
resolution of the Arbitration. CNC plans to vigorously pursue its options to
compel prompt resolution of this dispute. CNC believes that Mr. Trump's lawsuit
is without merit and intends to vigorously pursue its own rights to acquire the
GM Building. The ultimate outcome cannot be predicted with certainty. On
February 21, 2003, the Trump entities filed a proof of claim asserting a general
unsecured claim of $1 billion against CNC. On March 3, 2003, CNC and Carmel
Fifth initiated an adversary proceeding against the Trump entities. CNC and
Carmel Fifth's adversary complaint seeks declaratory and injunctive relief
against the Trump entities. CNC and Carmel Fifth's adversary action requests
that the court find (1) that the July 3rd Agreement terminated due to Trump's
failure to comply with the terms of that agreement, and (2) that the Trump
entities are required to convey their interest in 767 LLC to Carmel Fifth
pursuant to Carmel Fifth's rights under the LLC Agreement. On March 5, 2003, CNC
and Carmel Fifth, in the adversary proceeding, filed an emergency motion for
preliminary injunction and an emergency motion for expedited hearing. Through
those motions, CNC and Carmel Fifth sought: an accelerated schedule for
resolution of their claims against the Trump entities, removal of Mr. Trump from
management of the GM Building, and
137
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
an order restraining Mr. Trump and the Trump entities from interference with CNC
and Carmel Fifth's efforts to market the GM Building. The Bankruptcy Court has
assumed jurisdiction of the matters related to the July 3rd Agreement and has
denied jurisdiction with respect to Carmel Fifth's rights under the LLC
Agreement and ordered that the arbitration of the LLC Agreement matters be
completed or nearly completed by May 19, 2003. After such time, the Bankruptcy
Court will set the July 3rd Agreement matters for trial. In connection with the
Bankruptcy Court's ruling on the jurisdictional issues, the parties stipulated
that they would appear before the Bankruptcy Court to provide updates with
respect to the pending arbitration in order to keep the arbitration process on
schedule for resolution or near resolution by May 19, 2003. The Court also
ordered the Trump entities to stipulate that they would take no actions that
would delay completion or near completion of arbitration by May 19, 2003.
On June 24, 2002, the heirs of a former officer, Lawrence Inlow,
commenced an action against CNC, Conseco Services, LLC, and two former officers
in the Boone Circuit Court (Inlow et al. v. Conseco, Inc., et al., Cause No.
06C01-0206-CT-244). The heirs assert that unvested options to purchase 756,248
shares of CNC common stock should have been vested at Mr. Inlow's death. The
heirs further claim that if such options had been vested, they would have been
exercised, and that the resulting shares of common stock would have been sold
for a gain of approximately $30 million based upon a stock price of $58.125 per
share, the highest stock price during the alleged exercise period of the
options. CNC believes the heirs' claims are without merit and will defend the
action vigorously. The maximum exposure to the Company for this lawsuit is
estimated to be $33 million. The ultimate outcome cannot be predicted with
certainty.
CNC is also a party to litigation related to the death of Lawrence Inlow
with the manufacturer of a corporate helicopter and other parties. This
litigation was consolidated in the United States District Court for the Southern
District of Indiana (In re: Inlow Accident Litigation, Cause No.
IP99-0830-C-H/G) and is currently on appeal to the Seventh Circuit Court of
Appeals. The maximum exposure for this litigation is estimated to be $25
million, although CNC believes that the claims against it are without merit. The
ultimate outcome cannot be predicted with certainty. CNC is also party to
litigation with Associated Aviation Underwriters, Inc. in Hamilton County
Superior Court (Associated Aviation Underwriters, Inc. v. Conseco Inc., et al,
Cause No. 29C01-9909-CP588) relating to Associated Aviation Underwriters'
obligation to defend and/or indemnify CNC in the aforementioned litigation. If
CNC prevails in this lawsuit, Associated Underwriters may be obligated to
indemnify CNC for all or part of its liability in the aforementioned litigation.
This litigation has been stayed until final judgments are rendered in the former
litigation.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other lawsuits and arbitrations (including purported class actions)
related to their operations. These actions include one action brought by the
Texas Attorney General regarding long-term care policies, two purported
nationwide class actions involving claims related to "vanishing premiums," and
two purported nationwide class actions involving claims related to "modal
premiums" (the alleged imposition and collection of insurance premium surcharges
in excess of stated annual premiums. The ultimate outcome of all of these other
legal matters pending against the Company or its subsidiaries cannot be
predicted, and, although such lawsuits are not expected individually to have a
material adverse effect on the Company, such lawsuits could have, in the
aggregate, a material adverse effect on the Company's consolidated financial
condition, cash flows or results of operations.
Other Proceedings
The Company has been notified that the staff of the SEC has obtained a
formal order of investigation in connection with an inquiry that relates to
events in and before the spring of 2000, including CFC's accounting for its
interest-only securities and servicing rights. These issues were among those
addressed in the Company's write-down and restatement in the spring of 2000, and
were the subject of shareholder class action litigation, which has recently been
settled as described above. The Company is cooperating with the SEC staff in
this matter.
The Company has been notified that the Alabama Securities Commission is
examining the Company's 1998 Directors/Officers & Key Employees Stock Purchase
Program and the 2000 Employee Stock Purchase Program Work-Down Plan. The Company
is cooperating with the Commission's staff in this matter.
Guaranty Fund Assessments
The balance sheet at December 31, 2002, includes: (i) accruals of $11.5
million, representing our estimate of all known assessments that will be levied
against the Company's insurance subsidiaries by various state guaranty
associations based on premiums written through December 31, 2002; and (ii)
receivables of $7.5 million that we estimate will be recovered through a
reduction in future premium taxes as a result of such assessments. At December
31, 2001, such guaranty fund assessment related accruals were $18.7
138
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
million and such receivables were $8.0 million. These estimates are subject to
change when the associations determine more precisely the losses that have
occurred and how such losses will be allocated among the insurance companies. We
recognized expense (benefit) for such assessments of $(1.7) million in 2002,
$6.5 million in 2001 and $7.6 million in 2000.
Guarantees
We have guaranteed D&O loans totaling $481.3 million. As previously
described, Conseco has defaulted on certain notes, which has resulted in the
immediate maturity of the D&O loans through cross-acceleration and cross-default
provisions contained in the governing instruments. The proceeds of the bank
loans were used by the participants to purchase approximately 18.0 million
shares of Conseco common stock in open market or negotiated transactions with
independent parties. Such shares have been held by the D&O lenders as collateral
for the loans. In addition, Conseco has provided loans to participants for
interest on the D&O loans totaling $179.2 million.
The Company is exploring a number of alternatives to reduce the balance
of certain participants' D&O loans. The plan currently being considered would
reduce the D&O loan balance of certain participants who collectively owe less
than 10 percent of the entire amount due under the stock purchase program.
Conseco also granted a security interest in most of its assets in conjunction
with the guarantee of a portion of the bank loans. In 2002, 2001, and 2000, we
established a noncash provision in connection with these guarantees and loans of
$240.0 million, $169.6 million and $231.5 million, respectively. Such provision
is included as a component of the provision for losses. At December 31, 2002,
the reserve for losses on the loan guarantees and on the loans held by Conseco
totaled $660.0 million. During 2002, Conseco purchased $55.5 million of loans
from the banks utilizing cash held in a segregated cash account as collateral
for our guarantee of the bank loans (including accrued interest, the balance on
these loans was $56.7 million at December 31, 2002). At December 31, 2002, the
guaranteed bank loans and interest loans exceeded the value of the collateral
held and the reserve for losses by approximately $50 million. All participants
have agreed to indemnify Conseco for any loss incurred on their loans. We
regularly evaluate these guarantees and loans in light of the collateral and the
creditworthiness of the participants.
CIHC is the guarantor of an aggregate principal amount of $125 million with
respect to CFC's residual and warehouse lines of credit with Lehman Brothers,
Inc. and its affiliates ("Lehman"). Such facilities are collectively referred to
as the "CFC Lehman Facilities". In addition, CIHC is the guarantor of: (i) the
term portion of the Secured Super-Priority Debtor in Possession Credit
Agreement, dated as of December 19, 2002, among CFC, various subsidiaries of
CFC, CIHC and FPS DIP, LLC (the "FPS DIP"); and (ii) a cash management facility
with U.S. Bank National Association (the "U.S. Bank Facility"). The term portion
of the FPS DIP provides for funding in a maximum aggregate amount of $60 million
and is fully drawn. The guarantee obligations of CIHC under the FPS DIP and the
U.S. Bank Facility are limited to an aggregate of $125 million. The December 31,
2002 balances outstanding on the CFC Lehman Facilities and CFC's
debtor-in-possession facility are included in the caption "Liabilities of
discontinued operations" in the liability section of the consolidated balance
sheet. Also, see the note to the consolidated financial statement entitled
"Financial Information Regarding CFC." Assuming the sale of CFC's assets is
completed and CFC receives the proceeds from the sale of such assets as
contemplated by the CFN and GE transactions, Conseco believes the proceeds will
be sufficient to satisfy CFC's obligations pursuant to the Lehman and CFC's
debtor-in-possession facility and all claims senior to such facilities. CFC's
unsecured creditors have indicated that they intend to challenge Lehman's
security position and otherwise attempt to prevent Lehman from being paid in
full out of the proceeds from the sale of CFC's assets. If Lehman were not paid
in full from the proceeds, Lehman would likely pursue its claim on the CIHC
guarantee which, if successful, could impact the ability of the Debtors to
complete their proposed Plan.
In accordance with the terms of the Company's former Chief Executive
Officer's employment agreement, Bankers Life & Casualty Company, a wholly-owned
subsidiary of the Company, is the guarantor of the former executive's
nonqualified supplemental retirement benefit. The liability for such benefit at
December 31, 2002 was $14.8 million and is included in the caption "Other
liabilities" in the liability section of the consolidated balance sheet.
Trust Preferred Securities
Certain wholly-owned subsidiary trusts have issued preferred securities
in public offerings. The trusts used the proceeds from these offerings to
purchase subordinated debentures from Conseco. The terms of the preferred
securities parallel the terms of the debentures, which account for substantially
all trust assets. The preferred securities are to be redeemed on a pro rata
basis, to the same extent as the debentures are repaid. Under certain
circumstances involving a change in law or legal interpretation, the debentures
may be distributed to the holders of the preferred securities. Our obligations
under the debentures and related agreements, taken together, provide a full and
unconditional guarantee of payments due on the preferred securities. The
debentures issued to the subsidiary trusts
139
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
and the common securities purchased by Conseco from the subsidiary trusts are
eliminated in the consolidated financial statements.
On February 16, 2001, the trust preferred securities component of the
FELINE PRIDES were retained by the Company (and subsequently retired) as payment
under the stock purchase contract in accordance with their terms and, as a
result, we issued 11.4 million shares of Conseco common stock to the holders of
the FELINE PRIDES. The $496.6 million carrying value of the FELINE PRIDES that
were retired (and used for payment pursuant to the stock purchase contracts) was
transferred from minority interest to common stock and additional paid-in
capital.
In April 2000, the Company and the holder of the Redeemable Hybrid Income
Overnight Shares ("RHINOS") issued in 1999 agreed to the repurchase by the
Company of the RHINOS at their $250 million par value. The Company recognized an
extraordinary loss of $3.3 million (net of income taxes of $1.8 million) in the
second quarter of 2000 related to the redemption.
Trust Preferred Securities at December 31, 2002, were as follows:
Year Carrying Distribution Earliest/mandatory
issued Par value value rate redemption dates
------ --------- ----- ---- ----------------
(Dollars in millions)
Trust Originated Preferred Securities................ 1999 $ 300.0 $ 296.5 9.44% 2004/2029 (b)
Trust Originated Preferred Securities ............... 1998 500.0 496.9 8.70 2003/2028 (b)
Trust Originated Preferred Securities................ 1998 230.0 228.1 9.00 2003/2028 (b)
Capital Securities (a)............................... 1997 300.0 300.0 8.80 2027
Trust Originated Preferred Securities................ 1996 275.0 275.0 9.16 2001/2026 (b)
Capital Trust Pass-through Securities (a)............ 1996 325.0 325.0 8.70 2026
--------- --------
$ 1,930.0 $1,921.5
========= ========
- ---------------
(a) These securities may be redeemed anytime at: (i) the principal balance;
plus (ii) a premium equal to the excess, if any, of the sum of the
discounted present value of the remaining scheduled payments of principal
and interest using a current market interest rate over the principal
amount of securities to be redeemed.
(b) The mandatory redemption dates of these securities may be extended for up
to 19 years.
So long as no event of default under the debentures has occurred and is
continuing, Conseco has the right to defer interest payments on the subordinated
debentures for up to 20 consecutive quarters, but not beyond the maturity date
of the subordinated debentures. If Conseco defers interest payments on the
subordinated debentures, the trust will also defer distributions on the Trust
Preferred Securities. During the deferral period, distributions continue to
accumulate on the par amount plus any unpaid distributions at the stated
distribution rate. Since the third quarter of 2002, Conseco has not paid certain
interest and principal payments on its notes payable which resulted in defaults
with respect to the Trust Preferred Securities through cross-default provisions.
140
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Reclassification Adjustments Included in Comprehensive Income
The changes in unrealized appreciation (depreciation) included in
comprehensive income are net of reclassification adjustments for after-tax net
gains (losses) from the sale of investments included in net income (loss) of
approximately $545 million, $240 million and $220 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
Sale of Interest in Riverboat
In the first quarter of 2001, the Company sold its 29 percent ownership
interest in the riverboat casino in Lawrenceberg, Indiana, for $260 million. We
recognized a net gain on the sale of $192.4 million.
10. SPECIAL CHARGES
2002
The following table summarizes the special charges incurred by the
Company during 2002, which are further described in the paragraphs which follow
(dollars in millions):
Loss related to reinsurance transactions and businesses sold to raise cash..... $47.5
Costs related to debt modification and refinancing transactions................ 17.7
Other items.................................................................... 31.3
-----
Special charges before income tax benefit.................................. $96.5
=====
Loss related to reinsurance transactions and businesses sold to raise
cash
We completed various asset sales and reinsurance transactions to raise
cash which resulted in net losses of $47.5 million in 2002. Such amounts
included: (i) a loss of $39.0 million related to the reinsurance of a portion of
our life insurance business; (ii) a loss of $20.0 million associated with the
sale of Exl; partially offset by (iii) asset sales resulting in a net gain of
$11.5 million.
Costs related to debt modification and refinancing transactions
In conjunction with the various modifications to borrowing arrangements
(including the debt exchange offer completed in April 2002), we incurred costs
of $17.7 million in 2002 which are not permitted to be deferred pursuant to
GAAP.
Other items
Other items include expenses incurred: (i) as a result of the termination
of our chief financial officer; (ii) in conjunction with the transfer of certain
customer service and backroom operations to our India subsidiary; (iii) for
severance benefits; and (iv) for other items which are not individually
significant. The Company sold its India subsidiary in the fourth quarter of 2002
and has significantly reduced the customer service and backroom operations
conducted there.
141
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2001
The following table summarizes the special charges incurred by the
Company during 2001, which are further described in the paragraphs which follow
(dollars in millions):
Organizational restructuring:
Severance benefits.................................................................... $12.4
Office closings and sale of artwork................................................... 7.9
Transfer of certain customer service and backroom operations to our
India subsidiary.................................................................... 10.6
Amounts related to disputed reinsurance balances......................................... 8.5
Litigation expenses...................................................................... 23.8
Other items.............................................................................. 17.2
-----
Special charges before income tax benefit............................................. $80.4
=====
Severance benefits
During 2001, Conseco undertook several restructuring actions in an effort
to improve the Company's operations and profitability. The planned changes
included moving a significant number of jobs to India. Pursuant to GAAP, the
Company is required to recognize the costs associated with most restructuring
activities as the costs are incurred. However, costs associated with severance
benefits are required to be recognized when the costs are: (i) attributable to
employees' services that have already been rendered; (ii) relate to obligations
that accumulate; and (iii) are probable and can be reasonably estimated. Since
the severance costs associated with our planned activities met these
requirements, we recognized a charge of $12.4 million in 2001.
Office closings and sale of artwork
In conjunction with our restructuring activities, we closed certain
offices, which resulted in the abandonment of certain leasehold improvements.
Further, certain antiques and artwork, formerly displayed in the Company's
executive offices were sold. We recognized losses of $7.9 million related to
these actions in 2001.
Amounts related to disputed reinsurance balances
During 2001, we discontinued marketing certain medical insurance
products. Several reinsurers who assumed most of the risks associated with these
products disputed the reinsurance receivables due to us. We established an
allowance of $8.5 million for disputed balances that were ultimately written off
due to their uncollectibility.
Litigation expenses
Litigation expenses primarily include the cost and proposed settlement
related to our securities litigation class action lawsuit. Such lawsuit is
further discussed in the note to the consolidated financial statements entitled
"Other Disclosures".
Other items
Other items include expenses incurred: (i) for consulting fees with
respect to services provided related to various debt and organizational
restructuring transactions; (ii) pursuant to the terms of the employment
agreement for our chief executive officer; and (iii) for other items which are
not individually significant.
142
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2000
The Company incurred significant special charges during 2000, primarily
related to the restructuring of our debt, asset sales to raise cash and payments
made pursuant to employment contracts. The following table summarizes the
special charges, which are further described in the paragraphs which follow
(dollars in millions):
Advisory and professional fees related to debt restructuring................ $ 9.9
Restructuring of finance business:
Loss on sale of asset-based loans...................................... 15.2
Loss on sale of subprime automobile business........................... 71.6
Advisory fees paid to Lehman and other investment banks................ 44.0
Executive contracts:
Executive termination payment ......................................... 72.5
Chief Executive Officer signing payment................................ 45.0
Warrants issued to General Electric Company............................ 21.0
Other items................................................................. 25.8
------
Special charges before income tax benefit.......................... $305.0
======
Advisory and professional fees related to debt restructuring
During 2000, we incurred $9.9 million of non-deferrable advisory and
professional fees primarily related to the restructuring of our bank credit
facilities.
Loss on sale of asset-based loans
During the third quarter of 2000, we sold asset-based loans with a
carrying value of $63.9 million in whole loan sale transactions. We recognized a
loss of $15.2 million on these sales.
Loss on sale of subprime automobile business
During the second quarter of 2000, we sold all of the finance receivables
of our subprime automobile financing and servicing companies and terminated
their operations. We recognized a net loss on these sales of $71.6 million.
Advisory fees paid to Lehman and other investment banks
We paid Lehman $20.0 million in fees for its efforts to form an investor
group to purchase Conseco Finance. In addition, the Company paid other
investment banks and financial institutions $24.0 million in advisory fees
related to the potential sale of Conseco Finance and consultation regarding
various other transactions.
Executive Terminations
On April 28, 2000, Conseco and Stephen C. Hilbert, the Company's former
Chairman and Chief Executive Officer, entered into an agreement pursuant to
which Mr. Hilbert's employment was terminated. As contemplated by the terms of
his employment agreement, Mr. Hilbert received: (i) $72.5 million (prior to
required withholdings for taxes), an amount equal to five times his salary and
the non-discretionary bonus amount (as defined in his employment agreement) for
2000; less (ii) the amount due under a secured loan of $23 million, plus accrued
interest, made to Mr. Hilbert on April 6, 2000. Mr. Hilbert also received the
bonus of $3,375,000 payable under his employment agreement for the first quarter
of 2000. Conseco agreed to continue to treat Mr. Hilbert as though he were an
employee/participant for purposes of the guaranteed bank loans and the loans for
interest on such loans pursuant to the stock purchase program. Conseco also
entered into a consulting agreement with Mr. Hilbert pursuant to which Mr.
Hilbert agreed to provide consulting services up to an average of 25 hours per
month for a period of three years. Mr. Hilbert also agreed not to compete with
Conseco during the term of the consulting agreement. On April 27, 2000, Mr.
Hilbert was granted options to purchase an aggregate of 2,000,000 shares of
Conseco common stock at a price of $5.75 per share (the average of the high and
low sales prices on the New York Stock Exchange on such date). The options
expire on April 26, 2003.
143
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
On April 28, 2000, Conseco and Rollin M. Dick, the Company's former Chief
Financial Officer, entered into an agreement pursuant to which Mr. Dick's
employment was terminated. As contemplated by the terms of his employment
agreement, Conseco agreed to pay Mr. Dick his salary of $250,000 per year
through December 31, 2001, and he also received the bonus of $187,500 payable
under his employment agreement for the first quarter of 2000. Conseco also
agreed to continue to treat Mr. Dick as though he were an employee/participant
for purposes of the guaranteed bank loans and the loans for interest on such
loans pursuant to the stock purchase program. Conseco also entered into a
consulting agreement with Mr. Dick pursuant to which Mr. Dick agreed to provide
consulting services up to an average of 25 hours per month for a period of three
years. Mr. Dick also agreed not to compete with Conseco during the term of the
consulting agreement. On April 27, 2000, Mr. Dick was granted options to
purchase an aggregate of 600,000 shares of Conseco common stock at a price of
$5.75 per share. The options expire on April 26, 2003.
Executive Hiring
On June 28, 2000, the Company hired Gary C. Wendt as its Chief Executive
Officer. Pursuant to the terms of his employment agreement, Mr. Wendt received a
payment of $45 million (prior to required withholdings for taxes) and was
granted options to purchase an aggregate of 10,000,000 shares of Conseco common
stock at a price of $5.875 per share (the average of the high and low sales
price on the New York Stock Exchange on the date on which the substantial terms
of Mr. Wendt's employment were agreed to). The options vest over five years and
expire on June 28, 2010. The Company also issued 3,200,000 shares of restricted
stock to Mr. Wendt. The restrictions on the stock lapse if Mr. Wendt remains
employed by Conseco through June 30, 2002, or upon a "change in control" of the
Company. The value of the restricted shares ($18.8 million) was recognized as an
expense to the Company over the two year period ending June 30, 2002. In 2002,
Mr. Wendt's restricted stock agreement was amended to extend the date that the
restrictions on the stock would lapse. Prior to the date that the restrictions
would lapse, Mr. Wendt resigned his position of Chief Executive Officer
(although he remains Chairman of the Board of Conseco) and the shares were
canceled. Mr. Wendt is also being provided certain supplemental retirement,
insurance and other benefits under the terms of his employment agreement.
In conjunction with Mr. Wendt's hiring and his release from noncompete
provisions of a prior agreement, the Company issued a warrant to a subsidiary of
General Electric Company to purchase 10,500,000 shares of Conseco common stock
at a purchase price of $5.75 per share. The estimated value of the warrant
($21.0 million) was recognized as a special charge.
11. SHAREHOLDERS' EQUITY:
We are authorized to issue up to 20 million shares of preferred stock. On
December 15, 1999, we issued $500.0 million (2.6 million shares) of Series F
Preferred Stock to Thomas H. Lee Company and affiliated investors. The Series F
Preferred Stock is convertible into Conseco common stock at a common equivalent
rate of $19.25 per share. The Series F Preferred Stock pays a 4 percent
dividend, of which an amount at least equal to the common dividend will be
payable in cash, and the remainder may be paid in additional Series F shares
valued at a common equivalent rate of $19.25 per share. In September 2000, we
suspended the payment of common stock dividends and, as a result, all dividend
payments since that date have been paid in additional Series F shares (the
carrying value of such additional shares is determined based on the fair value
of the equivalent number of Conseco common shares that such shares are
convertible into as of the date the dividend is paid). The Series F Preferred
Stock ranks senior to the common stock outstanding and has a liquidation
preference of $192.50 per share plus all declared and unpaid dividends.
144
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the number of shares of common stock outstanding during the
years ended December 31, 2002, 2001 and 2000 were as follows:
2002 2001 2000
---- ---- ----
(Shares in thousands)
Balance, beginning of year.......................................................... 344,743 325,318 327,679
Stock options exercised......................................................... 6 432 95
Stock warrants exercised........................................................ - 3,327 -
Shares issued in conjunction with the acquisition of Exl........................ - 3,411 -
Shares issued pursuant to stock purchase contracts related to the
FELINE PRIDES................................................................ - 11,351 -
Shares issued under employee benefit compensation plans......................... 1,258 904 1,791
Settlement of forward contract and common stock acquired........................ - - (4,247)
------- ------- -------
Balance, end of year................................................................ 346,007 344,743 325,318
======= ======= =======
In February 2001, the Company issued 11.4 million shares of Conseco
common stock pursuant to stock purchase contracts related to the FELINE PRIDES.
This transaction is discussed in further detail in the note to the consolidated
financial statements entitled "Other Disclosures".
Dividends declared on common stock for 2000, were $.10 per common share.
No dividends were declared in 2002 or 2001.
During 1999, we sold 3.6 million shares of our common stock to an
unaffiliated party (the "Buyer"). Simultaneous with the issuance of the common
stock, we entered into a forward transaction with the Buyer to be settled at
$29.0625 per share in a method of our choosing (i.e., cash settlement, transfer
of net shares to or from the Buyer, or transfer of net cash to or from the
Buyer). We settled the contract in March 2000 by repurchasing 3.6 million shares
held by the Buyer.
Conseco's 1994 Stock and Incentive Plan authorizes the granting of
options to employees and directors of the Company to purchase up to 24 million
shares of Conseco common stock at a price not less than its market value on the
date the option is granted. In 1997, the Company adopted the 1997 Non-qualified
Stock Option Plan, which authorizes the granting of non-qualified options to
employees of the Company to purchase shares of Conseco common stock. The
aggregate number of shares of common stock for which options may be granted
under the 1997 plan, when added to all outstanding, unexpired options under the
Company's employee benefit plans, shall not exceed 20 percent of the total of
shares of common stock outstanding plus the number of shares issuable upon
conversion of any outstanding convertible security on the date of grant
(calculated in the manner set forth in the 1997 plan). The options may become
exercisable immediately or over a period of time. The 1994 plan also permits
granting of restricted stock, stock appreciation rights and certain other
awards.
145
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
A summary of the Company's stock option activity and related information
for the years ended December 31, 2002, 2001 and 2000, is presented below (shares
in thousands):
2002 2001 2000
----------------------- --------------------- ----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
------ ----- ------ ----- ------ -----
Outstanding at the beginning of year.... 40,292 $15.01 36,107 $18.38 33,750 $32.15
Options granted......................... 2,572 3.57 8,609 6.32 18,404 7.10
Exercised............................... (6) 1.51 (432) 9.88 (95) 8.15
Forfeited or terminated................. (19,338) 12.35 (3,992) 27.27 (15,952) 34.56
------- ------ -------
Outstanding at the end of the year...... 23,520 15.95 40,292 15.01 36,107 18.38
======= ====== =======
Options exercisable at year-end......... 13,593 13,591 13,905
======= ====== =======
Available for future grant.............. 52,668 34,903 34,853
======= ====== =======
The following table summarizes information about stock options
outstanding at December 31, 2002 (shares in thousands):
Options outstanding Options exercisable
---------------------------------------- ------------------------
Weighted Weighted Weighted
average average average
Range of Number remaining exercise Number exercise
exercise prices outstanding life (in years) price exercisable price
- --------------- ----------- --------------- ----- ----------- -----
$ 1.51 - 4.24................... 6,781 8.9 $ 3.70 1,432 $ 3.61
5.75 - 8.87................... 3,587 2.3 6.20 2,852 5.92
9.19 - 14.73................... 3,520 4.7 11.41 1,659 13.49
15.03 - 16.57................... 162 6.4 15.25 73 15.43
17.63 - 26.19................... 3,510 5.5 22.67 2,668 22.83
27.19 - 30.41................... 1,606 10.5 30.11 963 29.92
30.81 - 45.44................... 3,964 3.5 34.72 3,700 34.88
46.71 - 51.28................... 390 5.3 50.51 246 50.44
------ ------
23,520 13,593
====== ======
146
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We apply Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for our
stock option plans. Since the amount an employee must pay to acquire the stock
is equal to the market price of the stock on the grant date, no compensation
cost has been recognized for our stock option plans. Had compensation cost been
determined based on the fair value at the grant dates for awards granted after
January 1, 1995, consistent with the method of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation", the Company's pro
forma net income (loss) and pro forma earnings (loss) per share for the years
ended December 31, 2002, 2001 and 2000 would have been as follows:
2002 2001 2000
------------------------- ------------------------- ------------------------
As reported Pro forma As reported Pro forma As reported Pro forma
----------- --------- ----------- --------- ----------- ---------
(Dollars in millions, except per share amounts)
Net loss.............................. $(7,835.7) $(7,848.1) $(405.9) $(434.1) $(1,191.2) $(1,218.3)
Basic loss per share.................. (22.67) (22.70) (1.24) (1.32) (3.69) (3.77)
Diluted loss per share................ (22.67) (22.70) (1.24) (1.32) (3.69) (3.77)
We estimated the fair value of each option grant used to determine the
pro forma amounts summarized above using the Black-Scholes option valuation
model with the following weighted average assumptions for 2002, 2001 and 2000:
2002 Grants 2001 Grants 2000 Grants
----------- ----------- -----------
Weighted average risk-free interest rates...... 4.7% 4.8% 6.3%
Weighted average dividend yields............... 0.0% 0.0% 2.4%
Volatility factors............................. 40% 40% 40%
Weighted average expected life................. 6.4 years 6.4 years 6.1 years
Weighted average fair value per share.......... $1.73 $3.04 $2.84
At December 31, 2002, a total of 115 million shares of common stock were
reserved for issuance under stock options, stock bonus and deferred compensation
plans, Series F Preferred Stock, warrants to buy 700,000 shares of Conseco
common stock for $19.71 per share at anytime through September 29, 2006 and
warrants to buy 5,250,000 shares of Conseco common stock for $5.75 at any time
through June 2005.
At December 31, 2002, a total of 50,000 shares of restricted common
shares issued pursuant to employment agreements were outstanding. The
restrictions on such shares will expire in September 2004.
147
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
A reconciliation of net income (loss) and shares used to calculate basic
and diluted earnings per share is as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions and shares in thousands)
Net loss:
Net loss............................................................ $(7,835.7) $(405.9) $(1,191.2)
Preferred stock dividends........................................... 2.1 12.8 11.0
--------- ------- ---------
Loss applicable to common ownership for basic and diluted
earnings per share.............................................. $(7,837.8) $(418.7) $(1,202.2)
========= ======= =========
Shares:
Weighted average shares outstanding for basic and diluted earnings
per share......................................................... 345,807 338,145 325,953
======= ======= =======
There were no dilutive common stock equivalents during 2002, 2001 and
2000 because of the net loss realized by the Company.
The following summarizes the equivalent common shares for securities that
were not included in the computation of diluted earnings per share during 2002,
2001 and 2000 because doing so would have been antidilutive in the periods
presented:
2002 2001 2000
---- ---- ----
(Shares in thousands)
Equivalent common shares that were antidilutive during the period:
Stock options....................................................... 75 9,117 2,798
Employee benefit plans.............................................. 3,080 2,786 1,438
Assumed conversion of convertible preferred stock................... 28,557 27,443 26,405
Forward contract.................................................... - - 476
------ ------ ------
Antidilutive equivalent common shares............................. 31,712 39,346 31,117
====== ====== ======
148
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
12. OTHER OPERATING STATEMENT DATA:
Insurance policy income consisted of the following:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Traditional products:
Direct premiums collected......................................................... $5,100.2 $5,426.3 $5,389.3
Reinsurance assumed............................................................... 78.7 146.0 300.5
Reinsurance ceded................................................................. (327.8) (249.4) (237.2)
-------- -------- --------
Premiums collected, net of reinsurance...................................... 4,851.1 5,322.9 5,452.6
Change in unearned premiums....................................................... (19.7) 1.9 1.1
Less premiums on universal life and products
without mortality and morbidity risk which are
recorded as additions to insurance liabilities ................................ (1,792.7) (1,828.2) (1,833.5)
-------- -------- --------
Premiums on traditional products with mortality or morbidity risk,
recorded as insurance policy income...................................... 3,038.7 3,496.6 3,620.2
Fees and surrender charges on interest-sensitive products............................. 563.6 496.1 550.5
-------- -------- --------
Insurance policy income..................................................... $3,602.3 $3,992.7 $4,170.7
======== ======== ========
The five states with the largest shares of 2002 collected premiums were
Florida (8.5 percent), California (7.5 percent), Illinois (7.3 percent), Texas
(7.1 percent), and Michigan (5.3 percent). No other state accounted for more
than 5 percent of total collected premiums.
Other operating costs and expenses were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Commission expense.................................................................... $195.1 $218.6 $270.9
Salaries and wages.................................................................... 215.1 206.0 240.0
Other................................................................................. 301.9 297.6 362.0
------ ------ ------
Total other operating costs and expenses....................................... $712.1 $722.2 $872.9
====== ====== ======
149
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the cost of policies purchased were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Balance, beginning of year............................................................ $1,657.8 $1,954.8 $2,258.5
Additional acquisition expense on acquired policies............................... 11.3 12.5 14.6
Amortization...................................................................... (215.5) (242.0) (266.0)
Amounts related to fair value adjustment of actively managed fixed maturities..... (81.9) (49.0) (68.1)
Reinsurance transactions.......................................................... (73.4) - -
Net amounts related to discontinued operations ................................... (66.6) (13.9) (20.2)
Amounts related to sales of subsidiaries.......................................... (60.0) - -
Other ............................................................................ (1.7) (4.6) 36.0
-------- -------- --------
Balance, end of year.................................................................. $1,170.0 $1,657.8 $1,954.8
======== ======== ========
Based on current conditions and assumptions as to future events on all
policies inforce, the Company expects to amortize approximately 12 percent of
the December 31, 2002 balance of cost of policies purchased in 2003, 11 percent
in 2004, 9 percent in 2005, 8 percent in 2006 and 7 percent in 2007. The
discount rates used to determine the amortization of the cost of policies
purchased averaged 7 percent in 2002, 6 percent in 2001 and 7 percent in 2000.
Changes in the cost of policies produced were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Balance, beginning of year............................................................ $2,570.2 $2,480.5 $2,087.4
Additions.......................................................................... 486.0 612.8 695.6
Amortization....................................................................... (544.3) (396.3) (269.6)
Amounts related to fair value adjustment of actively managed fixed maturities...... (121.0) (28.2) 7.5
Reinsurance transactions........................................................... (134.6) - -
Net amounts related to discontinued operations..................................... (103.3) 15.0 66.8
Amounts related to sales of subsidiaries........................................... (140.8) - -
Other.............................................................................. 2.2 (113.6) (107.2)
-------- -------- --------
Balance, end of year.................................................................. $2,014.4 $2,570.2 $2,480.5
======== ======== ========
In 2001, the Company stopped renewing portions of our major medical lines
of business in several unprofitable states in accordance with the contractual
terms of the policies. As a result, we determined that approximately $77.4
million of the cost of policies produced and the cost of policies purchased
would not be recoverable. Such amount is recorded as amortization in the
accompanying statement of operations.
Policyholder redemptions of annuity and, to a lesser extent, life
products have increased in recent periods. We have experienced additional
redemptions following the downgrade of our A.M. Best financial strength rating
to "B (fair)". When redemptions are greater than our previous assumptions, we
are required to accelerate the amortization of our cost of policies produced and
cost of policies purchased to write off the balance associated with the redeemed
policies. Accordingly, amortization expense has increased. We have changed the
lapse assumptions used to determine the amortization of the cost of policies
produced and the cost of policies purchased related to certain universal life
products and our annuities to reflect our current estimates of future lapses.
For certain universal life products, we changed the ultimate lapse assumption
from: (i) a range of 6 percent to 7 percent; to (ii) a tiered assumption based
on the level of funding of the policy of a range of 2 percent to 10 percent.
Policyholder withdrawals in recent periods have exceeded our estimates. Such
withdrawals were $3,708.3 million in 2002 and $2,528.3 million in 2001.
Accordingly, we increased the expected future lapse rates on these products to
reflect our current belief that lapses on these policies will continue to be
higher than previously expected for the next several quarters. These changes
resulted in additional amortization of the cost of policies produced and the
cost of policies purchased of $203.2 million in 2002.
The cost of policies produced and the cost of policies purchased are
amortized in relation to the estimated gross profits to be earned
150
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
over the life of our annuity products. As a result of economic developments,
actual experience of our products and changes in our expectations, we changed
our investment yield assumptions used in calculating the estimated gross profits
to be earned on our annuity products. Such changes resulted in additional
amortization of the cost of policies produced and the cost of policies purchased
of $35.0 million (of which $7.2 million related to discontinued operations) and
$25.6 million in 2001 and 2000, respectively.
13. CONSOLIDATED STATEMENT OF CASH FLOWS:
The following disclosures supplement our consolidated statement of cash
flows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Non-cash items not reflected in the investing and financing activities section
of the consolidated statement of cash flows:
Issuance of common stock under stock option and employee benefit plans............. $12.7 $ 19.7 $ 5.8
Issuance of convertible preferred shares........................................... 2.1 12.8 8.4
Value of FELINE PRIDES retired and transferred from minority interest to
common stock and additional paid-in capital...................................... - 496.6 -
Issuance of common stock in connection with the acquisition of Exl................. - 52.1 -
Decrease in notes payable-direct corporate obligations and increase in other
liabilities reflecting the estimated fair value of interest rate swap agreements. - 13.5 -
Issuance of warrants to Lehman..................................................... - - 48.1
Issuance of warrants to General Electric Company................................... - - 21.0
The following reconciles net loss to net cash provided by operating
activities:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Cash flows from operating activities:
Net loss............................................................................ $(7,835.7) $ (405.9) $(1,191.2)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Interest-only securities investment income...................................... (10.6) (51.5) (106.6)
Cash received from interest-only securities, net................................ (73.3) 14.3 187.6
Servicing income................................................................ (83.9) (115.3) (108.2)
Cash received from servicing activities......................................... 46.9 71.7 123.8
Provision for losses............................................................ 1,160.8 707.2 576.2
(Gain) loss on sale of finance receivables...................................... 49.5 (26.9) (7.5)
Amortization and depreciation................................................... 1,017.8 848.0 745.9
Income taxes.................................................................... 758.3 (140.7) (531.1)
Insurance liabilities........................................................... 509.5 334.4 539.7
Accrual and amortization of investment income................................... 227.9 97.2 174.6
Deferral of cost of policies produced and purchased............................. (509.2) (667.0) (794.3)
Gain on sale of interest in riverboat........................................... - (192.4) -
Impairment charges.............................................................. 1,514.4 386.9 515.7
Goodwill impairment............................................................. 500.0 - -
Special charges................................................................. 171.2 72.4 483.1
Cumulative effect of accounting change.......................................... 2,949.2 - 85.2
Minority interest............................................................... 173.2 183.9 223.5
Net investment losses........................................................... 673.7 413.7 358.3
Loss on CVIC sale............................................................... 93.1 - -
Extraordinary (gain) loss on extinguishment of debt............................. (8.1) (26.9) 7.7
Other........................................................................... (29.0) (178.4) (77.1)
-------- -------- ---------
Net cash provided by operating activities..................................... $ 1,295.7 $1,324.7 $ 1,205.3
========= ======== =========
151
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
14. STATUTORY INFORMATION:
Statutory accounting practices prescribed or permitted by regulatory
authorities for the Company's insurance subsidiaries differ from GAAP. Our
insurance subsidiaries reported the following amounts to regulatory agencies,
after appropriate elimination of intercompany accounts:
2002 2001
---- ----
(Dollars in millions)
Statutory capital and surplus.................................................................... $1,063.4 $1,649.8
Asset valuation reserve.......................................................................... 11.6 105.1
Interest maintenance reserve..................................................................... 311.3 379.3
-------- --------
Total...................................................................................... $1,386.3 $2,134.2
======== ========
The statutory capital and surplus shown above included investments in
up-stream affiliates, all of which were eliminated in the consolidated financial
statements prepared in accordance with GAAP, as follows:
2002 2001
---- ----
(Dollars in millions)
Securitization debt issued by special purpose entities and guaranteed by our
finance subsidiary, all of which was purchased by our insurance subsidiaries
prior to the
acquisition of Conseco Finance (a)........................................................... $ 2.0 $ 71.7
Preferred and common stock of intermediate holding company......................................... 146.4 145.9
Common stock of Conseco (39.8 million shares)...................................................... - 14.9
Other ............................................................................................. 2.5 2.5
------ ------
Total........................................................................................ $150.9 $235.0
====== ======
- --------------------
(a) Total par value, amortized cost and fair value of securities issued by
special purpose entities which hold loans originated by our finance
subsidiary (including the securities that are not guaranteed by Conseco
Finance, and therefore are not considered affiliated investments) were
$269.3 million, $197.1 million and $177.7 million, respectively.
The statutory net loss of our life insurance subsidiaries was $466.0
million, $137.8 million and $70.8 million in 2002, 2001 and 2000, respectively.
Included in such net loss are net realized capital losses, net of income taxes,
of $514.7 million, $188.0 million and $200.8 million in 2002, 2001 and 2000,
respectively. In addition, the insurance subsidiaries incur fees and interest to
Conseco or its non-life subsidiaries; such amounts totaled $194.8 million,
$279.2 million and $264.4 million in 2002, 2001 and 2000, respectively.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid from earned surplus of the insurance company for any
12-month period in amounts equal to the greater of (or in a few states, the
lesser of): (i) net gain from operations or net income for the prior year; or
(ii) 10 percent of capital and surplus as of the end of the preceding year. Any
dividends in excess of these levels require the approval of the director or
commissioner of the applicable state insurance department. During 2002, our
insurance subsidiaries paid dividends to Conseco totaling $240.0 million.
On October 30, 2002, Bankers National Life Insurance Company and Conseco
Life Insurance Company of Texas (on behalf of itself and its insurance
subsidiaries), our insurance subsidiaries domiciled in Texas, each entered into
consent orders with the Commissioner of Insurance for the State of Texas whereby
they agreed: (i) not to request any dividends or other distributions before
January 1, 2003 and, thereafter, not to pay any dividends or other distributions
to parent companies outside of the insurance system without the prior approval
of the Texas Insurance Commissioner; (ii) to continue to maintain sufficient
capitalization and reserves as required by the Texas Insurance Code; (iii) to
request approval from the Texas Insurance Commissioner before making any
disbursements not in the ordinary course of business; (iv) to complete any
pending transactions previously reported to the proper insurance regulatory
officials prior to and during Conseco's restructuring, unless not approved by
the Texas Insurance Commissioner; (v) to obtain a commitment from Conseco and
CIHC to maintain their infrastructure, employees, systems and physical
facilities prior
152
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
to and during Conseco's restructuring; and (vi) to continue to permit the Texas
Insurance Commissioner to examine its books, papers, accounts, records and
affairs. Conseco Life Insurance Company of Texas is the parent of all of the
Company's insurance subsidiaries, except for Bankers National Life Insurance
Company. The consent orders do not prohibit the payment of fees in the ordinary
course of business pursuant to existing administrative, investment management
and marketing agreements with our non-insurance subsidiaries.
The National Association of Insurance Commissioners ("NAIC") adopted
codified statutory accounting principles in a process referred to as
codification. Such principles are summarized in the Accounting Practices and
Procedures Manual. The revised manual was effective January 1, 2001. The
domiciliary states of our insurance subsidiaries have adopted the provisions of
the revised manual or, with respect to some states, adopted the manual with
certain modifications. The revised manual has changed, to some extent,
prescribed statutory accounting practices and resulted in changes to the
accounting practices that our insurance subsidiaries use to prepare their
statutory-basis financial statements. The impact of these changes increased our
insurance subsidiaries' statutory-based capital and surplus as of January 1,
2001, by approximately $198 million.
The NAIC's Risk-Based Capital for Life and/or Health Insurers Model Act
(the "Model Act") provides a tool for insurance regulators to determine the
levels of statutory capital and surplus an insurer must maintain in relation to
its insurance and investment risks and whether there is a need for possible
regulatory attention. The Model Act provides four levels of regulatory
attention, varying with the ratio of the insurance company's total adjusted
capital (defined as the total of its statutory capital and surplus, asset
valuation reserve and certain other adjustments) to its authorized control level
risk based capital ("ACLRBC"): (i) if a company's total adjusted capital is less
than or equal to 200 percent but greater than 150 percent of its ACLRBC (the
"Company Action Level"), the company must submit a comprehensive plan to the
regulatory authority proposing corrective actions aimed at improving its capital
position; (ii) if a company's total adjusted capital is less than or equal to
150 percent but greater than 100 percent of its ACLRBC (the "Regulatory Action
Level"), the regulatory authority will perform a special examination of the
company and issue an order specifying the corrective actions that must be
followed; (iii) if a company's total adjusted capital is less than or equal to
100 percent but greater than 70 percent of its ACLRBC (the "Authorized Control
Level"), the regulatory authority may take any action it deems necessary,
including placing the company under regulatory control; and (iv) if a company's
total adjusted capital is less than or equal to 70 percent of its ACLRBC (the
"Mandatory Control Level"), the regulatory authority must place the company
under its control. In addition the Model Law provides for an annual trend test
if a company's total adjusted capital is between 200 percent and 250 percent of
its ACLRBC at the end of the year. The trend test calculates the greater of the
decrease in the margin of total adjusted capital over ACLRBC: (i) between the
current year and the prior year; and (ii) for the average of the last 3 years.
It assumes that such decrease could occur again in the coming year. Any company
whose trended total adjusted capital is less than 190 percent of its ACLRBC
would trigger a requirement to submit a comprehensive plan as described above
for the Company Action Level.
The 2002 statutory annual statements filed with the state insurance
regulators of each of our insurance subsidiaries reflected total adjusted
capital in excess of the levels subjecting the subsidiary to any regulatory
action. However, our ACLRBC ratios have declined significantly over the last
year and some of our subsidiaries are near the level which would require them to
submit a comprehensive plan aimed at improving their capital position.
The aggregate ACLRBC ratio for our insurance subsidiaries was 332 percent
at December 31, 2002, compared to 480 percent at December 31, 2001. The ratios
for our insurance subsidiaries that are subject to the four levels of regulatory
attention described above ranged from 250 percent (just above the trend test
level) to 563 percent. We are taking actions intended to improve the ACLRBC
ratios of our insurance subsidiaries. Such actions include: (i) discontinuing or
reducing sales of products that create initial reductions in statutory surplus
because of the costs of selling the products; (ii) reducing operating expenses;
(iii) merging some of our insurance subsidiaries with other insurance
subsidiaries; and (iv) restructuring our investment portfolio to better match
the risk profile of the portfolio with the insurance subsidiary's earnings and
capital requirements. We have discussed these actions with insurance regulators
in each of the states in which our insurance subsidiaries are domiciled. The
audited financial statements of our insurance subsidiaries generally are not
completed until around June 1 of each year (the date such audited financial
statements are generally required to be filed with state insurance departments).
Any significant audit adjustments to the financial statements of our insurance
subsidiaries resulting in a reduction in capital could cause the ACLRBC ratio of
one or more of our insurance subsidiaries to fall below the trend test level
requiring the trended total adjusted capital to be calculated. In addition, the
Company has been and will be discussing the appropriate statutory accounting
treatment for certain investments with the state insurance regulators. If the
ultimate outcome of these discussions resulted in adjustments to the December
31, 2002 statutory financial statements of our insurance subsidiaries, some of
our subsidiaries could be required to complete the trend test. If a trend test
were required for any of our subsidiaries, such a test would likely result in
trended total adjusted capital which is less than 190 percent of ACLRBC.
Our internal actuaries must annually render opinions concerning the
adequacy of our insurance reserves. Our actuaries
153
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
rendered unqualified opinions at December 31, 2002. Such opinions reference the
Chapter 11 Cases and recent downgrades of our insurance company ratings as being
outside the scope of the actuarial opinion, meaning that the actuaries did not
believe it was appropriate to calculate what impact, if any, such events would
have on the life insurance reserves. Regulators have raised the question as to
whether or not such references result in the actuarial opinions becoming
qualified opinions. We continue to believe the actuarial opinions are
unqualified opinions. If the actuarial opinions were qualified opinions, more
stringent rules would apply for calculating ACLRBC which we believe would result
in the ACLRBC for several of our insurance subsidiaries falling below the trend
test level.
15. BUSINESS SEGMENTS:
We have historically managed our business operations through two
segments, based on the products offered, in addition to the corporate segment.
Insurance and fee-based segment. Our insurance and fee-based segment
provides supplemental health, annuity and life insurance products to a broad
spectrum of customers through multiple distribution channels, each focused on a
specific market segment. These products are primarily marketed through career
agents, professional independent producers and direct marketing. Fee-based
activities include services performed for other companies, including investment
management and insurance product marketing.
Finance segment. CFC has historically provided a variety of finance
products including: (i) loans for the purchase of manufactured housing, home
improvements and various consumer products; (ii) home equity loans; and (iii)
private label credit card programs. As a result of the formalization of the plan
to sell the finance business and the filing of petitions under the Bankruptcy
Code by the Finance Company Debtors, the finance business is being accounted for
as a discontinued business in Conseco's consolidated financial statements. See
the note to our consolidated financial statements entitled "Discontinued Finance
Business - Planned Sale of CFC" for additional information on this segment.
Corporate and other segment. Our corporate segment includes certain
investment activities, such as our venture capital investment in AWE, and, prior
to its sale, our ownership interest in the riverboat casino in Lawrenceberg,
Indiana. In addition, the corporate segment includes interest expense related to
the Company's corporate debt, special corporate charges, income (loss) from the
major medical business in run-off and other income and expenses. Corporate
expenses are net of charges to our subsidiaries for services provided by the
corporate operations.
154
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Operating information regarding the insurance and corporate segments was
as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Revenues:
Insurance and fee-based segment:
Insurance policy income:
Annuities............................................................. $ 160.9 $ 88.2 $ 125.5
Supplemental health................................................... 2,279.1 2,229.9 2,136.6
Life ................................................................ 628.9 795.7 855.2
Other ................................................................ 114.6 126.7 148.1
Net investment income (a)............................................... 1,416.2 1,564.0 1,707.7
Fee and other revenue (a)............................................... 85.8 100.2 128.9
Net realized investment losses (a)...................................... (597.0) (379.4) (346.5)
--------- --------- ---------
Total insurance and fee-based segment revenues........................ 4,088.5 4,525.3 4,755.5
--------- --------- ---------
Corporate and other:
Net investment income................................................... 13.6 19.2 50.1
Venture capital loss related to investment in AWE....................... (99.3) (42.9) (199.5)
Gain on sale of interest in riverboat................................... - 192.4 -
Revenue from the major medical business in run-off...................... 439.2 777.7 946.3
Other income............................................................ - .9 6.7
--------- --------- ---------
Total corporate segment revenues...................................... 353.5 947.3 803.6
--------- --------- ---------
Eliminations.............................................................. (23.7) (5.5) (.5)
--------- --------- ---------
Total revenues........................................................ 4,418.3 5,467.1 5,558.6
--------- --------- ---------
Expenses:
Insurance and fee-based segment:
Insurance policy benefits............................................... 3,063.8 2,945.4 3,050.1
Amortization............................................................ 745.3 665.7 646.5
Interest expense on investment borrowings............................... 15.4 30.5 15.8
Other operating costs and expenses...................................... 548.6 556.1 663.9
Goodwill impairment..................................................... 500.0 - -
Special charges......................................................... 44.3 21.5 -
--------- --------- ---------
Total insurance and fee-based segment expenses........................ 4,917.4 4,219.2 4,376.3
--------- --------- ---------
(continued on following page)
155
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
(continued from previous page)
Corporate and other:
Interest expense on corporate debt........................................ 325.6 369.5 438.4
Provision for losses and expenses related to stock purchase plan.......... 240.0 169.6 231.5
Expenses from the major medical business in run-off....................... 439.2 908.0 997.6
Special charges and other corporate expenses, less charges to
subsidiaries for services provided.................................... 153.8 66.7 285.2
--------- --------- ---------
Total corporate segment expenses...................................... 1,158.6 1,513.8 1,952.7
-------- --------- ---------
Eliminations.............................................................. (23.7) (5.5) (.5)
--------- --------- ---------
Total expenses........................................................ 6,052.3 5,727.5 6,328.5
--------- --------- ---------
Income (loss) before income taxes, minority interest, extraordinary gain (loss)
and cumulative effect of accounting change:
Insurance and fee-based operations...................................... (828.9) 306.1 379.2
Corporate interest expense and other items.............................. (805.1) (566.5) (1,149.1)
--------- --------- ---------
Loss before income taxes, minority interest,
extraordinary gain (loss) and cumulative
effect of accounting change......................................... $(1,634.0) $ (260.4) $ (769.9)
========= ========= =========
Segment balance sheet information was as follows:
2002 2001
---- ----
(Dollars in millions)
Assets:
Insurance and fee-based................................................... $28,649.1 $38,768.2
Discontinued operations................................................... 17,964.9 22,267.9
Corporate................................................................. 5,343.7 12,175.8
Eliminate intercompany amounts............................................ (5,448.7) (11,779.7)
--------- ---------
Total assets......................................................... $46,509.0 $61,432.2
========= =========
Liabilities:
Insurance and fee-based................................................... $24,118.5 $30,128.5
Discontinued operations................................................... 18,051.1 20,318.4
Corporate................................................................. 5,472.6 5,508.3
Eliminate intercompany amounts............................................ (1,004.3) (1,190.5)
--------- ---------
Total liabilities.................................................... $46,637.9 $54,764.7
========= =========
- -------------------
(a) It is not practicable to provide additional components of revenue by
product or services.
156
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
16. QUARTERLY FINANCIAL DATA (UNAUDITED):
We compute earnings per common share for each quarter independently of
earnings per share for the year. The sum of the quarterly earnings per share may
not equal the earnings per share for the year because of: (i) transactions
affecting the weighted average number of shares outstanding in each quarter; and
(ii) the uneven distribution of earnings during the year.
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
2002
- ----
Revenues................................................................ $ 1,253.0 $ 981.8 $ 982.3 $ 1,201.2
Loss before income taxes, minority interest, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change . (85.7) (275.7) (846.1) (426.5)
Net loss................................................................ (3,045.1) (1,333.1) (1,769.0) (1,688.5)
Income (loss) per common share:
Basic:
Loss before discontinued operations, extraordinary gain (loss)
and cumulative effect of accounting change ....................... $ (.26) $(3.39) $(2.98) $(1.10)
Discontinued operations.............................................. (.03) (.47) (2.13) (3.79)
Extraordinary gain (loss)............................................ .01 - - .01
Cumulative effect of accounting change............................... (8.54) - - -
----- ------ ------ ------
Net loss.......................................................... $(8.82) $(3.86) $(5.11) $(4.88)
====== ====== ====== ======
Diluted:
Loss before discontinued operations, extraordinary gain (loss) and
cumulative effect of accounting change............................ $ (.26) $(3.39) $(2.98) $(1.10)
Discontinued operations.............................................. (.03) (.47) (2.13) (3.79)
Extraordinary gain (loss)............................................ .01 - - .01
Cumulative effect of accounting change............................... (8.54) - - -
------- ------ ------ ------
Net loss.......................................................... $(8.82) $(3.86) $(5.11) $(4.88)
====== ====== ====== ======
157
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
2001
- ----
Revenues................................................................. $1,485.2 $1,456.8 $1,168.3 $1,356.8
Income (loss) before income taxes, minority interest, discontinued
operations and extraordinary gain (loss)............................... 124.6 .6 (280.2) (105.4)
Net income (loss)........................................................ 84.1 (25.7) (407.5) (56.8)
Income (loss) per common share:
Basic:
Income (loss) before discontinued operations and extraordinary
gain (loss)....................................................... $.14 $(.14) $(.67) $(.30)
Discontinued operations................................................ .10 .06 (.54) .07
Extraordinary gain (loss) on extinguishment of debt.................... - (.01) - .06
---- ----- ----- -----
Net income (loss)................................................. $.24 $(.09) $(1.21) $(.17)
==== ===== ====== =====
Diluted:
Income (loss) before discontinued operations and extraordinary
gain (loss)....................................................... $.14 $(.14) $(.67) $(.30)
Discontinued operations.............................................. .09 .06 (.54) .07
Extraordinary gain (loss) on extinguishment of debt.................. - (.01) - .06
---- ----- ------ -----
Net income (loss)................................................. $.23 $(.09) $(1.21) $(.17)
==== ===== ====== =====
158
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
17. FINANCIAL INFORMATION REGARDING CFC
As previously described, CFC filed a petition for relief under the
Bankruptcy Code in the United States Bankruptcy Court on December 17, 2002. On
March 14, 2003, the Bankruptcy Court entered orders approving the terms of the
sale of substantially all of CFC's assets. The closing of the sale of the CFC
assets is subject to various closing conditions, but is currently expected to
occur in the second quarter of 2003. As a result of the formalization of the
plan to sell the finance business and the filing of petitions for relief under
the Bankruptcy Code by the Finance Company Debtors, the finance business is
being accounted for as a discontinued business in our consolidated financial
statements. The consolidated statement of operations reflects the operations of
the discontinued finance business in the caption "Discontinued operations" for
all periods. Our December 31, 2002 consolidated balance sheet includes the total
assets of the finance segment in the caption "Assets of discontinued operations"
and the total liabilities of the finance segment in the caption "Liabilities of
discontinued operations". We currently believe that it is unlikely that the
Company will receive any net proceeds from the ultimate disposition of CFC
beyond the extinguishment of CFC's liabilities and the release of related
Company guarantees on CFC's debt. Accordingly, we wrote off our entire remaining
investment in CFC of $64.5 million on December 31, 2002.
159
The following summarizes selected balance sheet information of CFC as of
December 31, 2002 and 2001:
CFC
CONSOLIDATED BALANCE SHEET INFORMATION
December 31, 2002 and 2001
(Dollars in millions)
2002 2001
---- ----
ASSETS
Retained interests in securitization trusts at fair value (amortized cost:
2002 - $189.1; 2001 - $876.1)............................................................. $ 252.6 $ 710.1
Cash and cash equivalents..................................................................... 562.3 394.5
Cash held in segregated accounts for investors in securitizations............................. 394.7 550.2
Cash held in segregated accounts related to servicing agreements and
securitization transactions................................................................ 998.4 994.6
Finance receivables........................................................................... 2,023.1 3,810.7
Finance receivables - securitized............................................................. 12,460.0 14,198.5
Receivables due from Conseco, Inc.(a)......................................................... 276.1 358.0
Income tax assets............................................................................. - 267.2
Other assets.................................................................................. 997.7 984.1
--------- ---------
Total assets........................................................................... $17,964.9 $22,267.9
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Investor payables.......................................................................... $ 394.7 $ 550.2
Guarantee liability related to interests in securitization trusts held by others........... 326.7 39.9
Liabilities related to certificates of deposit............................................. 2,326.0 1,790.3
Servicing liability........................................................................ 333.4 17.8
Income tax liability....................................................................... 34.6 -
Other liabilities.......................................................................... 279.1 548.5
Preferred stock dividends payable to Conseco, Inc.(a)...................................... - 86.1
Notes payable:
Related to securitized finance receivables structured as collateralized borrowings....... 13,069.7 14,484.5
Debtor in possession facilities.......................................................... 82.0 -
Master repurchase agreements............................................................. - 1,691.8
Credit facility collateralized by retained interests in securitizations.................. - 507.3
Due to Conseco, Inc.(a).................................................................. - 249.5
Other borrowings......................................................................... - 352.5
--------- ---------
Total liabilities not subject to compromise......................................... 16,846.2 20,318.4
--------- ---------
Liabilities subject to compromise ............................................................ 1,204.9 -
--------- ---------
Total Liabilities................................................................... 18,051.1 20,318.4
--------- ---------
Shareholder's equity (deficit):
Preferred stock (a)........................................................................ 750.0 750.0
Common stock and additional paid-in capital (a)............................................ 1,209.4 1,209.4
Accumulated other comprehensive income (loss) (net of applicable deferred
income tax benefit: 2002 - $(63.8); 2001 - $(63.8)) (a)................................. 110.6 (108.6)
Retained earnings (deficit) (a)............................................................ (2,156.2) 98.7
--------- ---------
Total shareholder's equity (deficit)................................................ (86.2) 1,949.5
--------- ---------
Total liabilities and shareholder's equity (deficit)................................ $17,964.9 $22,267.9
========= =========
- -------------
(a) Intercompany accounts were eliminated when consolidated with Conseco and
its other wholly-owned subsidiaries.
160
The following summarizes selected statement of operations information of
CFC for the years ended December 31, 2002, 2001 and 2000:
CFC
CONSOLIDATED STATEMENT OF OPERATIONS INFORMATION (a)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
---- ---- ----
Revenues:
Net investment income:
Finance receivables and other.......................................... $ 2,062.4 $2,150.1 $1,826.7
Retained interests..................................................... 75.0 125.3 180.7
Affiliated (b)......................................................... 11.8 19.6 26.9
Gain (loss) on sale of finance receivables............................... (49.5) 26.9 7.5
Servicing income......................................................... 83.9 115.3 108.2
Impairment charges....................................................... (1,449.9) (386.9) (515.7)
Fee revenue and other income............................................. 189.9 220.5 257.4
--------- -------- --------
Total revenues..................................................... 923.6 2,270.8 1,891.7
--------- -------- --------
Expenses:
Provision for losses..................................................... 950.0 537.7 344.7
Interest expense - affiliated (b)........................................ 10.3 28.5 156.3
Interest expense......................................................... 1,119.7 1,205.9 996.1
Other operating costs and expenses....................................... 608.0 639.4 750.0
Other operating costs and expenses - affiliated (b)...................... 8.0 3.0 3.5
Special charges.......................................................... 121.9 21.5 394.3
Reorganization items..................................................... 17.3 - -
--------- -------- --------
Total expenses..................................................... 2,835.2 2,436.0 2,644.9
--------- -------- --------
Loss before income taxes, cumulative effect of accounting change
and extraordinary gain (loss) on extinguishment of debt.......... (1,911.6) (165.2) (753.2)
Income tax expense (benefit):
Tax (benefit) expense on period income................................... 34.4 (56.4) (262.8)
Valuation allowance for deferred tax assets.............................. 245.3 - -
--------- -------- --------
Loss before cumulative effect of accounting change and
extraordinary gain (loss) on extinguishment of debt.............. (2,191.3) (108.8) (490.4)
Extraordinary gain (loss) on extinguishment of debt, net of income taxes.. 3.9 6.1 -
Cumulative effect of accounting change, net of income taxes................. - - (45.5)
--------- -------- ---------
Net loss........................................................... (2,187.4) (102.7) (535.9)
Preferred stock dividends payable to Conseco (b)............................ 67.5 67.5 18.6
--------- -------- --------
Net loss applicable to common stock................................ $(2,254.9) $ (170.2) $ (554.5)
========= ======== ========
161
- ----------------
(a) CFC's statement of operations information has been presented as a
discontinued operation in Conseco's consolidated financial statements for
the periods summarized.
(b) Intercompany accounts were eliminated when consolidated with Conseco and
its other wholly-owned subsidiaries.
The following table reconciles CFC's loss before extraordinary gain (loss)
and cumulative effect of accounting change as presented on the previous page to
the amount included in discontinued operations in the accompanying consolidated
statement of operations:
2002 2001 2000
---- ---- ----
(dollars in millions)
Loss before extraordinary gain (loss) and cumulative
effect of accounting change........................ $(2,191.3) $(108.8) $(490.4)
Income taxes(a)....................................... 279.7 - -
Net expenses eliminated in consolidation, net of
income tax......................................... 6.5 7.7 90.8
Impairment charge related to investment in CFC........ (64.5) - -
--------- ------- -------
Loss recognized as discontinued operations............ $(1,969.6) $(101.1) $(399.6)
========= ======= =======
- -------------
(a) Amount is considered in determining the income tax expense in the
consolidated statement of operations.
Refer to the note to the consolidated financial statements entitled
"Summary of Significant Accounting Policies" for disclosures related to the
accounting policies of CFC. Disclosures related to the significant accounts of
CFC are summarized below:
Liabilities Subject to Compromise
Under the Bankruptcy Code, actions by creditors to collect indebtedness CFC
owes prior to the Petition Date are stayed and certain other prepetition
contractual obligations may not be enforced against the Finance Company Debtors.
CFC has received approval from the Bankruptcy Court to pay certain prepetition
liabilities including employee salaries and wages, benefits, and other employee
obligations. All other prepetition liabilities have been classified as
"liabilities subject to compromise" in CFC's December 31, 2002 consolidated
balance sheet.
162
The following table summarizes the components of the liabilities included
in the line "liabilities subject to compromise" in CFC's consolidated balance
sheet as of December, 2002 (dollars in millions):
Other liabilities:
Liability for litigation................................................... $ 38.8
Accounts payable and accrued expenses...................................... 65.8
--------
Total other liabilities subject to compromise.......................... 104.6
--------
Preferred stock dividends payable to Conseco, Inc............................. 153.6
--------
Notes payable:
Master repurchase agreements (a)........................................... 174.4
Credit facility collateralized by retained
interests in securitizations (a) ........................................ 497.7
Due to Conseco, Inc........................................................ 273.2
Other borrowings........................................................... 1.4
--------
Total notes payable subject to compromise.............................. 946.7
--------
Total liabilities subject to compromise................................ $1,204.9
========
- ----------------
(a) The Finance Company Debtors have guaranteed these facilities.
Finance Receivables and Retained Interests in Securitization Trusts
During 2002, CFC completed six securitization transactions, securitizing
$2.7 billion of finance receivables. These securitizations were structured in a
manner that requires them to be accounted for as secured borrowings, whereby the
loans and securitization debt remain on our balance sheet, rather than as sales,
pursuant to SFAS 140. Such accounting method is referred to as the "portfolio
method".
CFC classifies the finance receivables transferred to the securitization
trusts and held as collateral for the notes issued to investors as "finance
receivables-securitized". The average interest rate on these receivables was
approximately 12.4 percent and 12.5 percent at December 31, 2002 and 2001,
respectively. We classify the notes issued to investors in the securitization
trusts as "notes payable related to securitized finance receivables structured
as collateralized borrowings".
Conseco's leveraged condition and liquidity difficulties eliminated CFC's
ability to access the securitization markets. This has required CFC to pursue
whole loan sales to maintain availability under its warehouse facilities for new
originations. Accordingly, CFC has classified its unsecuritized finance
receivables as held for sale which requires the assets to be carried at the
lower of cost or market. At December 31, 2002, CFC has an allowance of $47.1
million for certain finance receivables with current estimated market values
below cost.
During 2002 and 2001, CFC completed various loan sale transactions. During
2002, CFC sold $2.1 billion of finance receivables which generated net losses of
$49.5 million. CFC also recognized a loss of $96.0 million related to the sale
of $.5 billion of certain finance receivables sold as part of its cash raising
initiatives in order to meet its debt obligations. See "Special Charges"
elsewhere in the notes to the consolidated financial statements. In 2001, CFC
sold $1.6 billion of receivables including: (i) $802.3 million vendor services
loan portfolio (which was marked-to-market in the fourth quarter of 2000 and no
additional gain or loss was recognized in 2001); (ii) $568.4 million of
high-loan-to-value mortgage loans; and (iii) $269.0 million of other loans.
These sales resulted in net gains of $26.9 million in 2001.
163
The following table summarizes CFC's finance receivables - securitized by
business line and categorized as either part of CFC's primary lines or part of
other lines (discontinued in previous periods):
December 31,
---------------------
2002 2001
---- ----
(Dollars in millions)
Primary lines:
Manufactured housing............................................................. $ 6,965.3 $ 6,940.4
Mortgage services................................................................ 5,005.9 5,658.2
Retail credit.................................................................... 641.5 878.9
Consumer finance - closed-end.................................................... 407.7 580.8
--------- ---------
13,020.4 14,058.3
Less allowance for credit losses................................................. 560.4 288.5
--------- ---------
Net other finance receivables for primary lines................................ 12,460.0 13,769.8
--------- ---------
Other lines (discontinued in previous periods)...................................... - 436.9
Less allowance for credit losses................................................. - 8.2
--------- ---------
Net other finance receivables for other lines.................................. - 428.7
--------- ---------
Total finance receivables - securitized........................................ $12,460.0 $14,198.5
========= =========
The following table summarizes CFC's other finance receivables by business
line and categorized as either a part of CFC's primary lines or a part of other
lines (discontinued in previous periods):
December 31,
---------------------
2002 2001
---- ----
(Dollars in millions)
Primary lines:
Manufactured housing............................................................... $ 159.5 $ 609.3
Mortgage services.................................................................. 260.7 1,128.9
Retail credit...................................................................... 1,599.1 1,811.1
Consumer finance closed-end........................................................ 35.8 6.3
-------- --------
2,055.1 3,555.6
Less allowance for credit losses................................................... 86.5 111.6
-------- --------
Net other finance receivables for primary lines.................................. 1,968.6 3,444.0
-------- --------
Other lines (discontinued in previous periods)........................................ 71.4 379.7
Less allowance for credit losses................................................... 16.9 13.0
-------- --------
Net other finance receivables for other lines.................................... 54.5 366.7
-------- --------
Total other finance receivables.................................................. $2,023.1 $3,810.7
======== ========
164
The changes in CFC's allowance for credit losses included in finance
receivables (both securitized and other portfolios) were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Allowance for credit losses, beginning of year................................... $ 421.3 $ 306.8 $ 88.4
Additions to the allowance:
Provision for losses.......................................................... 950.0 537.7 344.7
Provision for losses related to discontinued lines (further discussed
under the caption "Special Charges" below).................................. - - 45.9
Provision for losses related to regulatory changes related to CFC's bank
subsidiary (further discussed under the caption "Special Charges" below).... - - 48.0
Change in allowance due to purchases and sales of certain
finance receivables......................................................... (21.3) (.1) 24.7
Credit losses.................................................................... (686.2) (423.1) (244.9)
------- ------- -------
Allowance for credit losses, end of year......................................... $ 663.8 $ 421.3 $ 306.8
======= ======= =======
165
The securitizations structured prior to September 8, 1999, met the
applicable criteria to be accounted for as sales. At the time the loans were
securitized and sold, CFC recognized a gain and recorded its retained interest
represented by the interest-only security and servicing rights. The
interest-only security represents the right to receive, over the life of the
pool of receivables: (i) the excess of the principal and interest received on
the receivables transferred to the special purpose entity over the principal and
interest paid to the holders of other interests in the securitization; and (ii)
contractual servicing fees. In some of those securitizations, CFC also retained
B-2 securities. CFC's net retained interests in securitization trusts at
December 31, 2002 and 2001 are summarized below:
December 31, 2002 December 31, 2001
------------------------- ----------------------
Amortized Estimated Amortized Estimated
cost fair value cost fair value
---- ---------- ---- ----------
(Dollars in millions)
Retained interests in securitization trusts:
Interests securitized in the form of B-2 securities............. $ 548.0 $ 611.5 $704.9 $528.5
Interest-only securities........................................ (358.9) (358.9) 171.2 181.6
------- ------- ------ ------
Total retained interests, excluding guarantee liabilities... 189.1 252.6 876.1 710.1
Guarantee liability related to interests in securitization
trusts held by others........................................... (326.7) (326.7) (39.9) (39.9)
------- ------- ------ ------
Total retained interests, net of guarantee liabilities...... $(137.6) $ (74.1) $836.2 $670.2
======= ======= ====== ======
During 2002 and 2001, CFC recognized no gain on sale related to securitized
transactions.
The retained interests in securitization trusts on CFC's balance sheet
represent an allocated portion of the cost basis of the finance receivables in
the securitization transactions accounted for as sales. CFC's retained interests
in those securitization transactions are subordinate to the interests of other
investors. Their values are subject to credit, prepayment, and interest rate
risk on the securitized finance receivables. Management of CFC determines the
discount rate to value these securities based on our estimates of current market
rates of interest for securities with similar yield, credit quality and maturity
characteristics. CFC includes the difference between estimated fair value and
the amortized cost of the retained interests (after adjustments for impairments
required to be recognized in earnings) in "accumulated other comprehensive
income (loss), net of taxes."
The determination of the value of CFC's retained interests in
securitization trusts requires significant judgment. CFC has recognized
significant charges when the interest-only securities did not perform as well as
anticipated based on its assumptions and expectations. CFC's current valuation
of retained interests may prove inaccurate in future periods. In securitizations
to which these retained interests relate, CFC has retained certain contingent
risks in the form of guarantees of certain lower-rated securities issued by the
securitization trusts. As of December 31, 2002, the total nominal amount of
these guarantees was approximately $1.4 billion. CFC considers any potential
payments related to these guarantees in the projected cash flows used to
determine the value of its retained interests. The discounted present value of
the expected future payments related to the guarantees are classified as the
"Guarantee liability related to interests in securitization trusts held by
others" in CFC's balance sheet. If CFC would have to make more payments on these
guarantees than anticipated, or if CFC experienced higher than anticipated rates
of repayment, including due to foreclosure or charge-offs, or any adverse
changes in its assumptions used for valuation, CFC would be required to
recognize additional impairment charges. The $1.4 billion nominal amount of
these guarantees represents the par value of the guaranteed lower-rated
securities. The maximum potential amount of undiscounted future payments which
CFC could be required to make on these guarantees would include both the par
value and interest. Because the guaranteed securities do not have fixed maturity
dates, such maximum potential amount is not possible to calculate. During 2002,
2001 and 2000, interest and principal payments related to such guarantees
totaled $45.5 million, $32.7 million and $22.3 million, respectively. CFC
suspended guarantee payments in the fourth quarter of 2002 and without
additional liquidity in the near future, CFC will be unable to make these
guarantee payments when such payments are required to be made.
Together, the interest-only securities and the B-2 securities, represent
CFC's retained interests in these securitization trusts.
During 2002, CFC's ability to access the securitization markets was
eliminated. The securitization markets are CFC's main source of funding for
loans made to purchasers of repossessed manufactured homes. CFC believes that
its loss severity rates were
166
positively impacted when it used retail channels to dispose of repossessed
inventory (where the repossessed units are sold through company-owned sales lots
or its dealer network). Since CFC is no longer able to fund the loans made on
repossessed homes sold through these channels, sales through these channels have
decreased and CFC must use the wholesale channel to dispose of repossessed
manufactured housing units, through which recovery rates are significantly
lower. Accordingly, CFC changed the loss severity assumptions used to value its
retained interests to reflect the higher loss severity expected to be
experienced in the future. In addition, CFC's previous assumptions reflected its
belief that the adverse manufactured housing default experience in recent
periods would continue through the first half of 2002 and then improve over
time. Given recent circumstances, default experience is not expected to improve
as previously expected. Accordingly, CFC increased the default assumptions it
used to value its retained interests to reflect its future expectations. CFC's
home equity/home improvement assumptions have also been adjusted to reflect
recent default experience as well as CFC's future expectations.
As described in the note to the consolidated financial statements entitled
"Summary of Significant Accounting Policies", the Company adopted the
requirements of EITF 99-20 effective July 1, 2000. Under EITF 99-20, declines in
the value of CFC's retained interests in securitization trusts are recognized
when: (i) the fair value of the retained beneficial interests are less than
their carrying value; and (ii) the timing and/or amount of cash expected to be
received from the retained beneficial interests have changed adversely from the
previous valuation which determined the carrying value of the retained
beneficial interests. When both occur, the retained beneficial interests are
written down to fair value as an other-than-temporary impairment.
As a result of the requirements of EITF 99-20 and the assumption changes
described above, CFC recognized an impairment charge of $1,077.2 million in 2002
for the retained beneficial interests. CFC also recognized a $336.5 million
increase in the valuation allowance as a result of changes to the expected
future cost of servicing the finance receivables. The levels of delinquent and
defaulting loans have caused servicing costs to increase. In addition, future
servicing costs are expected to increase as the portfolio ages.
CFC recognized impairment charges of $386.9 million and $515.7 million in
2001 and 2000, respectively, for the interest-only securities that were not
performing as well as expected based on its previous valuation estimates.
The following table summarizes certain cash flows received from and paid to
the securitization trusts during 2002 and 2001 (dollars in millions):
2002 2001
--------- ---------
Servicing fees received......................................................... $ 46.9 $ 71.7
Cash flows from retained interests, net of guarantee payments................... 22.3 71.3
Servicing advances paid......................................................... (275.9) (677.0)
Repayment of servicing advances................................................. 257.1 665.2
During the third quarter and again in the fourth quarter of 2002, CFC
changed the assumptions used to estimate the value of its retained interests to:
(i) project higher severity losses related to the defaults, reflecting CFC's
inability to finance the sale of repossessed manufactured homes resulting in
reliance on the wholesale disposition channel for repossessed manufactured
homes; and (ii) project higher rates of default in the future, based on its
current expectations. As a result of these assumptions, CFC projects that
payments related to guarantees issued in conjunction with the sales of certain
finance receivables will exceed the gross cash flows from the retained interests
by approximately $225 million in 2003, $100 million in 2004, $60 million in 2005
and $10 million in 2006. These projected payments are considered in the
projected cash flows CFC used to value its retained interests. Without
additional liquidity in the near future, CFC will be unable to make these
projected guarantee payments when such payments are required to be made. CFC
projects the gross cash flows from the retained interests will exceed the
payments related to guarantees issued in conjunction with the sales of certain
finance receivables by approximately $175 million in all years thereafter.
Effective September 30, 2001, CFC transferred substantially all of its
interest-only securities into a securitization trust. The transaction provided a
means to finance a portion of the value of its interest-only securities by
selling some of the cash flows to Lehman. The transfer was accounted for as a
sale in accordance with SFAS 140. However, no gain or loss was recognized
because the aggregate fair value of the interest retained by CFC and the cash
received from the sale were equal to the carrying value of the interest-only
securities prior to their transfer to the trust. The trust is a qualifying
special purpose entity and is not consolidated pursuant to SFAS 140. CFC
received a trust security representing an interest in the trust equal to 85
percent of the estimated future
167
cash flows of the interest-only securities held in the trust. Lehman purchased
the remaining 15 percent interest. The value of the interest purchased by Lehman
was $20.4 million at December 31, 2002. CFC continues to be the servicer of the
finance receivables underlying the interest-only securities transferred to the
trust. Lehman has the ability to accelerate the principal payments related to
their interest after a stated period. Until such time, Lehman is required to
maintain a 15 percent interest in the estimated future cash flows of the trust.
By aggregating the interest-only securities into one structure, the impairment
tests for these securities are conducted on a single set of cash flows
representing CFC's 85 percent interest in the trust. Accordingly, adverse
changes in cash flows from one interest-only security are offset by positive
changes in another. The new structure does not avoid an impairment charge if
sufficient positive cash flows in the aggregate are not available (such as was
the case at December 31, 2002).
On December 2, 2002, Conseco Finance elected not to make approximately $4.7
million in guarantee payments of which $.6 million was owed to outside third
parties. Upon filing for protection under Chapter 11 of the United States
Bankruptcy Code on December 17, 2002, Conseco Finance has not made any
additional guarantee payments. The continued payment of guarantee payments
depends on the restructuring results of Conseco Finance Corp. as approved by the
Bankruptcy Court. There can be no guarantee that the Court will uphold the
continuation of the required guarantee fees (refer to the caption entitled
"Subsequent events related to CFC" for further discussion regarding the
guarantee payments).
168
At December 31, 2002, key economic assumptions used to determine the
estimated fair value of CFC's retained interests in securitizations and the
sensitivity of the current fair value of residual cash flows to immediate 10
percent and 20 percent changes in those assumptions are as follows:
Home equity/ Interests Interests
Manufactured home Consumer/ held by held by
housing improvement equipment Total others Conseco
------- ------------ --------- ----- ------ -------
(Dollars in millions)
Carrying amount/fair value of retained interests:
Retained interests..................................... $ 24.6 $ 234.4 $ 14.0 $ 273.0 $(20.4) $ 252.6
Guarantee liability.................................... (299.7) (5.8) (21.2) (326.7) - (326.7)
Servicing liabilities.................................. (320.1) (5.9) (7.4) (333.4) - (333.4)
------- -------- ------ --------- ------ -------
Total retained interests........................... $ (595.2) $ 222.7 $(14.6) $ (387.1) $(20.4) $(407.5)
========= ======== ====== ========= ====== =======
Cumulative principal balance of sold finance
receivables at December 31, 2002....................... $15,429.6 $3,723.2 $787.2 $19,940.0
Weighted average life in years.............................. 6.9 3.6 2.5 6.1
Weighted average stated customer interest rate
on sold finance receivables............................ 9.7% 11.9% 10.5% 10.2%
Assumptions to determine estimated fair value
of retained interests at December 31, 2002:
Expected prepayment speed as a percentage
of principal balance of sold finance receivables (a)... 7.1% 18.9% 18.0% 9.8%
Impact on fair value of 10 percent decrease............ $(6.7) $2.0 $(.6) $(5.3)
Impact on fair value of 20 percent decrease............ (18.1) 5.9 (1.1) (13.3)
Impact on fair value of 10 percent increase............ 8.0 (1.3) .4 7.1
Impact on fair value of 20 percent increase............ 15.8 (1.9) .9 14.8
Expected nondiscounted credit losses as a percentage of
principal balance of related finance receivables (a)... 20.3% 9.0% 11.7% 17.9%
Impact on fair value of 10 percent decrease............ $26.8 $17.4 $2.2 $46.4
Impact on fair value of 20 percent decrease............ 115.3 37.6 5.2 158.1
Impact on fair value of 10 percent increase............ (6.3) (15.8) (2.0) (24.1)
Impact on fair value of 20 percent increase............ (30.3) (30.3) (3.5) (64.1)
Weighted average discount rate.............................. 16.0% 16.0% 16.0% 16.0%
Impact on fair value of 10 percent decrease............ $(11.8) $20.3 $.9 $9.4
Impact on fair value of 20 percent decrease............ (24.4) 43.6 2.0 21.2
Impact on fair value of 10 percent increase............ 11.2 (17.8) (1.0) (7.6)
Impact on fair value of 20 percent increase............ 21.6 (33.5) (1.8) (13.7)
169
- -----------------
(a) The valuation of retained interests in securitization trusts is affected
not only by the projected level of prepayments of principal and net credit
losses, but also by the projected timing of such prepayments and net credit
losses. Should such timing differ materially from CFC's projections, it
could have a material effect on the valuation of its retained interests.
Additionally, such valuation is determined by discounting cash flows over
the entire expected life of the receivables sold.
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10 percent variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might magnify or counteract the
sensitivities.
The following table summarizes quantitative information about
delinquencies, net credit losses, and components of managed finance receivables:
Principal balance
60 days or more Net credit
Principal balance past due losses
--------------------- ----------------- ------
for the year ended
at December 31, December 31,
---------------------------------------------- --------------------
2002 2001 2002 2001 2002 2001
---- ---- ---- ---- ---- ----
(Dollars in millions)
Type of finance receivables
Manufactured housing...................... $23,022.4 $25,575.1 $ 803.3 $610.5 $ 756.3 $ 555.5
Home equity/home improvement.............. 8,842.8 11,851.4 122.6 139.9 282.7 244.4
Consumer.................................. 3,334.6 4,198.8 83.8 112.6 219.3 199.5
Commercial................................ 82.7 1,377.0 6.5 16.2 17.7 38.3
--------- --------- -------- ------ -------- --------
Total managed receivables................. 35,282.5 43,002.3 1,016.2 879.2 1,276.0 1,037.7
Less finance receivables securitized
and repossessed assets................. 19,908.8 24,297.3 528.5 464.9 589.8 614.7
--------- --------- -------- ------ -------- --------
Finance receivables held on balance sheet
before allowance for credit losses and
deferred points and other, net......... 15,373.7 18,705.0 $ 487.7 $414.3 $ 686.2 $ 423.0
======== ====== ======== ========
Less allowance for credit losses.......... 663.8 421.3
Less deferred points and other, net....... 226.8 274.5
--------- ---------
Finance receivables held on
balance sheet.......................... $14,483.1 $18,009.2
========= =========
170
The following schedule reconciles CFC's retained interests, net of
guarantee liabilities, from the beginning to the end of the years presented:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Balance, beginning of year......................................................... $ 670.2 $ 927.5 $1,599.3
Investment income............................................................... 75.0 125.3 180.7
Cash paid (received):
Gross cash received........................................................... (67.8) (132.6) (279.9)
Guarantee payments related to clean-up calls (a).............................. - 45.3 100.3
Guarantee payments related to interests held by others........................ 45.5 32.7 22.3
Impairment charge to reduce carrying value...................................... (1,077.2) (264.8) (434.1)
Sale of securities related to a discontinued line and other..................... 15.9 (12.4) -
Change in interest purchased by Lehman in conjunction with
securitization transaction.................................................... 34.8 (55.2) -
Transfer to servicing rights in conjunction with securitization transaction..... - (50.0) -
Cumulative effect of change in accounting principle............................. - - (70.2)
Change in unrealized appreciation (depreciation) recorded in shareholders'
equity (deficit).............................................................. 229.5 54.4 (190.9)
--------- ------- --------
Balance, end of year............................................................... $ (74.1) $ 670.2 $ 927.5
========= ======= ========
- -----------------------
(a) During 2001 and 2000, clean-up calls were exercised for certain
securitizations that were previously recognized as sales. The interest-only
securities related to these securitizations had previously been separately
securitized with other interest-only securities in transactions recognized
as sales. CFC holds the residual interests issued by the securitization
trusts. The terms of the residual interests require the holder to make
payments to the securitization trust when a clean-up call related to an
underlying trust (a trust which issued interest-only securities held by the
securitization trust) occurs. These payments are used to accelerate
principal payments to the holders of the other securities issued by the
securitization trusts. During 2001, CFC was required to make payments to
the securitization trusts. These payments increased our basis in the
retained interests, as the related liability assumed by CFC (and reflected
in the value of the retained interest) was extinguished.
171
Income Taxes
CFC's income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting and tax bases of assets
and liabilities. These amounts are reflected in the balance of deferred income
tax assets which totaled $925.7 million at December 31, 2002. In assessing the
realization of deferred income tax assets, CFC considers whether it is more
likely than not that the deferred income tax assets will be realized. The
ultimate realization of deferred income tax assets depends upon generating
future taxable income during the periods in which temporary differences become
deductible. CFC evaluates the realizability of its deferred income tax assets by
assessing the need for a valuation allowance on a quarterly basis. A valuation
allowance of $925.7 million has been provided for the entire net deferred tax
asset balance as of December 31, 2002, as CFC believes that the realization of
such assets in future periods is uncertain. The components of CFC's income tax
assets and liabilities were as follows:
2002 2001
---- ----
(Dollars in millions)
Deferred tax assets (liabilities):
Net operating loss carryforwards................................................................. $ 193.3 $ -
Deductible timing differences:
Interest-only securities...................................................................... 536.3 (75.2)
Unrealized (appreciation) depreciation........................................................ (22.4) 61.5
Allowance for loan losses..................................................................... 252.2 148.2
Other......................................................................................... (33.7) 110.8
-------- ------
Total deferred tax assets................................................................ 925.7 245.3
Valuation allowance....................................................................... (925.7) -
-------- ------
Net deferred tax asset (liability)........................................................ - 245.3
Current income taxes prepaid (payable)............................................................. (34.6) 21.9
------- ------
Net income tax assets (liabilities)....................................................... $ (34.6) $267.2
======= ======
Income tax expense (benefit) was as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Current tax provision.............................................................................. $ 34.4 $ 59.5 $ 60.6
Deferred tax provision (benefit)................................................................... - (115.9) (323.4)
------ ------ -------
Income tax expense (benefit).......................................................... 34.4 (56.4) (262.8)
Valuation allowance................................................................................ 245.3 - -
------ ------ -------
Net income tax expense (benefit)........................................................ $279.7 $(56.4) $(262.8)
====== ====== =======
The income tax benefit differed from that computed at the applicable
federal statutory rate (35 percent) for the following reasons:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Tax expense (benefit) on income (loss) before income taxes at statutory rate....................... $(669.1) $(57.8) $(259.9)
Valuation allowance................................................................................ 245.3 .2 1.6
Net deferred benefits not recognized in the current period......................................... 760.9 - -
State taxes, net................................................................................... (57.4) 1.2 (4.5)
------- ------ -------
Income tax benefit.......................................................................... $279.7 $(56.4) $(262.8)
====== ====== =======
172
At December 31, 2002, CFC had $552.4 million of net operating loss
carryforwards. The carryforwards will expire as follows: $54.7 in 2018; $273.6
in 2020; and $224.1 in 2022.
CFC is under examination by the Internal Revenue Service for the periods
ending June 30, 1998 through December 31, 1999. No material deficiencies are
known at this time; however, the net operating losses may be reduced, utilized
or reattributed as a result of the examinations.
The above deferred income tax assets are scheduled assuming a continuation
of business. The actual realization of CFC's deferred items may be materially
different as the result of the conclusion of bankruptcy proceedings and the
disposition of certain businesses.
Pension Plan of CFC
CFC provided certain pension benefits for certain eligible retired
employees under a partially funded plan. Amounts related to the pension plan
were as follows:
Pension benefits
----------------
2002 2001
---- ----
(Dollars in millions)
Benefit obligation, beginning of year............................. $14.8 $17.9
Interest cost................................................. .9 1.1
Actuarial loss................................................ 7.1 .6
Benefits paid................................................. (4.6) (4.8)
----- -----
Benefit obligation, end of year................................... $18.2 $14.8
===== =====
Fair value of plan assets, beginning of year...................... $14.2 $19.9
Actual return on plan assets.................................. (1.1) (1.4)
Employer contributions........................................ .4 .5
Benefits paid................................................. (4.6) (4.8)
----- -----
Fair value of plan assets, end of year............................ $ 8.9 $14.2
===== =====
Funded status..................................................... $(9.3) $ (.6)
Unrecognized net actuarial loss................................... 12.9 6.5
----- -----
Prepaid benefit cost....................................... $ 3.6 $ 5.9
===== =====
CFC used the following weighted average assumptions to calculate benefit
obligations for its 2002 and 2001 valuations: postretirement discount rate of
approximately 5.0 percent and 6.5 percent, respectively; preretirement discount
rate of approximately 6.0 percent and 7.0 percent, respectively; and an expected
return on plan assets of approximately 9.0 percent and 9.0 percent,
respectively. Beginning in 2000, as a result of plan amendments, no assumption
for compensation increases was required. Included as an adjustment to
accumulated other comprehensive income (loss) is a $12.7 million adjustment
representing the additional minimum liability associated with this plan.
173
Components of the cost CFC recognized related to its pension plan were as
follows:
Pension benefits
--------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
Interest cost.................................................... $ .9 $ 1.1 $ 1.4
Expected return of plan assets................................... (1.1) (1.5) (1.7)
Settlement (gain) loss........................................... 2.2 1.3 (.3)
Recognized net actuarial loss.................................... .6 .3 -
----- ----- -----
Net periodic cost (benefit)............................... $ 2.6 $ 1.2 $ (.6)
===== ===== ======
Notes Payable, Representing Direct Finance Obligations (Excluding Notes
Payable Related to Securitized Finance Receivables Structured as
Collateralized Borrowings)
Notes payable (excluding notes payable related to securitized finance
receivables structured as collateralized borrowings) of CFC at December 31, 2002
and 2001, were as follows (interest rates as of December 31, 2002):
2002 2001
---- ----
(Dollars in millions)
Master repurchase agreements ("Warehouse Facilities") due on various
dates in 2003 (3.10%)..................................................... $ 176.3 $1,679.0
Residual facility collateralized by retained interests in securitizations
due 2004 ("Residual Facility") (3.88%).................................... 497.7 507.3
Debtor in possession facility due May 2003 (10.0%)........................... 82.0 -
Medium term notes due September 2002 and April 2003.......................... - 189.7
10.25% senior subordinated notes due June 2002............................... - 161.9 (a)
Bank credit facility due December 2002 ("U.S. Bank Facility")................ - 21.0
Note payable to Conseco (2.91%).............................................. 273.2 249.5
Other........................................................................ 1.4 1.5
-------- --------
Total principal amount.................................................. 1,030.6 2,809.9
Unamortized net discount and deferred fees................................... (1.9) (8.8)
-------- --------
Direct finance obligations.............................................. $1,028.7 $2,801.1
======== ========
- -----------------
(a) Includes $23.7 million held by Conseco.
As of the Petition Date, CFC's remaining liquidity sources were a warehouse
facility (the "Warehouse Facility") and a residual facility ("Residual
Facility") with Lehman and a bank credit facility with U.S. Bank and together
with the Warehouse Facility and Residual Facility, the "CFC Facilities". The
direct borrower under (i) the Warehouse Facility is CFC's non-debtor subsidiary
Green Tree Finance Corp. - Five ("GTFC"), and (ii) the Residual Facility is
CFC's non-debtor subsidiary Green Tree Residual Finance Corp. I ("GTRFC"). The
Warehouse Facility and the Residual Facility are fully guaranteed by CFC and, up
to an aggregate of $125 million, by CIHC. CFC was the direct borrower under the
U.S. Bank Facility, which was also guaranteed by CIHC up to an aggregate of $125
million.
Prior to the Petition Date, CFC was in default under the CFC Facilities as
a result of (i) cross-defaults triggered by CNC's defaulting on its debt
obligations, (ii) cross-defaults among the U.S. Bank Facility, the Warehouse
Facility and the Residual Facility, (iii) failure to make payments required by
CFC's guarantees of payments on B-2 securities, which were issued to investors
in certain finance receivable securitization transactions; and (iv) breaches of
several financial covenants under the CFC Facilities. CFC entered into
forbearance agreements with Lehman with respect to the Warehouse Facility and
Residual Facility and with U.S. Bank with
174
respect to U.S. Bank Facility, pursuant to which Lehman and U.S. Bank agreed to
temporarily refrain from exercising any rights arising from events of default
that occurred under each CFC Facility prior to the Petition Date.
The Warehouse Facility is a repurchase facility under which primarily newly
originated manufactured housing, home equity, home improvement and recreational
vehicle loans originated by CFC or affiliates of CFC and transferred to GTFC are
sold by GTFC to Lehman with an agreement to repurchase those loans at a later
date and at a higher price. The price differential reflects the cost of
financing. The Warehouse Facility provides funding to CFC for new loan
origination. The Warehouse Facility and the Residual Facility are
cross-collateralized.
The Residual Facility is collateralized by retained interests in
securitizations. CFC is required to maintain collateral based on current
estimated fair values in accordance with the terms of such facility. Due to the
decrease in the estimated fair value of its retained interests, CFC's collateral
was deficient at December 31, 2002 (as calculated in accordance with the
relevant transaction documents, which provide that Lehman calculates the value
of CFC's collateral within its sole discretion). Pursuant to the forbearance
agreement entered into with Lehman on December 20, 2002, Lehman agreed not to
accelerate the repayment of the Residual Facility based on the collateral
deficiency through June 1, 2003. Under the terms of this forbearance agreement,
Lehman retains the cash flows from CFC's retained interests pledged under this
facility and applies those cash flows to the margin deficit. As mentioned above,
this forbearance agreement is subject to a number of conditions that may cause
it to terminate prior to June 1, 2003. The filing by CNC, CIHC and CFC of a
Chapter 11 petition triggered additional defaults under the CFC Facilities.
On December 19, 2002, shortly after the filing of the Chapter 11 Cases, CFC
obtained the FPS DIP provided by U.S. Bank and FPS DIP LLC, an affiliate of
Fortress Investment Group LLC ("Fortress"), J.C. Flowers & Co. LLC. ("Flowers")
and Cerberus Capital Management, L.P. ("Cerberus"). The DIP financing is for up
to $125,000,000. The DIP financing motion was granted by the Bankruptcy Court on
January 14, 2003.
From time to time, CFC has failed to comply with certain covenants
regarding the maximum permissible variance of the budgets provided to the FPS
DIP lenders in connection with the FPS DIP. In each instance, CFC has obtained
appropriate waivers. The occurrence of events of default under the FPS DIP, may
cause events of default under the Lehman December 20 Agreements (as defined
below).
On December 20, 2002, CFC, GTFC, and GTRFC, entered into several agreements
with Lehman: (the "Lehman December 20 Agreements") (i) providing that Lehman
temporarily refrain from exercising any rights arising from events of default
that occurred under each relevant CFC Facility (including, but not limited to,
those arising out of CNC, CIHC and CFC filing for Chapter 11 relief) until June
1, 2003; (ii) indirectly providing CFC with up to $25,000,000 in postpetition
financing by allowing GTFC to provide intercompany loans to CFC with cash flows
obtained from the Warehouse Facility; (iii) decreasing the capacity of the
Warehouse Facility to a maximum of $250,000,000; and (iv) otherwise amending the
Warehouse Facility and the Residual Facility. These agreements are subject to a
number of conditions that may cause them to terminate prior to June 1, 2003.
As a result of CFC's defaults and the Lehman December 20 Agreements, CFC
may not draw funds from the Residual Facility.
During 2002, CFC repurchased $46.9 million par value of its senior
subordinated notes and medium term notes resulting in an extraordinary gain of
$3.9 million (net of income taxes). In March 2002, CFC completed a tender offer
pursuant to which it purchased $75.8 million par value of its senior
subordinated notes due June 2002. The purchase price was equal to 100 percent of
the principal amount of the notes plus accrued interest. The remaining principal
amount outstanding of $58.5 million (including $23.7 million held by Conseco) of
the senior subordinated notes was retired at maturity on June 3, 2002.
In April 2002, CFC completed a tender offer pursuant to which it purchased
$158.5 million par value of its medium term notes due September 2002 and $3.7
million par value of its medium term notes due April 2003. The purchase price
was equal to 100 percent of the principal amount of the notes plus accrued
interest. In June 2002, CFC tendered for the remaining $8.2 million par value of
its medium term notes due September 2002. Pursuant to the tender offer $5.5
million par value of the notes was tendered in July. The purchase price was
equal to 101 percent of the principal amount of the notes plus accrued interest.
The remaining principal amount outstanding of the medium term notes after giving
effect to both tender offers and other debt repurchases completed prior to the
tender offers of $2.7 million was retired at maturity on September 26, 2002.
During 2001, CFC repurchased $55.4 million par value of its 10.25% senior
subordinated notes due June 2002 for $51.9 million (resulting in an
extraordinary gain of $2.1 million, net of income taxes of $1.3 million). Also
during 2001, CFC repurchased $34.0
175
million par value of its 6.5% medium term notes due September 2002 for $27.5
million (resulting in an extraordinary gain of $4.0 million, net of income taxes
of $2.5 million).
Notes Payable Related to Securitized Finance Receivables Structured as
Collateralized Borrowings
Notes payable related to securitized finance receivables structured as
collateralized borrowings were $13,069.7 million and $14,484.5 million at
December 31, 2002 and 2001, respectively. The principal and interest on these
notes are paid using the cash flows from the underlying finance receivables
which serve as collateral for the notes. Accordingly, the timing of the
principal payments on these notes is dependent on the payments received on the
underlying finance receivables which back the notes. In some instances, CFC is
required to advance principal and interest payments even though the payments on
the underlying finance receivables which back the notes have not yet been
received. The average interest rate on these notes was 6.7 percent and 6.4
percent at December 31, 2002 and 2001, respectively. The notes payable balance
also includes amounts related to financing transactions securitized by: (i)
capitalized expenses related to the refurbishment of repossessed assets; and
(ii) principal and interest advances. The outstanding liability on these
facilities at December 31, 2002 was $85 million.
Special Charges
2002
The following table summarizes the special charges incurred by CFC during
2002, which are further described in the paragraphs which follow (dollars in
millions):
Loss related to assets sold to raise cash...................................... $ 97.6
Costs related to debt modification and refinancing transactions................ 39.4
Reduction in value of Lehman warrant........................................... (38.1)
Abandonment of computer processing system...................................... 16.3
Other items.................................................................... 6.7
------
Special charges before income tax benefit.................................. $121.9
======
Loss related to assets sold to raise cash
CFC completed various asset sales which resulted in net losses of $97.6
million in 2002. Such amounts included the loss of $96.0 million related to the
sales of $463 million of certain finance receivables and $1.6 million of
additional loss related to receivables required to be repurchased from the
purchaser of the vendor services receivables pursuant to the repurchase clauses
in the agreements.
Costs related to debt modification and refinancing transactions
In conjunction with the various modifications to borrowing arrangements and
refinancing transactions and the recognition of deferred expenses for terminated
financing arrangements, CFC incurred costs of $39.4 million in 2002 which are
not permitted to be deferred pursuant to GAAP.
Reduction in value of Lehman warrant
As partial consideration for a financing transaction, Conseco Finance
issued a warrant to Lehman which permits the holder to purchase 5 percent of
Conseco Finance at a nominal price. The holder of the warrant or Conseco Finance
may cause the warrant and any stock issued upon its exercise to be purchased for
cash at an appraised value in May 2003. Additionally, until May 2003, the holder
has the right (subject to certain terms and conditions) to convert the warrant
into convertible preferred stock of Conseco. Since the warrant permits cash
settlement at fair value at the option of the holder of the warrant, it has been
included in other liabilities and is measured at fair value, with changes in its
value reported in earnings. The estimated fair value of the warrant at December
31, 2002 was nil based on current valuations of Conseco Finance. Accordingly,
CFC recorded a $38.1 million reduction in the value of the warrant during 2002.
176
Abandonment of computer processing systems
In 2002, CFC incurred a $16.3 million charge for the abandonment of certain
computer processing systems. CFC is abandoning such systems given the recent
changes to its business and its decision to no longer originate certain types of
loans.
177
2001
The following table summarizes the special charges incurred by CFC during
2001, which are further described in the paragraphs which follow (dollars in
millions):
Severance benefits, litigation reserves and other restructuring charges................... $ 20.3
Loss related to sale of certain finance receivables....................................... 11.2
Change in value of warrant................................................................ (10.0)
-----
Special charges before income tax benefit............................................ $ 21.5
======
Severance benefits, litigation reserves and other restructuring charges
During 2001, Conseco developed plans to change the way it operates. Such
changes were undertaken in an effort to improve CFC's operations and
profitability. The planned changes included moving a significant number of jobs
to India, where a highly-educated, low-cost, English-speaking labor force is
available. Pursuant to GAAP, CFC was required to recognize the costs associated
with most restructuring activities as the costs were incurred. However, costs
associated with severance benefits are required to be recognized when the costs
are: (i) attributable to employees' services that have already been rendered;
(ii) relate to obligations that accumulate; and (iii) are probable and can be
reasonably estimated. Since the severance costs associated with their planned
activities met these requirements, CFC recognized a charge of $6.2 million in
2001 related to severance benefits and other restructuring charges. CFC also
recognized charges of: (i) $7.5 million related to its decision to discontinue
the sale of certain types of life insurance in conjunction with lending
transactions; and (ii) $6.6 million related to certain litigation matters.
Loss related to the sale of certain finance receivables
During 2001, CFC recognized a loss of $2.2 million on the sale of $11.2
million of finance receivables. Also, during 2001, the purchaser of certain
credit card receivables returned certain receivables pursuant to a return of
accounts provision included in the sales agreement. Such returns and the
associated losses exceeded the amounts CFC initially anticipated when the
receivables were sold. CFC recognized a loss of $9.0 million related to the
returned receivables.
Change in value of warrant
As partial consideration for a financing transaction, CFC issued a warrant
which permits the holder to purchase 5 percent of Conseco Finance at a nominal
price. The holder of the warrant or CFC may cause the warrant and any stock
issued upon its exercise to be purchased for cash at an appraised value in May
2003. Additionally, until May 2003, the holder has the right (subject to certain
terms and conditions) to convert the warrant into preferred stock of Conseco.
Since the warrant permits cash settlement at fair value at the option of the
holder of the warrant, it has been included in other liabilities and is measured
at fair value, with changes in its value reported in earnings. The estimated
fair value of the warrant at December 31, 2001 was $38.1 million. The estimated
value was determined based on discounted cash flow and market multiple valuation
techniques. During 2001, CFC recognized a $10.0 million benefit as a result of
the decreased value of the warrant (which was classified as a reduction to
special charges).
178
2000
CFC incurred significant special charges during 2000, primarily related to
the restructuring of its debt and its business. The following table summarizes
the special charges, which are further described in the paragraphs which follow
(dollars in millions):
Lower of cost or market adjustment for finance receivables
identified for sale.................................................... $103.3
Loss on sale of transportation loans and vendor services
financing business..................................................... 51.0
Loss on sale of asset-based loans........................................... 53.0
Costs related to closing offices and streamlining businesses................ 29.5
Abandonment of computer processing systems.................................. 35.8
Transaction fees paid and warrant issued.................................... 78.4
Reserve methodology change at bank subsidiary............................... 48.0
Net gain on sale of certain loans and other items........................... (4.7)
------
Special charges before income tax benefit.......................... $394.3
======
Lower of cost or market adjustment for finance receivables identified for
sale
On July 27, 2000, CFC announced several courses of action to restructure
its business, including the sale or runoff of the finance receivables of several
business lines. The carrying value of the loans held for sale was reduced to the
lower of cost or market, consistent with CFC's accounting policy for such loans.
The reduction in value of these loans of $103.3 million (including a $45.9
million increase to the allowance for credit losses) primarily related to
transportation finance receivables (primarily loans for the purchase of trucks
and buses). These loans had experienced a significant decrease in value as a
result of the adverse economic effect that increases in oil prices and
competition had on borrowers in the transportation business during 2000.
Loss on sale of transportation loans and vendor service financing business
During the fourth quarter of 2000, CFC sold transportation loans with a
carrying value of $566.0 million (after the market adjustment described above)
in whole loan sale transactions. CFC recognized an additional loss of $30.7
million on the sale. During 2000, CFC recognized a special charge and reduced
goodwill by $20.3 million, representing the difference between: (i) the carrying
value of the net assets of the vendor services financing business; and (ii) the
anticipated proceeds from the sale of such business, which was completed in the
first quarter of 2001.
Loss on sale of asset-based loans
During the third quarter of 2000, CFC sold asset-based loans with a
carrying value of $152.2 million in whole loan sale transactions. CFC recognized
a loss of $53.0 million on these sales.
Costs related to closing offices and streamlining businesses
CFC's restructuring activities included the closing of several branch
offices and streamlining its businesses. These activities included a reduction
in the work force of approximately 1,700 employees. CFC incurred a charge of
$6.9 million related to severance costs paid to terminated employees in 2000.
CFC also incurred lease termination and direct closing costs of $12.3 million
associated with the branch offices closed in conjunction with the restructuring
activities. In addition, fixed assets and leasehold improvements of $10.3
million were abandoned when the branch offices were closed.
Abandonment of computer processing systems
CFC recorded a $35.8 million charge in 2000 to write off the carrying value
of capitalized computer software costs for projects that have been abandoned in
conjunction with its restructuring. These costs are primarily associated with:
(i) computer processing systems under development that would require significant
additional expenditures to complete and that were inconsistent with its business
plan; and (ii) computer systems related to the lines of business discontinued by
CFC and therefore were no longer required.
179
Advisory fees and warrant paid and/or issued to Lehman and other investment
banks
In May 2000, CFC sold approximately $1.3 billion of finance receivables to
Lehman and its affiliates for cash and a right to share in future profits from a
subsequent sale or securitization of the assets sold. CFC paid a $25.0 million
transaction fee to Lehman in conjunction with the sale, which was included in
special charges. Such loans were sold to Lehman at a value which approximated
net book value, less the fee paid to Lehman.
During the second and third quarters of 2000, CFC repurchased a significant
portion of the finance receivables sold to Lehman. These finance receivables
were subsequently included in securitization transactions structured as
financings. The cost of the finance receivables purchased from Lehman did not
differ materially from the book value of the loans prior to their sale to
Lehman.
Lehman has also amended its master repurchase financing facilities to
expand the types of assets financed. As partial consideration for the financing
transaction, Lehman received a warrant, with a nominal exercise price, for five
percent of the common stock of CFC. The initial $48.1 million estimated value of
the warrant was recognized as an expense during the second quarter of 2000. The
estimated fair value of the warrant did not change materially during 2000.
CFC also paid Lehman $5.3 million in advisory fees related to the business
and debt restructuring.
Reserve Methodology Change at Bank Subsidiary
During the fourth quarter of 2000, CFC increased the allowance for credit
losses related to credit card receivables held by its bank subsidiary. CFC
implemented a more conservative approach pursuant to a regulatory examination,
which resulted in this special charge.
Gain on sale of certain loans and other items
During 2000, CFC sold substantially all of the finance receivables related
to its bankcard (Visa and Mastercard) portfolio. CFC recognized a gain of $9.7
million on the sale.
During 2000, CFC recognized $5.0 million of other costs related to its
restructuring.
Reorganization Items
During 2002, CFC incurred professional fees associated with its bankruptcy
proceedings which totaled $17.3 million. Such items are expensed and classified
in accordance with SOP 90-7.
Subsequent events related to CFC
On March 14, 2003, the Bankruptcy Court approved a new servicing agreement
which was agreed upon by CFC and the securitization bondholders. Pursuant to the
agreement the servicing fee for the manufactured housing securitization trusts
will increase to 125 bps for the first 12 months subsequent to the closing of
the sale of CFC's assets to CFN and 115 bps thereafter. This is an increase from
the original servicing fee of 50 bps. This agreement also moves the payment of
the servicing fee to the top of the cash flow streams before distributions to
the bondholders. Previously, this servicing fee was distributed after all
principal and interest payments were made to all bondholders. The modifications
to the servicing agreements will have a favorable impact on the cash flow and
valuation of CFC's servicing rights. Under the new servicing assumptions, CFC's
servicing rights would have been valued at $180.8 million as of December 31,
2002, an increase in value of $514.2 million. The change adversely affects the
valuation of our retained interests and guarantee liability related to interests
in securitization trusts held by others by $10.3 million and $216.1 million,
respectively. The valuations for the retained interests and the guarantee
liability related to interests in securitization trusts held by others as of
December 31, 2002 under the new assumptions would have been $242.2 million and
$(542.8) million, respectively.
Through April 1, 2003, CFC has failed to make $254.2 million in guarantee
payments of which $91.8 million was owed to outside third parties. These amounts
are contemplated in the above mentioned valuations using the new servicing
agreement and related assumptions.
On April 14, 2003, the Bankruptcy Court approved an amendment to the FPS
DIP to increase the maximum permitted borrowings thereunder, from $125 million
to $150 million.
180
18. FINANCIAL INFORMATION REGARDING CVIC
In October 2002, Conseco Life Insurance Company of Texas (a wholly-owned
subsidiary of the Company) completed the sale of CVIC to Inviva, Inc.
("Inviva"), a holding company that owns The American Life Insurance Company of
New York. CVIC marketed tax qualified annuities and certain employee
benefit-related insurance products through professional independent agents.
Pursuant to SFAS 144, CVIC is accounted for as a discontinued operation. Our
consolidated statement of operations reflects the operations of CVIC in the
caption "Discontinued operations" for all periods. The consideration received
from Inviva at closing (subject to adjustment based upon the adjusted statutory
balance sheet of CVIC at September 30, 2002) totaled $83.7 million, of which
$35.0 million was in the form of Series D Preferred Shares (the "Preferred
Shares") issued by Inviva and the remainder was in cash. Under the terms of the
purchase agreement, if the adjusted statutory book value of CVIC at September
30, 2002, is less than a specified value, the purchase price shall be reduced by
the amount that such specified value exceeds the adjusted statutory book value.
In addition, Conseco Life Insurance Company of Texas received a dividend of
approximately $75 million from CVIC immediately prior to the closing. We
recognized a loss on the sale of $93.1 million. There was no income tax benefit
recognized on the transaction.
The Preferred Shares accrue dividends (in-kind) at an annual rate of 19
percent. On or after December 31, 2002, our insurance subsidiary that holds
these shares may elect to exchange the Preferred Shares for non-voting common
stock of JNF Holding Company, Inc., a wholly-owned subsidiary of Inviva, ("JNF")
that now owns all of the stock of CVIC. If not previously exchanged, on October
15, 2003, the Preferred Shares will be mandatorily exchanged into the common
stock of JNF and our insurance subsidiary that holds the Preferred Shares will
be entitled to receive a $1.67 million cash fee upon the occurrence of such
exchange. After the exchange has occurred, such JNF common stock may be
repurchased by JNF at any time at 115 percent of the stated value of the
Preferred Shares plus accrued and unpaid dividends thereon immediately prior to
the exchange.
In connection with the sale of CVIC, we agreed to provide, for a fee,
various administrative and technical services in order to allow CVIC to continue
to operate and to facilitate the transition of CVIC to Inviva. Such services are
being provided pursuant to an Administrative and Transition Services Agreement
(the "Transition Agreement"). The term of the Transition Agreement is nine
months subject to extension or early termination. As part of the CVIC sale,
Conseco agreed that it would not engage in the variable annuity or variable
insurance business for a period of three years after the closing.
The following summarizes selected financial information of CVIC:
December 31,
2001
-----------
(Dollars in millions)
Total investments.......................................................................... $1,399.6
Cost of policies purchased................................................................. 100.7
Cost of policies produced.................................................................. 228.0
Assets held in separate accounts........................................................ 1,649.1
Total assets............................................................................... 3,631.1
Insurance liabilities...................................................................... 1,382.9
Liabilities related to separate accounts................................................... 1,649.1
Investment borrowings...................................................................... 151.8
Total liabilities.......................................................................... 3,242.6
Net assets of discontinued operations.................................................... 388.5
181
Year ended
December 31,
---------------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
Insurance policy income..................................................... $ 30.5 $ 73.0 $ 49.6
Net investment income....................................................... (217.3) (61.7) 309.9
Net realized investment losses.............................................. (76.7) (34.3) (11.8)
Total revenues.............................................................. (263.3) (23.0) 347.9
Insurance policy benefits................................................... (234.7) (81.7) 263.4
Amortization................................................................ 117.4 33.7 27.3
Total expenses.............................................................. (102.9) (17.4) 319.5
Pre-tax income (loss)....................................................... (160.4) (5.6) 28.4
Net income (loss)........................................................... $(101.6) $ (5.6) $17.7
Income taxes................................................................ (58.8)(a) - -
Loss on sale of CVIC........................................................ (93.1) - -
----- ------ -----
Amount classified as discontinued operations............................ $(253.5) $ (5.6) $17.7
======= ====== =====
- ---------------
(a) Amount is considered in determining the income tax expense in the
consolidated statement of operations.
182
19. INVESTMENTS IN VARIABLE INTEREST ENTITIES
The Company has investments in various types of special purpose entities
and other entities, some of which are VIEs under FIN 46, as described in the
note to the consolidated financial statements entitled "Summary of Significant
Accounting Policies". The following are descriptions of our significant
investments in VIEs:
Brickyard Trust
In 1998, the Company invested in an investment trust known as the Brickyard
Loan Trust ("Brickyard"). Brickyard is a collateralized debt obligation trust
which participates in an underlying pool of commercial loans. The initial
capital structure of Brickyard consisted of $575 million of senior financing
provided by unrelated third party investors and $127 million of notes and
certificates owned by the Company and others. As a result of our 85 percent
ownership interest in the subordinated certificates, we are the primary
beneficiary of Brickyard. In accordance with ARB 51 "Consolidated Financial
Statements", Brickyard is consolidated in our financial statements, because of:
(i) our investment management subsidiary, Conseco Capital Management, Inc. was
the investment manager; and (ii) our significant ownership of the subordinated
certificates. Included in "Assets held in separate accounts and investment
trust" were $410.2 million and $481.1 million at December 31, 2002 and 2001,
respectively, of assets which serve as collateral for Brickyard's obligations.
These amounts are offset by a corresponding liability account, the value of
which fluctuates in relation to changes in the values of the investments. At
December 31, 2002 the net carrying value of our investment was $66.7 million,
which is also the maximum loss we could recognize if the loans held in the trust
experiences significant defaults. The senior note obligations have no recourse
to the general credit of the Company.
Other Investment Trusts
In December 1998, the Company formed three investment trusts which were
special purpose entities formed to hold various fixed maturity, limited
partnership and other types of investments. The initial capital structure of
each of the trusts consisted of: (i) approximately 96 percent
principal-protected senior notes; (ii) approximately 3 percent subordinated
junior notes; and (iii) 1 percent equity. The senior principal-protected notes
are collateralized by zero coupon treasury notes with par values and maturities
matching the par values and maturities of the principal-protected senior notes.
Conseco's life insurance subsidiaries own 100 percent of the senior
principal-protected notes. Certain of Conseco's non-life insurance subsidiaries
own all of the subordinated junior notes, which have a preferred return equal to
the total return on the trusts' assets in excess of principal and interest on
the senior notes. The equity of the trusts is owned by unrelated third parties.
The three investment trusts are VIEs under FIN 46 because the trusts'
equity represents significantly less than 10 percent of total capital and the
subordinated junior notes were intended to absorb expected losses and receive
virtually all expected residual returns. Based on our 100 percent ownership of
the subordinated junior notes, we are the primary beneficiary of the investment
trusts. All three trusts are consolidated in our financial statements at
December 31, 2002. The carrying value of the total invested assets in the three
trusts were approximately $382 million at December 31, 2002, which also
represents Conseco's maximum exposure to loss as a result of our ownership
interests in the trusts. The trusts have no obligations or debt to outside
parties.
Investment in General Motors Building
In 1998, Conseco invested in a partnership which was formed to acquire and
own the 50 story office building in New York City known as the General Motors
Building (the "GM Building"). The partnership acquired the GM Building for
approximately $878 million. The initial capital structure of the partnership
consisted of: (i) a $700 million senior mortgage; (ii) $200 million of
subordinated debt with a stated fixed return of 12.7 percent payable-in-kind,
and the opportunity to earn an additional residual return; and (iii) $30 million
of partnership equity, owned 50 percent by Conseco and 50 percent by an
affiliate of Donald Trump. A Trump affiliate also served as general manager of
the acquired building. We own 100 percent of the subordinated debt. The
partnership is a VIE under FIN 46 because the $30 million of equity represents
significantly less than 10 percent of total partnership capital and the
subordinated debt was intended to absorb virtually all expected losses and
receive a significant portion of expected residual returns. Based on our 100
percent ownership of the subordinated debt, we are the primary beneficiary of
the GM Building partnership. Accordingly, the partnership will be consolidated
in our financial statements beginning in the third quarter 2003. We do not
expect the consolidation of the GM Building partnership to have a material
impact on our financial condition or results of operations. The real estate
asset, which will be added to our balance sheet as a result of consolidation,
collateralizes the partnership's senior mortgage obligation. The existing senior
mortgage obligation, which would also be added to our balance sheet as a result
of consolidation, is not guaranteed by Conseco and does not have recourse
against Conseco's general credit. The existing senior mortgage obligation
matures
183
on August 1, 2003.
At December 31, 2002, actively managed fixed maturities at fair value
included $277.8 million of subordinated debt and accrued interest in the GM
Building partnership. Other invested assets included our $15 million equity
investment at December 31, 2002. The investments in subordinated debt and equity
represent our maximum exposure to investment loss as a result of our involvement
in the partnership. As more fully described in the note to the consolidated
financial statements entitled "Other Disclosures", the other investor in the
partnership has filed a lawsuit against Conseco.
Other Investments in Variable Interest Entities
Certain limited partnerships and other entities, which are part of our
non-traditional investment portfolio, are VIEs. However, our investments in each
of those entities are not significant and, therefore, the disclosure and
consolidation requirements of FIN 46 are not applicable. In each case, the
carrying value included in other invested assets represents the Company's
maximum exposure to loss as a result of its involvement with the entity.
184
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information regarding Executive Officers is included under a separate
caption at the end of Part I.
The following information regarding each Director includes, as of April 11,
2003, such person's age, positions with Conseco, principal occupation and
business experience for the last five years, and tenure as a Director of
Conseco.
Director Positions with Conseco, Principal Term
Name and Age Since Occupation and Business Experience Expiring
-------------------------- -------- ------------------------------------------------- --------
John M. Mutz, 67 1997 Since 1999, investor and consultant. 2005
President of PSI Energy Inc. (electric utility) from
1994 to 1999. From 1989 to 1993 President of Lilly
Endowment, Inc. (charitable foundation). From
1980 to 1988, Lieutenant Governor of the State of
Indiana.
Robert S. Nickoloff, 74 1998 From 1993 to present, Chairman of KMN, Inc. 2005
(medical venture capital).
From 1999 to present, General
Counsel of Venturi Group LLC
(medical venture capital).
Gary C. Wendt, 61 2000 Since June 2000, Chairman of Conseco. From June 2005
2000 until October 2002, Chief Executive Officer of
Conseco. From 1999 to 2000, associated with Global
Opportunity Advisors (a private equity investment
fund). From 1986 to 1998, Chairman and Chief
Executive Officer of GE Capital Services. From
1984 to 1986, President and Chief Operations Officer
of GE Credit Corp. Also a director of Sanchez
Computer Associates, Inc.
Julio A. Barea, 55 2001 Since 2002, partner of Kiwi Holdings, Inc. From 1998 2003
to 2002, Vice President of Sara Lee Corporation.
From 1997 to 1998 President and Chief Executive
Officer of Sara Lee Underwear.
Carol Bellamy, 60 2001 Since 1995, Executive Director of UNICEF. 2003
Lawrence M. Coss, 64 1998 Private Investor. Founder, Chief Executive Officer 2003
and Director of Green Tree Financial Corporation
(now known as Conseco Finance Corp.) from 1975 to
1998).
Thomas M. Hagerty, 40 2000 From July 2000 until March 2001, Senior Vice 2003
President and Acting Chief Financial Officer of
Conseco. Since 1988 employed by Thomas H. Lee
Partners, L.P. and its predecessor, Thomas H. Lee
Company. Also a Director of Metris Companies,
Inc., ARC Holdings, Cott Corp.and Syratech Corp.
David V. Harkins, 62 1999 From April 28 until June 28, 2000, interim Chairman 2004
of the Board and Chief Executive Officer of Conseco.
Since 1999, President of Thomas H. Lee Partners
and since its founding in 1974 has been affiliated
with Thomas H. Lee Partners, L.P. and its
predecessor, Thomas H. Lee Company. Also a
Director of Metris Companies, Inc., Cott Corp.,
Fisher Scientific International Inc., Stanley
Furniture Company, Inc., and Syratech Corp.
M. Phil Hathaway, 73 1984 Retired. Formerly Treasurer of Cook Group Inc. 2004
(medical equipment, property and casualty insurance
and real estate development operations). Also a
Certified Public Accountant.
185
Director Positions with Conseco, Principal Term
Name and Age Since Occupation and Business Experience Expiring
-------------------------- -------- ------------------------------------------------- --------
Samme Thompson, 57 2002 Since April 2002, President of Telit Associates, Inc. 2004
(consulting). From 1999 until April 2002, Senior
Vice President Strategy and Corporate
Development of Motorola Corporation. From 1994 to
1999 President of Telit Associates, Inc.
William J. Shea, 55 2002 Since November 2002, Chief Executive Officer, since 2001
September 2001 President and from March 2002
until November 2002 Acting Chief Financial Officer of
Conseco. From 1998 to 2001, Chairman of the
Board of Demoulas Supermarkets, Inc.; from 1999
to 2000, CEO of View Tech, Inc. (integrated video-
conferencing) and from 1993 to 1998, Vice
Chairman and Chief Financial Officer of BankBoston
Corporation.
Because of Conseco's bankruptcy filing on December 17, 2002, the foregoing
officers (disclosed at the end of Part I) and directors have served as such of a
bankrupt company. Additionally, the officers listed in Part I serve as officers
and/or directors of various subsidiaries of Conseco that also filed bankruptcy
petitions on December 17, 2002.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires Conseco's Directors and
executive officers, and each person who is the beneficial owner of more than 10
percent of any class of Conseco's outstanding equity securities, to file with
the SEC initial reports of ownership and reports of changes in ownership of
Common Stock and other equity securities of Conseco. Specific due dates for
these reports have been established by the SEC, and Conseco is required to
disclose any failure by such persons to file such reports for fiscal year 2002
by the prescribed dates. Officers, Directors and greater than ten percent
beneficial owners are required by SEC regulations to furnish Conseco with copies
of all reports filed with the SEC pursuant to Section 16(a) of the Exchange Act.
To Conseco's knowledge, based solely on review of the copies of reports
furnished to Conseco and written representations that no other reports were
required, all filings required pursuant to Section 16(a) of the Exchange Act
applicable to Conseco's officers, Directors and greater than 10 percent
beneficial owners were made for the year ended December 31, 2002, with the
exception of one report that was not filed by Mr. Wendt to report the
cancellation of his restricted stock.
ITEM 11. EXECUTIVE COMPENSATION.
Summary Compensation Table
The following Summary Compensation Table sets forth the cash compensation
and certain other components of the compensation paid to each person who served
as chief executive officer and the other four most highly compensated
individuals who served as executive officers of Conseco in 2002 (collectively,
the "Named Officers") for services rendered during 2002.
186
Long-Term Compensation
----------------------
Annual Compensation Awards
------------------------------ ----------------------
Number of
Securities
Restricted Underlying
Stock Options/SARs All Other
Name and Principal Position Year Salary Bonus Other(1) Awards(2) (in shares)(3) Compensation(4)
- ---------------------------- ------- -------- -------- --------- --------- --------------- ----------------
Gary C. Wendt 2002 $129,487 $8,000,000 $ 70,163 $ -- -- $ --
2001 -- -- 58,617 -- -- 661,281
2000 -- -- 25,641 24,400,000 10,000,000 45,870,278
William J. Shea (5) 2002 774,038 1,100,000 87,625 -- -- 3,677
President and Chief Executive 2001 147,756 250,000 340,000 450,000
Officer 92
Edward M. Berube 2002 660,000 660,000 -- -- 5,500
Senior Vice President 2001 660,000 693,000 -- 100,000 269,778
2000 600,000 500,000 -- 230,000 552
Maxwell E. Bublitz 2002 700,000 450,000(5) -- -- 6,790
Senior Vice President, 2001 625,000 450,000 -- 25,000 6,750
Investment 2000 250,000 900,000 -- 30,000 6,750
Eugene M. Bullis (5)(7) 2002 243,590 600,000 -- -- --
Executive Vice President
and Chief Financial Officer
John R. Kline (5)(8) 2002 214,571 1,052,500 -- -- 6,310
Senior Vice President
and Chief Accounting Officer
- --------------------
(1) Includes for Mr. Wendt $56,008 in 2002, $45,839 in 2001 and $17,452 in
2000 relating to his personal use of Company aircraft. Includes for Mr.
Shea $68,541 relating to his personal use of Company aircraft in 2002.
The Named Officers did not otherwise have other annual compensation for
2002, 2001 or 2000 that is required to be disclosed under SEC rules
concerning executive officer and director compensation disclosure.
(2) The amount shown in this column for Mr. Wendt represents the value of
the award of 3,200,000 shares of restricted Common Stock based on the
closing price of the Common Stock on June 28, 2000. Those shares were
scheduled to vest on November 1, 2002, but were cancelled because he was
not then employed by Conseco. The amount shown in this column for Mr.
Shea represents the value of the award of 50,000 shares of restricted
Common Stock based on the closing price of the Common Stock on September
17, 2001. The shares are scheduled to vest as follows if Mr. Shea
remains employed by Conseco: 20 percent on June 30, 2003, 40 percent on
September 17, 2003 and 40 percent on September 17, 2004. Mr. Shea is
entitled to receive any dividends paid on the Common Stock during the
restricted period after the shares have vested. The value of those
shares at December 31, 2002 was $1,950.
(3) No stock appreciation rights have been granted.
(4) For 2002, the amounts reported in this column represent amounts paid for
the Named Officers for: (i) individual life insurance premiums; (ii)
group life insurance premiums; and (iii) the employer contribution under
the ConsecoSave Plan. The table below shows such amounts for each Named
Officer.
187
Individual Group Life
Life Insurance Insurance ConsecoSave Plan
Name Premiums Premiums Contributions
---------------------- ------------------ ------------------ ------------------
Gary C. Wendt $ -- $ -- $ --
William J. Shea 2,435 1,242 --
Edward M. Berube -- -- 5,500
Maxwell E. Bublitz 1,290 -- 5,500
Eugene M. Bullis -- -- --
John R. Kline -- 810 5,500
- ----------------
(5) No compensation information is reported for years prior to the year in
which the Named Officer became an executive officer of the Company.
(6) The bonus for Mr. Bublitz has not been paid and is subject to approval of
the Bankruptcy Court.
(7) Mr. Bullis' employment commenced in July 2002.
(8) Mr. Kline became an executive officer in July 2002.
Employment Contracts and Change-In-Control Arrangements
Mr. Shea has an employment agreement with Conseco for a term ending July
31, 2005, with a minimum annual salary of $750,000, annual bonuses at the
discretion of the Compensation Committee of the Board of Directors, various
restricted stock and stock option awards, supplemental bonuses of $1,500,000 on
June 30, 2004, and $2,500,000 on March 31, 2005, a severance allowance upon
termination of employment and certain insurance and other fringe benefits.
Mr. Berube has an agreement with Conseco Services, LLC, a subsidiary of
Conseco, which provides for a base salary of $660,000 per year, annual bonuses
based on the achievement of performance parameters and certain other benefits.
Conseco also has an employment agreement with Mr. Bublitz for a term ending
December 31, 2003, with a minimum annual salary of $250,000, annual bonuses in
the discretion of the Compensation Committee or Board of Directors, a severance
allowance upon termination of employment and certain insurance and other fringe
benefits.
Each of the employment agreements described above includes provisions
pursuant to which the employee may elect to receive, in the event of a
termination of the agreement in anticipation of or following a change in control
of Conseco (a "Control Termination"), a severance allowance. Under the terms of
Mr. Shea's employment agreement, upon a Control Termination, Mr. Shea is
entitled to the greater of: (i) 1.5 times his base salary for the most recent
fiscal year; or (ii) $4,000,000 multiplied by a fraction, the numerator of which
is equal to the number of months from June 1, 2002, until the date of
termination of his employment agreement, and the denominator of which is 34.
Under the terms of his agreement with Conseco, Mr. Berube is entitled to a
severance payment equal to two years of total cash compensation, but in no case
less then $2,320,000 in the event of a change of control, a major change in
strategy resulting in the elimination of his role, a material reduction in his
responsibilities or termination of employment for other than cause. Upon any
such event, Mr. Berube is also entitled to receive a payment of up to $1,234,000
depending on the gains realized from 200,000 stock options granted to him during
2000 at a price of $7.63 per share.
Under the terms of Mr. Bublitz's employment agreement with Conseco, he
would be entitled to receive a lump sum payment, net of applicable taxes, within
30 days of a Change of Control equal to the purchase price paid by Mr. Bublitz
to acquire shares of Common Stock under the Company's stock purchase plans plus
all accrued interest, less the value of the consideration to be paid for such
stock in any transaction relating to a Change of Control. Within 30 days after a
"Termination of Service" (similar to the definition of Control Termination
above), Mr. Bublitz is entitled to receive a lump sum payment equal to the
lesser of (a) five times the base salary, bonuses and other incentive
compensation paid to him by Conseco during the calendar year immediately
preceding the Change of Control or (b) five million dollars ($5,000,000). As
defined in the employment agreement with Mr. Bublitz, "Change of Control" means
the acquisition prior to December 31, 2003 by any person of securities of the
Company representing 51% or more of the combined voting power of the Company's
then outstanding securities entitled to vote with respect to the election of its
Board of Directors.
Conseco entered into an employment agreement with Mr. Wendt on June 28,
2000. Pursuant to the employment agreement, Mr. Wendt received no salary for the
first two years and was to receive a salary of $1 million per year thereafter.
The agreement also provided for a cash bonus at the end of two years of between
$8 million and $50 million, depending on the price of the company's common
stock. Because the common stock was trading at less than $10 per share in 2002,
the amount of the bonus paid to Mr. Wendt was $8 million. Mr. Wendt resigned
from his position as the Chief Executive Officer of Conseco. Because of Mr.
Wendt's
188
resignation, his agreement terminated.
Mr. Bullis has an employment agreement with Conseco Services, LLC for a
term ending June 30, 2003, with an annual salary of $500,000, a bonus for the
period ending December 31, 2002 of up to $250,000, a bonus for the period ended
June 30, 2003 of up to $250,000, a severance allowance upon termination of
employment and certain insurance and other fringe benefits. Mr. Kline has an
employment agreement with Conseco for a term ending July 14, 2004, with an
annual salary of at least $275,000, bonuses at the discretion of Conseco, a
signing bonus of $865,000 subject to payment to Conseco in a pro rata amount in
the event Mr. Kline voluntarily left Conseco (based on the portion of the 2-year
period ending July 14, 2004, remaining after the date of such voluntary
termination of employment), a severance allowance upon termination of employment
and other fringe benefits.
See the discussion under the table headed Option Grants in 2002 concerning
change-in-control provisions related to stock options.
Stock Options
The following table sets forth certain information concerning the exercise
in 2002 of options to purchase Common Stock by the Named Officers and the
unexercised options to purchase Common Stock held by such individuals at
December 31, 2002.
Aggregated Option Exercises in 2002 and Year-End Option Values
Number of Securities
Underlying Unexercised Value of Unexercised
Number of Options (in shares) at In-the-Money Options at
Shares Acquired Value December 31, 2002 December 31, 2002
--------------------------- -----------------------
Name On Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ------------------ --------------- -------- ------------ -------------- ------------ --------------
Gary C. Wendt 0 0 0 0 0 0
William J. Shea 0 0 90,000 360,000 0 0
Edward M. Berube.. 0 0 28,500 518,500 0 0
Maxwell E. Bublitz 0 0 551,356 315,000 0 0
Eugene M. Bullis.. 0 0 0 0 0 0
John R. Kline 0 0 15,835 25,725 0 0
All outstanding options under the 1994 Stock Plan and the 1997 Plan
immediately vest and become exercisable or satisfiable upon the occurrence of a
Change of Control. The Compensation Committee, in its discretion, may determine
that upon the occurrence of such a transaction, each option outstanding shall
terminate within a specified number of days after notice to the holder thereof,
and such holder shall receive, with respect to each share of Common Stock
subject to such option, cash in an amount equal to the excess of: (i) the higher
of (x) the Fair Market Value (as defined in the 1994 Stock Plan and the 1997
Plan) of such shares of Common Stock immediately prior to the occurrence of such
transaction or (y) the value of the consideration to be received in such
transaction for one share of Common Stock; over (ii) the price per share, if
applicable, of Common Stock set forth in such option. If the consideration
offered to shareholders of Conseco in any transaction described in this
paragraph consists of anything other than cash, the Compensation Committee shall
determine the fair cash equivalent of the portion of the consideration offered
which is other than cash. These provisions will not terminate any rights of a
holder to further payments pursuant to any agreement between Conseco and such
holder following a Change of Control. A "Change of Control" of Conseco is deemed
to occur under the 1994 Stock Plan and the 1997 Plan if: (i) any person becomes
the beneficial owner, directly or indirectly, of securities of Conseco
representing 25 percent or more of the combined voting power of Conseco's
outstanding securities then entitled to vote for the election of directors; or
(ii) as the result of a tender offer, merger, consolidation, sale of assets, or
contest for election of directors, or any combination of the foregoing
transactions or events, individuals who were members of the Board of Directors
of Conseco immediately prior to any such transaction or event shall not
constitute a majority of the Board of Directors following such transaction or
event. However, no Change of Control shall be deemed to have occurred if and
when either: (i) any such change is the result of a transaction which
constitutes a "Rule 13e-3 transaction" as such term is defined in Rule 13e-3
promulgated under the Exchange Act; or (ii) any such person becomes, with the
approval of the Board of Directors of Conseco, the beneficial owner of
securities of Conseco representing 25 percent or more but less than 50 percent
of the combined voting power of Conseco's then outstanding securities entitled
to vote with respect to the election of its Board of Directors and in connection
therewith represents, and at all times continues to represent, in a filing, as
amended, with the SEC on Schedule 13D or Schedule 13G (or any successor Schedule
thereto) that "such person has acquired such securities for investment and not
with the purpose nor with the effect of changing or influencing the control of
Conseco, nor in connection with or as a participant in any transaction having
such purpose or effect," or words of comparable meaning and import.
Mr. Bublitz has an employment agreement with Conseco (see Employment
Contracts and Change-in-Control Agreements) that provide, in the event of a
Control Termination such Named Officer may elect, within 60 days after such
Control Termination, to receive a lump sum payment from Conseco in return for
surrender by such Named Officer of all or any portion of the options then
189
outstanding held by such Named Officer to purchase shares of Common Stock or
successor securities ("Unexercised Options"). Unexercised Options include all
outstanding options whether or not then exercisable. For each Unexercised Option
to purchase one share of Common Stock, Conseco must pay to the Named Officer an
amount equal to the Put Price. Amounts to be paid to Mr. Bublitz for Unexercised
Options in the event of a Control Termination of his employment agreement are to
be reduced by the exercise price of his Unexercised Options.
Compensation of Directors
Directors who are not also employees of Conseco are entitled to receive an
annual fee of $50,000, a fee of $500 for each Board or committee meeting they
attend, and an annual fee of $3,000 for serving as chairman of a Board
committee. The 1994 Stock Plan provides for an annual grant to each non-employee
director of options to purchase 5,000 shares of Common Stock on the date of the
annual meeting of shareholders at a price equal to the market price of Common
Stock on the date of grant. Messrs. Barea, Bellamy, Coss, Hagerty, Harkins,
Hathaway, Mutz, Nickoloff and Thompson each received such a grant in 2002. The
options were scheduled to vest 20 percent per year on each of the first five
anniversary dates of grant, subject to acceleration upon a Change of Control.
Compensation Committee Interlocks and Insider Participation in Compensation
Decisions
The members of the Compensation Committee during 2002 were Messrs. Barea,
Hathaway, Nickoloff and Thompson.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The following table sets forth information as of April 11, 2003 regarding
ownership of Common Stock (excluding shares held by subsidiaries) and Series F
Preferred Stock by the only persons known to own beneficially more than 5
percent thereof, by the Directors individually, by the executive officers named
in the Summary Compensation Table in Item 11 individually, and by all current
Directors and executive officers of Conseco as a group. Where any footnote
indicates that shares included in the table are owned by, or jointly with,
family members or by an affiliate of such person, the Director or executive
officer may be deemed to exercise shared voting and investment power with
respect to those shares, unless otherwise indicated.
Shares Owned and
Nature of Ownership
Title of Class Name and Address(1) Number (2) Percent
------------------ ------------------------------------------ ------------------ ---------
5-Percent Owners:
Preferred Thomas H. Lee Equity Fund IV, L.P.(2) 2,855,502 (3) 100%
Stock 75 State Street
Boston, MA 02109
Common Stock Thomas H. Lee Equity Fund IV, L.P. 28,555,020(3)(4) 7.6%
75 State Street
Boston, MA 02109
Directors and Executive Officers:
Common Stock Julio A. Barea 1,000 *
Common Stock Carol Bellamy 0 *
Common Stock Edward M. Berube 28,500 *
Common Stock Maxwell E. Bublitz 1,167,226 *
Common Stock Eugene M. Bullis 0 *
Common Stock Lawrence M. Coss 7,337,123(5) 2.1%
Common Stock Thomas M. Hagerty 25,437,717(6) 6.8%
Common Stock David V. Harkins 25,459,648(7) 6.9%
Common Stock M. Phil Hathaway 199,255(8) *
Common Stock John R. Kline 35,417 *
Common Stock John M. Mutz 60,600(9) *
Common Stock Robert S. Nickoloff 127,498 *
Common Stock William J. Shea 140,000 *
Common Stock Samme Thompson 5,000 *
Common Stock Gary C. Wendt 1,692,567(10) *
Common Stock Directors and executive officers
as a group (16 persons) 36,319,664(11) 9.7%
190
- --------------
(1) Address given for 5-percent owners only.
(2) The number of shares listed includes shares of Common Stock that the
individual has a right to acquire as of or within 60 days of April 11, 2003
upon exercise of outstanding stock options or warrants (although in each
case the exercise price far exceeds the trading price of the Common Stock)
as follows: Mr. Berube (28,500), Mr. Bublitz (586,356), Mr. Coss
(2,245,659), Mr. Hagerty (4,000), Mr. Harkins (4,000), Mr. Hathaway
(68,000), Mr. Kline (15,835), Mr. Mutz (18,000), Mr. Nickoloff (62,990),
Mr. Shea (90,000) and all current executive officers and directors as a
group (3,123,340).
(3) The shareholder listed, together with certain affiliates and other entities
and individuals (including Messrs. Hagerty and Harkins), jointly filed a
Schedule 13D on December 22, 1999 relating to the purchase of an aggregate
of 2,597,403 shares of Series F Preferred Stock, each share of which is
convertible into 10 shares of Common Stock. The amount listed in the table
reflects additional shares of Series F Preferred Stock which have been
issued in payment of dividends since the date of the Schedule 13D filing.
(4) Represents shares of Common Stock that may be acquired upon conversion of
Series F Preferred Stock.
(5) Includes 79,918 shares held by his spouse and 14,663 shares held by his
children. Mr. Coss expressly disclaims beneficial ownership of the shares
held by his wife and children.
(6) The address for Mr. Hagerty is c/o Thomas H. Lee Company, 75 State Street,
Boston, MA 02109. Represents shares of Common Stock that may be acquired
upon conversion of the Series F Preferred Stock. Of those shares of Common
Stock, 22,422,065 shares are beneficially owned by the Thomas H. Lee Equity
Fund IV, L.P., 768,117 shares are beneficially owned by Thomas H. Lee
Foreign Fund IV, L.P. and 2,177,705 shares are beneficially owned by Thomas
H. Lee Foreign Fund IV-B, L.P. Mr. Hagerty disclaims beneficial ownership
of such shares except to the extent of his pecuniary interest.
(7) The address for Mr. Harkins is c/o Thomas H. Lee Company, 75 State Street,
Boston, MA 02109. Represents shares of Common Stock that may be acquired
upon conversion of Series F Preferred Stock. Of those shares of Common
Stock, 8,838 shares are beneficially owned by the 1995 Harkins Gift Trust,
22,422,065 shares are beneficially owned by the Thomas H. Lee Equity Fund
IV, L.P., 768,117 shares are beneficially owned by Thomas H. Lee Foreign
Fund IV, L.P. and 2,177,705 shares are beneficially owned by Thomas H. Lee
Foreign Fund IV-B, L.P. Mr. Harkins disclaims beneficial ownership of all
shares except to the extent of his pecuniary interest.
(8) Includes 16,000 shares owned by Mr. Hathaway's wife.
(9) Includes 42,600 shares held by Mr. Mutz's wife. Mr. Mutz expressly
disclaims beneficial ownership of the shares held by his wife.
(10) Includes 64,282 shares held by Mr. Wendt's wife as to which shares Mr.
Wendt expressly disclaims beneficial ownership.
(11) Includes 25,521,478 shares of Common Stock which may be acquired upon
conversion of Series F Preferred Stock.
* Less than 1%.
191
Equity Compensation Plan Information
The following table sets forth information about the Company's common stock
that may be issued under all of the Company's existing equity compensation plans
as of December 31, 2002, including the 1994 Stock Plan and the 1997 Plan.
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted-average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
Plan category warrants or rights warrants or rights column (a))
------------- ------------------ ------------------ ----------
Equity compensation
plans approved by
security holders 23,520,000 $15.95 52,668,000
Equity compensation
plans not approved
by security holders - - -
---------- ------ -----------
Total 23,520,000 $15.95 52,668,000
========== ====== ==========
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Conseco adopted stock purchase plans (the "Purchase Plans") to encourage
direct, long-term ownership of Conseco stock by Directors, executive officers
and certain key employees. Purchases of Common Stock under the Purchase Plans
were financed by personal loans made to the participants from banks. Such loans
were collateralized by the Common Stock purchased. Approximately 170 Directors,
officers and key employees of Conseco and its subsidiaries participated in the
Purchase Plans and purchased an aggregate of approximately 19.0 million shares
of Common Stock offered under the Purchase Plans. Conseco guaranteed the loans
but has recourse to the participants if it incurs a loss under the guarantees.
As a result of declines in the price of the Common Stock, the value of shares
pledged as collateral for the bank loans is substantially less than the amount
of such loans. The aggregate number of shares of Common Stock purchased by each
current director or executive officer that is participating in the Purchase
Plans and the largest amount owed on the guaranteed bank loans during 2002 were
as follows: Mr. Bublitz - 420,631 shares and $13,466,130 and John R. Kline (an
executive officer) - 10,000 shares and $371,702. As of March 31, 2003, the
outstanding bank loan balance for Mr. Bublitz was $13,466,130. Mr. Kline repaid
his loan during 2002.
In addition, Conseco agreed to provide loans to these participants for the
interest payments payable on the guaranteed bank loans. The largest amounts owed
by current directors or executive officers on the interest-payment loans during
2002 were as follows: Mr. Bublitz, $3,991,865 and Mr. Kline $106,042. As of
March 31, 2003, the outstanding principal balance of the interest-payment loan
for Mr. Bublitz was $4,715,904. Mr. Kline repaid his interest payment loan
during 2002. The interest payment loans bear interest at a variable rate per
annum equal to the lowest interest rate per annum being paid by Conseco under
its most senior borrowing facility, and as of March 31, 2003, the interest rate
was 8.75 percent per annum.
During 2000, the Board of Directors approved two plans (the "Work-Down
Plans") relating to the Purchase Plans. One of the Work-Down Plans applies, with
certain exceptions, to current employees and the other applies to all other
participants in the Purchase Plans. Participants who elected to participate in
the Work-Down Plans participated in a refinancing of the bank loans through
December 31, 2003. The Work-Down Plans require participants to make payments on
or provide additional collateral to secure their obligations under the Purchase
Plan in specified amounts or on such other terms as the special committee of the
Board of Directors administering the Work-Down Plans approves. Employees also
have an opportunity to be awarded bonus points tied to the achievement of
specified goals. The bonus points will have a value tied to the employee's
Purchase Plan obligations. The bonus points may be redeemed at the expiration of
the Work-Down Plan in which event, the employee must pay the Company a portion
of the amount, if any, by which the value of the employee's stock in the
Purchase Plan exceeds $25.00 per share.
ITEM 14. CONTROLS AND PROCEDURES.
Based on their evaluations as of a date within 90 days of the filing of
this Annual Report on Form 10-K, the Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures were
effective. Effective disclosure controls and procedures are designed to ensure
that information required to be disclosed in our reports filed or submitted
under the
192
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Commission's rules and forms.
There have been no significant changes in our internal controls or in other
factors that could significantly affect our internal controls subsequent to the
date we carried out this evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements. See Index to Consolidated Financial
Statements on page 79 for a list of financial statements included
in this Report.
2. Financial Statement Schedules. The following financial statement
schedules are included as part of this Report immediately following
the signature page:
Schedule II -- Condensed Financial Information of Registrant
(Parent Company)
Schedule IV -- Reinsurance
All other schedules are omitted, either because they are not applicable,
not required, or because the information they contain is included elsewhere in
the consolidated financial statements or notes.
3. Exhibits. See Exhibit Index immediately preceding the Exhibits
filed with this report.
(b) Reports on Form 8-K
A report on Form 8-K dated October 3, 2002, was filed with the
Commission to report under Item 5, a memorandum issued by the
Registrant's Chief Operating Officer to the Company's shareholders and
other interested parties summarizing information about the Company.
A report on Form 8-K dated October 22, 2002, was filed with the
Commission to report under Item 9, the Company's plan to seek new
investors for Conseco Finance Corp.'s businesses.
A report on Form 8-K dated December 3, 2002, was filed with the
Commission to report under Item 5, a memorandum issued by the
Registrant's Chief Executive Officer to the Company's shareholders and
other interested parties summarizing information about the Company.
A report on Form 8-K dated December 17, 2002, was filed with the
Commission to report under Item 3, the Company's filing for relief
under Chapter 11 of the United States Bankruptcy Code.
A report on Form 8-K dated December 18, 2002, was filed with the
Commission to report under Item 5, the United States Bankruptcy
Court's equity trading restriction order and the related motion.
193
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, this 14th day of April, 2003.
CONSECO, INC.
By: /s/ William J. Shea
--------------------
William J. Shea, President and
Chief Executive Officer
194
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Signature Title (Capacity) Date
- --------- ---------------- ----
/s/ WILLIAM J. SHEA President and Chief Executive Officer April 14, 2003
- --------------------------------- and Director
William J. Shea (Principal Executive Officer)
/s/ EUGENE M. BULLIS Executive Vice President April 14, 2003
- --------------------------------- and Chief Financial Officer
Eugene M. Bullis (Principal Financial Officer)
/s/ JOHN R. KLINE Senior Vice President April 14, 2003
- --------------------------------- and Chief Accounting Officer
John R. Kline (Principal Accounting Officer)
/s/ GARY C. WENDT Director April 14, 2003
- ---------------------------------
Gary C. Wendt
/s/ LAWRENCE M. COSS Director April 14, 2003
- ---------------------------------
Lawrence M. Coss
/s/ THOMAS M. HAGERTY Director April 14, 2003
- ---------------------------------
Thomas M. Hagerty
/s/ M. PHIL HATHAWAY Director April 14, 2003
- ---------------------------------
M. Phil Hathaway
/s/ JOHN M. MUTZ Director April 14, 2003
- ---------------------------------
John M. Mutz
/s/ ROBERT S. NICKOLOFF Director April 14, 2003
- ---------------------------------
Robert S. Nickoloff
/s/ DAVID V. HARKINS Director April 14, 2003
- ---------------------------------
David V. Harkins
/s/ JULIO A. BAREA Director April 14, 2003
- ---------------------------------
Julio A. Barea
/s/ CAROL BELLAMY Director April 14, 2003
- ---------------------------------
Carol Bellamy
/s/ SAMME THOMPSON Director April 14, 2003
- ---------------------------------
Samme Thompson
195
CONSECO, INC. AND SUBSIDIARIES
CERTIFICATION
I, William J. Shea, certify that:
1. I have reviewed this annual report on Form 10-K of Conseco, Inc.:
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the year covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the years presented in this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the year in which this annual report is
being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the Registrant's auditors and the audit committee of
Registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
6. The Registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 14, 2003
/s/ William J. Shea
--------------------------------------------
William J. Shea, President and Chief Executive Officer
196
CONSECO, INC. AND SUBSIDIARIES
CERTIFICATION
I, Eugene M. Bullis, certify that:
1. I have reviewed this annual report on Form 10-K of Conseco, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the year covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the years presented in this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the year in which this annual report is
being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the Registrant's auditors and the audit committee of
Registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
6. The Registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 14, 2003
/s/ Eugene M. Bullis
--------------------------------------------
Eugene M. Bullis, Executive Vice President and
Chief Financial Officer
197
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Shareholders and Board of Directors
Conseco, Inc.
Our report on the consolidated financial statements of Conseco, Inc. and
subsidiaries is included on page 80 of this Form 10-K. In connection with our
audits of such financial statements, we have also audited the related financial
statement schedules listed in the index on page 193 of this Form 10-K. In our
opinion, the financial statement schedules referred to above, present fairly, in
all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
The accompanying consolidated financial statements have been prepared
assuming that Conseco, Inc. will continue as a going concern, which contemplates
continuity of Conseco's operations and realization of its assets and payments of
its liabilities in the ordinary course of business. As more fully described in
the notes to the consolidated financial statements, on December 17, 2002,
Conseco, Inc. and several of its wholly-owned subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the United States Bankruptcy
Code. The uncertainties inherent in the bankruptcy process and Conseco's
recurring losses from operations raise substantial doubt about Conseco's ability
to continue as a going concern. Conseco, Inc. is currently operating its
business as a Debtor-in-Possession under the jurisdiction of the Bankruptcy
Court, and continuation of Conseco as a going concern is contingent upon, among
other things, the confirmation of Conseco's Plan of Reorganization and Conseco's
ability to generate sufficient cash from operations and obtain financing sources
to meet its future obligations. If no reorganization plan is approved, it is
possible that Conseco's assets may be liquidated. The consolidated financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of these
uncertainties.
As discussed in note 4 to the consolidated financial statements, the
Company adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" in 2000 and Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" in 2002.
/s/ PricewaterhouseCoopers LLP
--------------------------------
PricewaterhouseCoopers LLP
Indianapolis, Indiana
April 11, 2003
198
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 2002 and 2001
(Dollars in millions)
ASSETS
2002 2001
---- ----
Cash and cash equivalents................................................................. $ 41.9 $ 152.2
Cash held in segregated accounts for the payment of debt.................................. - 54.7
Other invested assets..................................................................... 8.0 15.3
Investment in wholly-owned subsidiaries (eliminated in consolidation)..................... 3,899.7 9,528.5
Notes receivable from Conseco Finance (eliminated in consolidation)....................... - 249.5
Receivable from subsidiaries (eliminated in consolidation)................................ 1,272.9 1,643.7
Income tax assets......................................................................... 54.3 521.2
Other assets.............................................................................. 66.9 10.7
-------- ---------
Total assets.................................................................... $5,343.7 $12,175.8
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable......................................................................... $ - $ 4,085.0
Notes payable to subsidiaries (eliminated in consolidation)........................... - 353.5
Payable to subsidiaries (eliminated in consolidation)................................. 5.1 477.7
Liabilities subject to compromise..................................................... 4,873.3 -
Affiliated liabilities subject to compromise.......................................... 572.4 -
Other liabilities..................................................................... 21.8 592.1
--------- ---------
Total liabilities............................................................... 5,472.6 5,508.3
--------- ---------
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts........ 1,921.5 1,914.5
Shareholders' equity (deficit):
Preferred stock....................................................................... 501.7 499.6
Common stock and additional paid-in capital (no par value, 1,000,000,000
shares authorized, shares issued and outstanding: 2002 - 346,007,133;
2001 - 344,743,196) .............................................................. 3,497.0 3,484.3
Accumulated other comprehensive income (loss)......................................... 580.6 (439.0)
Retained earnings (deficit)........................................................... (6,629.7) 1,208.1
--------- ---------
Total shareholders' equity (deficit)............................................ (2,050.4) 4,753.0
--------- ---------
Total liabilities and shareholders' equity (deficit)............................ $ 5,343.7 $12,175.8
========= =========
The accompanying notes are an integral part
of the condensed financial information.
199
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Operations
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
---- ---- ----
Revenues:
Net investment income.......................................................... $ 3.3 $ 29.9 $ 77.3
Dividends from subsidiaries (eliminated in consolidation)...................... 276.0 216.3 178.0
Fee and interest income from subsidiaries (eliminated in consolidation)........ 68.6 170.2 347.3
Net investment losses.......................................................... (2.1) (53.5) (66.8)
Gain on sale of interest in riverboat.......................................... - 192.4 -
Other income................................................................... 1.5 1.6 7.6
--------- ------- ---------
Total revenues............................................................. 347.3 556.9 543.4
--------- ------- ---------
Expenses:
Interest expense on notes payable (contractual interest for 2002 of $328.7).... 325.3 369.5 438.4
Provision for loss............................................................. 147.2 169.6 231.5
Intercompany expenses (eliminated in consolidation)............................ - 21.0 28.0
Operating costs and expenses................................................... 91.9 53.8 37.0
Special charges................................................................ 30.5 49.6 281.6
Reorganization items, net...................................................... 14.4 - -
--------- ------- ---------
Total expenses............................................................. 609.3 663.5 1,016.5
--------- ------- ---------
Loss before income taxes, equity in undistributed earnings of
subsidiaries, distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change..... (262.0) (106.6) (473.1)
Income tax expense (benefit):
Tax benefit on period income................................................... (50.5) (115.6) (185.7)
Valuation allowance for deferred tax assets.................................... 811.2 - -
--------- ------- ---------
Income (loss) before equity in undistributed earnings of subsidiaries,
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts, discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change................... (1,022.7) 9.0 (287.4)
Equity in undistributed loss of subsidiaries before discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change
(eliminated in consolidation).................................................. (1,475.6) (205.9) (316.3)
--------- ------- ---------
Loss before distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, discontinued operations,
extraordinary gain (loss) and cumulative effect of
accounting change........................................................ (2,498.3) (196.9) (603.7)
Distributions on Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts (contractual distributions for 2002 of $179.8)............ 173.2 119.5 145.3
--------- ------- ---------
Loss before discontinued operations, extraordinary gain (loss)
and cumulative effect of accounting change............................... (2,671.5) (316.4) (749.0)
Discontinued operations of subsidiaries, net of income taxes...................... (2,223.1) (106.7) (381.9)
Extraordinary gain (loss) on extinguishment of debt, net of income taxes:
Parent company................................................................. 1.9 11.1 (5.0)
Subsidiary..................................................................... 6.2 6.1 -
Cumulative effect of accounting change of subsidiaries, net of income taxes....... (2,949.2) - (55.3)
--------- ------- ---------
Net loss................................................................... (7,835.7) (405.9) (1,191.2)
Preferred stock dividends (contractual distributions for 2002 of $2.1)............ 2.1 12.8 11.0
--------- ------- ---------
Loss applicable to common stock............................................ $(7,837.8) $(418.7) $(1,202.2)
========= ======= =========
The accompanying notes are an integral part
of the condensed financial information.
200
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Cash Flows
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net loss....................................................................... $(7,835.7) $ (405.9) $(1,191.2)
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of consolidated subsidiaries *............ 1,475.6 205.9 316.3
Discontinued operations of subsidiaries.................................... 2,223.1 106.7 381.9
Cumulative effect of accounting change of subsidiaries..................... 2,949.2 - -
Provision for loss on loan guarantees...................................... 147.2 169.6 231.5
Net investment losses...................................................... 2.1 53.5 66.8
Income taxes .............................................................. 723.4 (80.1) (351.7)
Extraordinary charge on extinguishment of debt............................. (8.1) (26.9) 7.7
Cumulative effect of change in accounting.................................. - - 85.2
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts.......................................... 173.2 183.9 223.5
Special charges............................................................ 10.2 41.9 112.1
Gain on sale of interest in riverboat...................................... - (192.4)
Other...................................................................... 272.7 71.8 (19.9)
--------- --------- ---------
Net cash provided (used) by operating activities........................... 132.9 128.0 (137.8)
--------- --------- ---------
Cash flows from investing activities:
Sales and maturities of investments.............................................. 16.7 375.9 228.2
Investments and advances to consolidated subsidiaries*........................... (72.2) - (1,427.2)
Purchases of investments......................................................... (59.2) (50.1) (220.0)
Payments from subsidiaries*...................................................... 21.5 535.9 2,218.0
--------- --------- ---------
Net cash provided by investing activities.................................. (93.2) 861.7 799.0
--------- --------- ---------
Cash flows from financing activities:
Issuance of common and convertible preferred shares.............................. - 4.1 .8
Repurchase of Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts................................................ - - (250.0)
Issuance of notes payable and commercial paper................................... - 410.8 3,537.2
Payments on notes payable........................................................ (75.5) (1,349.4) (3,114.6)
Payments on notes payable to affiliates*......................................... - - (3.1)
Payments to repurchase equity securities of Conseco, Inc......................... - - (102.6)
Dividends to subsidiaries*....................................................... (43.0) (43.0) (52.8)
Dividends and distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts...................................... (86.2) (181.2) (302.1)
--------- --------- ----------
Net cash used by financing activities...................................... (204.7) (1,158.7) (287.2)
--------- --------- ----------
Net increase (decrease) in cash and cash equivalents....................... (165.0) (169.0) 374.0
Cash and cash equivalents, beginning of year..................................... 206.9 375.9 1.9
--------- --------- ----------
Cash and cash equivalents, end of year........................................... $ 41.9 $ 206.9 $ 375.9
========= ========= ==========
* Eliminated in consolidation
The accompanying notes are an integral part
of the condensed financial information.
201
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
1. Basis of Presentation
The condensed financial information should be read in conjunction with the
consolidated financial statements of Conseco, Inc. ("Conseco" or "CNC"). The
condensed financial information includes the accounts and activity of the parent
company and its wholly-owned non-insurance subsidiaries which act as the holding
companies for Conseco's life insurance subsidiaries.
2. Condensed Consolidating Financial Information
The obligations under our current bank credit facilities, which had a
principal balance of $1,531.4 million at December 31, 2002, are guaranteed by
CIHC, Incorporated, ("CIHC") a wholly-owned subsidiary of Conseco, and the
ultimate holding company for Conseco's principal operating subsidiaries. In
addition, CIHC has guaranteed up to $250.0 million of debt of Conseco Finance
Corp. ("CFC"), and up to $481.3 million of bank loans to certain of our current
and former directors, officers and key employees which were used to purchase
shares of our common stock.
As described in the note to the consolidated financial statements entitled
"Notes Payable", Conseco completed an exchange of approximately $1.3 billion
aggregate principal amount of newly issued guaranteed notes for its senior
unsecured notes held by "qualified institutional buyers," institutional
"accredited investors," or non U.S. persons in transactions outside the United
States. The bonds which were exchanged have identical principal and interest
amounts, but the new bonds have extended maturities and are guaranteed on a
senior subordinated basis by CIHC. Such guarantee is subordinated to the
guarantees of CIHC summarized in the preceding paragraph. The guarantee is on
parity with CIHC's senior subordinated debt including a $177.4 million note to
CFIHC, Inc. CFIHC, Inc. is a subsidiary of CIHC.
The following condensed consolidating financial information as of December
31, 2002 and 2001, and for the three years ended December 31, 2002, summarizes
the accounts of CIHC, Conseco and other holding companies which comprise the
parent company. Such condensed consolidating financial information should be
read in conjunction with the consolidated financial statements of Conseco.
202
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 2002
(Dollars in millions)
ASSETS
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
----------------- --------- ------------ --------
Cash and cash equivalents......................................... $ 25.9 $ 16.0 $ - $ 41.9
Other invested assets............................................. 5.8 2.2 - 8.0
Investment in wholly-owned subsidiaries
(eliminated in consolidation)................................. 4,440.3 5,360.9 (5,901.5) 3,899.7
Receivable from subsidiaries (eliminated in consolidation)........ 1,278.7 1,007.8 (1,013.6) 1,272.9
Income tax assets................................................. (4.7) 59.0 - 54.3
Other assets...................................................... .1 66.8 - 66.9
-------- --------- --------- ---------
Total assets............................................ $ 5,746.1 $ 6,512.7 $(6,915.1) $ 5,343.7
========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Payable to subsidiaries (eliminated in consolidation)......... $ 4.8 $ 71.3 $ (71.0) $ 5.1
Liabilities subject to compromise............................. 7.4 4,865.9 - 4,873.3
Affiliated liabilities subject to compromise.................. 1,030.3 558.1 (1,016.0) 572.4
Other liabilities............................................. - 21.8 - 21.8
--------- --------- --------- ---------
Total liabilities....................................... 1,042.5 5,517.1 (1,087.0) 5,472.6
--------- --------- --------- ---------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts......................................... - 1,921.5 - 1,921.5
Shareholders' equity (deficit):
Preferred stock............................................... 268.8 1,401.7 (1,168.8) 501.7
Common stock and additional paid-in capital................... 8,718.8 3,800.0 (9,021.8) 3,497.0
Accumulated other comprehensive income........................ 585.6 580.6 (585.6) 580.6
Retained earnings (deficit)................................... (4,869.6) (6,708.2) 4,948.1 (6,629.7)
--------- --------- --------- ---------
Total shareholders' equity (deficit).................... 4,703.6 (925.9) (5,828.1) (2,050.4)
--------- --------- --------- ---------
Total liabilities and shareholders' equity (deficit).... $ 5,746.1 $ 6,512.7 $(6,915.1) $ 5,343.7
========= ========= ========= =========
203
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 2001
(Dollars in millions)
ASSETS
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
----------------- --------- ------------ --------
Cash and cash equivalents......................................... $ 1.0 $ 151.2 $ - $ 152.2
Cash held in segregated accounts for the payment of debt.......... - 54.7 - 54.7
Other invested assets............................................. 3.5 11.8 - 15.3
Investment in wholly-owned subsidiaries
(eliminated in consolidation)................................. 10,240.6 10,166.6 (10,878.7) 9,528.5
Notes receivable from Conseco Finance
(eliminated in consolidation)................................. 249.5 - - 249.5
Receivable from subsidiaries (eliminated in consolidation)........ 1,535.8 2,685.1 (2,577.2) 1,643.7
Income taxes...................................................... (210.8) 648.8 83.2 521.2
Other assets...................................................... 1.0 9.7 - 10.7
--------- --------- ---------- ---------
Total assets............................................ $11,820.6 $13,727.9 $(13,372.7) $12,175.8
========= ========= ========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable................................................. $ - $ 4,085.0 $ - $ 4,085.0
Notes payable to subsidiaries (eliminated in consolidation)... 1,279.8 77.0 (1,003.3) 353.5
Payable to subsidiaries (eliminated in consolidation)......... 313.3 1,094.0 (929.6) 477.7
Other liabilities............................................. 35.7 556.4 - 592.1
--------- --------- ---------- ---------
Total liabilities....................................... 1,628.8 5,812.4 (1,932.9) 5,508.3
--------- --------- ---------- ---------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts......................................... - 1,914.5 - 1,914.5
Shareholders' equity:
Preferred stock............................................... 250.8 1,399.6 (1,150.8) 499.6
Common stock and additional paid-in capital................... 8,763.4 3,789.0 (9,068.1) 3,484.3
Accumulated other comprehensive loss.......................... (478.2) (438.9) 478.1 (439.0)
Retained earnings............................................. 1,655.8 1,251.3 (1,699.0) 1,208.1
--------- --------- ---------- ---------
Total shareholders' equity.............................. 10,191.8 6,001.0 (11,439.8) 4,753.0
--------- --------- ---------- ---------
Total liabilities and shareholders' equity.............. $11,820.6 $13,727.9 $(13,372.7) $12,175.8
========= ========= ========== =========
204
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Statement of Operations
for the year ended December 31, 2002
(Dollars in millions)
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
----------------- --------- ------------ --------
Revenues:
Net investment income......................................... $ .1 $ 3.2 $ - $ 3.3
Dividends from subsidiaries (eliminated in consolidation)..... 276.0 - - 276.0
Fee and interest income from subsidiaries
(eliminated in consolidation).............................. 67.3 39.6 (38.3) 68.6
Net investment gains (losses)................................. - (2.1) - (2.1)
Other income.................................................. - 1.5 - 1.5
--------- --------- -------- ---------
Total revenues.......................................... 343.4 42.2 (38.3) 347.3
--------- --------- -------- ---------
Expenses:
Interest expense on notes payable............................. - 325.3 - 325.3
Provision for loss............................................ - 147.2 - 147.2
Intercompany expenses (eliminated in consolidation)........... 32.5 1.2 (33.7) -
Operating costs and expenses.................................. 4.7 89.6 (2.4) 91.9
Special charges............................................... .1 30.4 - 30.5
Reorganization items, net..................................... - 14.4 - 14.4
--------- --------- -------- ---------
Total expenses.......................................... 37.3 608.1 (36.1) 609.3
--------- --------- -------- ---------
Income (loss) before income taxes, equity in
undistributed earnings ofsubsidiaries, distributions
on Company-obligated mandatorilyredeemable preferred
securities of subsidiary trusts, discontinued
operations, extraordinary gain and cumulative effect
of accounting change................................. 306.1 (565.9) (2.2) (262.0)
Income tax expense (benefit):
Tax benefit on period income .............................. 37.0 (87.5) - (50.5)
Valuation allowance for deferred tax assets................ - 811.2 - 811.2
--------- --------- -------- ---------
Income (loss) before equity in undistributed earnings of
subsidiaries,distributions on Company-obligated
mandatorily redeemable preferredsecurities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effectof
accounting change.................................... 269.1 (1,289.6) (2.2) (1,022.7)
Equity in undistributed earnings of subsidiaries before
discontinued operations,extraordinary gain and cumulative
effect of accounting change(eliminated in consolidation)...... (1,664.1) (6,274.1) 6,462.6 (1,475.6)
--------- --------- -------- ---------
Income (loss) before distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect
of accounting change................................. (1,395.0) (7,563.7) 6,460.4 (2,498.3)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts..................... - 173.2 - 173.2
--------- --------- -------- ---------
Income (loss) before discontinued operations,
extraordinary gain and cumulative effect of
accounting change.......................................... (1,395.0) (7,736.9) 6,460.4 (2,671.5)
Discontinued operations of subsidiaries, net of tax............... (2,223.1) - - (2,223.1)
Extraordinary gain on extinguishment of debt, net of tax..........
Parent company................................................ - 1.9 - 1.9
Subsidiary.................................................... 6.2 - - 6.2
Cumulative effect of accounting change of subsidiaries,
net of tax.................................................... (2,857.1) (92.1) - (2,949.2)
--------- --------- -------- ---------
Net income (loss).......................................... (6,469.0) (7,827.1) 6,460.4 (7,835.7)
Preferred stock dividends......................................... 27.1 38.1 (63.1) 2.1
--------- --------- -------- ---------
Income (loss) applicable to common stock................... $(6,496.1) $(7,865.2) $6,523.5 $(7,837.8)
========= ========= ======== =========
205
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Statement of Operations
for the year ended December 31, 2001
(Dollars in millions)
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
----------------- --------- ------------ --------
Revenues:
Net investment income......................................... $ .7 $ 29.2 $ - $ 29.9
Dividends from subsidiaries (eliminated in consolidation)..... 192.3 24.0 - 216.3
Fee and interest income from subsidiaries
(eliminated in consolidation).............................. 172.5 180.4 (182.7) 170.2
Net investment gains (losses)................................. 4.3 (57.8) - (53.5)
Gain on sale of interest in riverboat......................... - 192.4 - 192.4
Other income.................................................. - 1.6 - 1.6
------- ------- ------- -------
Total revenues.......................................... 369.8 369.8 (182.7) 556.9
------- ------- ------- -------
Expenses:
Interest expense on notes payable............................. 2.6 369.2 (2.3) 369.5
Provision for loss............................................ - 169.6 - 169.6
Intercompany expenses (eliminated in consolidation)........... 122.0 5.3 (106.3) 21.0
Operating costs and expenses.................................. 2.5 70.4 (19.1) 53.8
Special charges............................................... .2 36.9 12.5 49.6
------- ------- ------- -------
Total expenses.......................................... 127.3 651.4 (115.2) 663.5
------- ------- ------- -------
Income (loss) before income taxes, equity in
undistributed earnings ofsubsidiaries, distributions
on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts, discontinued
operations, extraordinary gain and cumulative effect
of accounting change................................. 242.5 (281.6) (67.5) (106.6)
Income tax expense (benefit)...................................... 16.3 (107.5) (24.4) (115.6)
------- ------- ------- -------
Income (loss) before equity in undistributed earnings of
subsidiaries, distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change.................................... 226.2 (174.1) (43.1) 9.0
Equity in undistributed earnings of subsidiaries before
discontinued operations, extraordinary gain and cumulative
effect of accounting change (eliminated in consolidation)..... (193.9) (78.3) 66.3 (205.9)
------- ------- ------- -------
Income (loss) before distributions on Company-obligated
redeemable mandatorily preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change.................................... 32.3 (252.4) 23.2 (196.9)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts..................... - 119.5 - 119.5
------- ------- ------- -------
Income (loss) before discontinued operations, extraordinary
gain and cumulative effect of accounting change............ 32.3 (371.9) 23.2 (316.4)
Discontinued operations of subsidiaries, net of tax............... (106.7) - - (106.7)
Extraordinary gain on extinguishment of debt, net of tax:
Parent company................................................ - 11.1 - 11.1
Subsidiary.................................................... 6.1 - - 6.1
------- ------- ------- -------
Net income (loss).......................................... (68.3) (360.8) 23.2 (405.9)
Preferred stock dividends......................................... - 12.8 - 12.8
------- ------- ------- -------
Income (loss) applicable to common stock................... $ (68.3) $(373.6) $ 23.2 $(418.7)
======= ======= ======= =======
206
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Statement of Operations
for the year ended December 31, 2000
(Dollars in millions)
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
----------------- --------- ------------ --------
Revenues:
Net investment income......................................... $ - $ 77.3 $ - $ 77.3
Dividends from subsidiaries (eliminated in consolidation)..... 178.0 - - 178.0
Fee and interest income from subsidiaries
(eliminated in consolidation).............................. 197.4 335.3 (185.4) 347.3
Net investment gains (losses)................................. 2.7 (69.5) - (66.8)
Other income.................................................. - 7.6 - 7.6
------- --------- ------- ---------
Total revenues.......................................... 378.1 350.7 (185.4) 543.4
------- --------- ------- ---------
Expenses:
Interest expense on notes payable............................. 12.5 425.9 - 438.4
Provision for loss............................................ - 231.5 - 231.5
Intercompany expenses (eliminated in consolidation)........... 198.9 11.6 (182.5) 28.0
Operating costs and expenses.................................. 6.9 30.1 - 37.0
Special charges............................................... - 281.6 - 281.6
------- --------- ------- ---------
Total expenses.......................................... 218.3 980.7 (182.5) 1,016.5
------- --------- ------- ---------
Income (loss) before income taxes, equity in undistributed
earnings of subsidiaries, distributions on Company-
obligated mandatorily redeemable preferred securities
of subsidiary trusts, discontinued operations,
extraordinary charge and cumulative effect of
accounting change.................................... 159.8 (630.0) (2.9) (473.1)
Income tax expense (benefit)...................................... (2.6) (182.1) (1.0) (185.7)
------- --------- ------- ---------
Income (loss) before equity in undistributed earnings of
subsidiaries, distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,extraordinary
charge and cumulative effect of accounting change.... 162.4 (447.9) (1.9) (287.4)
Equity in undistributed earnings of subsidiaries before discontinued
operations, extraordinary charge and cumulative effect of
accounting change (eliminated in consolidation)............... (321.1) (584.4) 589.2 (316.3)
------- --------- ------- ---------
Loss before distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts,
discontinued operations, extraordinary charge and
cumulative effect of accounting change............... (158.7) (1,032.3) 587.3 (603.7)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts..................... - 145.3 - 145.3
------- --------- ------- ---------
Loss before discontinued operations, extraordinary charge
and cumulative effect of accounting change................. (158.7) (1,177.6) 587.3 (749.0)
Discontinued operations of subsidiaries, net of tax............... (381.9) - - (381.9)
Extraordinary charge on extinguishment of debt, net of tax........ (4.9) (.1) - (5.0)
Cumulative effect of accounting change, net of tax, of
subsidiaries.................................................. (55.3) - - (55.3)
------- --------- ------- ---------
Net loss................................................... (600.8) (1,177.7) 587.3 (1,191.2)
Preferred stock dividends......................................... - 11.0 - 11.0
------- --------- ------- ---------
Loss applicable to common stock............................ $(600.8) $(1,188.7) $ 587.3 $(1,202.2)
======= ========= ======= =========
207
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE IV
Reinsurance
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
---- ---- ----
Life insurance inforce:
Direct............................................................ $ 94,098.3 $116,075.0 $117,556.2
Assumed........................................................... 3,380.7 1,996.5 4,878.0
Ceded ............................................................ (26,368.9) (26,088.6) (27,106.3)
---------- ---------- -----------
Net insurance inforce....................................... $ 71,110.1 $91,982.9 $ 95,327.9
========== ========= ==========
Percentage of assumed to net................................ 4.8% 2.2% 5.1%
=== === ===
Premiums recorded as revenue for generally accepted
accounting principles:
Direct.......................................................... $ 3,287.8 $ 3,600.0 $ 3,556.7
Assumed......................................................... 78.7 146.0 300.5
Ceded........................................................... (327.8) (249.4) (237.1)
--------- --------- ---------
Net premiums................................................ $ 3,038.7 $ 3,496.6 $ 3,620.1
========= ========= =========
Percentage of assumed to net................................ 2.6% 4.2% 8.3%
=== === ===
208
Exhibit
No. Document
- ------- --------
2.1 Second Amended Disclosure Statement with Respect to Joint Plan
of Reorganization of Conseco, Inc. and its affiliated Debtors
dated March 18, 2003 was filed with the Commission as Exhibit
2.1 to the Registrant's Report on Form 8-K, dated March 18,
2003, and is incorporated herein by this reference.
2.2 Second Amended Joint Plan of Reorganization of Conseco, Inc.
and its affiliated Debtors dated March 18, 2003 was filed with
the Commission as Exhibit 2.2 to the Registrant's Report on
Form 8-K, dated March 18, 2003, and is incorporated herein by
this reference.
2.3 Amended Final Order Under 11 U.S.C. section 105(a), 362(a)(3)
and 541 (A) Limiting Certain Transfers of, and Trading in,
Equity Interests and (B) Approving Related Notification
Procedures (including exhibits thereto) was filed with the
Commission as Exhibit 99.1 to the Registrant's Report on Form
8-K, dated January 21, 2003, and is incorporated herein by
this reference.
2.4 Disclosure Statement for Finance Company Debtors' Joint
Liquidating Plan of Reorganization dated April 1, 2003.
2.5 Finance Company Debtors' Joint Liquidating Plan of
Reorganization dated April 1, 2003.
2.6 Amended and Restated Asset Purchase Agreement by and among
Conseco Finance Corp., various subsidiaries of Conseco Finance
Corp. and CFN Investment Holdings LLC dated as of March 14,
2003 and Amendment No. 1 to Amended and Restated Asset
Purchase Agreement dated April 1, 2003.
2.7 Asset Purchase Agreement by and among Conseco Finance Corp.,
various subsidiaries of Conseco Finance Corp. and General
Electric Capital Corporation dated as of March 14, 2003.
3.1 Amended and Restated Articles of Incorporation and Articles of
Amendment thereto of the Registrant were filed with the
Commission as Exhibit 3.1 to the Registrant's Registration
Statement on Form S-3 (No. 333-94683), and are incorporated
herein by this reference.
3.2 Amended and Restated By-Laws of the Registrant was filed with
the Commission as Exhibit 3.2 to the Registrant's Report on
Form 10-Q for the quarter ended September 30, 2002 and is
incorporated herein by this reference.
4.22.1 Senior Indenture, dated November 13, 1997, by and between the
Registrant and Bank of New York as successor in interest to
LTCB Trust Company, as Trustee (the "Senior Indenture"), was
filed with the Commission as Exhibit 4.1 to Post-Effective
Amendment No. 1 to the Registrant's Registration Statement on
Form S-3, No. 333-27803, and is incorporated herein by this
reference.
4.22.6 First Supplemental Indenture dated June 29, 2001 was filed
with the Commission as Exhibit 4.1 to the Registrant's Report
on Form 8-K, dated June 29, 2001, and is incorporated herein
by this reference.
4.30.1 Warrant No. 2000-2, dated September 5, 2000, issued to GE
Capital Equity Investments, Limited was filed as
Exhibit 4.30.1 to the Registrant's Report on Form 10-K for the
year ended December 31, 2000 and is incorporated herein by
this reference.
4.30.2 Warrant No. 2000-3, dated September 5, 2000, issued to
Westport Insurance Corporation was filed as Exhibit 4.30.2 to
the Registrant's Report on Form 10-K for the year ended
December 31, 2000 and is incorporated herein by this
reference.
4.31.1 First Amendment to the Five-Year Credit Agreement dated as of
September 22, 2000 was filed with the Commission as Exhibit
4.1 to the Registrant's Report on Form 8-K/A, dated September
28, 2000, and is incorporated herein by this reference.
4.31.13 Second Amendment to Five-Year Credit Agreement, dated as of
May 30, 2001, by and among Conseco, Inc., the various
financial institutions signatory thereto and Bank of America,
N.A. was filed as Exhibit 4.31.13 to the Registrant's Report
on Form 10-K for the year ended December 31, 2001 and is
incorporated herein by this reference
4.31.14 Third Amendment to Five-Year Credit Agreement, dated as of
March 20, 2002, by and among Conseco, Inc., the various
financial institutions signatory thereto and Bank of America,
N.A. was filed as Exhibit 4.31.14 to the Registrant's Report
on Form 10-K for the year ended December 31, 2001 and is
incorporated herein by this reference.
4.31.15 Five-Year Credit Agreement, dated as of September 25, 1998,
among Conseco, Inc., Bank of America National Trust and
Savings Association, as Agent, First Union National Bank and
JPMorgan Chase Bank, as Syndication Agents, Morgan Guaranty
Company of New York, as Documentation Agent, and the other
financial institutions party thereto incorporated by reference
to Exhibit 4.11 to Amendment No. 1 to Conseco, Inc.'s
Registration Statement on Form S-4 (No. 333-89802), dated July
25, 2002.
4.31.16 Forbearance agreement relating to $1,500,000,000 five-year
credit agreement was filed with the Commission as Exhibit
4.31.15 to the Registrant's Report on Form 10-Q for the
quarter ended September 30, 2002 and is incorporated herein by
this reference.
4.32.1 First Senior Supplemental Indenture, dated as of April 24,
2002 to Second Senior Indenture for the 10.75% Guaranteed
Senior Notes dated as of April 24, 2002 between Conseco, Inc.,
CIHC, Incorporated and State Street Bank and Trust Company
incorporated by reference to Exhibit 4.1 to Conseco, Inc.'s
Registration Statement on Form S-4 (No. 333-89802), dated June
5, 2002.
4.32.2 Second Senior Indenture, dated as of April 24, 2002 for
10.75% Guaranteed Senior Notes, between Conseco, Inc., CIHC,
Incorporated and State Street Bank and Trust Company
incorporated by reference to Exhibit 4.2 to Conseco, Inc.'s
Registration Statement on Form S-4 (No. 333-89802), dated June
5, 2002.
4.32.3 First Senior Indenture, dated as of April 24, 2002 among
Conseco, Inc., CIHC, Incorporated and State Street Bank and
Trust Company incorporated by reference to Exhibit 4.3 to
Conseco, Inc.'s Registration Statement on Form S-4 (No.
333-89802), dated June 5, 2002.
4.32.4 Terms Resolution, dated as of April 24, 2002 with respect to
the 6.4% Guaranteed Senior Notes, due February 10, 2004
incorporated by reference to Exhibit 4.4 to Conseco, Inc.'s
Registration Statement on Form S-4 (No. 333-89802), dated June
5, 2002.
4.32.5 Terms Resolution, dated as of April 24, 2002 with respect to
the 8.5% Guaranteed Senior Notes due October 15, 2003
incorporated by reference to Exhibit 4.5 to Conseco, Inc.'s
Registration Statement on Form S-4 (No. 333-89802), dated June
5, 2002.
4.32.6 Terms Resolution, dated as of April 24, 2002 with respect to
the 6.8% Guaranteed Senior Notes due June 15, 2007
incorporated by reference to Exhibit 4.6 to Conseco, Inc.'s
Registration Statement on Form S-4 (No. 333-89802), dated June
5, 2002.
4.32.7 Terms Resolution, dated as of April 24, 2002 with respect to
the 9% Guaranteed Senior Notes due April 15, 2008 incorporated
by reference to Exhibit 4.7 to Conseco, Inc.'s Registration
Statement on Form S-4 (No. 333-89802), dated June 5, 2002.
4.32.8 Terms Resolution, dated as of April 24, 2002 with respect to
the 8.75% Guaranteed Senior Notes due August 9, 2006
incorporated by reference to Exhibit 4.8 to Conseco, Inc.'s
Registration Statement on Form S-4 (No. 333-89802), dated June
5, 2002.
4.32.9 Registration Rights Agreement, dated as of April 24, 2002
among Conseco, Inc., CIHC, Incorporated and Banc of America
Securities LLC, J.P. Morgan Securities Inc. and Lehman
Brothers Inc., as Dealer Managers incorporated by reference to
Exhibit 4.9 to Conseco, Inc.'s Registration Statement on Form
S-4 (No. 333-89802), dated June 5, 2002.
There have not been filed as exhibits to this Form 10-K certain long-term debt
instruments, none of which relates to authorized indebtedness that exceeds 10%
of the consolidated assets of the Registrant. The Registrant agrees to furnish
the Commission upon its request a copy of any instrument defining the rights of
holders of long-term debt of the Company and its consolidated subsidiaries.
10.1.13 Employment Agreement, dated February 9, 1996 between Green
Tree and Lawrence Coss and related Noncompetition agreement
dated February 9, 1996, as amended by the Amendment Agreement
dated April 6, 1998 were filed with the Commission as an
exhibit to Green Tree's Registration Statement on Form S-3,
and are incorporated herein by this reference.
10.1.14 Employment Agreement, amended and restated as of December 15,
1999, between the Registrant and Maxwell E. Bublitz was filed
with the Commission as Exhibit 10.1.14 to the Registrant's
Report on Form 10-K for the year ended December 31, 1999 and
is incorporated herein by this reference.
10.1.16 Description of incentive compensation and severance
arrangement with Edward M. Berube was filed with the
Commission as Exhibit 10.1.16 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.1.24 Second Amendment Agreement, dated as of November 1, 1999,
between Conseco Finance Corp. and Lawrence M. Coss was filed
with the commission as Exhibit 10.1.24 to the Registrant's
Report on Form 10-K/A for the year ended December 31, 1999,
and is incorporated herein by this reference.
10.1.27 Employment Agreement by and between Gary C. Wendt and Conseco,
Inc., dated as of June 28, 2000 was filed as Exhibit 10.1.27
to the Registrant's Report on Form 8-K, dated July 10, 2000,
and is incorporated herein by this reference.
10.1.28 Nonqualified Stock Option Agreement by and between Gary C.
Wendt and Conseco, Inc., dated as of June 28, 2000 was filed
as Exhibit 10.1.28 to the Registrant's Report on Form 8-K,
dated July 10, 2000, and is incorporated herein by this
reference.
10.1.29 Restricted Stock Agreement by and between Gary C. Wendt and
Conseco, Inc., dated as of June 28, 2000 was filed as Exhibit
10.1.29 to the Registrant's Report on Form 8-K, dated July 10,
2000, and is incorporated herein by this reference.
10.1.31 Supplemental Retirement Agreement dated as of August 16, 2000,
between Conseco, Inc. and Gary C. Wendt was filed as Exhibit
10.1.31 to the Registrant's Report on
Form 10-Q for the quarter ended September 30, 2000 and is
incorporated herein by this reference.
10.1.32 Guaranty dated as of August 16, 2000, between Bankers Life and
Casualty Company as Guarantor, and Gary C. Wendt was filed as
Exhibit 10.1.32 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 2000 and is incorporated
herein by this reference.
10.1.38 Employment Agreement between William J. Shea and Conseco,
Inc., dated as of June 1, 2002, was filed with the Commission
as Exhibit 10.1.38 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 2001 and is incorporated
herein by this reference.
10.1.39 Restricted Stock Agreement dated as of September 17, 2001
between Conseco, Inc. and William J. Shea was filed with the
Commission as Exhibit 10.1.39 to the Registrant's Report on
Form 10-Q for the quarter ended September 30, 2002 and is
incorporated herein by this reference.
10.1.41 Amendment to Employment and Restricted Stock Agreements by and
between William J. Shea and Conseco, Inc., dated as of
September 16, 2002 was filed with the Commission as Exhibit
10.1.41 to the Registrant's Report on Form 10-Q for the
quarter ended September 30, 2002 and is incorporated herein by
this reference.
10.1.42 Employment Agreement by and between John R. Kline and Conseco,
Inc., dated as of July 15, 2002 was filed with the Commission
as Exhibit 10.1.42 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 2002 and is incorporated
herein by this reference.
10.1.43 Amendment to Employment and Restricted Stock Agreements by and
between Gary C. Wendt and Conseco, Inc., dated as of June 26,
2002, was filed with the Commission as Exhibit 10.1.27 to the
Registrant's Report on Form 10-Q for the quarter ended June
30, 2002 and is incorporated herein by this reference.
10.1.44 Second Amendment to Employment and Restricted Stock
Agreements, between William J. Shea and Conseco, Inc. dated
December 16, 2002.
10.1.45 Employment Agreement between Conseco Services, LLC and Eugene
M. Bullis dated as of July 1, 2002.
10.8 The Registrant's Stock Option Plan was filed with the
Commission as Exhibit B to its definitive Proxy Statement
dated December 10, 1983; Amendment No. 1 thereto was filed
with the Commission as Exhibit 10.8.1 to its Report on Form
10-Q for the quarter ended June 30, 1985; Amendment No. 2
thereto was filed with the Commission as Exhibit 10.8.2 to its
Registration Statement on Form S-1, No. 33-4367; Amendment No.
3 thereto was filed with the Commission as Exhibit 10.8.3 to
the Registrant's Annual Report on Form 10-K for 1986;
Amendment No. 4 thereto was filed with the Commission as
Exhibit 10.8 to the Registrant's Annual Report on Form 10-K
for 1987; Amendment No. 5 thereto
was filed with the Commission as Exhibit 10.8 to the
Registrant's Report on Form 10-Q for the quarter ended
September 30, 1991; and are incorporated herein by this
reference.
10.8.4 Amended and Restated Conseco Stock Bonus and Deferred
Compensation Program was filed with the Commission as Exhibit
10.8.4 to the Registrant's Annual Report on Form 10-K for
1992, and is incorporated herein by this reference.
10.8.6 Conseco Performance-Based Compensation Plan for Executive
Officers was filed with the Commission as Exhibit 10.8.15 to
the Registrant's Report on Form 10-Q for the quarter ended
March 31, 1998, and is incorporated herein by this reference.
10.8.7 Conseco, Inc. Amended and Restated Deferred Compensation Plan
was filed with the Commission as Exhibit A to the Registrant's
definitive Proxy Statement dated April 26, 1995, and is
incorporated herein by this reference.
10.8.8 Amendment to the Amended and Restated Conseco Stock Bonus and
Deferred Compensation Program was filed with the Commission as
Exhibit 10.8.8 to the Registrant's Annual Report on Form 10-K
for 1994, and is incorporated herein by this reference.
10.8.9 Conseco Amended and Restated 1994 Stock and Incentive Plan was
filed as Exhibit 10.8.9 to the Registrant's Report on Form
10-K for the year ended December 31, 2001 and is incorporated
herein by this reference.
10.8.10 Amendment Number 2 to the Amended and Restated Conseco Stock
Bonus and Deferred Compensation Program was filed with the
Commission as Exhibit 10.8.10 to the Registrant's Annual
Report on Form 10-K for 1995 and is incorporated herein by
reference.
10.8.11 Amended and Restated Director, Officer and Key Employee Stock
Purchase Plan of Conseco was filed with the Commission as
Exhibit 10.8.11 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1999, and is incorporated
herein by this reference.
10.8.13 Form of Promissory Note payable to the Registrant relating to
the Registrant's Director, Officer and Key Employee Stock
Purchase Plan was filed with the Commission as Exhibit 10.8.13
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998, and is incorporated herein by
reference.
10.8.14 Conseco, Inc. Amended and Restated 1997 Non-qualified Stock
Option Plan was filed with the Commission as Exhibit 10.8.14
to the Registrant's Annual Report on Form 10-K for 1997, and
is incorporated herein by this reference.
10.8.21 Amended and Restated 1999 Director and Executive
Officer Stock Purchase Plan of Conseco was filed with the
Commission as Exhibit 10.8.21 to the Registrant's Report on
Form 10-Q for the quarter ended September 30, 1999 and is
incorporated herein by this reference.
10.8.22 Guaranty regarding 1999 Director and Executive Officer Stock
Purchase Plan was filed with the Commission as Exhibit 10.8.22
to the Registrant's Report on Form 10-Q for the quarter ended
September 30, 1999 and is incorporated herein by this
reference.
10.8.23 Form of Borrower Pledge Agreement dated as of September 15,
1999 with The Chase Manhattan Bank relating to the 1999
Director and Executive Officer Stock Purchase Plan was filed
with the Commission as Exhibit 10.8.23 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 1999
and is incorporated herein by this reference.
10.8.24 Form of note payable to the Registrant relating to the 1999
Director and Executive Officer Stock Purchase Plan was filed
with the Commission as Exhibit 10.8.24 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 1999
and is incorporated herein by this reference.
10.8.25 Conseco, Inc. 2000 Employee Stock Purchase Program Work-Down
Plan was filed with the Commission as Exhibit 10.8.25 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000 and is incorporated herein by this
reference.
10.8.26 Conseco, Inc. 2000 Non-Employee Stock Purchase Program
Work-Down Plan was filed with the Commission as Exhibit
10.8.26 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 2000 and is incorporated herein by
this reference.
10.8.27 Guaranty, dated as of November 22, 2000 between Conseco, Inc.,
as Guarantor, and Bank of America, National Association, as
Administrative Agent; Guaranty and Subordination Agreement,
dated as of November 22, 2000, made by CIHC, Incorporated, as
Guarantor and Subordinated Borrower, and Conseco, Inc., as
Obligor and Subordinated Lender, in favor of Bank of America,
National Association, as Administrative Agent under the Credit
Agreement dated as of November 22, 2000; and Form of Credit
Agreement, dated as of November 22, 2000 among the Borrowers,
the other financial institutions party thereto and Bank of
America, National Association, as Administrative Agent
(Relating to Refinancing of certain Loans under that certain
Credit Agreement, dated as of August 21, 1998) was filed with
the Commission as Exhibit 10.8.27 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.8.28 Guaranty, dated as of November 22, 2000, between Conseco,
Inc.,as Guarantor,and Bank of America, National Association,as
Administrative Agent; Guaranty and Subordination Agreement,
dated as of November 22, 2000 made by CIHC, Incorporated,as
Guarantor and Subordinated Borrower, and Conseco, Inc., as
Obligor and Subordinated Lender, in favor of Bank of America,
National Association, as Administrative Agent under the Credit
Agreement dated as of November 22, 2000; and the Form of
Credit Agreement, dated as of November 22, 2000, among the
Borrowers, the other financial institutions party thereto and
Bank of America, National Association, as Administrative Agent
(Relating to the Refinancing of Certain Loans under that
certain Amended and Restated Credit Agreement, dated as of
August 26, 1997) was filed with the Commission as Exhibit
10.8.28 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 2000 and is incorporated herein by
this reference.
10.8.29 Guaranty, dated as of November 22, 2000, between Conseco,
Inc.,as Guarantor, and The Chase Manhattan Bank,as
Administrative Agent; Guaranty and Subordination Agreement,
dated as of November 22, 2000 made by CIHC, Incorporated, as
Guarantor and Subordinated Borrower, and Conseco, Inc., as
Obligor and Subordinated Lender, in favor of The Chase
Manhattan Bank, as Administrative Agent under the Credit
Agreement dated as of November 22, 2000; and the Form of
Credit Agreement, dated as of November 22, 2000, among the
Borrowers, the other financial institutions party thereto and
The Chase Manhattan Bank, as Administrative Agent (Relating to
the Refinancing of Certain Loans under that certain Credit
Agreement, dated as of September 15, 1999, as terminated and
replaced by that certain Termination and Replacement
Agreement, dated as of May 30, 2000) was filed with the
Commission as Exhibit 10.8.29 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.8.30 Forms of note payable to Conseco Services, LLC regarding the
2000 Work-Down Plans, Form of Unconditional Guarantee and Form
of Indemnification Agreement was filed with the Commission as
Exhibit 10.8.30 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2000 and is incorporated
herein by this reference.
10.8.31 First Stage Amendment and Agreement re: Non-Refinanced 1998
D&O Loans, dated as of March 20, 2002, among Conseco, Inc.,
CDOC, Inc., CIHC, Incorporated, Bank of
America, N.A. and the various financial institutions parties
thereto was filed as Exhibit 10.8.31 to the Registrant's
Report on Form 10-K for the year ended December 31, 2001 and
is incorporated herein by this reference.
10.8.32 First Stage Amendment and Agreement re: 1997 D&O Loans, dated
as of March 20, 2002, among Conseco, Inc., CDOC, Inc., CIHC,
Incorporated, Bank of America, N.A. and the various financial
institutions parties thereto was filed as Exhibit 10.8.32 to
the Registrant's Report on Form 10-K for the year ended
December 31, 2001 and is incorporated herein by this
reference.
10.8.33 Cash Collateral Pledge Agreement among CDOC, Inc. and JP
Morgan Chase Bank, dated as of March 20, 2002 was filed as
Exhibit 10.8.33 to the Registrant's Report on Form 10-K for
the year ended December 31, 2001 and is incorporated herein by
this reference.
10.8.34 First Stage Amendment and Agreement Re: 1998 D&O Loans, dated
as of March 20, 2002, among Conseco, Inc., CDOC, Inc., CIHC,
Incorporated, Bank of America, N.A. and the various financial
institutions parties thereto was filed as Exhibit 10.8.34 to
the Registrant's Report on Form 10-K for the year ended
December 31, 2001 and is incorporated herein by this
reference.
10.8.35 Amended and Restated Collateral Agreement made by Conseco,
Inc. and CIHC, Incorporated in favor of JP Morgan Chase Bank,
dated as of March 20, 2002 was filed as Exhibit 10.8.35 to the
Registrant's Report on Form 10-K for the year ended December
31, 2001 and is incorporated herein by this reference.
10.8.36 First Stage Amendment and Agreement re: 1999 D&O Loans, dated
as of March 20, 2002, among Conseco, Inc., CDOC, Inc., CIHC,
Incorporated, JPMorgan Chase Bank and the various financial
institutions parties thereto was filed as Exhibit 10.8.36 to
the Registrant's Report on Form 10-K for the year ended
December 31, 2001 and is incorporated herein by this
reference.
10.8.37 Forbearance agreement relating to 1997 D&O loans was filed
with the Commission as Exhibit 10.1.37 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 2002
and is incorporated herein by this reference.
10.8.38 Forbearance agreement relating to 1998 D&O loans was filed
with the Commission as Exhibit 10.8.38 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 2002
and is incorporated herein by this reference.
10.8.39 Forbearance agreement relating to 1998 (non-refinanced) D&O
loans was filed with the Commission as Exhibit 10.8.39 to the
Registrant's Report on Form 10-Q for the quarter ended
September 30, 2002 and is incorporated herein by this
reference.
10.8.40 Forbearance agreement relating to 1999 D&O loans was filed
with the Commission as Exhibit 10.8.40 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 2002
and is incorporated herein by this reference.
10.8.41 Forbearance agreement relating to 1997 D&O loans was filed
with the Commission as Exhibit 99.2 to the Registrant's Form
8-K dated December 3, 2002, and is incorporated herein by this
reference.
10.8.42 Forbearance agreement relating to 1998 D&O loans was filed
with the Commission as Exhibit 99.3 to the Registrant's Form
8-K dated December 3, 2002, and is incorporated herein by this
reference.
10.8.43 Forbearance agreement relating to 1998 (non-refinanced) D&O
loans was filed with the Commission as Exhibit 99.4 to the
Registrant's Form 8-K dated December 3, 2002, and is
incorporated herein by this reference.
10.8.44 Forbearance agreement relating to 1999 D&O loans was filed
with the Commission as Exhibit 99.5 to the Registrant's Form
8-K dated December 3, 2002, and is incorporated herein by this
reference.
10.8.45 Forbearance agreement relating to $1,500,000,000 five-year
credit agreement was filed with the Commission as Exhibit 99.6
to the Registrant's Form 8-K dated December 3, 2002, and is
incorporated herein by this reference.
10.43 Amended and Restated Securities Purchase Agreement dated as of
December 15, 1999 between the Registrant and the purchasers
named therein was filed with the Commission as Exhibit 10.43
to the Registrant's Report on Form 8-K dated December 15,
1999, and is incorporated herein by this reference.
10.45.1 Warrant to Purchase Common Stock of Conseco Finance Corp.,
dated May 11, 2000, by and between Conseco Finance Corp. and
Lehman Brothers Holdings Inc. was filed with the Commission as
Exhibit 10.45 to the Registrant's Report on Form 10-Q for the
quarter ended June 30, 2000 and is incorporated herein by this
reference.
10.45.2 Exchange Agreement by and between Lehman Brothers Holdings
Inc. and Conseco, Inc., dated January 30, 2002 was filed as
Exhibit 10.45.2 to the Registrant's Report on Form 10-K for
the year ended December 31, 2001 and is incorporated herein by
this reference.
10.46.1 Amended and Restated Agreement dated January 30, 2002, by and
among Conseco Finance Corp., Conseco, Inc., CIHC,
Incorporated, Green Tree Residual Finance Corp. I, Green Tree
Finance Corp. - Five and Lehman Brothers Holdings Inc. was
filed as Exhibit 10.46.1 to the Registrant's Report on Form
10-K for the year ended December 31, 2001 and is incorporated
herein by this reference.
10.46.2 Amended and Restated Master Repurchase Agreement dated as of
April 5, 2001 between Merrill Lynch Mortgage Capital Inc. and
Green Tree Finance Corp. - Three was
filed with the Commission as Exhibit 10(a) to the Conseco
Finance Corp. Report on Form 10-K for the years ended December
31, 2001 and is incorporated herein by reference.
10.46.3 Second Amended and Restated Master Repurchase Agreement dated
January 30, 2002 between Lehman Commercial Paper Inc. and
Green Tree Finance Corp.-Five was filed with the Commission as
Exhibit 10(b) to the Conseco Finance Corp. Report on Form 10-K
for the year ended December 31, 2001 and is incorporated
herein by reference.
10.46.4 Asset Assignment Agreement dated as of February 13, 1998
between Green Tree Residual Finance Corp. I and Lehman
Commercial Paper, Inc. (incorporated by reference to the
Conseco Finance Corp. Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1998; File No. 1-08916);
Amendment to the First Residual Facility, dated as of
September 22, 2000, by and among Lehman ALI Inc. and Green
Tree Residual Finance Corp. I (incorporated by reference to
Exhibit 10(c) to Conseco Finance Corp.'s Annual Report on Form
10-K for the year ended December 31, 2000); Amendment, dated
January 30, 2002, by and between Lehman ALI Inc. and Green
Tree Residual Finance Corp. was filed with the Commission as
Exhibit 10(c) to the Conseco Finance Corp. Report on Form 10-K
for the year ended December 31, 2001 and is incorporated
herein by reference.
10.46.5 Amendment to First Residual Facility (Asset Assignment
Agreement), dated October 9, 2002, by and between Lehman ALI
Inc. and Green Tree Residual Finance Corp. I was filed with
the Commission as Exhibit 10.46.6 to the Registrant's Report
on Form 10-Q for the quarter ended September 30, 2002 and is
incorporated herein by this reference.
10.46.6 Third Amendment to Master Repurchase Agreement, dated October
9, 2002, by and between Lehman Commercial Paper Inc. and Green
Tree Finance Corp. - Five was filed with the Commission as
Exhibit 10.46.7 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 2002 and is incorporated
herein by this reference.
10.46.7 Amended and Restated Forbearance Agreement, dated October 9,
2002, by and among Conseco Finance Corp., Green Tree Finance
Corp. - Five, Green Tree Residual Finance Corp. I, Lehman
Commercial Paper, Inc. and Lehman Brothers, Inc. was filed
with the Commission as Exhibit 10.46.8 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 2002
and is incorporated herein by this reference.
10.46.9 Secured Super-Priority Debtor In Possession Credit Agreement
dated as of December 19, 2002 among Conseco Finance Corp.,
various subsidiaries of Conseco Finance Corp. and CIHC,
Incorporated, the lenders from time to time party thereto and
FPS DIP LLC, Amendment No. 1 thereto, dated as of December 23,
2002, Amendment No. 2 thereto, dated as of December 24, 2002,
Amendment No. 3 thereto, dated as of January 17, 2003,
Amendment No. 4 thereto, dated as of February 7, 2003 and
Amendment No. 5 thereto, dated as of March 14, 2003.
10.47 Insurance Agreement by and between Registrant and Gary C.
Wendt 2000 Irrevocable Insurance Trust dated 11/22/00 ("Wendt
Trust"), dated December 1, 2000 and Collateral Assignment by
Wendt Trust in favor of Registrant dated December 1, 2000 was
filed with the Commission as Exhibit 10.47 to the Registrant's
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.48 Insurance Agreement by and between Registrant and Wendt Trust,
dated January 16, 2001 and Collateral Assignment by Wendt
Trust in favor of Registrant dated January 16, 2001 was filed
with the Commission as Exhibit 10.48 to the Registrant's
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.49 Insurance Agreement by and between Registrant and Wendt Trust,
dated January 16, 2001 and Collateral Assignment by Wendt
Trust in favor of Registrant dated January 16, 2001 was filed
with the Commission as Exhibit 10.49 to the Registrant's
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.50 Agreement and Plan of Merger dated as of July 27, 2001 by and
among Conseco, Inc., Noida Acquisition Corp. and
ExlService.com, Inc. was filed with the Commission as Exhibit
10.50 to the Registrant's Report on Form 10-Q for the quarter
ended June 30, 2001 and is incorporated herein by this
reference.
10.51 Restricted Stock Agreement dated as of July 31, 2001, between
Conseco, Inc., Gary Wendt and Rosemarie Wendt was filed with
the Commission as Exhibit 10.51 to the Registrant's Report on
Form 10-Q for the quarter ended June 30, 2001 and is
incorporated herein by this reference.
10.52.1 Conseco Life Insurance Company of Texas Official Order of the
Commissioner of Insurance of the State of Texas was filed with
the Commission as Exhibit 10.52.1 to the Registrant's Report
on Form 10-Q for the quarter ended September 30, 2002 and is
incorporated herein by this reference.
10.52.2 Bankers National Life Insurance Company Official Order of the
Commissioner of Insurance of the State of Texas was filed with
the Commission as Exhibit 10.52.2 to the Registrant's Report
on Form 10-Q for the quarter ended September 30, 2002 and is
incorporated herein by this reference.
12.1 Computation of Ratio of Earnings to Fixed Charges, Preferred
Dividends and Distributions on Company-Obligated Mandatorily
Redeemable Preferred Securities of Subsidiary Trusts.
21 List of Subsidiaries.
23.1 Consent of PricewaterhouseCoopers LLP with respect to the
financial statements of Conseco, Inc.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
COMPENSATION PLANS AND ARRANGEMENTS.
10.1.13 Employment Agreement, dated February 9, 1996 between Green
Tree and Lawrence Coss and related Noncompetition agreement
dated February 9, 1996, as amended by the Amendment Agreement
dated April 6, 1998 were filed with the Commission as an
exhibit to Green Tree's Registration Statement on Form S-3,
and are incorporated herein by this reference.
10.1.14 Employment Agreement, amended and restated as of December 15,
1999, between the Registrant and Maxwell E. Bublitz was filed
with the Commission as Exhibit 10.1.14 to the Registrant's
Report on Form 10-K for the year ended December 31, 1999 and
is incorporated herein by this reference.
10.1.15 Description of incentive compensation and severance
arrangement with Edward M. Berube was filed with the
Commission as Exhibit 10.1.16 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.1.24 Second Amendment Agreement, dated as of November 1, 1999,
between Conseco Finance Corp. and Lawrence M. Coss was filed
with the commission as Exhibit 10.1.24 to the Registrant's
Report on Form 10-K/A for the year ended December 31, 1999,
and is incorporated herein by this reference.
10.1.27 Employment Agreement by and between Gary C. Wendt and Conseco,
Inc., dated as of June 28, 2000 was filed as Exhibit 10.1.27
to the Registrant's Report on Form 8-K, dated July 10, 2000,
and is incorporated herein by this reference.
10.1.28 Nonqualified Stock Option Agreement by and between Gary C.
Wendt and Conseco, Inc., dated as of June 28, 2000 was filed
as Exhibit 10.1.28 to the Registrant's Report on Form 8-K,
dated July 10, 2000, and is incorporated herein by this
reference.
10.1.29 Restricted Stock Agreement by and between Gary C. Wendt and
Conseco, Inc., dated as of June 28, 2000 was filed as Exhibit
10.1.29 to the Registrant's Report on Form 8-K, dated July 10,
2000, and is incorporated herein by this reference.
10.1.31 Supplemental Retirement Agreement dated as of August 16, 2000,
between Conseco, Inc. and Gary C. Wendt was
filed as Exhibit 10.1.31 to the Registrant's Report on Form
10-Q for the quarter ended September 30, 2000 and is
incorporated herein by this reference.
10.1.32 Guaranty dated as of August 16, 2000, between Bankers Life and
Casualty Company as Guarantor, and Gary C. Wendt was filed as
Exhibit 10.1.32 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 2000 and is incorporated
herein by this reference.
10.1.38 Employment Agreement between William J. Shea and Conseco,
Inc., dated as of June 1, 2002, was filed with the Commission
as Exhibit 10.1.38 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 2001 and is incorporated
herein by this reference.
10.1.39 Restricted Stock Agreement dated as of September 17, 2001
between Conseco, Inc. and William J. Shea was filed with the
Commission as Exhibit 10.1.39 to the Registrant's Report on
Form 10-Q for the quarter ended September 30, 2002 and is
incorporated herein by this reference.
10.1.41 Amendment to Employment and Restricted Stock Agreements by and
between William J. Shea and Conseco, Inc., dated as of
September 16, 2002 was filed with the Commission as Exhibit
10.1.41 to the Registrant's Report on Form 10-Q for the
quarter ended September 30, 2002 and is incorporated herein by
this reference.
10.1.42 Employment Agreement by and between John R. Kline and Conseco,
Inc., dated as of July 15, 2002 was filed with the Commission
as Exhibit 10.1.42 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 2002 and is incorporated
herein by this reference.
10.1.43 Amendment to Employment and Restricted Stock Agreements by and
between Gary C. Wendt and Conseco, Inc., dated as of June 26,
2002, was filed with the Commission as Exhibit 10.1.27 to the
Registrant's Report on Form 10-Q for the quarter ended June
30, 2002 and is incorporated herein by this reference.
10.1.44 Second Amendment to Employment and Restricted Stock
Agreements, between William J. Shea and Conseco, Inc. dated
December 16, 2002.
10.1.45 Employment Agreement between Conseco Services, LLC and Eugene
M. Bullis dated as of July 1, 2002.
10.8 The Registrant's Stock Option Plan was filed with the
Commission as Exhibit B to its definitive Proxy Statement
dated December 10, 1983; Amendment No. 1 thereto was filed
with the Commission as Exhibit 10.8.1 to its Report on Form
10-Q for the quarter ended June 30, 1985; Amendment No. 2
thereto was filed with the Commission as Exhibit 10.8.2 to its
Registration Statement on Form S-1, No. 33-4367; Amendment No.
3 thereto was filed with the Commission as Exhibit 10.8.3 to
the Registrant's Annual Report on Form 10-K for 1986;
Amendment No. 4 thereto was filed with the Commission as
Exhibit 10.8 to the Registrant's Annual
Report on Form 10-K for 1987; Amendment No. 5 thereto was
filed with the Commission as Exhibit 10.8 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 1991;
and are incorporated herein by this reference.
10.8.4 Amended and Restated Conseco Stock Bonus and Deferred
Compensation Program was filed with the Commission as Exhibit
10.8.4 to the Registrant's Annual Report on Form 10-K for
1992, and is incorporated herein by this reference.
10.8.6 Conseco Performance-Based Compensation Plan for Executive
Officers was filed with the Commission as Exhibit 10.8.15 to
the Registrant's Report on Form 10-Q for the quarter ended
March 31, 1998, and is incorporated herein by this reference.
10.8.7 Conseco, Inc. Amended and Restated Deferred Compensation Plan
was filed with the Commission as Exhibit A to the Registrant's
definitive Proxy Statement dated April 26, 1995, and is
incorporated herein by this reference.
10.8.8 Amendment to the Amended and Restated Conseco Stock Bonus and
Deferred Compensation Program was filed with the Commission as
Exhibit 10.8.8 to the Registrant's Annual Report on Form 10-K
for 1994, and is incorporated herein by this reference.
10.8.9 Conseco Amended and Restated 1994 Stock and Incentive Plan was
filed as Exhibit 10.8.9 to the Registrant's Report on Form
10-K for the year ended December 31, 2001 and is incorporated
herein by this reference.
10.8.10 Amendment Number 2 to the Amended and Restated Conseco Stock
Bonus and Deferred Compensation Program was filed with the
Commission as Exhibit 10.8.10 to the Registrant's Annual
Report on Form 10-K for 1995 and is incorporated herein by
reference.
10.8.11 Amended and Restated Director, Officer and Key Employee Stock
Purchase Plan of Conseco was filed with the Commission as
Exhibit 10.8.11 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1999, and is incorporated
herein by this reference.
10.8.13 Form of Promissory Note payable to the Registrant relating to
the Registrant's Director, Officer and Key Employee Stock
Purchase Plan was filed with the Commission as Exhibit 10.8.13
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998, and is incorporated herein by
reference.
10.8.14 Conseco, Inc. Amended and Restated 1997 Non-qualified Stock
Option Plan was filed with the Commission as Exhibit 10.8.14
to the Registrant's Annual Report on Form 10-K for 1997, and
is incorporated herein by this reference.
10.8.21 Amended and Restated 1999 Director and Executive Officer Stock
Purchase Plan of Conseco was filed with the Commission as
Exhibit 10.8.21 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1999 and is incorporated
herein by this reference.
10.8.22 Guaranty regarding 1999 Director and Executive Officer Stock
Purchase Plan was filed with the Commission as Exhibit 10.8.22
to the Registrant's Report on Form 10-Q for the quarter ended
September 30, 1999 and is incorporated herein by this
reference.
10.8.23 Form of Borrower Pledge Agreement dated as of September 15,
1999 with The Chase Manhattan Bank relating to the 1999
Director and Executive Officer Stock Purchase Plan was filed
with the Commission as Exhibit 10.8.23 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 1999
and is incorporated herein by this reference.
10.8.24 Form of note payable to the Registrant relating to the 1999
Director and Executive Officer Stock Purchase Plan was filed
with the Commission as Exhibit 10.8.24 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 1999
and is incorporated herein by this reference.
10.8.25 Conseco, Inc. 2000 Employee Stock Purchase Program Work-Down
Plan was filed with the Commission as Exhibit 10.8.25 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000 and is incorporated herein by this
reference.
10.8.26 Conseco, Inc. 2000 Non-Employee Stock Purchase Program
Work-Down Plan was filed with the Commission as Exhibit
10.8.26 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 2000 and is incorporated herein by
this reference.
10.8.27 Guaranty, dated as of November 22, 2000 between Conseco, Inc.,
as Guarantor, and Bank of America, National Association, as
Administrative Agent; Guaranty and Subordination Agreement,
dated as of November 22, 2000, made by CIHC, Incorporated, as
Guarantor and Subordinated Borrower, and Conseco, Inc., as
Obligor and Subordinated Lender, in favor of Bank of America,
National Association, as Administrative Agent under the Credit
Agreement dated as of November 22, 2000; and Form of Credit
Agreement, dated as of November 22, 2000 among the Borrowers,
the other financial institutions party thereto and Bank of
America, National Association, as Administrative Agent
(Relating to Refinancing of certain Loans under that certain
Credit Agreement, dated as of August 21, 1998) was filed with
the Commission as Exhibit 10.8.27 to the Registrant's Annual
Report on Form 10-K for the year ended December
31, 2000 and is incorporated herein by this reference.
10.8.28 Guaranty, dated as of November 22, 2000, between Conseco,
Inc.,as Guarantor,and Bank of America, National Association,as
Administrative Agent; Guaranty and Subordination Agreement,
dated as of November 22, 2000 made by CIHC, Incorporated,as
Guarantor and Subordinated Borrower, and Conseco, Inc., as
Obligor and Subordinated Lender, in favor of Bank of America,
National Association, as Administrative Agent under the Credit
Agreement dated as of November 22, 2000; and the Form of
Credit Agreement, dated as of November 22, 2000, among the
Borrowers, the other financial institutions party thereto and
Bank of America, National Association, as Administrative Agent
(Relating to the Refinancing of Certain Loans under that
certain Amended and Restated Credit Agreement, dated as of
August 26, 1997) was filed with the Commission as Exhibit
10.8.28 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 2000 and is incorporated herein by
this reference.
10.8.29 Guaranty, dated as of November 22, 2000, between Conseco,
Inc.,as Guarantor, and The Chase Manhattan Bank,as
Administrative Agent; Guaranty and Subordination Agreement,
dated as of November 22, 2000 made by CIHC, Incorporated, as
Guarantor and Subordinated Borrower, and Conseco, Inc., as
Obligor and Subordinated Lender, in favor of The Chase
Manhattan Bank, as Administrative Agent under the Credit
Agreement dated as of November 22, 2000; and the Form of
Credit Agreement, dated as of November 22, 2000, among the
Borrowers, the other financial institutions party thereto and
The Chase Manhattan Bank, as Administrative Agent (Relating to
the Refinancing of Certain Loans under that certain Credit
Agreement, dated as of September 15, 1999, as terminated and
replaced by that certain Termination and Replacement
Agreement, dated as of May 30, 2000) was filed with the
Commission as Exhibit 10.8.29 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.8.30 Forms of note payable to Conseco Services, LLC regarding the
2000 Work-Down Plans, Form of Unconditional Guarantee and Form
of Indemnification Agreement was filed with the Commission as
Exhibit 10.8.30 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2000 and is incorporated
herein by this reference.
10.8.31 First Stage Amendment and Agreement re: Non-Refinanced 1998
D&O Loans, dated as of March 20, 2002,
among Conseco, Inc., CDOC, Inc., CIHC, Incorporated, Bank of
America, N.A. and the various financial institutions parties
thereto was filed as Exhibit 10.8.31 to the Registrant's
Report on Form 10-K for the year ended December 31, 2001 and
is incorporated herein by this reference.
10.8.32 First Stage Amendment and Agreement re: 1997 D&O Loans, dated
as of March 20, 2002, among Conseco, Inc., CDOC, Inc., CIHC,
Incorporated, Bank of America, N.A. and the various financial
institutions parties thereto was filed as Exhibit 10.8.32 to
the Registrant's Report on Form 10-K for the year ended
December 31, 2001 and is incorporated herein by this
reference.
10.8.33 Cash Collateral Pledge Agreement among CDOC, Inc. and JP
Morgan Chase Bank, dated as of March 20, 2002 was filed as
Exhibit 10.8.33 to the Registrant's Report on Form 10-K for
the year ended December 31, 2001 and is incorporated herein by
this reference.
10.8.34 First Stage Amendment and Agreement Re: 1998 D&O Loans, dated
as of March 20, 2002, among Conseco, Inc., CDOC, Inc., CIHC,
Incorporated, Bank of America, N.A. and the various financial
institutions parties thereto was filed as Exhibit 10.8.34 to
the Registrant's Report on Form 10-K for the year ended
December 31, 2001 and is incorporated herein by this
reference.
10.8.35 Amended and Restated Collateral Agreement made by Conseco,
Inc. and CIHC, Incorporated in favor of JP Morgan Chase Bank,
dated as of March 20, 2002 was filed as Exhibit 10.8.35 to the
Registrant's Report on Form 10-K for the year ended December
31, 2001 and is incorporated herein by this reference.
10.8.36 First Stage Amendment and Agreement re: 1999 D&O Loans, dated
as of March 20, 2002, among Conseco, Inc., CDOC, Inc., CIHC,
Incorporated, JPMorgan Chase Bank and the various financial
institutions parties thereto was filed as Exhibit 10.8.36 to
the Registrant's Report on Form 10-K for the year ended
December 31, 2001 and is incorporated herein by this
reference.
10.8.37 Forbearance agreement relating to 1997 D&O loans was filed
with the Commission as Exhibit 10.1.37 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 2002
and is incorporated herein by this reference.
10.8.38 Forbearance agreement relating to 1998 D&O loans was filed
with the Commission as Exhibit 10.8.38 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 2002
and is incorporated herein by this reference.
10.8.39 Forbearance agreement relating to 1998 (non-refinanced) D&O
loans was filed with the Commission as Exhibit 10.8.39 to the
Registrant's Report on Form 10-Q for the quarter ended
September 30, 2002 and is incorporated herein by this
reference.
10.8.40 Forbearance agreement relating to 1999 D&O loans was filed
with the Commission as Exhibit 10.8.40 to the Registrant's
Report on Form 10-Q for the quarter ended September 30, 2002
and is incorporated herein by this reference.
10.8.41 Forbearance agreement relating to 1997 D&O loans was filed
with the Commission as Exhibit 99.2 to the Registrant's Form
8-K dated December 3, 2002, and is incorporated herein by this
reference.
10.8.42 Forbearance agreement relating to 1998 D&O loans was filed
with the Commission as Exhibit 99.3 to the Registrant's Form
8-K dated December 3, 2002, and is incorporated herein by this
reference.
10.8.43 Forbearance agreement relating to 1998 (non-refinanced) D&O
loans was filed with the Commission as Exhibit 99.4 to the
Registrant's Form 8-K dated December 3, 2002, and is
incorporated herein by this reference.
10.8.44 Forbearance agreement relating to 1999 D&O loans was filed
with the Commission as Exhibit 99.5 to the Registrant's Form
8-K dated December 3, 2002, and is incorporated herein by this
reference.
10.8.45 Forbearance agreement relating to $1,500,000,000 five-year
credit agreement was filed with the Commission as Exhibit 99.6
to the Registrant's Form 8-K dated December 3, 2002, and is
incorporated herein by this reference.
10.47 Insurance Agreement by and between Registrant and Gary C.
Wendt 2000 Irrevocable Insurance Trust dated 11/22/00 ("Wendt
Trust"), dated December 1, 2000 and Collateral Assignment by
Wendt Trust in favor of Registrant dated December 1, 2000 was
filed with the Commission as Exhibit 10.47 to the Registrant's
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.48 Insurance Agreement by and between Registrant and Wendt Trust,
dated January 16, 2001 and Collateral Assignment by Wendt
Trust in favor of Registrant dated January 16, 2001 was filed
with the Commission as Exhibit 10.48 to the Registrant's
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.
10.49 Insurance Agreement by and between Registrant and Wendt Trust,
dated January 16, 2001 and Collateral Assignment by Wendt
Trust in favor of Registrant dated January 16, 2001 was filed
with the Commission as Exhibit 10.49 to the Registrant's
Report on Form 10-K for the year ended December 31, 2000 and
is incorporated herein by this reference.